CROWN FINANCIAL INSTITUTIONS
The Standing Senate Committee on Banking, Trade and Commerce
Chairman, The Honourable Michael Kirby
Deputy Chairman, The Honourable David Angus
April 1996
INTRODUCTION
On 29 June 1995, the Committee held hearings on Bill C-91, An Act to continue the Federal Business Development Bank under the name Business Development Bank of Canada. During the course of the hearings on this bill, which significantly expanded the mandate of the Bank, it became clear that fundamental questions about the role of the Business Development Bank in the economy, and as an instrument of public policy, were not addressed.
Further, the Farm Credit Corporation (FCC) received a new and broader mandate with the passage of the Farm Credit Corporation Act in April 1993 as did the Export Development Corporation (EDC) with passage of An Act to amend the Export Development Act in June 1993. Finally, the Canadian Commercial Corporation (CCC) was directed by its minister "to double our business in terms of dollar volume and the number of clients with whom we deal.<1>
In none of these cases was the mandate of the particular organization subjected to fundamental examination. With respect to the BDC, EDC, and FCC, Parliament raised questions about details in the governing legislation, but did not raise broader questions of public policy. In view of the importance of these institutions in the economy and their effect on private suppliers of capital, the time has come for a more comprehensive examination.
At the suggestion of the Minister of Industry, John Manley, the Committee undertook a study of the broad issue of how the federal government's financial institutions now function in relation to the private sector. The Committee was particularly interested in understanding how these institutions should function in an environment in which the role of the government in the economy is declining and in which government is striving to improve the efficiency with which its various institutions operate.
In his appearance before the Committee to discuss Bill C-91, An Act to continue the Federal Business Development Bank under the name Business Development Bank of Canada, the Minister of Industry stated:
In looking at the question of how the federal government's financial institutions as a whole function in relation to the private sector, the appropriate role for them to play, and the kinds of gaps that they are endeavouring to fill, a horizontal and deeper review by this committee would be very helpful to the government.<2>
In response, the Committee suggested:
After the committee has made what the minister calls a "horizontal study" and makes a report to the Senate, perhaps the minister would commit himself on behalf of the government - and that commits the government - to table in the Senate and presumably in the House of Commons, a written and responsive reply to recommendations and observations made by this Committee.<3>
The minister made such a commitment.
ISSUES
To stimulate discussion, the Committee invited parties knowledgeable about these institutions or about the environment in which these institutions operate to address eleven basic questions:
- are any of these four federal financial institutions competing directly against private sector financial institutions? Are any of these four financial institutions providing a service that the private sector could otherwise provide? By increasing the ability of governmental financial institutions to engage in lending, is this causing government institutions to do things that would otherwise be done in the private sector? and, if so
- is the government impeding the development of new initiatives in the private sector?
- is each of these four federal financial institutions truly complementary to the private sector?
- what joint ventures, or co-operative arrangements, exist between these four federal financial institutions and market-based financial institutions? what arrangements should exist?
- are there gaps in private sector financial markets that some government institution should meet, but which no government institution is now meeting?
- are there policy tools, or organizational structures other than the four organizations that are the subject of this study, that the government could make use of which would more efficiently achieve its public policy goals with respect to encouraging Canadian firms to increase their exports, and encouraging the growth of the small business sector in Canada? Is it necessary to have four distinct Crown financial institutions, or is a reorganization of the four institutions possible that would improve service delivery and achieve cost savings?
- how do other policy instruments, such as the Small Business Loans Act and the Farm Improvements and Cooperatives Loans Act, fit into the government's overall strategy to provide financial assistance to businesses?
- are there activities, such as debt management, that these federal financial institutions now engage in that are not directly related to their mission? Would these activities be more appropriately undertaken by the private sector, or by some other government institution?
- should these four financial institutions be subject to independent oversight of their activities in the same way that OSFI oversees the activities of federally chartered financial institutions? Should their governing legislation include a sunset clause parallel to that in the legislation governing federally chartered financial institutions?
- what client groups do these four federal government financial institutions serve? Are market-based financial institutions dealing adequately with these same client groups?
- overall, is the Canadian financial market place adequately responsive to the needs of Canadian business in general, and to new and emerging enterprises in particular?
Once the study was underway, it became clear to the Committee that the Atlantic Canada Opportunities Agency (ACOA), Western Diversification (WD) and the Federal Office of Regional Development (Quebec) (FORD(Q)) were engaged in activities strongly related to those of the BDC and FCC and should be included in the study.
A. Legislative Histories of the Four Crown Financial Institutions: A Summary
Typically, there have been three stages in the evolution of public sector financial institutions. At the first stage, a perceived credit gap is identified and the institution is created. At the second stage, the institution is criticized for being too conservative, and, in response to this criticism, the mandate of the institution is much enhanced. At the third stage, the institution explores the limits of its statutory powers and the potential for increasing these powers; once again, the powers of the institution are much enhanced at this stage. For details about each of the four public financial institutions, see Appendix A.
B. The Economic Council of Canada
The last comprehensive study of Crown financial institutions was carried out by the Economic Council of Canada as part of its study Intervention and Efficiency, A Study of Government Credit and Credit Guarantees to the Private Sector (1982). The Council examined issues ranging from the rationale for government intervention in financial markets to how government exercises control over its public enterprises.
The Economic Council Study examined four major elements that may warrant government intervention in financial markets: obstacles to the proper functioning of the markets themselves (such as the tax system and lack of competition), externalities, public goods and uninsurable risks. To these the Council added a fifth: problems arising in other markets, which might best be resolved through measures taken in financial markets.
The study concluded that when the government intervened in financial markets as an intermediary, the goal of correcting imperfections in markets
· has usually taken a back seat. It would appear that government intervention has almost always been aimed at achieving economic and social objectives that went well beyond the scope of financial markets. (p. 5)
With respect to business financial assistance the Council found that externalities, the positive impact of government assistance to business on other businesses in the economy, is the most frequently mentioned objective. The Council concluded that:
Whatever the cause, it remains that Canadian firms, particularly small or medium-sized firms, have a weak equity base. (p. 29)
Further:
The approach and procedures developed by public agencies in the past do not fully correspond to the present needs. Today, judging by their debt-to-asset ratios, businesses have little difficulty in borrowing regardless of their size. They may, however, encounter some difficulty in increasing or maintaining their equity base, and this is where government could play a complementary role in the financial markets. (p. 35)
The Council view was that the government should pursue avenues that would enable it to increase a firm's equity; further, public loan programs would become the exception, to be used only for assistance to victims of a credit gap and without involving a subsidy.
In the export financing area, the Council concluded that there are few deficiencies in the export credit and credit insurance markets, but that the export subsidy programs of Canada's competitors make it unreasonable to expect Canada to withdraw from this area.
Finally, with respect to the Farm Credit Corporation, the Council concluded that the broader objective of public policy was that of a "healthy farm sector." The Council stated:
We believe that adequate funds from private sources are generally available to Canadian farms and conditions that are appropriate in relation to the risk involved and to prevailing trends. A serious problem remains, however with respect to the design of farm financing instruments. The introduction of indexed farm mortgages would help to alleviate the financial problems faced by farmers, without generating some of the adverse effects of subsidized government loans and guarantees. (p. 106)
C. The Standing Committee on Industry of the House of Commons
In October 1994, the Standing Committee of Industry of the House of Commons released its study, Taking Care of Small Business, an examination of access to capital for small and medium-sized businesses both from traditional as well as new sources of financing. Although the focus of the Industry Committee study was not the institutions under examination by this Committee, problems of market access to credit by small and medium-sized businesses is one of the arguments used to expand the powers and resources of Crown financial institutions.
The Industry Committee saw a need for the chartered banks to do a better job in responding to the needs of small business. (It noted that the chartered banks account for about 90% of lending to small and medium-sized businesses.) But it also noted that alternative sources of financing - the trust companies, the caisses populaires, the credit unions, the leasing companies - have an important role to play. Further, consistent with the Economic Council recommendations, the Industry Committee recommended that the tax system, and specifically the capital gains tax, be designed to encourage patient equity capital.
The Industry Committee saw the role of the Federal Business Development Bank (now the Business Development Bank of Canada) as a complementary - not competitive - lender to small and medium-sized business. The role of the CCC, of the EDC, of the FCC and of the regional development agencies was not discussed in the report despite their public mandates to provide services to the small and medium-sized business sector.
Finally, with respect to "gaps" in the capital market the Industry committee concluded:
Underpinning all of our recommendations are the twin findings that while there are barriers to the provision of smaller amounts of equity capital, there is an adequate flow of larger amounts of capital (above $1 million) from institutional investors.<4>
WHAT THE BANKING COMMITTEE HEARD
The Committee heard from a wide range of witnesses: users of the services of the Crown financial institutions, competitors of, and sometime collaborators with, the Crown financial institutions, experts on capital markets, the Crown financial institutions, the Departments responsible for the Crown financial institutions, and the regional economic development agencies.
One of the most striking points that came out of the hearings was that, while there are many agencies and programs charged with providing assistance to business, the "smaller" end of the business spectrum does not appear to be well served by public policies. According to The Canadian Federation of Independent Business, an organization representing 85,000 small and medium-sized enterprises stated:
Government financial institutions and their programs are not well known by small business. Those programs that are known are poorly understood. Only a small fraction of firms have benefited from or accessed these programs agencies. There is seldom a cultural or financial fit between the needs of small firms and the existing agencies, institutions and programs.<5>
If the Industry Committee conclusion that there is an adequate flow of larger amounts of capital (more than one million dollars ) is valid and if smaller businesses are by and large not benefiting from the programs of public financial institutions, then what "gaps" are these institutions filling? Who are the clients of Crown financial institutions? Who serves small business? And, what does small business mean?
A. What Does Small Business Mean?
There is no consistent definition of small business. (See Appendix B for an aperçu of different definitions.) Consequently, the data that are released by lenders, government agencies and trade associations are rarely comparable. This makes detailed analysis of lending patterns next to impossible. It also inhibits the identification of "gaps" in the market for debt capital, and makes credible evaluation of existing public policy a formidable task.
In response to encouragement from the House Industry Committee, the Canadian Bankers Association now publishes quarterly Small and Medium-Size Enterprise Business Credit Statistics. The banking industry's credit statistics will eventually be broken out by authorization thresholds of $25,000: $50,000; $100,000; $250,000; $500,000; $1 million; $5 million and total business lending. It would be helpful if the Crown financial institutions provided comparable data.
B. Where Are the "Gaps" in Debt Capital Markets?
There was overwhelming support for the view that government should not compete with the private sector in lending, investment or consulting assistance; that is, that the role of government is at the "margin", to deal with gaps in capital markets. There is, however, no generally accepted way to identify such gaps.
An expert on the venture capital industry in Canada told the Committee:
... in the past, the gaps have definitely been in terms of smaller financings, companies that needed less than a million dollars, in many instances - certainly anything less than three-quarters of a million. It was often very difficult to access an equity source that could do that sort of deal. In part, ... venture capital and straight equity are really expensive ways to finance your company if it is only money. Typically, what should happen - in principle, at least - is that an entrepreneur should be looking for an investor who, in fact, is able to be an effective partner and contribute something, be it in accessing markets in distribution, or subsequent rounds of financing, or whatever the particular areas is. Because of that very active involvement, it is a labour-intensive form of investing; it is not passive in any way, shape or form, so you start very quickly to move into an area where your economics become an issue. Therefore, you can only justify the costs, both of exercising due diligence and actually doing the transaction, and then the costs of managing the transaction, if you have a certain floor of money at stake in terms of the investment on which you will ultimately generate your return. That smaller end of the spectrum is an area where, historically, there has been something of a gap.
The other area involved is the technology side, and I am pleased to see that this area is starting to change...<6>
The Farm Credit Corporation in its brief argued:
Farmers and business operators are telling us they require more flexible terms during start-up of new ventures. Traditional lending practices are often rigid and don't take into account unique circumstances of running a business from remote areas in rural Canada. And they're telling us they need access to more equity financing and equity capital.
Over the past few months, FCC has declined millions of dollars in loan requests because they were considered ineligible under the current FCCA. Examples of these are:
· In B.C., an individual who ran an artificial insemination service was refused his request for $20,000 because he was not a farmer;
· In Alberta, a food processing company was refused $2 million for a packing and processing plant for edible oils because it was solely owned by non- farming individuals;
· In Saskatchewan, a fertilizer/chemical dealership located on a 40-acre subdivision was refused $100,000 to buy a high clearance sprayer because he was not a farmer;
· In Quebec, three individuals were refused a $900,000 loan to buy a building where they planned to establish a machinery dealership. They did not qualify because the enterprise was located off the farm, it was not under the control of farmers and only one of the individuals was involved in farming.<7>
The four preceding examples certainly make it clear that there is a restriction on FCC lending activities. They do not, however, illustrate the existence of a gap in credit markets that calls for FCC action.
The Business Development Bank of Canada made a similar argument that where gaps exist, the bank is there to fill them.
The Bank concentrates on areas and market niches to fill the gaps left by commercial lending institutions. It offers flexibility and a longer term outlook than private sector institutions. This is how the Bank achieves its complementary role. It provides leadership in the market place by designing products and services that act as demonstrations for private sector financial institutions that may choose not to be active in certain areas due to risk-reward ratios.
Far from impeding the development of new initiatives by the private sector, BDC is stimulating and facilitating private sector responses. Much of the Bank's new mandate is to work in partnership with the private sector. It may accomplish this by taking the lead in product development or it may develop and deliver services in conjunction with private sector institutions.<8>
Witnesses from the BDC also said:
BDC is careful to ensure that it fully plays its complementary role and recognizes that the commercial banks are the major source of financing for small business.
BDC serves commercially viable businesses unable to obtain financing from traditional lenders on reasonable terms. Every customer of BDC is a customer of a commercial bank. BDC simply provides a different type of financing product to many of the same customers to complete their financing needs. Under its revised mandate, BDC notifies the client's financial institution when it receives a loan application. This notification, coupled with the Bank's higher interest rates, ensure that private sector lenders have the first opportunity to meet their customer's requests.
