Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 25 - Evidence - Morning sitting
TORONTO, Thursday, July 30, 1998
The Standing Senate Committee on Banking, Trade and Commerce met this day at 9:00 a.m. to examine the present state of the financial system in Canada (Small Business Loans Act).
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: Our first witnesses today are from the Canadian Finance and Leasing Association, Mr. Simmons and Mr. Powell. We appreciate your attendance, gentlemen.
Thank you for the brief, which you have just handed us. I would ask you to begin by summarizing your brief. Following that, we would like to have a discussion with you about it.
Mr. Tom Simmons, Chairman, Canadian Finance and Leasing Association: On behalf of the Canadian Finance and Leasing Association, I would like to thank the committee for this opportunity to present our views on the Small Business Loans Act.
This submission, like our written brief, will be presented in three parts. The first part will be a brief description of the asset-based financing and leasing industry and its growing significance for the Canadian economy.
The second part will address questions raised by the committee in its June 22, 1998 memorandum.
The third part will raise certain fundamental questions that are not being asked in this year's consultation exercise. From our perspective, the SBLA remains a program designed in the early sixties, ill-equipped to accommodate the accelerating evolution in the delivery systems, products and services of the financial service sector today.
We will conclude with some thoughts on how the government might meet its policy goals for SME financing that combine SME needs, government constraints and more modern financing techniques.
I would now ask David Powell, the President of CFLA, to deal with our first two points -- a brief description of our industry, followed by some of the specific questions raised by the committee.
Mr. David Powell, President, Canadian Finance and Leasing Association: This committee, probably more so than any parliamentary committee, is aware of the Canadian Financing and Leasing Association and the industry it represents, but permit me to take two minutes to describe briefly where we think we are at today.
The association has 160-plus members who are active in the asset-based financing, equipment and vehicle-leasing industry in Canada. The membership crosses the financial-services spectrum, from banks, insurance companies, trust companies and investment dealers to manufacturers' finance companies and independent leasing companies. The customers of this industry are Canadian small, medium and large business as well as consumers. The funders of this industry are pension funds, insurance companies and banks.
The services of this industry are complimentary to traditional banking and other lending, providing incremental capital to the pool of available credit in Canada.
Our members are pioneering joint venturing, out-sourcing, partnering or creating alliances for financial risk-sharing. For example, today Canadian banks are out-sourcing their customer leasing transactions including those with SMEs to members of CFLA. Expanding bank out-sourcing of other financing products is also under discussion. In many ways, our members are symbolic of the changes that the financial services sector is undergoing and their innovative products and services are a driver of change in financial services.
Today, we estimate that our industry has about $80 billion to $100 billion of financing in place with Canadian customers and consumers.
Statistics Canada reported that $55.3 billion was invested by Canadian business in new plant and equipment in 1996. It is our best estimate that about 25 per cent of that investment was financed by our industry. This is a significant advance from the 5 per cent or less of just about 10 or 12 years ago. That is on the equipment side.
On the vehicle-leasing side, a total of 1.1, 1.2 million new light passenger vehicles and trucks/vans were sold in Canada in 1996; of these, 45 per cent, or over half a million, were leased. Forty-six per cent of the new leased vehicles were leased by businesses: largely vehicles for sales forces, customer delivery, service and maintenance.
Hence, vehicles leased by businesses in Canada represent almost 25 per cent of all new vehicles sold in the country. Therefore, Canadian members of the CFLA are key partners of Canadian business.
I stress that because I know that in the discussions around the SBLA, there have been a number of areas that have been excluded, and one of them was just the notion of vehicles. There is a misunderstanding in some quarters as to how important vehicles are to make a business work.
A revealing analysis of the financing realities of the SME sector was brought forward last year by the Conference Board in a study entitled, "What's New in Debt Financing for Small and Medium-Sized Business?"
Two major findings came out of that study. One is that the methods that we use to track small business financing in Canada today miss about 50 per cent of what is actually going on in the marketplace. In other words, the means used to determine the amount of small business financing that is actually going on are such that they are picking up only half of what is actually going on. The second major finding is that a lot of the other 50 per cent is from our industry.
These Conference Board findings underline a very significant point: the inability of traditional means of gathering statistics and analyzing financial service activity to provide a comprehensive picture of what is actually going on. This phenomenon begs the question whether the government policy planning process is adequately informed. We wonder whether the government mindset surrounding the SBLA program has been shaped by incomplete information. The program is designed around a set of assumptions that are less and less reflective of today's financing realities.
I would like to turn briefly to some of the questions that were raised in your June memorandum. You posed six specific questions relating to the current review of the program and we have some brief comments to make on three of them.
The first questions was: Should the SBLA be expanded to target knowledge-based enterprises, KBEs?
Certainly from our experience, KBEs are a significant growth area, both in terms of the creation of new businesses and in the development of innovative products and services and processes. We would support particular attention being paid to ensure that the program offers effective support to KBEs without neglecting eligible SMEs from other sectors.
The second question you asked was: Should the current maximum loan size be maintained or changed?
We question any reduction in the maximum loan size. While cost efficiencies and competitive pressures often result in a decrease in the cost of new technologies, industrial production equipment, and specialized vehicles, reducing the maximum loan size imposes an additional barrier to SME financing that would not seem to be warranted by the real costs of doing business.
While the committee memorandum reports that "larger loans (between $150,000 and $250,000) default more often and more quickly than smaller loans which results in higher program costs," the solution to this problem may lie elsewhere than a simple reduction in the maximum eligible loan amount. Revisiting the procedures for approving loans and the overall program structure may be a more productive approach.
The third question -- the final question we would like to comment on -- was: Are there provisions of the act that could be modified to facilitate SBLA administration? Small-value financings today, whether by way of loans or by way of leases, are high-tech, high automation, low-touch, large volume businesses in financial services -- high-tech, high automation, low-touch, large volume businesses.
Asset-based finance and leasing companies as well as banks are increasingly using technology to provide automatic credit approvals with low or no touch. This is the antithesis of the SBLA structure, which resists high-tech communications, imposes a heavy paper burden, and requires considerable costly attention to each individual transaction.
