Thank you very much. As a former banker and a business school professor, I want to thank these two committees for inviting me. I clearly have a bias. I think you are the two most important committees in Parliament, finance and industry, because you're dealing with the most important issues of how we create wealth in our economy.
Just by way of background, I was in banking in the 1970s, in the bank right across the street, the Bank of Montreal, which I understand Parliament is now going to be using. It's a beautiful building. I hope you'll treat it well.
I was a consumer loan manager, a mortgage manager, a commercial loan officer, and I have a Ph.D. in public policy. Now I'm the MBA director in the Sprott School of Business. I do want to mention that I've taught over one hundred times in the Middle East, Asia, and Eastern Europe, including most of the former communist countries, where I saw, up close and personally, the impact of coercive government regulations in destroying the environment, the economy, and human rights.
Finally, I don't consult, advise, or invest in any firm, union, NGO, non-profit, government, or political party, so I come here with complete transparency.
I read all of the transcripts for the past two months in both your committee and the Senate committee. I really want to be somewhat provocative today and suggest that many of the witnesses—the Retail Council, CFIB—suggested that the payment system today in Canada is very expensive and inefficient, and I think this is really an urban myth.
Just to put some reality into the conversation, from time immemorial until the 1970s, even until the early 1980s, banks opened at 10 in the morning and closed at 3. If you couldn't get into the bank during that time, you didn't get your money. There were no debit cards, there was no Internet banking, there was no phone banking. Credit cards only emerged in the mid to late 1970s.
There were two payment systems: cash and cheque. Both were expensive, slow, and dangerous. Why were they so? Because cheques bounced regularly, every day. This was a very large risk to retailers. Cash was stolen in holdups or by workers. Although that risk wasn't so great, it drove every business person to invest large amounts of money to buy insurance, to bond employees, the due diligence, safes, costly cash custody, and so forth.
To endorse what Professor Carr and Professor Scholnick said, the transaction costs are very expensive. But today, debit cards provide instant payment, no recourse, no bad cheques, and the same thing with credit cards. So I'm arguing that the transaction costs are very cheap, at 0.5% to 4%.
This was borne out by a study by two think tanks very recently in Washington, D.C. The conservative American Enterprise Institute and the very liberal Brookings Institution did a study of payment types, and not surprisingly they found that cash was the most expensive form of payment. I heard some of the witnesses suggesting discounting for cash. If I was running a business, I would demand a premium for someone to pay cash because cash is very expensive. Bankers understand that. There are large hidden costs with cash. You have to have complex, elaborate accounting systems. You have to have, for example, two people counting the cash, if you don't want to get ripped off. By contrast, credit cards stimulate big-ticket purchases and stimulate impulse items.
I want to alert you to a study that was done only eight months ago by the Bank of Canada in this city. They did a large survey of businesses across Canada, and they had three findings in this survey of actual business people. They found that debit cards are preferred as least risky—I have no problem with that. Secondly, many businesses perceived that cash was the cheapest and most reliable. That is empirically false. Thirdly, the cards were seen as the most costly and least reliable. For the same reason that I argue the second finding is wrong, I argue this too is wrong. What this demonstrates is that a lot of small businesses are financially illiterate, or at least partially illiterate, and this points to the need for more literacy programs.
In fact, what happened over the past ten years? What was their actual behaviour? On both the consumer side and the commercial side, the use of credit and debit cards went up. In a study done by the Federal Reserve, I believe—I have the sources in my laptop—we're at the mid-point across some 10 or 15 countries in terms of the cost to the merchant for the use of cards.
So what is the problem? I'm arguing that the problem is the misperception of the cost of cash versus credit by business, producing, as my colleagues have suggested, rent-seeking by trade associations coming to Parliament and trying to get you to give them more profits instead of earning it the traditional way, through competition.
This is from the Federal Reserve, showing the profitability of credit cards, and you'll simply note that it's cyclical. It's on the screen. It is cyclical based on two variables: the cost of money and of course the credit losses.
What we're experiencing in Canada right now--this is from the DBRS, the bond rating agency--is that credit losses are soaring. As you can see, the red line, which is the weighted average, is pushing up to 6% for all credit card balances that are going to be charged off to bad debt in 2009. That is a horrific charge-off.
When I was a mortgage manager I had a zero charge-off, and on personal loans we had between a quarter to a half of one per cent. They're up to 6%, which is just off the charts.
Again, you can see this on the next one, the delinquency on loan losses in Canada is up to 35%, and the loan loss rate on credit cards is up to 44%.
I won't belabour the Australian solution. We already know it. You know it from the people who have testified. But I do have a couple of graphs you'll want to look at. These are from the Federal Reserve, which did a study. I believe Professor Carr quoted that study. After, I think it was four years, there was no change in the relative share of credit card use or debit card use. However, what did happen is that merchant fees went down and the banks recouped a very large amount through increased card fees.
You can see the two lines. The green line going up is the card fees charged on standard credit cards and the red line is the fees on the premium credit cards. What the Australians did was they simply shifted the burden from the merchants to the consumers. So what the Retail Council and the CFIB are asking you to do is to not stick it to them; they want you to stick it to the consumer, who is me.
The bank issuers, as this slide shows, recovered 30% to 40%, or a half billion dollars, from consumers. The irony is that the merchant costs fell on a transaction basis. When you run through the numbers, they dropped about four cents on a $40 purchase, which is really quite trivial. So there were no dramatic changes.
I won't summarize, because Professor Carr already dealt with this. The same Federal Reserve economist that Professor Carr spoke about reported that the regulations of the central bank, the Reserve Bank of Australia, failed to achieve their policy goals.
So what are the alternatives? I'll just wrap up.
I make three assumptions. One is that you, the legislators, face a choice of governing instruments from the least coercive, such as required information disclosure, to the most coercive, such as government ownership or the price controls advocated by the Retail Council or the CFIB. My second assumption is that you should select coercive instruments only when all else has failed, when there's clear evidence of market failure, and there is no evidence of market failure in the card systems.
My recommended policy solutions include much more rigorous information disclosure concerning rates, fees, benefits, costs, and interest charges; secondly, enhanced regulatory oversight to address deceitful or anti-competitive practices; and thirdly, financial literacy in the schools, in the education system. And I mention that because some witnesses expressed deep skepticism about literacy programs, but we do in Canada spend billions on primary school education, secondary, and post-secondary, so it would be a bit disingenuous for a professor to advocate against literacy programs.