The most important way that the Bank ensures that it remains complementary is its focus on innovation. It is through identifying and finding new product and market niches that the Bank is able to fulfill its complementary role while remaining sensitive to the needs of small business. Due to its long experience in the financial market place and its close contact with SME customers it is well placed to react promptly with new and innovative solutions to financing requirements.<9>
Earlier this year, the Minister responsible for BDC provided his view of the gaps that BDC will address. Mr. Manley, in a letter to the Chair of The Committee following his appearance to discuss the bill creating the new Business Development Bank of Canada, discussed four gaps:
The first gap relates to risk. Chartered banks usually will not lend to higher risk business ventures even at higher rates. A second gap relates to size of loans. The chartered banks have acknowledged that they lose money on the smallest loans and find it difficult to serve this clientele profitably. Third is a knowledge gap. Chartered banks and other lenders have difficulty making loans to knowledge-based firms which do not have fixed assets for security. Lastly, there is a flexibility gap. Chartered banks base their financing on formula lending and have difficulty adjusting to meet the specific needs of many small businesses, particularly those in start-up or rapid growth phases.<10>
While Mr. Manley was addressing the role of the chartered banks, who clearly dominate the market for capital to small and medium-sized businesses, the Committee did hear evidence that new players, such as the asset-based lenders and CALMEADOW, show promise of developing as additional new sources of non-government capital. The question which then arises is whether extensive public participation in capital markets will impede private sector innovation.
The Export Development Corporation in its brief argued:
The "raison d'être" for EDC is to fill needs, or gaps, which are not being fully or adequately met by the private sector. The past few years have seen significant changes in the nature of the global market place. Companies have increasingly had to shift their perspective from a domestic market to a global one. A number of countries, particularly in South East Asia, have developed rapidly and are beginning to challenge the industrial countries in economic strength. Privatization has become a reality around the globe. Inevitably, these changes have had a profound impact on how Canadian exporters do business.
While the changes in the market place have encouraged increased export activity, these new export opportunities present the exporter with different, and often higher, risks than before. The exporter's needs with regard to export financing and insurance have therefore changed accordingly, creating gaps between what is available and what is now needed.<11>
Further, EDC argued that marked changes have been taking place in the nature of trade and project finance.
While some transactions can be serviced with traditional long-term, fixed-rate financing as defined under the OECD Export Credit Consensus, others require much more creative structures involving both public and private providers of capital. Private capital marks are increasingly prepared to accept some of the financing risk, but may need the involvement of agencies like the EDC before accepting that risk.<12>
With regard to the Canadian Commercial Corporation its work is not that of a financial institution. It does, however, assist small and medium-sized exporters in obtaining pre-shipment financing through commercial channels under its Progress Payment Program.
CCC's traditional role is to act a prime contractor in a sale by a Canadian firm to a foreign customer, guaranteeing contract performance to the foreign customer, and matching that obligation through a domestic contract with the Canadian supplier. As long as a foreign customer insists on dealing with a government agency then the private sector cannot fulfill this need.
Basically, CCC assists exporters by
· identifying and transmitting export bid opportunities
· evaluating and certifying bids
· contracting -- whether in helping develop a proposal, negotiating a contract with a customer jointly with the Canadian exporter, or advising on contract terms
· administering the contract, monitoring the progress of work
· administering financial instruments, collecting payments from the foreign customer and paying the supplier.<13>
The Crown financial institutions were not the only witnesses to identify gaps in capital markets.
According to the Executive Director of the Canadian Advanced Technology Association there is a gap
at the real start-up zero-revenue level. ... This niche has not been filled. This is a gap between the love money and the financial institution money or the traditional venture. If the government went into that area, it could make money.<14>
Tourism is an example of an industry in which externalities abound and consequently one which has had problems in dealing with the traditional institutions. The returns to investment in a specific tourist facility, a ski hill for example or the infrastructure for sport fishing, do not accrue solely to the firm making the investment. Those who establish complementary facilities in proximity to the facility, a restaurant or a hotel for example, also benefit. As the President of the Tourism Association of Canada stated:
We ... need some type of regional mechanism which understands the scope and variety within our industry and can deliver appropriate instruments. There is just no one-size-fits-all solution for tourism, it is far too varied, it is far too community and regionally based.<15>
According to the President of the Tourism Association of Canada, the Business Development Bank has been a strong and positive force for the tourism industry as have the regional development agencies.
With respect to export markets, the President of the Canadian Bankers Association gave two examples of gaps in relation to location and in relation to size.
...
In relation to location, there are countries in the world where we do not feel able to enter and to assume risks, partly because there is political and economic risks. And we would share those perspectives with any other major financial institution in the world. They are countries which have had histories of instability and where there is political turmoil or the possibility of social fallout, which would put us, as we see it, at too great a risk to operate without official support.
On the size front, the major gaps that both we and the government have identified in the market relate to risk capital for smaller borrowers. There have been, of course, a number of creative responses to the overall question of the availability of venture capital. But I would tell you that the economics of offering risk capital to small ventures are really not very good. I do not think that the structures that we found up until now really do meet the need very well.<16>
Many witnesses, while acknowledging the existence of gaps in capital markets and the need for the Crown financial institutions to deal with such gaps, expressed reservations about specific directions that the BDC, EDC and FCC were pursuing.
The President of the Canadian Bankers Association, for example, stated
that there are legitimate needs in the market which the private sector is unable to fill. ... As an aside, however, I would note that in this country, governments arguably see more gaps in private markets than do other governments. And, if you did a comparison of the span of Crown financial institutions in this market as compared to the other O.E.C.D. countries, you would see there being more of them in Canada and you would see them addressing a larger number of perceived gaps in the marketplace. A good accountability framework is one which requires Crowns, therefore, not just to show a profit or show growth in lending volumes or job creation, but also to show how funds have gone to ends which the private sector has been unable to service.<17>
The submission by the Canadian Finance and Leasing Association raised serious questions about what role public sector financial institutions are trying to play and what role they should be playing in a market where "bricks and mortar" are not the technology of the marketplace of tomorrow.
... we would like to address the emerging phenomenon of virtual banking. If we look at what is happening in the United States, one of the impacts of the information revolution has been the "thin-slicing" or unbundling of the business of banking.
Once upon a time, a bank was a full-service institution housed in bricks and mortar on thousands of street corners across North America. Today, with specialization and the increasing desegregation of banking, all enabled by advances in communications technologies, new as well as existing financial institutions are choosing to become more focused on just a few of the traditional components of banking, joint venturing, out-sourcing or partnering other services out or creating alliances of service companies. COMPUTER POWER INC. of Jacksonville, Florida is an interesting example. COMPUTER POWER INC. manages 42% of the residential mortgages in the United States. COMPUTER POWER INC. does not originate the mortgages, nor does it fund them. It simply manages them under contract for others across the U.S.
Driven by a customer focus and cost-efficiencies (which means more competitive pricing to the customer), the virtual bank assembles financing products from a number of different sources and delivers them as a complete package of services to the customer.
How does this example relate to the question at hand? Traditionally, most full-service financial institutions essentially do the same things under the same roof: they originate financings, they manage financings and they fund financings. This is the model CFLA would suggest that has been adopted in conceiving various of the Crown financial institutions. Is that model still relevant and appropriate?
If any financial institutions role vis-à-vis a customer is to originate, manage and fund, CFLA would submit that the huge existing private sector financial infrastructure delivery system is more than adequate to respond to the demand. There are over 10,000 branch offices of banks, trust companies and credit unions in Canada with vendor finance operations at hundreds of point of sale outlets, all originating transactions. Over 250,000 Canadians are employed by financial institutions. The necessary management expertise is in place. Key sources of funding from the banks to insurance and pension funds and venture capital programs, report major cash availability, particularly as formerly popular areas of financing, such as commercial real estate, are no longer so interesting to them.
...
When we look at some of the Crown financial institutions under discussion, we see institutions structurally-modeled after the traditional commercial banks, in some cases with proliferating branch networks, apparently moving increasingly in the direction of becoming fuller service financial institutions. We even see them sponsoring tables at dinners, hockey teams and golf tournaments! In the current context, we ask why?
Compounding this question of why, there is also a growing concern that Crown financial institutions being driven by a political imperative to be self-financing or to operate on a cost recovery basis, will seek revenues by competing more directly with the private sector. CFLA has repeatedly supported government decisions toward cost- recovery and self-financing of its agencies. But to respond to this imperative by duplicating services already provided by private sector financial institutions does not make sense at the best of times and certainly not now with the major demands on limited public funds. Is this the most cost-efficient way for government to achieve the desired public policy results?
...
CFLA believes that Crown financial institutions must get back to basics, strip down and focus their mandates. With cost-recovery/self- financing goals (no subsidization), Crown financial institutions should be limited to narrow focus, highly-specialized niches of expertise and services that would not otherwise be provided by the private sector.
There are a number of recent examples where the Government of Canada has retro-fitted specialized financing programs which we believe constitute a step in the right direction: the Canada Student Loan Program and the Small Business Loans Act. In both instances, private sector delivery infrastructure is used and the government role is limited to loan guarantees. The longer standing example from CMHC's loan insurance program also may be instructive. It insures that part of a loan which a private sector financial institution finds too risky.
If the public policy is to assist SMEs with the marginal transactions that would not otherwise happen, it would seem the questions should be: how much of the risk must be mitigated before the private sector will take the transaction on and how does government do provide such mitigation?
CFLA believes that the appropriate role for the government and its agencies should be to focus on means to enhance the credit of SMEs in relevant financial transactions. Credit enhancement can take different forms: guarantees or insurance, for instance. In this way, rather than building an expensive parallel delivery infrastructure, government can specialize, tailor and target its assistance to provide credit enhancement to assist SMEs to qualify for the marginal transaction, all the time taking advantage of the existing private sector infrastructure to originate, manage and fund the financial transaction.<18>
Witnesses such as the Canadian Federation of Agriculture provided detailed examples of where the gaps are and where the Crown financial institutions are not performing as expected.
CFA is in favour of the FCC's willingness to expand its mandate further into rural lending but only on the condition that it does not lose sight of its original mandate, to lend to the primary agriculture industry. However, we do have concerns over the competition it affords financial institutions, particularly credit unions and caisses populaires, which are active in rural areas. Significantly increased ceilings on loans, access to government rates of interest and the lack of necessity to live with the checks and balances required of other financial institutions can put them in competition with private lenders. A balance must be achieved between the FCC's ability to lead in interest rate setting or new initiatives, for example, and undo competition with private lenders.<19>
...
The Export Development Corporation is used by the agricultural industry in trading arrangements. Its original mandate was to facilitate Canadian exports. Its recently altered mandate now puts it in the position of having to be self-financing and as a result it is becoming risk averse. Its utility to the agriculture industry is hampered by its orientation to large shipment sellers with large margins of profit. Again with the requirement for self-financing EDC has shifted its interests to "paying customers." With margins on grain shipments of often less than 1%, there is no interest on the exporter side to pay 1% fees. This also means that the EDC has no real interest in commodities sold in small shipments with small margins such as the pork industry.<20>
Other witnesses provided specific examples that have arisen out of the expanded mandates of Crown financial institutions.
Both the credit unions and the banks expressed concerns about the expanded mandate of the FCC.
The witness from the Credit Union Central of Canada stated:
As an example, in the height of the downturn of the agriculture economy, the credit union movement had a lease operation called Agri-Finance out of Winnipeg which backs the leases of farm machinery for farmers. We have done this for years.
Through the worst of times we have been in that marketplace to ensure that producers have farm equipment with which to operate. We have done that successfully. There is a commitment between the producer and ourselves which has made it a successful business. We are used to competing with other large lending institutions for that business. There is a relationship between us, the dealers and the farmers.
Now, because FCC is under so much pressure to meet its own bottom line as an institution, it is going after that kind of business in the very markets in which we have always been doing that. That is a real difficulty for us. It is not that we will not sit down and work with them on this. However, it is one thing to talk about partnering, and another thing to get down to the nitty-gritty of what partnering means and what role each partner is to play.<21>
With respect to the BDC (formerly the FBDB), he went on to say:
My understanding is that the [BDC] is trying to work out its role with the FCC and us. Historically, we have worked very well with that institution. It has provided a range of concrete services to businesses which have proved to be effective. It has been given a new mandate. We are meeting with them to ensure that we do not step on each other's toes or get in each other's face. They now have a mandate which says that they must support Canadian entrepreneurship by providing financial and management services. In carrying out its activities, the [BDC] must give particular consideration to the needs of small- and medium-sized business.
In our mission statements we have that almost bang on. There has to be some serious understanding between the two. From a historical experience, this program at one time handled millions of dollars for minimal costs. Let us not destroy that capacity here by turning itsrole into an exaggerated one which is complex and which duplicates what other financial institutions are doing, no matter who they are and what they may be doing in terms of servicing those members.<22>
The President and Chief Executive Officer of the Caisse Desjardins also addressed the expanded mandate of the BDC.
At present, under the new mandate, when they exercise their ability to raise funds, they turn to traditional financing, the kind that any private institution could provide. I don't see any value-added since, when they consent to these financings, if these loans were granted to businesses at very good interest rates or conditions and so forth, you could say that this was a certain form of subsidy.
But if you do it for companies that are in good financial health and that don't need subsidies, why do it? Consequently, they have entered the traditional market. They have no value-added; they don't have a more competitive product. Nor do they give businesses any advantages, but often, to all intents and purposes, they now go looking more in niche markets, whereas they used to play a support role for much weaker businesses.<23>
With regard to the FCC, one witness from the Canadian Bankers Association expressed serious concerns about the expanded mandate of the FCC.
A couple of years ago [the FCC] received an increased mandate as a result of their problems in the mid-1980s. It seems that they always want more and more and more in terms of their mandate.
They compete with us directly every day, all the banks, the credit unions, the trust companies and so on, for farm lending services. Our people see them every day in the marketplace. And they have gone up-market in terms of quality, and really want the low-risk business for their return. So, basically, they are competing for the same business that we are and they do advertise. If you look in the farm papers you will see their advertisements regularly. They have even taken a swipe at banks and trust companies and other people in some of their ads depending on what month it is.
To follow that along, I would like to just read you one of their objectives from their annual report. It says "to develop and implement marketing strategies to achieve a $5 billion dollar loan portfolio of revenue-generating assets by the end of their planning period and to achieve the targeted financial performance."
Farm debt does not expand very rapidly, and I am not exactly sure what FCC's planning period is. However, to reach $5 billion is quite a stretch on any period of time, given the payback and the fact that their loan portfolio of farm and agribusiness is about $3.4 billion at this time. The only way that they could ever achieve that kind of growth would be to take business away from the other lenders in the private sector.
That begs the question: What public policy do they achieve doing that? It also begs the question: How will they do that? Will they underprice the market and so on? It just goes on and on with them.
As I say, we see them every day in the market. I think you mentioned gaps. Perhaps there is a gap, a perceived gap, around farmers who are starting out and unviable farms. Unfortunately, in the marketplace, however, you have to deal with the risks as you see them. But they have definitely changed and want more.