Mr. Simmons will now deal with the next part of our submission.
Mr. Simmons: Mr. Chairman, we feel that certain fundamental questions are not being asked as part of this process: Is the current program optimizing access to appropriate financing? Is it increasing the availability of credit? Is it enhancing choice of financing providers and of financing products? Does the program respond to the rapidly changing delivery systems, products and services of the financial services market?
Current discussions that advocate tinkering with the existing program have tended to concentrate on cost recovery and limiting government exposure rather than truly enhancing the availability of funds to SMEs.
Today, we are talking about extending the existing SBLA program probably to 2004. In the summer of 2003, if we find ourselves back here discussing how to continue to modify this program, we believe that the government will have let important opportunities slip by.
From our perspective, we see three basic problems with the existing program that are not being discussed. First, the SBLA distorts SME business decision-making. Second, it fails the new technology test. Third, it fails to reflect new funding techniques.
Turning briefly to the first basic problem. The effect of the existing SBLA program is to encourage an SME to concentrate its debt on financing that qualifies under the program, regardless of whether or not it may be the most appropriate form of debt for the business. Essentially, the program encourages SMEs to incur debt at a time when they can least afford it. By obliging bank debt, it excludes other financing options that may provide a more balanced debt portfolio.
In other words, the very limitations of the program serve to distort or bias SME business decision-making and restrict financing choices for SMEs.
The current program fails the new technology test. Designed in the early sixties, the SBLA is ill-equipped to accommodate the accelerating evolution in the delivery systems, products and services of the financial services sector.
The SBLA program fails to take advantage of new funding sources and techniques. It does not harness the strengths of the vendor financing programs offered by the so-called "captive" financing affiliates of equipment and vehicle manufacturers or by independent financing companies working with manufacturers; nor does the program reflect the increasing use of securitization to access new sources of both short- and long-term capital, particularly in the asset-based lending market.
We would like to look briefly at the third problem area, new sources and techniques of funding, specifically, vendor financing and securitization.
Vendor financing programs offered by the financing affiliates of equipment and vehicle manufacturers and by independent financing companies, working with manufacturers, are generating capital growth of significance today.
Well capitalized manufacturing companies with substantial earnings are leveraging their own equity base and core competencies rather than those of traditional financial institutions.
About 20 per cent of CFLA membership consists of the so-called captives or financing affiliates established by manufacturers to provide customer financing for the parents' products. Some of these captives are very big: Ford Motor Credit, GMAC, IBM Finance, Hewlett-Packard, Xerox Leasing, and many more. Interestingly, captives start off offering to finance their parents' products but, once they understand the business, many expand their horizons to finance not only similar products made by other manufacturers, but also products their parent company does not manufacture at all.
Increasingly, our members are becoming the lenders of first resort for SMEs. It is only after a refusal of credit for deficiency reasons by our members that the SME looks into SBLA bank financing. Should this growing financing opportunity be harnessed to the benefit of SMEs?
The second innovative funding technique is securitization. For asset-based financing and leasing companies, securitization offers a cost-effective alternative funding source. The SBLA structure does not encourage the use of this funding technique to access alternative sources of funds. Moreover, difficulties associated with transferring the government guarantee to a third party makes the use of this funding technique for SBLA loans questionable.
To conclude, Mr. Chairman, if the government policy goal is to ensure access to financing for small businesses, and the essence of the challenge is to enhance the possibilities for financing that is considered too small to justify the administrative cost or too risky to justify the credit risk, there are new solutions available that should be thoroughly considered. The government does a disservice to SMEs by excluding financial products which are of proven utility and value.
One alternative the government could consider, particularly for asset-based financing that reflects the expanded use of securitization, would be a kind of prototype SME loan-and-lease securitization pool. Such a program could be a joint public-private initiative, where the pool is structured and managed by the private sector and the government acts as a credit enhancer.
As the credit enhancer, the government would review the portfolio of loans on a periodic basis as opposed to reviewing and administering each individual transaction. Participating financial institutions who would originate the loans and leases could be required to take the first pre-determined portion of any losses to ensure the up-front application of the quality credit adjudication processes.
We believe that the marriage of new sources capital with the efficiencies of the latest in transaction origination, administration and communication technologies would lead to incremental financings at enhanced terms.
Government risk exposure would be limited to its predetermined share of the loss pool which could be decreased over time as institutional investors and capital markets become comfortable with SME asset-based securities.
All businesses, particularly SMEs, gain through the availability of leveraged financing options, flexibility and payments terms, product knowledge, and the remarketing expertise of the lessor.
The leasing company in this equation is much more than a purveyor of credit. It adds value throughout the manufacturing distribution and user chain.
Without the SBLA, it is presumed that SMEs currently qualifying under the program would not otherwise obtain a bank loan. Similarly, in the absence of a satisfactory program, such SMEs will remain unable to obtain asset-based or lease financing also.
In the context of the SBLA, the need to level the playing field between loans and leases has to do with the enlargement of the opportunities for end-users. The leasing industry has demonstrated a remarkable agility in recent years, a prodigious capacity for creativity, imagination and custom-designed solutions. SMEs should have the same financing advantages that are available to big businesses. That is the playing field that needs to be leveled.
In CFLA's view, an SME's financial assistance program expanded to reflect the realities of the accelerating evolution in financial services can lead to the following: more SMEs getting financing; SMEs getting more financing; SMEs getting access to different financing terms; and more added-value features to SMEs.
The position of CFLA should not be misunderstood. The asset-based financing and leasing industry does not seek any form of government financial assistance. Rather, the marketplace offers new ways of structuring financing for SMEs and new, previously untapped, sources of financing for SMEs.
That concludes our formal remarks, Mr. Chairman. We would be pleased to answer any questions the committee might have.
The Chairman: Before turning to my colleague for questions, I wonder if I might ask you to explore the following idea, which really picks up on the third part of your presentation and begins on page 8 of your brief.
Forget for a moment the confines or structure of the current SBLA. What you are really suggesting is that a way needs to be found to, at least on an experimental basis, try to find a way of including a government role in assisting SMEs in leasing various things.