...
The other thing I will mention is that Canadian banks have about 2,000 branches in rural Canada. And if Farm Credit was to attack that business and price it lower than the market, the livelihood of those branches is put at risk. If a number of loans leave those branches the branch will need less employees. If the deposits go somewhere else, they will need less people. All of a sudden those rural branches will be at risk. And we all know the problems that rural Canada has in keeping business and people employed in those small towns.Therefore, I think there are some far-reaching issues which must be considered in expanding the mandate of these corporations.<24>
One of the witnesses from the Caisses Desjardins stated:
Furthermore, the federal financial institutions are also beginning to "collect" the savings of individuals by offering this clientele access to their debt securities. For example, the Farm Credit Corporation issues debt securities in amounts as small as $25,000 and at very attractive rates.<25>
With respect to EDC a number of concerns were voiced. The President of the Canadian Exporters' Association stated:
In terms of risk, the Association remains concerned with EDC's mandate. In contrast to some export agencies in other countries, EDC is required by its mandate to put greater emphasis on the need to be self-sustaining. As a consequence, the corporation is not always able to be as aggressive as exporters would like in premium, policy and financing to help exports in the riskier markets. This is a question of its fundamental mandate.<26>
The Exporters were not, however, concerned that the EDC was competing with the chartered banks. They did not feel that the chartered banks were as active players in the export financing market as they could be.
The Canadian Bankers Association, on the other hand, was quite concerned about EDC competition.
... effectively what has happened in the export market is that the return to investing in the business and investing in the people in the business in export finance in Canada has not been what it could have been and that has happened instead in those jurisdictions where the relationship with the Export Credit Agency has been a better relationship. In many cases the investment happens through a Canadian bank, but I think you would find, if you talked to the Canadian banks about where there best trade finance expertise is, it might not necessarily be in Canada. It would be outside the country.<27>
The witness from the Canadian Bankers Association continued:
The OECD countries are competing against each other, and EDC has to provide some sort of level playing field for the Canadian exporter.
Where there is significant shortfall is not only in the capability of providing cover in some of those markets, but also that international business is now being done more by consortium and joint ventures. Major projects are being put together by groups of companies with representation globally. They seek out financial advice from financial institutions, they look for an advisor. Those advisors work with the Export Credit Agencies of all the countries. In fact, the Toronto Dominion Bank, have more assets on its books relating to Ex-Im Bank in Washington, JEX-IM Bank in Japan and the Hermes Bank of Germany than we do with EDC.
When an exporter wants to be part of the global marketplace, he has to be part of the team that is going to be doing these deals and they work through an advisor. The advisor does the structuring and looks for support from export credit agencies. The EDC does not work in that way at all. They work directly with an exporter, independent of that environment.
As a result, for example, we have a project finance team of 20 in New York and a project finance team of one in Toronto. We have a project finance tream in Singapore of five people and we have a project finance team in London, England. The reality is that EDC does not work with financial institutions. As a result, many Canadian exporters are excluded from bidding or being invited to bid on projects because they are not part of the international network .<28>
The problem of identifying gaps and of avoiding competition between the private sector and the Crown financial institutions is complex. Even if there are gaps, do all call for public intervention? Will not the private market respond if there are profits to be made in filling a gap? and do we run the danger of pre-empting the private sector if public intervention is always initiated? How do we control the proliferation of government programs?
Witnesses from the Canadian Federation of Independent Business argued that small business does have problems with the chartered banks. However, government, by jumping in to fill the gaps, is taking market pressure of the private sector to fill gaps.
Unfortunately, too often financial markets in Canada choose not to do business with small business, viewing it as inherently "too risky" or "not sufficiently profitable." Although there are certain fixed costs to processing a loan that are standard regardless of loan size, the banks' view is selective. If one looks only at the loan itself, it is perhaps not as appetizing as would be liked. However, CFIB has argued and research supports the fact that, when you examine all the attendant products and services such as deposits, mortgages, personal loans, RRSPs, car loans, payroll systems, etc. that come to the bank with the business loan, the total account is highly profitable. Because small businesses tend to stay with their banks through the good times and bad, there is a steady income flow to the banks. A second aspect of this issue is that with technology improvements some of the cost savings should be applied to reducing the cost of dealing with the small business loan. In many cases it is easier to get a credit card than it is to get a small business loan.
Too frequently the major financial institutions have indicated that they will only lend to small businesses, farmers, exporters, hi-tech firms or knowledge-based firms if there is a government loan guarantee in place. This does not auger well for a financially strapped government or for the economy as a whole. In the past, government has jumped in to fill gaps not serviced adequately by the private sector. In so doing, the government is effectively taking the market pressure off the private sector financial institutions. Also, once these agencies exist, it is in their interest to expand, further causing banks to back off, producing a vicious cycle. This approach is antiquated. Small business has said that in order to reduce the debt and cut the cost of capital in the longer term, the government must eliminate its deficit. Corporate Canada has expressed the same point repeatedly. Small business has told government to eliminate and rationalize subsidies and programs for business.
CFIB witnesses went on to discuss the discouraging effects of the proliferation of public programs.
Government programs to support debt financing for small business have proliferated with the result that there is now substantial overlap in program activities and duplication of administrative bureaucracies. This has increased the cost of delivering government assistance and served to discourage SMEs from using the system because of its complexity. The Committee recommends that the federal government significantly reduce its own debt levels which will serve to lower the cost and increase the availability of funds for small business. Thiscan be achieved by reducing and rationalizing government programs. Remaining government-sponsored programs should be refocused to fill financing gaps not currently served by the private sector.<29>
For some witnesses the existence of a gap was not a sufficient basis for use of a Crown corporation. Professor Trebilcock stated:
It is not sufficient in most policy contexts, including the one with which you are concerned, to identify simply a case for government intervention and then leap from the premise that some form of government intervention is required to the view that the form of the intervention should be through a Crown-owned enterprise. Governments have a vast array of policy instruments at their disposal. In every case, we must ask: Is this the appropriate choice of instrument to realize this particular policy objective?
In our 1982 study, we were particularly interested in this institutional boundary issue. Rather than using Crown corporations, why does the government not increase its use of tax, regulation or subsidization of private sector firms so as to align the conduct of these private sector enterprises with government public policy objectives? To put the question more bluntly: Is there ever a case for a Crown corporation in any context? Conversely, could one not imagine governments achieving their policy objectives through appropriate choice of tax, subsidy or regulatory instruments directed at the private sector?<30>
He followed up his testimony with a letter to the chairman in which he stated:
Whether there is a gap which should be filled, (and then what policy instrument is best adapted to filling it) to my mind should turn on serious evidence of market failure, e.g. monopoly, public goods/externalities, information failure, asking in every case (a) whether the government can do better than the private sector in resolving the demonstrated market failure and (b) what policy instrument is likely to do this at least cost and with fewest negative spillovers for other policy objectives. For example, is there insufficient competition among private sector financial institutions for SME business? Can a government agency better assess the prospects of a high technology enterprise than the private sector? Are there positive social or economic spillovers (externalities) from high technology activities that private sector agents cannot fully capture, leading to socially sub-optimal levels of private investment in such activities? Can a government agency reduce the fixed transactions costs faced by private lenders in making small business loans?
In the case of the FBDB, Mr. Manley in his evidence relied heavily on two factors as justifying a gap-filling role for the FBDB. (a) Financing for knowledge-based enterprises and new technology companies (...). (b) Providing small loans to business where the fixed costs of loan assessment make these loans unprofitable and unattractive to private sector lenders.
Here we need to ask whether there are any reasons to suppose that a Crown-owned financial institution can outperform private sector lenders in these two respects. Figures on lending to SMEs by the FBDB and the six major banks provided by Mr. Manley suggest that the scale of lending to SMEs by the major banks (even without considering capital provision by other private sector financial institutions) dwarfs that of the FBDB, raising serious question as to whether the FBDB is really filling a gap that needs to be filled.<31>
The President of Acorn Partners went even further.
The logic of my remark was that I was not looking at the organizations per se, but rather at what they did and what they put out. My experience of them varies substantially but, as I saw what was available publicly, it seemed to me that, for the most part these organizations are providing goods or services that are now being provided by the public sector. The private sector, intrinsically can be provided for by the private sector because, to use a brokering example, if I were brokering something, I could decide to take a client or not; I could decide what to charge them; I could exclude people. That is extremely important. If I am doing something that, if I give it to you, all of your colleagues automatically get it, then I cannot function as a for-profit organization in that setting. I am saying that the organizations that you have listed here, for the most part, are providing what I will call private goods, not public goods. Therefore the justification for public intervention is very weak and is a very slippery slope, in my judgment.
I made a particular exception with respect to CCC, and I think that was quite clear that there is something there that they do that I do not know how anybody would handle in a market system. I hope that has clarified the point. I have not hit the organizations; I have not said they do not have expertise because that would be wrong. They do have expertise but the public policy issue is should that expertise reside in a political culture, or should it reside in a private sector market where success can be rewarded and people can expand if they do something well or, on the other hand, if they do it badly, or if there is no demand they get punished, and they withdraw. I would suggest that you, in part, have answered that question elsewhere using the creeping mandate which I see as a problem. What I see over history is that mandate has become virtually uncontrollable. For example, the Business Development Corporation came into being for one reason: the banks were restricted from term lending, and nobody figured that there was any other way to get that business. Shortly after its institution, however, an organization called Roynet was established and that organization has been in term lending for a long time and is well regarded by many of its clients.
It is a very basic, philosophical problem, if you will, grounded in economics, and I just happen to have concluded, having watched things over the years, that while, there are some very good things that have happened as a result of these organizations, those things could come about in other ways, and in fact, that is what in fact Mr. Martin was saying in relation to a different environment. We do not need the public sector to make those things happen in a general policy sense. In the specific sense, yes, it is quite true that a particular deal may not have come together in the absence of such an organization. However, by and large, it is a policy failure; we do not have our overall rules right, and that is why we now have these organizations.<32>
C. The Canadian Commercial Corporation
It quickly became clear during the course of the hearings that the Canadian Commercial Corporation has made a positive impression on all who have worked with it.
The Canadian Commercial Corporation (CCC) is highly regarded by the business community for its support to a) defense exports, b) exports to UN agencies and IFIs (international financial institutions) and c) its initiatives to help SMEs in export financing. Concerns from another era about the CCC being a competitor to the private sector no longer exist under the current management and the Corporation is considered an effective member of "Team Canada", and one whose services deserve to be better known. We would, however, underscore that the line between providing support and being perceived as a competitor to the private sector is a fine one, and it is only by dint of hard work and sensitivity to the issue that the Corporation has regained the full confidence of the private sector.<33>
D. The Small Business Loans Act (SBLA) and the
Farm Improvements and Cooperatives Loans Act (FIMCLA)
While considerable attention was given to the Crown financial institutions, two federal programs delivered through the private sector received the widest praise - the Small Business Loans Act (SBLA) and the Farm Improvements and Cooperatives Loans Act (FIMCLA). The Canadian Federation of Independent Business described the SBLA as "the best known, understood and accessed federal government financing program.<34>
With respect to FIMCLA, the Canadian Federation of Agriculture indicated
that surveys and projections carried out by Agriculture and Agri-food Canada show that uptake will not only not diminish despite the increase in the cost of the loans but indeed will increase commensurate with their increased availability through private financial institutions. <35>
Given the popularity of these programs, the question was raised as to whether it would be more efficient from a social perspective to have the government design whatever financial assistance programs it deems appropriate but to deliver more of them through the existing private infrastructure. This would avoid duplicating the "existing bricks and mortar" framework, take advantage of private sector expertise and encourage innovation in the private sector.
The President of the CBA stated:
What I think you need to do is shake out the Crowns greatly and focus resources on those which are delivering valued-added to the economy. We need a very strong Export Development Corporation. We must ask ourselves: Do we really need an FCC, and can the funding that we put into the FCC not be redirected towards an EDC?<36>
But even with this sort of rationalisation, EDC programs should be looked at. With respect to trade finances, for example, one witness from the CBA stated:
There is an infrastructure within all the Canadian banks to deliver this product. The enhancement of EDC through insurance or guarantee programme is very easily added to the product that we would normally deliver. It would not necessitate huge additional staff on our part. In fact, what would happen is that we would probably increase our skills as a result because we would be looking at those higher risk markets.<37>
The witnesses from the Caisses Desjardins stated:
These new programs will be distributed through the network of branch banks, savings institutions and credit unions across the country. This complementarity is the cooperative route that we hope to develop with the public financial institutions.<38>
The Caisses were in accord with the view that the BDC should look at ways to deliver its programs using the private sector's infrastructure rather than having a set of branches and infrastructure of its own.
The witness from Credit Union Central of Canada took a somewhat more cautious approach. While arguing strongly:
Let us not destroy that capacity [the services to business provided by the private sector] here by turning [the BDC's] role into an exaggerated one which is complex and which duplicates what other financial institutions are doing, no matter who they are and what they may be doing in terms of servicing those members.<39>
his concern was for a "level playing field."
What is ironic is that we now have competitors who do not have to jump through those same regulatory hoops, and I am not referring to the banks but to the federal government.
...
What we would like to see is a set of similar rules across the piece in terms of the discipline that brings to the market. If they are to get into lending , then it should be a tight operation.<40>
He acknowledged the attempts by governments to be innovative but pleaded for a clear set of rules to be followed by all.
Traditionally, governments would deliver programs to the citizenry through any of the financial institutions. Now there are moves to partnering. Are those partnering paths done on the basis of a tender, or are they done because they are used to dealing with each other? What are the rules? It is simply a matter of knowing the rules.<41>
The Canadian Federation of Independent Business was also cautious in its response to the suggestion that the government devote its energy to designing appropriate programs and then using the private financial sector to distribute those programs.
In a perfect world, that would be a great idea.
[but]
Small firms sometimes have a problem just getting the banker's attention ...
The SBLA is fine. I have a book full of programs listed. If the banks tried to deliver all of them, they would not be doing traditional banking anymore. In a limited targeted way, such as the SBLA, private sector delivery is efficient and effective. If you try to deliver all government programs through the banks, the system will break.<42>
The CFIB witness acknowledged that a limited number of targeted and clearly defined programs could be delivered through the existing private sector distribution system.
E. Accountability
One issue that was raised by many witnesses is the need for greater accountability of the Crown financial institutions.
We ... see no link to Parliament for a regular review of their performance and powers. We do see them come before Parliament when they are looking for an expanded mandate. But we don't see them required on a regular basis to account for performance to Parliament and we don't see a system which has their overall mandate come up for review on a periodic basis.<43>
The Assistant Deputy Minister, Industry, addressed the current accountability situation of the Crown financial institutions.