In your paper, on page 14, and indeed in your comments, too, Mr. Simmons, you actually suggested a specific way of doing that, essentially what you call the public-private partnership mix.
Recognizing that it is unlikely that any government would engage in that kind of a program full scale without doing some kind of a pilot project, or trying it in a small framework initially to see how it works, can you tell us what a pilot project, meaning effectively a program that would be experimental in nature, would look like? What sort of dollars would make a reasonable test as to how this actually will work, etc?
Mr. Simmons: I would like to preface my remarks by saying that I am not an expert in securitization, but we would like to have as many originators of loans and leases as possible. I would think that that would be the government's goal.
The Chairman: By originators you mean lenders?
Mr. Simmons: We are talking about in our world today, in the asset-based leasing, the origination, the management, and the funding as separate, distinct functions that can be carried out in this world today. Everybody has expertise in origination. People have expertise in managing loans and leases. Then there is the funding mechanism where we securitize loans and leases, both on a private placement basis or in the capital markets.
So the concept we thought about -- and, once again, this is purely exploratory at this time. Assume you had a variety of lenders, say, 50, 100, as many as possible. These lenders have developed high-tech sophisticated scoring models. Initially, on a vendor base or on a direct base, the lenders would pass the loan application or the lease application through their credit scoring model.
Because of the parameters of the SBLA, the businesses are, generally, either a knowledge-based industry or a business that has only been operating for two years. If the credit criteria of that lender is that you have to be in business at least five years, then it will fall out. Hence, many rejects will come from all these originators or these original lenders.
A history of bad credit is the reason for many loan refusals, but we are not talking about those kinds of businesses. Obviously, the government is not interested in those kinds of businesses; they are interested in new business.
So we would take all the turn-downs, to use our terminology, and a new credit scoring model would be developed jointly by our industry and the government. It would set up the profile of the SME that the government wants to help.
The Chairman: If I can just stop you there -- this is a learning exercise for both of us. What you are saying is that you would first do a pass-through, and if an application is acceptable, the private sector would take it.
Mr. Simmons: Absolutely.
The Chairman: The applications that were turned down in the first pass-through would fall into one of two groups: those that would continue to be rejected; and those that are riskier than the private sector is prepared to accept but not so risky to be considered a foolish investment.
Mr. Simmons: Absolutely.
The Chairman: It is that last category we are now talking about.
Mr. Simmons: Let us just get back to the first category. Of the two that you do not want to take any further, there are lenders out there, what we call non-conventional funding and sub-prime lenders, if you will, in both the vehicle leasing and the equipment leasing that do focus on some of that business. So some of those people may be accommodated by those type of lenders.
But, in the main, with all these lenders knowing that capital leasing is part of the program, then in terms of the turn-downs -- not the sub-prime business, but all the other turn-downs who come into this next credit box -- their applications would be matched against the credit profile, developed jointly by industry and government.
The difficulty here is that we do not have historical data to develop a credit model; hence, there will be a learning curve. For instance, as I understand it, the mortgage industry has a 100-year history of lending money. So there is historical data; for example, what percentage goes down and what are the characteristics of the lenders or the borrowers. So this will be developed over time, as it relates to us; we can develop a data base over time, assuming we put our best efforts into it.
Once we have a pool of approved loans, we can -- the first loss will still be the originator of the loan, and today they would have to absorb at least 15 per cent.
The Chairman: Right.
Mr. Simmons: Then we have the credit enhancement component, which is the government. The model would be based on what you want the loss experience to be. In other words, if 400 basis points is what you want the losses to be, the model will be designed around 400 basis points; if 600 basis points is decided on, then the model will be designed to reflect that. That is the credit enhancement component.
Once again, I am not an expert, but let us take, as an example, $1,000. We have 15 per cent off the top. In the marketplace, the balance is A1 or AAA paper that the Canadian financial institutions, the pension funds, the insurance companies are quite happy to investment in. They are doing it today. They will give preferred rates, both for floating-rate and fixed-rate loans, and you would have different securitization models.
Whoever manages this process would, first, issue subordinated notes, which is the riskier portion, and then they would over-collateralize to cover the first loss.
Once again, I am no expert, but it can be done. It is being done today by members of our industry. Initially, the government would be involved but, over time, as the marketplace became more familiar with the structure, there would be a great willingness to invest more and more and I think the government's exposure would become less and less.
We are not talking about totally changing the existing program. This could be a product that would apply only to asset-based situations.
I will ask Mr. Powell to comment?
Mr. Powell: Only to say that we think it is worth exploring with the government, but it does not have to replace the existing program.
Our problem with the existing program is that we cannot find ways to effectively shoehorn a lot of what we do into the existing structure.
The Chairman: Right. I never took your proposal to mean that you were thinking of abandoning the existing program. This was to be an add-on.
Senator Tkachuk: When you mention the number of credit turndowns that you would have, apart from those that are high-credit risks because they do not pay their debt, is that not just a question of people getting into the business and charging more for that lease to those kind of people?
Mr. Simmons: It really does not happen in reality. It may happen from a direct lending standpoint from the bank, but from an asset-based point of view, where you have got a vendor relationship, if they meet the credit criteria, they get bought. We are dealing with a high volume, high-tech, low-touch type of business, and the bulk of your business has originated from 300-plus vendors in our particular organization.
Our industry does a lot of direct leasing -- you are interfacing with the customer -- and at that point in time it can be a risk-based pricing mechanism. But in the vendor-driven business, normally you do not do that. You usually have a credit scoring model. If it passes the model, it gets bought; if it does not, it gets turned down.
I do not know the ratio of turndowns; it would vary by company. It might be a 30 per cent ratio in one company, 20 per cent in another, and so on, but the turndowns are fairly significant even, I am sure, with the banks on direct loans.
Am I answering your question?
Mr. Powell: If I might continue. So much is done by credit scoring. We talked about vendor financing. As well, in our brief we use the example of a corner photocopy shop acquiring a photocopy machine, and how that process works. It goes through the process step-by-step -- for example, the advantages that leasing offers to a business. The credit decision is such that, I am told, almost invariably anyone who has not been in business for two years will be rejected. That is an automatic turndown. It is not a question of raising their lease rate to accommodate them; they are just rejected.
Senator Tkachuk: So the rejection rate is based on the fact that you have a model and it is so automated that you reject people like the machine rejects the people? Is there not a human element to it?
Mr. Simmons: There is a human override, high-side override and low-side override; they do look at them. However, historically, industry knows that start-up businesses, and I am sure the government has better statistics than us, businesses that have only been operating for less than two years, have a higher propensity to fail than businesses that have been in operation for five years.
Consequently, if you want your losses to be maintained at, say, 300-basis points, then your credit scoring model will reflect that and you will not buy the businesses that have been started less than two years ago. That is just a reality, if you want to maintain your loss ratio. As well, in businesses younger than two years, collection activities are greater.
By the same token, however -- do not get me wrong -- our industry is there to serve the vendors that are originating the business, whether it be a truck dealer or a computer vendor. We are trying to service that dealer. Therefore, as an industry, we want to help them sell their product, and we are trying to buy as much as possible.
On the other hand, we have to stay in business. We have to make a profit and we have to manage to a certain loss ratio. Otherwise, we would not be able to obtain the funding that we need because the institutional investors and the banks want us to maintain our loss ratios at an acceptable number -- and normally that number varies by industry. Nobody likes it to be more than, say, 100 basis points, if that is a reasonable target.
The Chairman: Let me just say, for the sake of our audience -- this is being televised on CPAC -- that 100 basis points is 1 per cent; 200 basis points is 2 per cent. Hopefully, that will help to clarify some of the technical language.
Senator Tkachuk: As legislators, our problem is that the program actually puts taxpayers at risk; someone has to pay for it. Therefore, you and I are paying for those risks. We are just spreading the risk over 30 million people and all the enterprises in the country.
I have a lot of problems philosophically with this program, but let us just talk about leasing for a little bit. Is there not a way for the leasing industry to do a pilot project, to determine what the failure rate would be, without government involvement, on these higher-risk models and then present the evidence to us in three years as a combined effort?
Therefore, instead of asking the government to assume the risk on future business, perhaps GMAC, Ford, to name a few, could get together to run a pilot project. You may even be surprised at the outcome.
By discharging a little more money to higher-risk people, you might even make money because that is how you got started in the first place, I would assume. The banks and other institutions failed the enterprise industry and hence leasing companies flourished because they were able to provide unique financing needs.
Down the road, maybe in two or three years, we could have a look at the results and see if there is a way, not to waste, but to invest taxpayers' money in this program; decide whether the program has a future for small business.
Mr. Powell: We do not want the program. We have been before various committees at various times, and we have said that we do not want the program.
The difficulty we see with the program is twofold: First, it exists out there for one of our competitor's products, so we do not have the advantage -- but that is our problem and perhaps the government is not too concerned about that.
The Chairman: Just to interrupt. When you say it exists for one of your competitor's products, what you really mean is that it exists for loans but does not exist for leasing.
Mr. Powell: Correct. Our other concern is that our presumption in coming here today was not to tell the government to scrap the program. We have said that; they have not listened to us up until now. Hence, our presumption is that the government may want to continue the program. In that regard, we want to point out that there have been some significant changes in the financial services sector environment since the program was originally designed, and we think that SMEs are missing out on what is out there by virtue of the way the program is designed.
So if you want to continue the program, if you want to expand the products that are available to SMEs, we would suggest that the government just start looking at other ways of doing it, that is all. That is our primary message today.
Senator Oliver: Did you prepare any draft amendments, amending the statute in its presents form to what you would like to accomplish?
Mr. Powell: We have worked with Industry Canada recently to look at the existing statute. For example, telling the word processor to change the word "loan" to "lease" will not achieve the desired result. The products are totally different; they are funded in a different way.
Our sense is that, if the government chooses to proceed, we will have to look at another means, another way of structuring it. It does not mean that it cannot be done; it just means that it has to be done a different way.
Mr. Simmons: If I may add to that point, there are a number of members of our industry and of our association who are in the vehicle leasing business who are focusing on either non-conventional leasing or sub-prime leasing. Sub-prime is kind of an all-catch. It could be people with bad credit or it could be companies or individuals, particularly companies, who have not been in business for more than two years. A growing number of companies are addressing that non-conventional lending and leasing business, both in terms of equipment leasing and vehicle leasing. So to some degree, the market is being served. They are paying a much higher rate in both leasing and lending, but the market is being served reasonably well.
Senator Angus: My question stems from the chairman's suggestion to you that you were not here to seek the scrapping of the SBLA program.
Is it not correct for me to infer from what you have said that your preference would be that it be scrapped?
Mr. Powell: We have always said that we disagree with the program, and that is our continuing position.
Senator Angus: Correct.
First of all, you have made some excellent points. As a general statement, you have said in several different ways in your brief that the legislation dates back to the early sixties, that it is outmoded, that it does not take into consideration all of the evolutions in the financial services sector, and so forth, the technological advances.
Have you discussed the points that you make in your brief so articulately with the officials in Industry Canada?
Mr. Powell: We have certainly sent them information, yes. I do not get a sense that there is a whole lot of consideration or interest. Every six months or so we are advised that a new study is underway, and someone comes to town to visit. We send them out to see various of our members and they spend three or four days going through actual files, and so on. They leave, and nothing happens. Then another study comes along.
We allude in our brief to the focus on cost recovery and on the government loss rates. The December report has set the agenda for the department, and that is all they are really focusing on.
Senator Angus: Given Senator Kenny's intervention and the chairman's wish that our viewers clearly understand what is going on -- it has been said that this committee is a non-partisan committee -- I want you to know that the senators on this side of the table are not partisan to the present government and, therefore, we are quite empathetic with your comments.
Mr. Simmons: I might just add one other point relative to Industry Canada. The key point that we have emphasized in our last meeting with Industry Canada was that members of our industry are the lenders for many SMEs, lenders of first resort, not last resort. If an SME is looking for a truck, a piece of gear, equipment, anything, to augment their business, it makes sense to lease it because they can manage the cash flow. They know the incremental revenue from the asset and they can manage the incremental cost. We help the SME manage that asset.