The CCFIs (Canadian Crown Financial Institutions) have no depositors and their sole shareholder is the Government of Canada. They operate under a system of controls which has been designed to protect the interests and control the liabilities of that one shareholder.
For example, each of the CCFIs is required to prepare a five-year corporate plan and an annual borrowing plan. These must be reviewed and approved by Treasury Board. The Minister of Finance must approve individual borrowings and their balance sheets, which appear in annual reports to Parliament, must be scrutinized and certified by the Auditor General of Canada.
As to whether there should be sunset clauses for the CCFIs, I would note that the Business Development Bank of Canada Act calls for a parliamentary review after five years.<44>
There are differences between what the President of the CBA wants and what the current situation is. The President of the Bankers Association is calling for a more regular debate on what the appropriate mandate is. Annual monitoring of the activities of a CCFI to ensure that such activities come under its mandate does not address this concern.
Consider the EDC, for example. Under its current mandate, it may provide direct financing and loan guarantees. The chartered banks prefer that EDC focus on loan guarantees which then enables the banks to earn the fees from providing the financing. The EDC view is that, if it is to take the risk in a financing arrangement by providing a guarantee, it might as well provide the direct financing itself and earn the financing fees. The monitoring process, to which the ADM, Industry, is referring, will result in approval of the EDC approach because the EDC legislation permits it. But, the banks argue that the mandate is too broad, permitting the EDC to be too active in the direct financing market. This is a significant policy question. There has been no broad public debate on the public policy issue.
F. Restructuring
During the course of the hearings, it became clear that the recently expanded mandates of the BDC, the EDC, and the FCC will lead to an ever increasing overlap of the activities of the Crown financial institutions. The FCC is expanding into off-the-farm activities; the BDC is expanding its export-related activities; and the EDC and the CCC are increasing their efforts to aid the small and medium-sized business sector.
Has co-operation among the Crown financial institutions grown significantly? According to the President of the FCC:
Regarding BDC, in my view, striking an arrangement with them at the senior executive level has not been high on my list of priorities. However, I have asked my field and regional people to stay in touch with BDC officers to ensure that the market is well served as between us and to look for opportunities where we can work together in terms of making people aware of their product line and having them make farmers and people in the agricultural field aware of our product line.<45>
According to the President and CEO of the BDC:
... we do have regular contact with Crowns and agencies to examine how we can work together, how we can serve the market and to find our common areas of interest. However, often the net result of this exercise is that we are serving different markets.<46>
While there is contact among the agencies, it does not flow from a well-defined, ongoing consultation process such as that which exists among the Bank of Canada, OSFI, CDIC and the Department of Finance .
Would there be net gains to society from merging two or more of these public agencies? There was considerable discussion during the hearings about this possibility. The witnesses from the public agencies were not very enthusiastic about this suggestion. They argued that there was a "culture" associated with each of their respective clienteles that would be lost if there was a merger.
For example, the President and chief executive officer of the FCC stated:
Our value to our clientele is that we are there when the economy is good bad or indifferent. Our whole organization is focused on providing that service to that part of the economy.<47>
Clearly, this is an organization that, on the one hand, appears to be dedicated to its clientele, but, on the other hand, is eager to branch out into non-farm activities and into loans to individuals who are not farmers. This sounds rather similar to the activities of the BDC. The "culture" argument is not a convincing one.
Furthermore, this argument does not address the question of why we need four treasury functions, four centralized management data systems, four human resource systems and so forth.
The chairman of the board of the BDC took a "longer" point of view:
In terms of looking at the client base of Crown corporations, we have to take into account -- and this is a problem -- that these are not static clientele. It is as if the manufacturing sector is moving into high technology and the agricultural sector is moving into agri- businesses, which in some cases would be high technology. This is an evolutionary process.
...
When it goes back to the question of whether you should put these organizations together, it raises the question: Are they now applying to the right fields in which they are involved? It must also be asked: Should there be a different process down the road than simply saying you can solve all the problems by joining them all up together, cut cost and do whatever else you might want to do?<48>
At an earlier point in the discussion he said:
If I were looking down the road, the question is, does someone look at some point in time at taking these institutions and privatizing them, changing them dramatically from where they are today, or leaving them as they are if they are fulfilling a particular niche. All those questions are on the table.<49>
With respect to merging the EDC and the CCC specifically, the President of the Export Development Corporation stated:
I am not too sure what kind of strength or advantages would be gained by merging those two enterprises, because they are two very different businesses. I see some disadvantages in us being merged into one operation.
Basically, when we make a loan to a foreign buyer, we have a fiduciary responsibility to that buyer in terms of that loan. If there are any problems on the Canadian side, we generally have to advise the buyer that there are problems developing.
We are engaged to him to lend the money, and he is engaged to us to give the money back. If, at the same time, we were the supplier of those products and there were some problems, we would be in a conflict of interest as to how we sort these things out. We would have to erect all kinds of fire walls inside the organization so that one side of the shop does not talk to the other side of the shop does not talk to the other side of the shop.<50>
This "conflict of interest" does not, however, seem to be a problem for private sector corporations, such as General Electric or General Motors, which not only produce and sell products, but also vigorously seek to earn income by providing financing to the purchasers of their products.
G. The Regional Development Agencies
Finally the Committee heard from senior officials of the Atlantic Canada Opportunities Agency (ACOA), the Department of Western Diversification (WD) and the Federal Office of Regional Development -Quebec (FORD - Q). (See Appendix C for a brief discussion of the original mandates of these agencies.)
The February 1995 budget changed the focus of the regional development agencies and decreased their funding (including Federal Economic Development in Northern Ontario) by $562 million over the next three years (from $1,138 million in 1994-95 to $576 million in 1997-98). Their focus is to be small and medium-sized enterprises and they are to make extensive use of repayable contributions and loans instead of grants.
The November 1995 Report of the Auditor General of Canada dealt with regional economic development programs, with specific chapters devoted to ACOA, FORD(Q) and WD, respectively. Problems were noted.
The entities do not have risk-based procedures to provide guidance to staff when they review projects. Such procedures would help staff to understand the degree of financial risk the government wishes to assume, and would give guidance on the types of projects the entity wishes to support (or avoid).<51>
Our chapters indicate that programs have funded projects where the case for incrementality was not made clearly, and the applicants appeared to have the financial resources available to proceed on their own.<52>
Taken as a whole, results measurement in the entities has been disappointing. Not all of the program elements have been evaluated and for newer elements it is too soon to tell. Given the government's evaluation policies, program managers have used their discretion (other than ACOA, where legislation dictates the program elements to be evaluated) to decide whether it was worth investing in evaluation of all program elements and, where they have done evaluations, what issues to review. Nevertheless, there is a lack of information on which programs have worked and which have not. Moreover, Parliament has not been provided with appropriate accountability information about the results achieved with the billions of dollars that have been invested .<53>
The Vice-President, Newfoundland Office, ACOA, made it clear that ACOA is making funds available to firms who not only cannot get capital from the chartered banks, but also from the BDC.
... our analysis has shown that 75 per cent of the clients of the Business Development Bank of Canada would not be eligible clients for ACOA's programs. The agency's programs focus specifically on those business opportunities which have high growth and employment potential but face numerous constraints in the start-up phase or expansion. As well, the [BDC's] cost recovery mandate does not allow for that sort of patient, unsecured capital that ACOA provides.<54>
ACOA's repayable assistance is not intended to compete with conventional financing. In fact, applicants are expected to access all the available conventional financing before ACOA financing is approved. ACOA's financial involvement is justified only as seed money to allow a project to complete its financing package.<55>
ACOA also works with the BDC on a variety of economic development initiatives.
Following the presentation of the 1995 Budget, WD announced that it would no longer provide any direct assistance to business. Its resources would be used to develop targeted funds in cooperation with the private sector and the Crown financial institutions. Areas for funding include agricultural biotechnology, agricultural value-added and knowledge-based industries. The agricultural biotechnology and biotechnology loan program, for example, is a $30 million fund entirely capitalized by the Royal Bank. The maximum federal exposure in this fund is $3.75 million. CIBC and the FCC are involved in the $100 million agricultural value-added loan program; the BDC is the key source of funds for the $25 million knowledge-based industries fund. According to the acting deputy minister, WD hopes to have nine of these up and running by the end of this fiscal year. Other areas under discussion include tourism, the health industries, telecommunications and environmental industries.
WD also indicated that it work on the development and delivery of services to business, including single-window access to information and services.
WD is basically becoming a service organization for small and medium-sized enterprises, "trying to build partnerships that help leverage complementary activity from both public and private sectors" and "working with [SMEs] to address some of the managerial and business expertise gaps that may have previously constrained them from obtaining financing.<56>
Finally, FORD(Q) assists SMEs in three ways:
by giving them access to strategic information in the key areas of markets and technological areas; by giving them access to partnerships and strategic alliances; and by giving them access to capital ...
Approximately 21 federal government departments address inter- national business development and technology development. We have attempted to make that process more user friendly in Quebec by signing MOUs in this area with key federal departments and players.<57>
H. Innovation at the Margin
One of the most innovative approaches to the provision of credit was that of Calmeadow Corporation, a nonprofit, charitable organization that provides credit to people in the market who cannot access traditional sources of business loans. According to the Executive Director of Calmeadow they are basically working on two models.
In Nova Scotia we have a decentralized community-based lending operation. Our goal (in Nova Scotia) is to create ten community run micro-loan funds under our Calmeadow Nova Scotia umbrella. We are working through the Royal Bank of Canada using a shared guarantee scheme.
In Toronto, through Calmeadow Metro Fund and in Vancouver, through Calmeadow West, we are developing a more centralized direct lending model whereby we lend from our own pool of capital.
We lend, using a group lending model ... whereby four to seven individuals form a business credit group. They agree within that group; all of them have their own businesses and each of them have their own loans. ... They find other good customers for us, they assess each other's loan requests and they follow up on repayment.<58>
To date Calmeadow has loaned one and a quarter million dollars to over 700 people. The size of the loans ranges from $500 to $5,000. To date, the organization is not covering costs. "The best of the micro-lenders in the U.S. are only covering 25% of their costs at the moment." (Ibid, p.33) To cover costs Calmeadow will need to generate larger volumes, larger loans (perhaps up to $15,000) and will have to charge higher interest rates. Borrowers may be willing and able to pay considerably higher interest rates, but such levels may be politically unacceptable.
The message that comes from the Calmeadow experiment is twofold. The first is that there is a tremendous capacity for innovation and experimentation in capital markets without direct government intervention. The second, however, is that the costs of servicing the "smaller" end of capital markets are significant.
VIEWS AND RECOMMENDATIONS OF THE COMMITTEE
A number of messages came out clearly in the course of the hearings, messages that are quite similar to those heard in the course of the Economic Council Study of Government Credit and Credit Guarantees to the Private Sector and those heard in the House Industry study of access to capital for small and medium-sized businesses.
There is a strong consensus that public institutions should address gaps in the capital markets and should not compete with the private sector. There is, however, no consensus about where the gaps are, and what method public institutions should take to address those gaps. Furthermore, existing data released by the Crown financial institutions do not permit an analysis of the businesses being served by those institutions, making any analyses of whether these institutions are filling capital market gaps impossible, even if the gaps to be filled were clearly defined.
Recommendation 1: The Committee recommends that the Crown financial institutions annually release data on the services they provide to small and medium-sized enterprises (e.g. business credit statistics) in a form which is comparable to the data now put out by the Canadian Bankers Association.
Only when such data are available will policymakers, parliamentarians, and the general public be able to begin to understand who is providing what services to small and medium-sized businesses, and hence begin to understand the extent to which public institutions are filling genuine gaps in the marketplace.
In addition to providing the basic data:
Recommendation 2: The Committee recommends that Crown financial institutions develop methods of identifying gaps in capital markets and that, in their annual reports, they indicate precisely what the gaps are which they are trying to fill and how they are trying to fill them.
Development and reporting of data such as this will enable public debate on whether government institutions are complementing, or competing with, private sector financial institutions to be carried on at a more informed level than is presently possible.
The Committee acknowledges that strong support has been expressed for public sector financial institutions being part of a comprehensive public policy to address gaps in capital markets. The Committee is, however, in agreement with the recurring observation that current policy, which consists of a multitude of programs and agencies dealing with capital markets, does not constitute a comprehensive policy.
Indeed, current policies can be counterproductive, leading to duplication of effort and waste, which is unacceptable under any circumstances, but particularly at this point in history when resources available to the government are scarce. To deal with this extensive overlapping of agencies and programs, some agencies (Western Diversification, for example) have now defined their role to be that of a "single window of access" to other agencies and programs. Clearly, something is very, very wrong if the system of government programs to assist business has become so complex and interwoven that a separate agency is required to help businesses find the program which best meets their needs.
Further, not only is there program overlap, there is also an unnecessary proliferation of administrative systems. The Committee sees no need for the duplication of treasury functions, centralised data systems, human resource systems and so forth, which now exists among federal Crown financial institutions.
The Committee laments the limited collaboration among the various government agencies working in this area. Clearly the government is coming to this view as well. For example, in a January 12, 1996 News Release from Industry Canada announcing a temporary moratorium on acceptance of new funding proposals by FEDNOR (the regional agency for Northern Ontario), it is stated that there is "a desire for increased collaboration among governments and economic development agencies." The Committee believes that the first step in such collaboration is the consolidation of some of the Crown financial institutions into new organisations which target specific types of business.
Recommendation 3: The Committee recommends that, in order to achieve a more efficient delivery of programs to business and to simplify access to government institutions by their private sector clients, the Business Development Bank of Canada and the Farm Credit Corporation be merged.
The two agencies overlap to some degree now, but with the new mandate which the FCC was given in 1993 with its increasing emphasis on encouraging farmers to diversify into off-farm activities, it is clear that the overlap between the BDBC and the FCC will become much greater in the future. Therefore, the Committee believes that there would be considerable synergy in having the expertise and the branch network of the two institutions merged.
In addition, such a merger would make one stop shopping possible for small and medium-sized businesses by eliminating the relatively artificial barriers which now exist between the roles of the BDBC and the FCC.
Recommendation 4: The Committee recommends that the Canadian Commercial Corporation and the Export Development Corporation be merged.