Our first expertise is in making sure that they specify the right asset to begin with -- whatever it is, a computer, an airplane, a backhoe, and then manage it throughout its life and help them re-market the asset or take the residual position in particular in the case of operating leases. Both the independents and the captives do the same thing.
When a business needs an asset to help them manage that business, whatever that asset is, they come to a manufacturer's dealer in most cases first and that funding comes to members of our industry. It is only when we turn them down, because it does not meet our credit criteria, that they go off to the banks. I just wanted to reiterate that point.
Senator Kenny: Senator Angus is just continuing the fine tradition of non-partisanship of this committee and I applaud him for it.
How public are the scoring models that you describe? Are they posted on the door? Does a client, before he comes in or she comes in, have some sense of how many hoops they have to jump through or how high the hurdle is before they are likely to be accepted?
Mr. Simmons: No. I think each company would have its own proprietary credit scoring system.
In the case of a motor vehicle or light duty truck, there is a ready resale market. In terms of other equipment <#0107> for example, whether there is a ready resale market for an airplane -- I do not know. My background is the car business.
So the scoring model will look at the underlying asset quite a bit. It will look at payment records. It will look at all the characteristics that our industry has accumulated over 30, 40 years.
A vendor would provide some guidance to the prospective lessee. They probably counsel them, and say, for example, "We think there is a 90 per cent chance that you will get bought," or "There is only a 30 per cent chance. We know that this particular company will probably approve you, but because of some credit problem in the past, we probably have to go to such and such a company to get approval."
Senator Kenny: Mr. Chairman, my question is a bit off topic, but there is frustration out there when folks are not successful. Part of the frustration emanates from a lack of knowledge of what it takes to be successful. I am curious as to why there is not a broader effort to educate or to make clear to people exactly what is required to be successful. In other words, if somebody is rejected because they have not been in business for two years, it would be beneficial to know that before even asking.
Mr. Powell: To reinforce Mr. Simmons' point, many companies have different ways of approaching it, and to my knowledge they are not made public.
You have to understand that this system evolved as a means of giving a very rapid credit decision, so that literally, within a matter of minutes. The vendor is generally educated or trained by the financing company to explain the financing structure. Hence, the vendor, after discussion with a potential purchaser, will know where or not the purchase's business is a suitable risk. The vendor may suggest that the purchaser go to the banker down the street.
Mr. Simmons: Excuse me, if I may add one point. By the same token, senator, it is not that cut-and-dry. The automatic credit scoring may say "yea" or "nay", but then the vendor may say, "Well, instead of 10 per cent down, if we had 20 per cent down we would have a deal."
Once again, the industry is servicing the manufacturer's vendors so we try to put the deal together. We would try to come back with conditions under which the lease or loan could be bought.
Obviously, there are some situations where you cannot do it regardless, because of past history, but we do try to consummate the loan or lease because we have to service our vendors.
Senator Kenny: Are there business reasons that this information is not readily available?
Mr. Simmons: I cannot answer that. With respect to consumers, provincial laws related to consumer credit files ensure that every consumer can access their credit history.
Senator Kenny: No. I am talking about the profile that it would take to get a decision.
Mr. Simmons: Once again, I think it is a competitive aspect of every business that they spend a great deal of time, money and research developing their scoring model. There are some generic scoring systems that can be purchased from Dun & Bradstreet, or some other commercial enterprise that markets a scoring system, based on their data base that they have accumulated over the years. Whether or not it could be disclosed, I think there would be so many variables to it by each company. They look at it differently, once again, and it would vary, depending on the underlying collateral that is being financed.
Mr. Powell: This industry has thrived for two essential reasons: First, new technology; and second, huge pools of capital that previously have not been made available to the lending market that they have been able to tap into, pension funds and insurance companies.
New technology is what I think most of them would recognize as what keeps them going in business. It is a highly competitive area, one that many would regard as being one of the most important competitive assets.
There may be a way of developing some sort of a generic standard of disclosing information, but right now I think there would be tremendous resistance to that.
The Chairman: Just so I am clear, when you say new technology, you mean technology that has allowed them to do credit scoring which is effectively a statistical analysis of past loans.
Mr. Simmons: Partly that, but also the electronic origination of the transaction coming from the vendor to the lessor's place of business.
Mr. Powell: So it is communications technologies and information technologies, the number crunching.
The Chairman: The number crunching does the credit scoring and the communications technology allows you to link lessees and lessors together.
Senator Kolber: What sort of rates do your members charge as opposed to, say, a bank?
Mr. Simmons: It depends on the size of the asset; it could have a value of $5,000, $50,000 or, say, $100,000. I certainly think our industry is quite competitive with the banks.
Senator Kolber: What would a typical rate be?
Mr. Simmons: As I say, it varies, depending on the collateral, the asset, the size of the ticket. It is a full range.
Senator Kolber: How would it compare to a bank rate?
Mr. Powell: I think you would have to do it on an asset-by-asset transaction.
Senator Kolber: You keep saying if they do not get it from you, they can go to the bank.
Mr. Powell: No. You have to do it on an asset-by-asset transaction. For example, a computer. A computer has a two-and-a-half to three-year life span. At the end of the term of the lease, the computer may have no value whatsoever. Therefore, the cost of leasing that computer will be different from the cost of leasing a truck that may have a third of its value at the end of the term. The cost factors are different.
We have never done it, but I think you would have to do it on an asset-by-asset basis. Typically, the key factor for most businesses is that they want to know how much they will have to pay a month.
Senator Kolber: I know, but it resolves itself to a rate.
Mr. Powell: On balance, you will find that leasing is not necessarily cheaper by any means.
Senator Kolber: I do not suspect it is.
Mr. Simmons: The unfortunate part is that there are other services reflected in the rate. For instance, in the vehicle-leasing industry, the rate may be 1 per cent over prime for a three-year vehicle lease; but other management services are provided -- asset remarketing, vehicle maintenance services, and so on -- and thus 1 per cent may be added for administrative services.
So if you worked out the yield, it may seem like a high rate, but management services are included in that rate.
Senator Kolber: Are you telling me that you actually make loans at prime-plus-1?
Mr. Simmons: I do not know. The cost of funds on a vehicle lease, which I am familiar with, would certainly be prime-plus-1 for a vehicle lessor. Services would be added to that.
Senator Kolber: Far be it for me to disagree with you; I would be mightily surprised.
In any event, thank you very much.
Senator Meighen: You pointed out that the SBLA is there, I presume we all agree, to encourage and increase the number of loans to SMEs but that the mechanisms that it incorporates are those of a number of years ago and that they do not take into consideration the evolution financial market. You specifically mentioned that if we do not scrap it, then perhaps we should look at some way of including leasing.
What about equity financing? Let us take the scenario that scraping it is not in the cards but that incorporating your suggestion about leasing is in the cards. Would you have any objection to incorporating equity financing as well?
Mr. Simmons: Are working capital loans being considered at this point in time?
Mr. Powell: When you say equity funding, do you mean that the government actually takes an equity position in a small business?
Senator Meighen: Or enables others to do so when they would not otherwise do so.
Mr. Powell: Our association does not have an opinion on that. Anything I might say would be more of a personal view.
Mr. Simmons: You are suggesting a venture capital-type of approach.
Senator Meighen: Perhaps incorporating that type of encouragement within the act, since you suggested that we also want to incorporate or to add a category whereby capital leasing would be encouraged.
Mr. Simmons: Once again -- and this is purely from a personal note -- there are plenty of venture capital companies out there servicing small businesses; they are quite happy to put in equity. Seed money is available from many venture capital companies. However, the government may choose to expand the program to, as you say, possibly guarantee a venture capital company to help a small business.
Senator Meighen: For better or for worse, we have some legislation. It seems to me that an artificial element is added to the market by encouraging debt financing. You said, "Hey, that does not include us. Please include us." I am not saying, "What about equity financing?" Have you got any objection to that?
Mr. Powell: I do not think we have any objection.
Mr. Simmons: Many leases do not show up on the balance sheet, which is why it is attractive for the lessee; it helps them keep the debt equity ratios in line by leasing off balance sheet. It is quite an accepted practice. Often, the customer will demand that a lease be treated as an operating lease for accounting purposes, whereas it may be a capital lease for taxation purposes.
Senator Oliver: In response to one of the questions that were put to the committee for us to review -- that is, whether the current maximum loan size should be maintained or changed -- your answer was that you do not think it should be reduced. However, you did not comment on whether it should be increased.
When we had our hearings in Atlantic Canada, in Charlottetown and in Nova Scotia, a number of people who appeared before us who were in the tourism business. In their opinion, $200,000 was not enough, for the kinds of things that people in tourism had to do, and a number of them suggested $500,000.
What is your opinion? Should the statute be updated to reflect a maximum of $500,00?
Mr. Simmons: We certainly would not have any objections to that. The comment from the Auditor General was that the government is experiencing higher losses on higher volume loans, in the $250,000 range. Is that not what they suggested?
Senator Oliver: Yes, it is.
Mr. Simmons: It would depend on the underlying collateral for the $500,000 loan. If it is just a working capital loan, the risk for the government will be high; but if the loan is secured with collateral, we would have no objections to it.
Mr. Powell: As well, there is a recognition that various forms of equipment that businesses need -- whether you are talking about telecommunications equipment, phone equipment, computer equipment, and so on -- are becoming more and more expensive and more and more sophisticated.
It comes down to this: What is the government's appetite for risk? And where should they draw the line, from a public policy standpoint? There is no doubt that the more sophisticated equipment gets, the more expensive it gets.
Senator Oliver: It is more expensive now than it was when this program began.
Mr. Simmons: Exactly. Since the 1960s.
The Chairman: When I asked Mr. Simmons at the beginning to outline what a pilot program would look like, he took us through a detailed way of developing it, and that was very helpful.
What I did not get any sense about was how long would it take to get a pilot program up and running. You talked about the need to develop a risk profile, a need for the government to decide the level of risk it is prepared to accept. How long would it take to get a pilot program up and running.
Secondly, can you give me an estimate of what sort of dollars the government would have to put into such a program, recognizing that it will get some of it back, that it will not lose all of it? I think you alluded to a three-year pilot program.
What would be a reasonable pilot program, such that you could actually determine whether it was working at the end of the program?
Mr. Simmons: The members of our industry who are experts in securitization and experts in developing credit scoring models would have to do a feasibility study with Industry Canada -- I presume it would be Industry Canada -- to determine if they have an appetite for it. I do not think it would take that long to put a pilot project together.
The Chairman: Any idea what kind of dollars we are talking about?
Mr. Simmons: I have no idea at this point.
Mr. Powell: It would come down to how much the government wants to invest in it. Again, it would require bringing some of our specialists together. The community of people who are doing this is relatively small. They all know each other.
If there was an interest from Industry Canada to make it go forward, I am sure that some models could be developed and run past some of the major funders. In the final analysis, the major funders are the ones who will be critical.
The Chairman: To pick up on a point you made a minute ago, Mr. Powell, your sense is that Industry Canada has talked to you about it periodically but without any real interest. What you are really saying is let us not start down the road toward developing a pilot project unless real interest genuinely exists; correct?
Mr. Powell: That is right.
The Chairman: Your sense up until now has been that, within the bureaucracy, that is not the case.
Mr. Simmons: Senator, could I ask you about your vision of a pilot project. Would it be one particular industry? How do you envision the pilot project?
The Chairman: I was actually asking you because I am not sure. It seems to me that the danger in involving only one industry -- automobiles or computers, or whatever it -- is that you may not get a realistic measure.
Mr. Simmons: Once again, I am not an expert, but my sense is that we would want to do the full range of assets within our industry, to make the project valid.
The Chairman: Exactly. If you do not do that, then you may be able to conclude that it works fine for vehicles but you have not concluded that it works fine for the leasing industry.
Mr. Simmons: Absolutely. We would be very interested in working on a pilot project with the government.