Given that
(i) both agencies focus on the encouragement of exports;
(ii) as both agencies acknowledged, during the hearings, their roles are complementary;
(iii)CCC uses EDC services directly, or its clients use them, in a whole range of areas;
(iv) both agencies are serving fundamentally the same range of clients; and finally
(v) the two agencies are having increasingly frequent sets of meetings to pursue areas of co-operation; a merger of the two organisations makes strong sense in terms of operating efficiency and providing improved services to clients.
The Committee views the argument put forth by EDC, about potential conflicts inherent in combining financing and contracting activities, against such a merger to be completely unconvincing. The Committee suggests that techniques used in the private sector by the many firms that have both production arms and financing arms (such as firms involved in telecommunications, power generation or vehicle production) be used in the public sector to deal with any potential conflicts.
Recommendation 5: The Committee recommends that a single integrated corporate structure be adopted for Crown financial institutions, consisting of a common central office and two operating divisions, one, the merged EDC and CCC and, the other, the merged BDBC and FCC.
This structure would eliminate duplication of central office functions, since the common central office would provide the accounting, data management, human resource and other services that all these institutions need in order to perform their functions.
Further, the common central office would provide the overall planning, co-ordination and internal (to the government) consultation function that does not exist today, but which is critical to ensure that clients are not overwhelmed with a bewildering array of alternative programs and paperwork.
Recommendation 6: The Committee recommends that there be a single minister responsible for the integrated corporate structure of Crown financial institutions.
Senior management of the integrated company and its divisions would work together on annual business plans to be submitted to the Minister responsible for the integrated company. In the annual planning process, input would be drawn from all parts of the institution (e.g. the part focusing on agricultural issues, the part focusing on knowledge-related issues, the part working in export markets and so forth) to develop a comprehensive plan for government assistance to business.
The integrated company, through its central office, would focus on identifying gaps in capital markets, regardless of the industry, and on allocating resources to those gaps. Therefore, the situation would not arise, as it does now, where a Crown financial institution perceives a gap that it feels qualified by expertise to fill, but that it is denied, by statute, the power to fill.
The FCC, for example, is constrained to work with farmers. It argued before the Committee that there are farm-related activities, initiated by individuals who are not farmers, that it should be able to serve. With a single integrated corporate structure, this situation would not arise because there would be no statutory restrictions of this kind on the clientele of the new institution.
Similarly the integrated corporate structure would eliminate the duplication and overlap which now exist among federal financial institutions. As we have stated above, this overlap is particularly noticeable between the BDBC and FCC, and between EDC and CCC.
The integrated corporate structure would, in addition, make the task of accountability - both for the institution and for Parliament - a much more effective process. The aspect of accountability that is of particular interest here is the issue of ensuring that the company actually meets the primary directive of filling capital market gaps.
The current situation, in which a wide range of programs and agencies are reviewed on a program by program, agency by agency, basis, makes it virtually impossible for Parliament to assess the trade-offs which are being made among competing demands for financial assistance, or whether Crown financial institutions are actually staying within their mandate and not competing directly with the private sector.
For example, at the present moment, one dollar more of assistance to off-farm activities of farmers must compete with the demand for one dollar more to on farm activities of farmers which must compete with the demand for one dollar more to knowledge-related industries and so forth. Whether the appropriate trade-offs are now being made is impossible to monitor, because there is no single decision-making body which must confront the choice of allocating resources to one target, at the cost of not allocating them to another.
Parliament would expect the management of the integrated company to be able to respond to questions about what factors underlie the company's decisions to allocate resources among competing demands. A consistent set of evaluation criteria would also be established, enabling the government and Parliament to evaluate the company's performance in a meaningful way.
The Committee recognises that there exists a process of accountability of current programs and agencies to the sole shareholder - the government. This does not, however, address the public policy mandate question.
Recommendation 7: The Committee recommends that there should be public debate on a regular basis - every five years - of the appropriateness of the integrated company's mandate and the mandates of each of its divisions.
Recommendation 8: The Committee recommends that the legislation establishing the integrated company and its divisions have a five-year sunset clause, similar to the sunset clauses which are contained in the legislation governing federally chartered, private sector, financial institutions.
The current annual accountability to the government meets the basic need of mandate accountability. The proposed five-year accountability to Parliament meets the basic need of public policy accountability. It will enable questions such as the following to be answered: Does the need that led to establishment of these programs or agencies still exist? Is the current structure the appropriate way to continue to meet this need?
The integrated corporate structure will also make the process of annual accountability to the sole shareholder - the government - more effective. The management and board of the integrated company will be able to take a broader perspective with respect to the identification of gaps in capital markets because it will not be constrained to deal with a particular clientele, a situation which now faces the FCC, for example. The integrated company, particularly through its central office, would focus on identifying gaps in capital markets regardless of who the client is.
With this general mandate and a single window through which to deliver programs, the management of the integrated company should be able to prepare business plans more efficiently, gather data needed to evaluate programs and respond more effectively to government direction.
Further, in the existing structure, if the management and board of a Crown financial institution find that they are unable to serve their traditional clientele because of mandate constraints or resource constraints, their natural inclination is to seek a broader mandate or more funds based on "special needs." This has led to the current multitude of agencies and programs with higher transactions costs imposed on clients - which the regional agencies are now trying to address by being the single window. The single integrated corporate structure approach would, in large measure, eliminate this problem.
With respect to the regional agencies, witnesses made it clear that the focus of these agencies has changed dramatically, as have their methods of delivering services. These changes, particularly the focus on small and medium-sized enterprises, and their increasingly limited funds, make it clear that, to be effective, the regional agencies will have to work closely with the Crown financial institutions, as well as with the private sector collaborators and competitors of Crown financial institutions.
Is there still a role for such agencies? The Committee does not feel that a convincing case can be made for their continuing existence, independent of the Crown financial institutions. In fact, witnesses for the regional agencies made the same argument for their existence - inadequate access to capital for small and medium-sized enterprises from conventional sources - that the Crown financial institutions made. They even pointed to similar gaps - the area of intangible investment, such as knowledge-based industries - which they are all interested in addressing, as is the BDBC and the FCC.
All these agencies - ACOA, BDBC, CCC, EDC, FCC, FORD(Q), WD - are interested in promoting entrepreneurship, in similar sectors, but not in competition with the private sector. The Committee feels that a rationalisation of the delivery system providing financial assistance to small and medium-sized enterprises in Canada will enable more resources to be devoted to direct assistance to business as overhead consumes less scarce funding. The Committee notes that the regional agencies are now under one ministry, Industry, but that no structural changes have been made to deal with the Committee's concerns outlined above.
Recommendation 9: The Committee recommends that the functions and the funds of the regional agencies be absorbed into the single integrated corporate structure described in Recommendation 5.
If there is a concern that, in a single agency, a particular region may not get its "fair" share, then Parliament or the government can establish a minimum level of funds that must be allocated in each region over some specified time period. This is essentially what happens now, except that the specific amounts are allocated to separate regional agencies - with their separate overheads and overlap with the Crown financial institutions - in the annual budget of the government.
If there are regional economic development programs to be funded at the federal level, that do not involve direct business-related services, then such programs are best delivered by provincial agencies.
Finally, it can also be argued that transferring the funds of the regional agencies to an integrated Crown financial institution would provide the potential for assistance to small and medium- sized enterprises that goes far beyond the dollar value of the amounts actually transferred. The Crown financial institution would be able to leverage these funds if they are added to its capital. For example, the BDBC can borrow funds to carry out its activities; the loan limit is twelve times its paid- in capital. Thus our proposal actually increases the level of funds which the integrated Crown financial institution could spend in the regions.
Recommendation 10: The Committee recommends that the funds of the regional agencies should be treated as paid-in capital by the Crown financial institution, thus enabling it to leverage these funds.
With respect to the issue of direct borrowing by Crown financial institutions, it is important to realise that these institutions are borrowing as agents of the Government of Canada. Because of this, a case can be made that all borrowing should be done by a central agency responsible for managing the overall government debt. The Government with the approval of Parliament would then make the appropriate allocations to each agency. If an agency were to need more funds it would have to come back to Parliament.
There is an another argument, however, that supports the borrowing authority of Crown financial institutions. These institutions are meant to operate at an "arm's length" from the government. We want to make them as independent as possible, endowing them with as much flexibility as is consistent with their being public agencies. Letting them do their own borrowing provides them with direct experience in raising funds in capital markets, experience which is valuable to them, given their mandate. It also enables them to raise funds as they are needed.
Finally, we come to the "self-sustaining" directive under which the Crown financial institutions operate. Clearly no government today can write a blank cheque for any of its agencies. Agencies are expected to minimise their draw on the public purse. This is not a situation unique to Canadian agencies. The growing pressure on finance ministers in OECD countries, for example, is providing an impetus to greater prudence by all export credit agencies.
The obvious solution to this financial constraint problem, and the easiest one, and the one that has been followed by Canadian Crown financial institutions, is to move into business areas that compete directly with the private sector. This, however, clearly takes business away from the private sector and inhibits the development of new products and services by private sector participants. The Committee strongly believes that this is not an appropriate path for Crown financial institutions to follow.
A second route to solve the financial constraint problem is for a Crown financial institution to undertake low risk or no risk activities, such as trading in financial instruments, to make profits to subsidise its higher risk business. Since, a Crown financial institution can borrow at privileged rates, it can then lend, at slightly higher rates, to other borrowers, thus generating profits by essentially acting as an intermediary between borrowers and capital markets.
EDC has used this approach quite successfully; earning $92 million from its investments in 1993, for example. Net EDC income without these earnings would have been negative (a loss of $49 million). In 1994, investment earnings of $38 million together with government debt relief of $151 million to two of EDC's "problem" accounts contributed to a very "profitable" year. But these facts also understate why only looking at the bottom line can give a misleading impression of how EDC is faring on its loan portfolio.
Trading in financial instruments also hides the fact that, by allowing EDC to generate investment earnings in the way it does now, the government is giving a subsidy to EDC equal to EDC's earnings from its investments. These earnings are a direct subsidy because they have alternative uses - other program spending or reducing the debt, for example. The fact that EDC earned them does make them any less of a subsidy. EDC is an agent of the government; its ability to engage in profitable treasury operations is based on that foundation. It is evident that EDC is a good trader, but this is not what it was established to do. EDC's role is to promote exports. If its earnings from its export-related operations do not break even and it needs a subsidy, this should be made explicit. The government can then decide what magnitude of subsidy should be provided to EDC. EDC should not be making that decision, which is effectively what it is now doing. Investment of corporate cash holdings is a central agency function and does not belong in a Crown financial institution.
A third route to solve the financial constraint problem is for the Crown financial institution to underwrite less risk, or charge prices that will more accurately reflect the risk of the product or service it is providing. One of the rationales for having a Crown financial institution intervene in markets is its ability to spread greater risks in a large portfolio backed ultimately by the public purse. This does not imply, however, that government agencies should be underwriting what are clearly unacceptable levels of risk. The question that arises then is: do the prices charged for the loans made by the Crown financial institutions reflect the risk involved?
We are asking the Crown financial institutions to identify gaps in capital markets and to address them, but under the basic directive that they should be self-sustaining. This means no net losses. We have been told that borrowers are willing to pay prices for loans that reflect the risks involved. However, for reasons related to public disapproval of high interest rates charged by lenders, regardless of the reasons for the high rates or the willingness of borrowers to pay the high rates, government financial institutions may not be able to price their loans appropriately. If this is the case, then there are really only two options: either, the Crown financial institution does not make loans that it cannot price appropriately, or the government recognises the problem and provides a subsidy by not requiring Crown financial institutions to be self-sustaining.
Having the Crown financial institutions follow this third route ensures that the private sector is encouraged to innovate and enter new markets. If private sector lenders observe that public institutions have entered certain areas and are capable of making profits at some level of price, the private entrepreneur can explore ways of undercutting the public institution. This is the sort of encouragement needed to spur innovation.
The Committee is aware that, in good times, the existence of gaps in capital markets has been a much less serious issue than in bad times. Unfortunately, available statistics on lending to small and medium-sized business do not permit a definitive answer to the question: do private sector financial institutions exacerbate the problems of small and medium-sized businesses during times of recession?
With the improved reporting of lending to small and medium-sized businesses by the chartered banks however, this issue will be amenable to analysis in the future. Further, the publication of the data, and of the analyses of such data, will put pressure on the banks to ensure that their lending policies do not create unwarranted problems for small and medium-sized business.
In the light of these statistical developments, the Committee is optimistic that the banks will meet their responsibility to serve the needs of borrowers across Canada.
Recommendation 11: The Committee recommends that the directive that Crown financial institutions be self-sustaining be pursued by these agencies but only by undertaking activities which are consistent with their mandate and with the rationale for their being a Crown rather than a private sector financial institution. They should operate in a manner complementary to the private sector and should not engage in activities not directly related to their mandate, such as treasury functions. While treasury functions are necessary to enable these institutions to pursue activities consistent with their mandates, such functions should not become significant "profit centers."
Recommendation 12: The Committee recommends that if the government decides that the self-sustaining directive followed in this manner does not lead the Crown financial institutions to be as active as the government wishes them to be, then the government should make explicit the magnitude of the subsidy it is prepared to provide to the Crown financial institutions to carry out the desired level of activity.
Only in this way, can informed debate over the performance of the Crown financial institutions be carried on.
The Committee views very positively the success of the Small Business Loans Act and the Farm Improvements and Co-operatives Loans Act, which are distributed through private sector financial institutions. Witnesses representing the users of these programs, and the financial institutions that distributed them, spoke very highly of this approach to public policy toward small and medium-sized business.
The Committee is aware of concerns expressed about the SBLA, that the financial community was using the SBLA for loans that could be provided under conventional criteria, for example. The Government is, however, taking steps to address these concerns and the Committee will review proposed amendments to the SBLA to ensure that these concerns are adequately dealt with.
The witnesses from the Canadian Federation of Independent Business made it clear that the small business preference is to work with contacts in local financial institutions with whom they have developed an ongoing relationship. There is in place in Canada an extensive "bricks and mortar" network of financial institutions - chartered banks, trust companies, caisses, credit unions, asset-based lenders and so forth. This is a superb distribution channel - one that is highly accessible to small and medium-sized enterprises - and one that the public sector should use to as great a degree as possible to develop and implement public policy towards small and medium-sized enterprises.
Recommendation 13: The Committee recommends that, as much as possible, programs aimed at small and medium-sized business should be delivered through private sector financial institutions (as the SBLA and FIMCLA are) rather than through "brick and mortar" branches of crown financial institutions.
Finally, the Committee was impressed with the increased degree for innovation and experimentation in private capital markets. The Committee heard about the remarkable growth in complexity of the venture capital market in Canada over the last few years, about the development of asset-based lending in Canada and about innovation at the "smaller" end of the capital market by Calmeadow. It is initiatives such as these that will fill the gaps in capital markets with minimal demands on government.