The Chairman: Mr. Simmons, Mr. Powell, thank you very much for taking the time to be with us this morning.
Mr. Simmons: Once again, thank you for the opportunity to be here.
The Chairman: Honourable senators, while we change witnesses, since CPAC was not on when we began this morning, let me tell the audience what our committee is all about.
We are the Standing Senate Committee on Banking, Trade and Commerce and we are conducting hearings on the Small Business Loans Act, which is coming up for renewal in Parliament this fall. We are trying to understand the extent to which the terms and conditions of loans ought to be changed, whether it ought to be expanded to include a leasing program, and so on.
The committee will be reporting the results of its discussions to the Minister of Industry in the next few weeks. We have held meetings in Halifax, Charlottetown, Montreal, Calgary, Vancouver and, of course, here in Toronto.
Our next witnesses form a panel from the Bank of Nova Scotia, the Royal Bank of Canada, the Canadian Imperial Bank of Commerce and the Hongkong Bank of Canada. I would ask them to come to the table, please.
I would ask each of you to make a brief opening statement, if you wish to, following which we will turn to a general discussion.
For the record, I would first ask each of you to identify yourself.
Mr. Dieter Jentsch, Senior Vice-President, Canadian Commercial Banking, Bank of Nova Scotia: My name is Dieter Jentsch. I am senior vice-president of Canadian Commercial Banking for the Bank of Nova Scotia.
Mr. Charles Coffey, Business Banking Division, Royal Bank of Canada: My name is Charlie Coffey. I head the Business Banking Division of the Royal Bank.
Mr. Kelly Shaughnessy, Senior Vice-President, Canadian Imperial Bank of Commerce: My name is Kelly Shaughnessy. I am a senior vice-president of the CIBC.
Mr. Robert Paterson, General Manager, Canadian Imperial Bank of Commerce: I am Robert Paterson, general manager, CIBC, small business.
Mr. James Howden, Senior Vice-President, Risk Management, Hongkong Bank of Canada: I am Jim Howden, senior vice-president of risk management, Hongkong Bank of Canada.
The Chairman: As a matter of curiosity, based here or Vancouver?
Mr. Howden: Here in Toronto.
Mr. Jentsch: It is my pleasure to appear before the committee to continue the dialogue on contemplated changes to the Small Business Loans Act. We have had the opportunity to consult with Industry Canada on major issues and we appreciate the opportunity to do that today.
The SBLA program is used extensively by our customers to finance new business start-ups and business expansion where additional comfort is required. The Canadian banks are an integral delivery mechanism for this program, as evidenced by recently released research that indicated that 72 per cent of the SMEs in Canada have one of the big seven banks as their main financial institution.
At our bank, between 45 and 50 per cent of our new customers are, by definition, start-up operations. In the last five years, the Bank of Nova Scotia has been first or second in terms of new SBLA accounts within all SBLA designated lenders.
We strongly support the continuation of this program while ensuring it continues to meet the needs of customers, lenders and the Canadian public. Scotiabank policy guidelines require lenders to underwrite SBLA loans with the same standard of care and due diligence applicable to all our underwriting.
We believe that the SBLA should remain focused on the general market and minimize accommodating market niches or different lending mechanisms or facility type. If as a matter of economic policy the government wishes to support specific sectors, then perhaps they would be best supported outside of the SBLA program.
We share a responsibility with government to mitigate loan losses and costs to the Canadian public and, hence, expansion of the programs into inherently riskier lending facilities should be carefully analyzed and perhaps be initially delivered on a pilot basis.
I would like to briefly address four areas often discussed and brought around the table for amendments to the SBLA. The first area is working capital enhancement.
Working capital financing is already widely available in the marketplace through credit products such as operating loans, which are generally used to finance accounts receivable and inventory. The federal government has already advanced access and supplemental working capital financing for companies of higher-risk profile through the Business Development Bank and working capital for growth and export lending programs.
If the government decides to enhance working capital, there should be a separate program, as it is fundamentally different from fixed-asset lending. We would expect default rates, loan losses and administrative costs to increase under such a program.
The second area is application to the voluntary and non-profit sector.
The market need of expanding the SBLA program into the voluntary and non-profit sector is not clear to us. Notwithstanding, lending to such sectors requires unique credit analysis and documentation and security requirements that could not easily be incorporated into the existing parameters of the program. Personal guarantee, collateral and collection issues all require special policies and procedures in this particular area. We recommend that, as these sectors are currently being served at the banks' risk, the SBLA program not be expanded in this direction.
Area number three is capital leasing.
Features of leasing -- for example, 100 per cent financing, residual risk issues, equipment title with the lender -- are different from present lending policy under the SBLA program. Additionally, small ticket leasing -- and by that I mean generally under $100,000 -- is generally not offered to start-up business due to 100 per cent financing and the associated residual risk, and is generally priced far above the SBLA program maximums to offset higher risk.
Accordingly, given the potential for greater write-offs on a portfolio basis and the fact that the very structure of leasing is different from term lending, we recommend that, for simplicity, leasing not be incorporated in the SBLA program. Favourable consideration should be given to the creation of a separate government guaranteed program on a pilot basis -- which I would see taking, to get a true indication, approximately six years and needing a portfolio size of approximately $1 billion.
I would also like to point out that the banks face some restrictions under the Bank Act as to the residual risk that they can carry on individual transactions and a portfolio basis that is different from the leasing industry.
The fourth area is enhancement for start-ups.
We use the program extensively for start-up operations. Neither pricing nor eligibility criteria requirements is deemed by our customers to be excessive. We do not see the need to reduce the yield on SBLA facilities, as availability, not price, is the key as we see it to small business. Loan-to-value and repayment terms are already generous, and we see no further need to enhance the program and potentially cause confusion in the field as to which criteria to apply.
In conclusion, I wish to reiterate that the SBLA program has been an important tool for our organization in the financing of Canadian small business. We encourage the government to maintain the program and emphasize that any change to existing parameters be clearly defined and not increase the complexity of lending under the program.
With that, I will turn it over to Mr. Coffey.