Recommendation 14: The Committee recommends that certain public policies (such as some aspects of the tax system), public programs (such as SBLA) and public institutions (such as the Crown financial institutions) be reviewed with an eye to changes which could be made to encourage the development of new initiatives in capital markets.
APPENDIX A
PUBLIC SECTOR FINANCIAL INSTITUTIONS
This note provides brief legislative histories of four public sector financial institutions -- the Farm Credit Corporation (FCC), the Business Development Bank of Canada (BDBC, formerly the Federal Business Development Bank, FBDB), the Export Development Corporation (EDC) and the Canadian Commercial Corporation (CCC). In doing so, it tries to pinpoint, where possible, the rationale behind the establishment of each institution. It also looks at periodic, legislated changes to the mandate and operations of each institution to see whether and how the original rationale has been changed.
Typically, there have been three stages in the evolution of public sector financial institutions. At the first stage, a perceived credit gap is identified and the institution is created. At the second stage, the institution is criticized for being too conservative, and, in response to this criticism, the mandate of the institution is much enhanced. At the third stage, the institution explores the limits of its statutory powers and the potential for increasing these powers; once again, the powers of the institution are much enhanced at this stage. The legislative histories below provide more detail about these three stages.
FARM CREDIT CORPORATION (FCC)<59>
What is now the Farm Credit Corporation (FCC) was established in the late 1920s as the Canadian Farm Loan Board (CFLB). Royal Assent to the Canadian Farm Loan Act was given in April 1927, but operations of the Canadian Farm Loan Board did not begin until January 1929.
The founding of the CFLB was influenced by the economic history of Canada -- by the traditional importance of agriculture and by long-standing populist pressure from farmers. The populist agricultural movement of the late nineteenth and early twentieth centuries had pushed for correctives to what was seen as monopolistic practices of the banks. The Western-based movement considered banks to be institutions of Central Canada, and proposals for financial assistance for agriculture were often seen in East-West or Centre-West terms.
More immediate factors also influenced the founding of the CFLB. The fall in the demand for Canadian wheat and agricultural prices in the 'twenties certainly raised concerns about the viability of Canadian agriculture.
The Fielding Committee in 1923 reviewed agricultural conditions and found that Canadian farmers paid more for long-term credit than farmers in other countries and non-farmers in Canada. Two commissioned studies of agricultural credit, under Henry Marshall Tory, were produced in 1924 and 1925. Tory found a lack of competition in private sector lending in the West and concluded that farm lending required a specialized public institution. Tory was concerned with global competition and argued that farmers needed credit at terms similar to those available to farmers in other countries. The existence of the U.S. Farm Loan Board and moves in other countries to establish similar institutions influenced his thinking.
The basic argument was that farmers in Canada and elsewhere faced a credit gap. This view that there was a credit gap remained even in the face of arguments from the private sector that government restrictions in the mortgage lending field were the main factor responsible for the lack of competition.
Under the Canadian Farm Loan Act of 1927, the Board was empowered to make long-term loans on first mortgages of up to half the appraised value of farm real estate. But the Act also required the interest rate on the loans to be set at a sufficiently high level to ensure that operating expenses were covered.
The Act was amended several times. For example, in 1934, the provincial boards, which had been a requirement for federal participation, were abolished. This removed difficulties involved with federal and provincial control and allowed the Board to operate throughout Canada. Other amendments to the Act raised loan limits, eased terms at which financing was made available and widened the purposes for which loans could be made.
In 1959, the Farm Credit Act repealed the previous Act and replaced the Board with the Farm Credit Corporation (FCC). The FCC assumed the Board's mandate and was able to exercise additional powers of providing consulting services to farmers and of making supervised loans to young farmers who were trying to establish viable farming enterprises. The government expanded the powers and operations of the FCC to meet criticism of the older Board that it was too conservative in making loans and that its policies did not help young farmers.
Part of the conservatism of the CFLB, of course, stemmed from the requirement that its interest rates covered costs. During the committee hearings for the Farm Credit Act the government agreed to fix the rate to be charged by the FCC at 5 per cent, a rate that would be below a break-even rate. This was an important change as it introduced a subsidy into the FCC's lending.
In a 1926 Parliamentary debate on an agricultural credit program, a representative from Ontario worried about the possible subsidy from ordinary taxpayers to farmers, while in the same debate a representative from the East worried that Maritime fishermen would not receive a similar subsidy. As the Canadian Farm Loan Board was operated, in fact, there was no subsidy. The introduction of a subsidy with the 1959 changes implied a shift in the rationale for the institution. Instead of filling a possible credit gap (and providing credit to farmers at terms that would be available with a competitive financial system) the FCC gave preferential treatment to farmers by giving them loans at below-market rates. That the operations of the FCC had also been expanded to include assistance to young farmers gave the organization a paternalistic bent consistent, perhaps, with the provision of subsidies to all farmers.
Given the pricing policy for its loans, it is not surprising that the FCC made more loans in its first four years than the Canadian Farm Loan Board had in the 30 years it operated. It is perhaps also not surprising that the FCC ran losses. By the mid-1970s, FCC loans were being priced at the cost of funds plus 1.25 per cent, and the organization was required to make a reasonable return on capital. The FCC had positive net income for the years 1978 to 1982, but economic developments (high inflation and interest rates, a recession and falling grain prices) soon swamped the conservative operating practices, and large losses re-emerged.
In 1992, the Farm Credit Corporation Act was introduced in Parliament to replace the Farm Credit Act. Once again, the new act greatly expanded the scope and powers of the FCC, and because the proposed changes were so substantial, the government chose to table entirely new legislation. Under the Farm Credit Act the FCC could lend money for agricultural purposes only, but under the new legislation the FCC can provide financial services to farmers and to businesses that are parallel to or downstream from the primary agricultural sector.
Supporters of the legislation argued that it better reflected conditions for farming in the 1990s (market globalization, the importance of diversification and the emphasis that has to be placed on value added in the agri-food sector). There is a counter argument, however, that the more powerful FCC will go beyond filling gaps in financial markets and will now provide direct competition for the chartered banks and the Business Development Bank of Canada (the former FBDB).
The evolution of the institution is interesting. The Canada Farm Loan Board was established to fill a credit gap; as such, it complemented other sources of credit for agriculture. The Farm Credit Corporation, as set up in 1959, provided interest rate subsidies to farmers; far from complementing other financial institutions, the FCC was able to offer terms that made it a direct and difficult-to-beat competitor for these other institutions. The recent expansion of the powers of the FCC show that it has moved from filling in credit gaps to being able to finance any activity related to agriculture.
BUSINESS DEVELOPMENT BANK OF CANADA (BDBC)
The Business Development Bank of Canada was established in 1944 as the Industrial Development Bank (IDB) and became the Federal Business Development Bank (FBDB) in 1975. The current name, Business Development Bank of Canada (BDBC), was given only recently with the passage of Bill C-91 in 1995.
There are similarities in the evolution of the business development bank and the evolution of the Farm Credit Corporation. In both cases, the original impulse was a desire to fill a perceived credit gap; the early organizations operated on break-even principles and were
criticized for being too conservative. Both the FCC and BDBC have got away from a simple lender of last resort role; both now have extensive powers that go far beyond filling a credit gap.
There are, however, noticeable differences between the two institutions. The Industrial Development Bank (IDB) was not the result of long years of lobbying by a special interest group. There were no public hearings (like the Fielding Committee) or public investigations (like the studies produced under Henry Marshall Tory). The IDB resulted from a wartime study by analysts at the Bank of Canada, a study that was part of broader concerns about post-war economic policy.
Relying on a history of the IDB by its former chief general manager, Doern and Devlin note:
The Bank concluded that in the post-war period both new firms and firms seeking to convert their production would have difficulties in finding resources. They would have little collateral to secure needed medium and long-term loans and existing financial institutions were not well situated to offer such loans even where adequate security did exist. Chartered banks restricted themselves to short-term lending. Insurance, trust and mortgage companies served the housing not the manufacturing sector. The Bank of Canada perceived a gap in the services of the financial industry, a gap that might restrict the conversion and growth of small industry. It was suggested that the gap should be filled through the creation of a special public credit agency. (Doern and Devlin, p. 369.)
The suggestion was consistent with the general drift of government economic policy at the time. Canada would be one of the first countries to pursue conscious Keynesian policy, and the creation of the IDB in 1944 was part of a broad interventionist package.
The IDB was not, however, established as a means to redistribute income or to pursue disguised government policies. It was to fill a perceived credit gap. To help ensure this, the IDB was made a subsidiary of the Bank of Canada. The IDB's policies, as mentioned above, were conservative; it was to lend to viable businesses with adequate security and reasonable prospects to be able to cover the borrowing costs. The policies were successful, and in the 31 years of its existence, the IDB never recorded a net loss.
By the mid-1950s, however, the IDB was criticized for being too conservative, for concentrating on industrial concerns and for not paying enough attention to the development of small business. Amendments to the IDB Act in 1961 broadened the definition of industrial enterprise to include business of any kind. But these changes led to criticism from private financial institutions that the IDB would provide unfair competition for them (note that there had been little criticism of the IDB when it was established; unlike the case with the CFLB in the late 1920s, the private sector did not argue that the perceived credit gap the IDB was to fill was due to government overregulation of private financial institutions).
In 1974, the Federal Business Development Bank Act was introduced in Parliament to replace the Industrial Development Act (Royal Assent was given in December 1974, but the FBDB did not begin operations until October 1975). There were several reasons for the establishment of the FBDB. The financial conservatism of the IDB, although intentional on the part of those who established it, proved an easy target of criticism for those who wanted the government to take a more active role in promoting the development of small business.
A decade or two after the creation of the IDB, the promotion of small business had become a political issue. In the late 1950s both major parties were promising special programs for small business. At the end of 1960, the Small Business Loans Act received Royal Assent. The 1967 revisions to the Bank Act enabled the chartered banks to expand financial assistance to small business. In its 1982 study Intervention and Efficiency: A Study of Government Credit and Credit Guarantees to the Private Sector, the Economic Council of Canada noted that at the end of March 1980, "there were 28 agencies, boards, and departmental divisions at the federal and provincial level whose primary activity was to provide business loans, investments, and loan guarantees." Of these, 15 had been created in the 1970s, while eight more had been created in the period 1965 to 1970.
In 1971, the small business lobby group, the Canadian Federation of Independent Business (CFIB), was established. As Doern and Devlin note: "In the early 1970s, well before the effects of the 1967 bank deregulation had worked their way through the economy, the CFIB strongly believed that credit gaps existed for small business and that the big banks and the IDB were still insensitive to the needs of small business." (p. 377.) Note that the credit gap here is slightly different from the one used to rationalize the creation of the IDB. The wartime study by the Bank of Canada, which suggested a public organization such as the IDB, worried that there would be no finance for post-war small business from the private sector at any reasonable price; the CFIB, according to Doern and Devlin, seemed to worry that the terms on IDB loans were not reasonable -- and that there was a gap in the provision of finance at reasonable terms.
Pressure for reform or replacement of the IDB also emerged within government during the early 1970s as a move for a coherent industrial policy. There were several departmental studies of the IDB in the early 1970s; as one example of the emerging pressures on the IDB, in July 1971, the Department of Finance studied the IDB's activities in economically depressed areas of Canada. By mid-1973 the government had decided to set up a new corporation to absorb the IDB and to sever links with the Bank of Canada.
The Industrial Development Bank was finally replaced by the Federal Business Development Bank in 1975. The FBDB expanded the operations of the IDB; the scope of lending activity, which had been increased in 1961, was increased further to include leasing; advisory services were increased to provide counselling, training and information services. The FBDB reported to Parliament through the Minister of Industry, Trade and Commerce, rather than the Minister of Finance as had been the case with the IDB.
In 1995, the Business Development Bank of Canada Act was introduced in Parliament to replace the Federal Business Development Bank Act. The new legislation, introduced as Bill C-91, was influenced by the small business policy review initiated in the 1994 Budget and by the small business community, many of whose members had been hurt by financing problems during the recessions of the early 1980s and 1990s. The FBDB was also affected by these recessions, running a series of net losses in the 1980s. These losses could indicate that the FBDB was responsive to political pressures and was less conservative in its lending policies than the IDB, but the losses were an obvious concern to governments facing deficit and debt problems, and this concern led to a re- examination of the operations and structure of the FBDB.
The BDBC will have borrowing powers and a capital structure different from that of the FBDB. Under the earlier legislation, the liabilities and capital of the FBDB could not exceed $3.2 billion; by mid-1995 the institution was near this ceiling. Under the new legislation, there will be no absolute ceiling on Bank assets, but debt will not be able to exceed 12 times the value of equity.
Another important change in the new legislation is the removal of the Bank's "lender of last resort" status. The BDBC may make a loan or give a guarantee to a person without that person first having to prove that it is impossible to secure the desired resources at reasonable terms and conditions. Instead of being a lender of last resort, the BDBC is to complement private financial institutions.
The question of complementarity -- how it would be defined and whether the actions implied by it were really different from those undertaken as a lender of last resort -- were at the centre of the Industry Committee hearings on Bill C-91. Some bankers felt that without the lender of last resort requirement (or without defining complementarity to exclude the provision of any financial service available at reasonable terms from the private sector) the BDBC would provide direct competition to the private sector. Officials from the FBDB argued that the lender of last resort role had to be dropped, because it led to a stigma being attached to borrowers from the Bank; the officials also argued that the BDBC might provide services where there was an apparent overlap with the private sector, but the higher rates that would be charged by the BDBC made this unlikely.
It is too early to say what the complementarity of the BDBC with the private sector will look like. But it is possible to note that the credit gap rationale for the BDBC would take on a new meaning if complementarity included some overlap in the provision of financial services. In this case, the gap would not be a lack of private institutions in the market (the rationale for the IDB), nor would it be a lack of credit for small business at reasonable rates (the rationale for the FBDB); the gap would be linked to an information flaw -- for some reason, private financial institutions would treat similar businesses differently, and some small businesses that would qualify for credit from the private sector at terms given to similar businesses will not receive that credit.
EXPORT DEVELOPMENT CORPORATION (EDC)
The Export Development Corporation (EDC) was established in 1944 as the Export Credits Insurance Corporation (ECIC). The current name was given in 1969, with legislation that significantly changed the institution. Recently, in 1993, Bill C-118 (An Act to Amend the Export Development Act) was passed into law; this legislation also significantly changed the institution, but the name was not changed.
Like the Industrial Development Bank, the Export Credits Insurance Corporation (ECIC) was created in 1944 as part of planned policy for post-war reconstruction. The purpose of the Export Credits Insurance Act was to fill gaps in Canadian export markets caused by the war. Introducing the Bill for the ECIC in Parliament, the Minister for Trade and Commerce noted:
As we approach, and later enter, the post-war period Canada is bound to experience a fall in exports of those kinds of goods that represent purely war-time trade, and every effort must be made, without delay, to see that the volume of our commercial exports increases as rapidly as possible. Every possible support must be given to the enterprise and sales efforts of Canadian exporters.
A considerable number of countries will emerge from this conflict with their financial resources greatly impaired. Particularly during the transition from war to peace, trade with many countries is likely to be uncertain either because of unsettled internal conditions in these countries, or because of measures taken by them to control trade and exchange. As a result Canadian exporters would be quite justified in being hesitant to offer goods because of the risks involved or because private financial institutions are reluctant to grant the necessary credit facilities. In this way valuable and inherently sound export business may be lost at a time when it may be imperative to develop overseas markets for the output of our greatly expanded productive capacity.<60>
The Act had two parts. The first authorized the ECIC to insure Canadian exporters against losses from non-payment by foreigners for actual exports of goods (in 1946, the Act was amended to cover the agreement to export and the export of services). The second part of the 1944 Act authorized the ECIC to provide loans and direct financial assistance on behalf of the Minister of Finance to foreign governments so they could buy Canadian goods. There was a sunset clause attached to the second part, and it lapsed in 1948 (although direct lending was introduced again in 1960 and extended to private companies as well as governments).
The 1944 Act appears to address two perceived gaps. The first is fairly familiar -- in the words of the Minister of Trade and Commerce, "private financial institutions are reluctant to grant the necessary credit facilities." Although private institutions were present in the market, they were not prepared to cover the risks envisioned for the ECIC. When the Bill to establish the ECIC was tabled, the Minister said: "It is not thought that the corporation will compete with the banks at all... " In 1946, the Minister noted: "The corporation does not invade the field of private enterprise in any way."<61>
The second gap is peculiar to export assistance, namely that there is a credit gap faced by potential importers of Canada goods. The story here is that the ravages of war in Europe led to unsettled markets and controls for foreign exchange and trade; these circumstances meant that importers could not finance the purchase of needed goods through their domestic financial institutions. The ECIC helped fill this credit gap with loans and financial assistance to foreign governments.
In addition to the amendments mentioned above, there were periodic amendments to raise the financial ceilings for the activities of the ECIC.
In 1969, the Export Development Act was introduced in Parliament to replace the Export Credits Insurance Act. Under the new legislation, the ECIC was replaced by the Export Development Corporation (EDC). There were several reasons for the establishment of the EDC. It was perhaps not surprising that exporters were very happy with the ECIC; they were, after all, receiving direct benefits from its operations. An influential report on export credits and insurance, written in 1968 and tabled in Parliament in 1969, did note one complaint from many exporters: "They believe that the ECIC is too conservative and not sufficiently export-oriented."<62>
As seen in the discussion of the Farm Credit Corporation and the Business Development Bank of Canada, the charge of being too conservative and the response to this charge mark the second stage in the evolution of a public sector financial institution. Also consistent with the second stage, the mandate of the EDC was much expanded in 1969. The EDC was allowed to engage in direct export financing on its own (the ECIC acted as agent for the government); it was allowed to insure Canadian investments in foreign countries against loss due to political factors (as well as the traditional commercial factors); and the possible coverage of export credits insurance was broadened to include virtually any transaction, including barter.
One rationale for these changes, again peculiar to export assistance, was that other countries were providing more support to their export industries.
The amendments in 1993 did not change the name of the EDC, but they did provide for sweeping changes to the institution. As a report by the Senate Banking Committee pointed out: "It [clause 4 of the amended Act] gives EDC the mandate to support and develop, directly and indirectly, international trade and Canada's international competitiveness. This would considerably expand EDC's former role, which was confined to facilitating international trade ('facilitate' being a less inclusive term than 'support') and made no mention of Canada's overall capacity to compete internationally."<63> The Senate report listed the expanded powers and then quoted from the impact statement accompanying the proposed regulations for the amended Act: "the Bill was purposely drafted to provide the EDC with broad powers so that the Corporation would be positioned to respond to Canadian exporters' current and 'future' needs in areas where there are weaknesses in the private marketplace for export support services."
This is a new variant of the market gap rationale -- the public financial institution must have broad powers so it has the flexibility to fill credit gaps that may develop in the future.
CANADIAN COMMERCIAL CORPORATION (CCC)
Unlike the other public financial institutions discussed in this paper, the Canadian Commercial Corporation (CCC) did not follow a three-stage pattern of evolution.
The Canadian Commercial Corporation Act was passed in 1946, establishing the Canadian Commercial Corporation (CCC) with the broad mandate to facilitate trade between Canada and other countries. The CCC was very much a Crown Corporation for reconstruction. When the bill was introduced in the House, the Minister of Trade and Commerce noted:
For some time it has been clear that there are many transactions in international trade which cannot be handled entirely by private enterprise and the work of the corporation is intended to supplement the activities of business organizations rather than to interfere with them.<6>
The Senate accepted that the CCC would have a temporary function and amended the bill to expire in 1949. The House concurred with the amendment, but in 1949 the relevant clause was repealed. There have been subsequent amendments to the Act, but none of these was substantial. Under its broad mandate the CCC has changed with the changing demands of the government and the corporation's clients. It became the primary vehicle for financing government-to-government trade; in the early years, most business involved defence contracting with the U.S.; about 15 years ago, the overseas market became more important for the CCC, as did international organizations such as the World Bank; recently, the CCC has tried to complement government trade policy and the emphasis on small and medium-sized enterprises (for example, the Progress Payment Program, which involves the CCC and private financial institutions in the provision of pre-shipment finance for smaller companies).
CONCLUSIONS
The main rationale for public intervention in any economic activity is market failure, and this rationale has figured repeatedly in the discussion above. A second rationale is that the distribution of income produced by private sector institutions is unfair. Although questions of distribution did arise during the debate about some of the four institutions examined, this second rationale did not play a prominent role in the establishment of public sector financial institutions.
In the case of public financial institutions the rationale has been that there are gaps or distortions in private financial markets. These perceived credit gaps fall into four categories. The first credit gap is that private sector financial institutions do not provide credit in a certain area at any price. The second credit gap is that the private financial institutions do not provide credit at reasonable terms (perhaps because of some monopoly power, perhaps because of a too cautious evaluation of risk). The third credit gap is that private financial institutions do provide credit at reasonable terms, but not for all those who would qualify for this credit -- in other words, the institutions practise non-price rationing. The fourth credit gap is that the economy is changing rapidly and a credit gap might develop, so a powerful public financial institution is needed to make sure that the gap can be filled.
As noted above, there have typically been three stages in the evolution of public financial institutions. It is at the first stage, when the public financial institution is created, that appeal is most often made to perceived credit gaps -- usually of the first or second kind -- as a rationale for the institution. At the second stage, when the institution becomes less conservative in its lending practices, appeal is sometimes made to the second and third types of credit gap (or the argument is made that the first type of gap holds for some part of the client group -- say, young farmers or very small businesses). At the third stage, when the institution has its powers greatly enhanced, the credit gap seems to be taken as an unstated given (or a vague, possible gap such as the fourth type is used).
The evolution of public financial institutions does not, of course, occur in a vacuum. There are changes to provincial and federal programs and legislation that can influence federal institutions. In addition, there are changes to the regulations governing private financial institutions, and these can have direct effects on the so-called credit gap used to rationalize public financial institutions. One of the most important revisions was that in 1967 to the Bank Act which gave the chartered banks additional lending powers and added to competition in several financial markets.
The client group for a particular public financial institution can also change. Farmers are a good example. There are many fewer of them since the 1920s, farms are much large on average and certainly more mechanized; these changes have affected the size and nature of loans demanded by farmers, and the change in loan demand has affected the financial market for agricultural loans.
APPENDIX B
OPERATIONAL DEFINITIONS OF SMALL BUSINESS
There are many ways of defining a small business. The usual way is to specify a ceiling for one of the characteristics of a business -- sales, revenue, employment, assets, amount of bank loan, etc. -- and say that any business that fits under this ceiling is a "small business" (often two ceilings are specified for a characteristic, so both "small-" and "medium-sized" businesses can be distinguished). Obvious difficulties arise in choosing which characteristic and what ceiling to use. There is no universally agreed-upon definition. This note takes a pragmatic approach to the questions and looks at how various institutions define "small business" in practice.
BUSINESS DEVELOPMENT BANK OF CANADA (BDBC)
The BDBC (formerly the Federal Business Development Bank, FBDB) does not use an explicit definition of small business for its financial activity. In one aspect of its non-financial activity (case counseling), it uses an employment-based definition. Case counseling is aimed at small businesses, and only firms with fewer than 200 full-time employees are eligible for it. Although it does not restrict its lending activity to firms that meet some formal criteria for being a small business, the BBC made 96% of its loans last year to firms with fewer than 50 employees (86% of its loans went to firms with fewer than 20 employees).
CAISSE CENTRALE DESJARDINS
Appearing before the Senate Banking Committee, officials from the Caisse downplayed the importance of statistical criteria -- employment, for example, or items from financial statements -- for determining what qualifies as a small business. Instead, they prefer what might be called the survivor approach. A business that depends on one or two owner/operators is unlikely to survive if the owner/operators die or sever their ties with the business; such a firm is, by this definition, a small business. By similar reasoning, a business is not small if it can survive the loss of one or two key executives.
CANADIAN BANKERS' ASSOCIATION (CBA)
In its 1995 Small Business Annual Report, the CBA notes: "There is no single definition for SMEs. Not only are the companies within the SME business sector extremely diverse, but their size can also be measured in various ways -- such as sales revenue, number of employees or credit requirements." The definition based on credit requirements is peculiar to financial institutions. In the tables in its report, the CBA used loan authorizations of under $500,000 as the ceiling for its small business category. Recently, the CBA has undertaken to provide to the House Industry Committee a finer breakdown of bank loans; it remains to be seen, however, whether the availability of these new data will change the credit ceiling used to define small business.
In October 1995, the CBA issued a Request for Proposal for research on the relationship of banks with small and medium-sized enterprises. The proposed instructed potential researchers to use definitions based on employment and sales: "A small business is an enterprise with fewer than 100 employees in the manufacturing sector and fewer than 50 in services and/or with annual sales below $5 million. A medium-sized business is an enterprise with up to 500 employees and/or with annual sales of up to $50 million."
CANADIAN COMMERCIAL CORPORATION (CCC)
The CCC uses a combination of sales and employment to define small business. For most of its activities where a size distinction is needed, the CCC uses ceilings of $10 million in sales or 200 employees. For the new Progress Payment Program, the CCC uses $50 million in sales or 200 employees.
CANADIAN FEDERATION OF INDEPENDENT BUSINESS (CFIB)
The CFIB uses an employment-based definition. An independently-owned business with fewer than 50 employees is considered a small business; a firm with 50 to 499 employees is considered a medium-sized business.
CANADIAN FINANCE AND LEASING ASSOCIATION (CFLA)
The CFLA, in a letter to the Chairman of the Senate Banking Committee, noted that its members had never had a pressing need in their ordinary activity to define small business. Nevertheless, the "CFLA has no difficulty in using the current Small Business Loans Act definition, that is, a business enterprise with an estimated gross annual revenue not exceeding $5 million."
EXPORT DEVELOPMENT CORPORATION (EDC)
Traditionally, the EDC has used total sales to distinguish firms; small firms had total sales of under $5 million, medium-sized firms had sales between $5 million and $25 million, and large firms had sales over $25 million. Recently, the EDC established an Emerging Exporters Team to focus on small businesses; firms with export sales between $1 and $1 million (the lower limit is specified to ensure that the firm has some export sales) are considered emerging exporters.
GOVERNMENT OF CANADA
With the emphasis placed in recent years on small business, many government departments and Crown corporations have programs geared to small business. There is, however, no standard definition of small business used across these organizations, as the government noted in its February 1994 report Growing Small Business. The report addresses the question What are Small Businesses? by citing the often-used description of a small business: "firms having fewer than 100 employees in the manufacturing sector and fewer than 50 in the service sector."
PRIVATE VENTURE CAPITAL FIRMS
Several private venture capital firms appeared before the Senate Banking Committee in November 1995. At the hearings, the Chairman asked the firms to supply a definition of small business. Three firms responded in letters to the Committee.
A. Acorn Partners (Merchant Bankers to Emerging Companies)
Acorn responded that no simple answer useful for policy development exists. Nevertheless, they thought that the executive structure of a business provided an indication of whether the business could be considered small. "A business that does not have a full-time person devoted to sales, a second to finance and a third to ?production' -- doing the work in a service firm -- plus a CEO, can be considered as small from a financing perspective. The presence of a full-time CFO is a fair but imperfect proxy for capacity to secure funding without deflecting half of the time of the CEO to that task."
B. Congress Financial
Congress replied that: "A small business borrower typically requires an operating line of credit no greater than $3 million. Businesses requiring this amount or less share some similar characteristics, including:
(a) they are owner operated;
(b) they may not have appropriate (qualified) in-house financial officers;
(c) they lack detailed/refined MIS system;
(d) owner/operators wear many hats and may not perform all duties well; and
(e) they are extremely entrepreneurial."
C. Macdonald & Associates Limited
(Venture Capital and Private Equity Advisory Services)
Macdonald also recognized the difficulty of defining a small business in a concrete way, especially for "knowledge-based businesses," and did not provide an explicit definition. To show the arbitrary nature of some definitions, they noted that the definition used by labour-sponsored venture capital funds for eligible SMEs (a definition based on employment and asset size) needed to be revised (the asset ceiling was raised from $35 million to $50 million) to come up with the "right" numbers.
REVENUE CANADA
The difficulties in defining a small business are reflected in the Income Tax Act. The Act includes all "Canadian-controlled private corporations" as small business, even though some of these would be considered large firms under any explicit definition that set a reasonable ceiling on any characteristic of a business.
SMALL BUSINESS LOANS ACT (SBLA)
The SBLA uses a revenue-based definition. Firms with annual revenues of less than $5 million are considered small businesses.
STATISTICS CANADA
For its small business financial statistics, Statistics Canada relies on tax returns from Revenue Canada and includes as small business all firms with gross revenue between $25,000 and $5 million. Much of Statistics Canada's work now involves custom tabulation, and clients may choose any definition they wish to distinguish firms by size. A common rule-of-thumb uses employment to distinguish five categories of business -- small (1 to 20 employees), small-medium (20 to 50), medium (50 to 100), medium-large (100 to 500) and large (500 and over).
WESTERN ECONOMIC DIVERSIFICATION CANADA (WED)
In an appearance before the Senate Banking Committee (23 November 1995), officials from WED noted: "With regard to our definition of SME, in terms of the discussions we have been holding with financial institutions, to date the agreements we have signed set that level at a company with a maximum of 100 employees or a maximum of $10 million in sales."
APPENDIX C
THE MANDATE OF FEDERAL REGIONAL
DEVELOPMENT AGENCIES IN CANADA:
HISTORICAL PERSPECTIVE
INTRODUCTION
Since 1988, federal regional development efforts have been divided among different departments and agencies, each responsible for a specific region of the country. Prior to that date, regional development was centred in one department - the Department of Regional Industrial Expansion (DRIE). The creation of region specific development agencies has several benefits, among which is the ability to more readily identify federal spending by region.
THE ATLANTIC CANADA OPPORTUNITIES AGENCY
The Atlantic Canada Opportunities Agency (ACOA) derives its mandate from Part I of the Government Organisation Act, Atlantic Canada 1987 (otherwise known as the Atlantic Canada Opportunities Agency Act), which received Royal Assent on 18 August 1988. The Agency has a broad mandate for economic development in Atlantic Canada. Other statutes of direct bearing on ACOA include the Industrial and Regional Development Act, the Small Business Loans Act, and the Special Areas Act and the Department of Regional Industrial Expansion Act.
ACOA was created to foster, in a strategic partnership with the people of Atlantic Canada, the long-term economic development of the region through a renewal of the Atlantic entrepreneurial spirit. The Agency has a particular responsibility to encourage the development of new small and medium-sized enterprises within Atlantic Canada. The Agency is also responsible for bringing a regional perspective to the design of national economic and social programs that affect Atlantic Canada, and to promote the interests of the region.
The overall program objective of ACOA is to develop and implement programs contributing to the long-term economic development of Atlantic Canada and to plan and coordinate federal activities contributing to the economic growth of the region. The Agency's activity structure is designed to separate those activities aimed at providing support to small and medium-sized businesses in the Atlantic from those activities aimed at improving the environment for economic growth through cooperative efforts with other levels of government. The Agency may also be called upon to become involved in special economic initiatives of the federal government.
FEDERAL OFFICE OF REGIONAL DEVELOPMENT-QUEBEC
On 13 June 1991, the responsibility for Quebec regional development and established federal economic programs was transferred to the Minister of National Health and Welfare from DRIE which had just been reorganised into the Department of Industry, Science and Technology (ISTC). The Federal Office of Regional Development-Quebec (FORD-Q) was designated as a separate department for the purposes of the Financial Administration Act and the Public Service Employment Act. On 4 November 1993, these powers were transferred to the Minister of Finance.
The Office is authorised to define goals and implement an integrated strategy for federal regional development in Quebec. FORD-Q is the federal agency responsible for coordinating regional development policies and other federal programs in the province, and as the federal government's primary regional development representative to the provincial government and other public and private organizations. It is also responsible for devising and delivering its programs so that business receives the support services it needs.
The objective of the agency is to promote the economic development of the regions of Quebec with low incomes, slow economic growth, or inadequate possibilities for productive employment, by emphasizing long term economic development and sustainable employment and income creation, while concentrating on small and medium-sized enterprises and on the development and enhancement of entrepreneurial talent.
THE ONTARIO REGION
Federal regional development activity in Ontario is centred within the Department of Industry, and is divided into two responsibility centres. The first looks after Ontario regional development in general and the second focuses on Northern Ontario.
The Federal Economic Development Initiative for Northern Ontario (FedNor) was established in July 1987 as part of a series of changes in the federal governments efforts directed at reducing regional disparities. Fednor was designed to promote economic development in Northern Ontario through the use of existing programs at the former Department of Regional
Industrial Expansion and to provide the federal government with local input and advice on policies, programs and services. Although the administrative offices of the program are located in Sault Ste. Marie, regional offices are also found in Sudbury, Thunder Bay, Elliot Lake and Kirkland Lake.
At its creation, FedNor was provided with a $55 million fund to cover its operations over a period of 5 years. It was expected that this fund would generate up to $100 million of private investments in the region through loans, grants and loan guarantees. The operations and policies of FedNor are supervised by a board whose members are drawn from the region.
FedNor's responsibilities are focused on Northern Ontario and include program management and delivery, program coordination , special regional initiatives, regional economic analysis at the micro level, and communication and services to the FedNor Advisory Board.
THE DEPARTMENT OF WESTERN DIVERSIFICATION
The Western Diversification Act, 1988, enables the Department of Western Economic Diversification (WD) to promote the development and diversification of the economy of western Canada and to advance the interests of western Canada in national economic policy. WD is also responsible for administering certain programs for the West previously administered by DRIE. Over the years 1989-90 to 1993-94, $307 million in resources were transferred to the Department from the DRIE for specific subsidiary agreements under the Economic and Regional Development Agreements (ERDAs), General Development Agreements, the Industrial and Regional Development Program (IRDP), and the Western Transportation Industrial Development Program (WTID).
The objective of the Department is to promote economic diversification in western Canada in a manner that provides added influence for the West in national policy and decision- making, that improves client services in the West and that facilitates federal-provincial coordination.
To ensure the achievement of its mandate, a $1.2 billion fund was established which is administered by WD through the Western Diversification Program.
The Department defines diversification as a lessening of an economy's dependence on exports of traditional primary products. WD seeks to help traditional industries develop new products and new markets in which to sell them. It encourages the development of new industries to export or replace imports. It provides assistance for the development of new technologies, and it fosters productivity improvements that could benefit entire industries.
Assistance comes in the form of contributions to which are attached certain conditions on disbursement, total funding and repayment. Funding approval will depend on whether a project is a new product, a new market, a new technology, an import replacement or if it will result in industry-wide productivity improvements. WD assistance is not an entitlement. Funding is designed to top up rather than replace financing available from other sources. Nor is funding provided for projects in fully competitive sectors where government assistance to one firm may upset the competitive balance in the industry. Although WD does not take an equity position - its contributions are expected to be repaid - if a project fails, then the Department shares the loss.
ENDNOTES
<1>"(5) Mr. Douglas Patriquin, Executive Vice-President and Chief Operating Officer, CCC, Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 35, 6 June 1995, p. 5.
<2>(5) The Honourable John Manley, Minister of Industry, Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 38, 29 June 1995, p. 38.
<3>(3) Senator Stewart, Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 38, 29 June 1995, p. 38.
<4>(5) Taking Care of Small Business, Report of the Standing Committee on Industry, October 1994, p. vi.
<5>(5) Mr. Brian Gray, Canadian Federation of Independent Business, Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 41, 17 October 1995, p. 5.
<6>(5) Ms. Mary Macdonald, Macdonald and Associates Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 44, 2 November 1995, pp. 10, 11.
<7>(7) Presentation to the Standing Senate Committee on Banking, Trade and Commerce, Farm Credit Corporation - 28 November 1995, p. 6.
<8>(8) Submission to the Standing Senate Committee on Banking, Trade and Commerce on the Study of Crown Financial Institutions in Canada, Business Development Bank of Canada, 23 November 1995, pp. 4, 5.
<9>(9) Ibid., pp. 3-4.
<10>10) Letter from the Honourable John Manley, Minister of Industry to the Honourable Michael J. Kirby, 10 July 1995.
<11>(11) EDC Presentation to the Standing Senate Committee on Banking, Trade and Commerce, 28 November 1995, p. 3.
<12>12) Ibid., p. 3.
<13>(5) Submission to the Standing Senate Committee on Banking, Trade and Commerce. The Study of Crown Financial Institutions, Canadian Commercial Corporation, 7 December 1995, p. 2.
<14>(5) Mr. Faraj Nukhleh, Canadian Advanced Technology Association, Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 41, 17 October 1995, p. 26.
<15>(5) Ms. Debra Ward. Tourism Industry Association of Canada. Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 42. 19 October 1995. p. 6.
<16>(5) Ms. Helen Sinclair, Canadian Bankers Association. Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 51, 7 December 1995. p. 11, 12.
<17>(5) Ibid., p. 5.
<18>(5) Brief from the Canadian Finance and Leasing Association to the hearings of the Standing Senate Committee on Banking, Trade and Commerce on Crown Financial Institutions. 2 November 1995, pp. 3-6.
<19>(5) Ibid., p. 3.
<20>(5) Ibid., p. 4.
<21>(5) Mr. Bill Knight. Credit Union Central of Canada. Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 43, 31 October 1995. pp. 8, 9.
<22>(5) Ibid., pp. 10, 11.
<23>(5) Mr. Langelier. Caisse centrale Desjardins. Proceedings of the Standing Senate Committee on Banking, Trade and Commerce. Issue No. 48, 28 November 1995. p. 55.
<24>(5) Mr. Craig Rothwell. Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 51, 7 December 1995, pp. 12, 13.
<25>(5) Mr. Jean-Guy Langelier. Caisse centrale Desjardins. Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 48. 28 November 1995, p. 44.
<26>(5) Mr. Mark Drake. Canadian Exporters' Association. Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 43, 31 October 1995, p. 22.
<27> (5) Ms. Helen Sinclair. Canadian Bankers Association. op. cit., p. 7, 8.
<28>(5) Mr. Raymond Gunn. Canadian Bankers Association. op. cit., pp. 12, 13 (emphasis added).
<29>(5) Senate Committee Study on Crown Financial Institutions in Canada. Canadian Federation of Independent Business. Submission to the Standing Senate Committee on Banking, Trade and Commerce. 17 October 1995, p. 6.
<30>(5) Professor Michael Trebilcock. University of Toronto. Proceedings of the Standing Senate Committee on Banking, Trade and Commerce. Issue No. 40. 3 October 1995, p. 10.
<31>(5) Letter from Michael J. Trebilcock to Senator Michael Kirby. 5 October 1995.
<32>(5) Mr. Peter Kemball. Acorn Partners. Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 44. 2 November 2 1995, p. 25, 26.
<33>(5) Canadian Exporters' Association. Brief to the Standing Senate Committee on Banking, Trade and Commerce. Re: Crown Financial Institutions and Exports. CEA Paper No. 95-90. 31 October 1995, p. 4.
<34>"(5) Submission of the Canadian Federation of Independent Business, op. cit., p. 3.
<35>(5) Canadian Federation of Agriculture. Brief to the Senate Committee on Banking, Trade and Commerce Concerning the Relationship Between Private Financial Institutions and Crown Financial Institutions. 19 October 1995, p. 6.
<36>(5) Ms. Helen Sinclair. Canadian Bankers Association. op. cit., p. 22.
<37>(5) Mr. Raymond Gunn. Canadian bankers Association. op. cit ., p. 11.
<38>(5) Mr. Jean-Guy Langelier. Caisse centrale Desjardins. Proceedings of the Standing Senate Committee on Banking, Trade and Commerce. Issue No. 48. 28 November 1995, p. 45.
<39>(5) Mr. Bill McKnight, Credit Union Central of Canada, op. cit ., p. 11.
<40>(5) Ibid., p. 8.
<41>(5) Ibid., p. 12.
<42>(5) Mr. Brian Gray, Canadian Federation of Independent Business, Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 41, 17 October 1995, p.19.
<43>(5) Ms. Helen Sinclair, Canadian Bankers' Association, op. cit ., p. 7.
<44>(5) Mr. Alan Nymark, Industry Canada, The Standing Senate Committee on Banking, Trade and Commerce, Evidence, 12 December 1995, p. 6.
<45>(5) Gerry Penny, Farm Credit Corporation of Canada, Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 48, 28 November 1995, p. 11.
<46>(5) Mr. François Beaudoin, Business Development, Bank of Canada, Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 47, 23 November 1995, p. 17.
<47>(5) Mr. Gerry Penny, Farm Credit Corporation, Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 48, 28 November 1995, p. 14.
<48>(5) Mr. Patrick J. Lavelle, Business Development, Bank of Canada, Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 47, 23 November 1995, p. 24.
<49>(5) Ibid., p. 22.
<50>(5) Mr. Paul Labbé, Export Development Corporation, Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 48, 28 November 1995, p. 31.
<51>(5) Report of the Auditor General of Canada to the House of Commons, November 1995, 17.37.
<52>(5) Ibid., 17.39.
<53>(5) Ibid., 17.47.
<54>(5) Mr. Gordon Slade, Atlantic Canada Opportunities Agency, Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 47, 23 November 1995, p. 32.
<55>(5) Ibid., p. 32.
<56>"(5) Ms. Maryantinett Flumian, Western Economic Diversification Canada, Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 47, 23 November 1995, p. 38.
<57>(5) Mr. Robert Bourgeois, Federal Office of Regional Development (Quebec), Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 47, 23 November 1995, p. 39.
<58>(5) Ms. Mary Coyle, Calmeadow Corporation, Proceedings of the Standing Senate Committee on Banking, Trade and Commerce, Issue No. 51, 7 December 1995, p. 28.
<59>(5) This section and the next draw heavily on G. Bruce Doern and John F. Devlin, "The Farm Credit Corporation and the Federal Business Development Bank," Chapter IX in Allan Tupper and G. Bruce Doern, eds., Privatization, Public Policy and Public Corporations in Canada, Montreal: The Institute for Research on Public Policy, 1988. Each of the four main sections, especially in the discussion of early legislative histories, draws on Basil Zafiriou, "Federal Crown Corporations: Origins and Reasons for Their Creation," Ottawa: Library of Parliament, 1984.
<60>(5) Canada, House of Commons, Debates, 5th Session, 19th Parliament, 28 July 1944, p. 5518, as quoted in Zafiriou (1984), p. 34.
<61>(5) This quote and the previous one are given in A. Raynauld, et al., Government Assistance to Export Financing, Study prepared for the Economic Council of Canada, Ottawa: Minister of Supply and Services, 1983, p. 6.
<62>(5) J. Douglas Gibson, Report on Export Credits and Insurance in Canada, mimeo, Ottawa: EDC, 14 May 1968.
<63>(5) Study of the Regulations Proposed to the Export Development Act, Report of the Standing Senate Committee on Banking, Trade and Commerce, March 1994, p. 1.
<64>(5) Canada, House of Commons, Debates, 2nd Session, 20th Parliament, 2 April 1946, p. 472, as quoted in Zafiriou (1984), p. 40.