Mr. Coffey: We welcome this opportunity to speak to you on what we consider to be a strategically important program. In addition to dealing with the SBLA issues, perhaps we can dispel some of the myths with respect to banks and bankers.
The Chairman: I hope that today we can narrow ourselves to the SBLA. We will have plenty of time to deal with your colleagues in the banking industry when we hold our hearings this fall on the McKay Task Force Report. So let us just focus on the SBLA today.
Mr. Coffey: Thank you, Mr. Chairman; I appreciate that.
To provide some context to Royal Bank's participation, in 1997, we made in excess of $415 million in new loans under the act. This accounted for about 21 per cent of all loans made under the SBLA in 1997. As a percentage of total loans to the strategically important SME market, that figure represents less than 5 per cent of the loans granted by the Royal Bank to small business in 1997. The percentage is small in some ways because we at the Royal Bank have sought new and innovative ways to serve the diverse needs of new and expanding businesses.
For example, in the past two years we have introduced a number of new financing solutions to this market. We introduced "CreditLine" for small business in late 1996. This was the first card-based rotating credit facility offered to small business in Canada.
In 1996 and 1997, we substantially expanded our venture capital programs for a segment of the market as well as six partnerships with the Government of Canada through the Department of Industry to provide higher-risk financing to knowledge-based enterprises.
In 1997, we introduced "Bricks and Mortar", long-term mortgage financing for small business, as well as "No Hassle Leasing" and "Lease Lines". In 1998, we brought "Connect@Work" to small businesses, with its economical Internet access to deposit and loan records as well as the ability to set up a website for electronic sales of products and services.
Like these solutions, the SBLA program has features for the needs of a group of small business customers. Concurrently, and as you well know, 48 per cent of the loans under the SBLA are for start-up and for first-year companies. Ninety-two per cent of the funds granted were for equipment and premises, particularly leaseholds. Individual loans in the program averaged $65,000. In the case of Royal Bank, since the inception of the program, in terms of our lease-based outstandings as at the end of March, the average loan is $52,000. In 1997, the average was $75,000.
So it is clear to all of us at Royal Bank that the program has played a key role in financing the entrepreneurial class in Canada. In their book on creative financing for Canadian entrepreneurs, Allan Riding and Barbara Orser noted that the SBLA allows -- and I quote:
...Canadian small firms access to debt capital at reasonable rates by international standards. In virtually all other respects, involvement of the government is "transparent" to the business borrower.
With our experience working with entrepreneurs and the SBLA, Royal Bank has been studying ways to improve the administration of the program and increase the opportunities for new businesses to succeed.
In our view, it is more than access to capital. Educational programs that develop entrepreneurial skills and aptitudes are critical to helping sustain and increase new start-ups in Canada. In cooperation with governments at all levels, universities and industry, Royal Bank is participating in no less than 16 individual initiatives to foster entrepreneurial support among young Canadians. We are currently developing an interactive, web-based entrepreneurial development program to assist SBLA and other loan applicants to improve their chances for success in their new enterprise.
At the same time, we have improved the processing of SBLA loan applications and documents. These changes free up the time of the entrepreneur as well as our account managers so the two can engage in more meaningful dialogue. For example, the start-up business has rapidly changing operational needs that require time to resolve. With the assistance of their banker and a heightened knowledge, entrepreneurs can make better informed decisions.
I will now quickly review, Mr. Chairman, the Royal Bank's ideas on several key issues related to the future of the SBLA.
We support extending the SBLA to include fixed-asset financing for the voluntary sector. Charitable, non-profit and other organizations are an integral part of the Canadian economy. Volunteers who are entrepreneurial often run them when raising funds from both the public and, increasingly, private sectors.
With respect to the potential exclusion of certain types of financing, we would suggest the Director General continuously review the performance of the portfolio and be given the flexibility to adjust the percentage of assets that can be financed.
This portfolio management approach should of course be conducted within the strategy of a self-sustaining program.
Concerning the maximum loan size, we suggest a declining ratio of percentage of asset financed to loan size.
The average SBLA loan, as I mentioned, is $65,000, and the program, very importantly, targets new and first-year start-ups. It is our experience that applicants with loan requirements in excess of $100,000 usually have a sufficient equity to maintain a competitive financial structure in their business.
The SBLA provides term financing mainly for premises, machinery and equipment. As such, it provides an important source of financing for new business. Leasing should be included in this term financing package.
The SBLA is flexible enough by encouraging all new entrepreneurs who have financing needs earlier defined. Our knowledge-based enterprises, for example, have access to the program for the purchase, installation and improvement of software used in their businesses.
The issue of personal guarantees has been raised. The current provision permits, but does not require, the taking of personal guarantees up to 25 per cent of the value of the loan. This flexibility, in our view, should remain in the program. There are often lending circumstances in which the business owner chooses to provide a partial guarantee instead of clear equity in the business.
The taking of security and the requirement for specific receipts prior to achieving the loan result in both expense and time delays to the applicant. We would suggest that security be limited to chattel mortgages and/or collateral mortgages.
An ongoing concern is the amount of paperwork and costs to the small business owner. As a means to reduce the legal costs incurred by customers, lenders should be allowed to charge a set fee for completing the security in-house.
In addition, receipts to prove the utilization of funds should be eliminated. In the case of leasehold improvements, a certificate of inspection by the lending officer should suffice.
The program should be open to all lenders who provide a full range of financing programs for small business.
As you are no doubt aware, Royal Bank and myself personally see no option but to seek ways to improve opportunities for aboriginal Canadians. A beginning might include expanding the SBLA to finance organizations such as the Aboriginal Capital Corporation. This would of course require that aboriginal lending on the reserve be accommodated under the SBLA.
In our view, the SBLA program is integral to the financing of new and rapidly growing small businesses that make up this country. There is no doubt in our minds about that. Its success to date has been its ability to be flexible and move in tandem with the needs of the Canadians it serves. The program can be self-sufficient and remain competitively priced provided that all the lenders involved and the director provide sound portfolio management.
If you require further information about the suggestions, I would be pleased to answer any questions you might have.
Mr. Shaughnessy: Today we would like to share with you CIBC's experience and perspective as a leading provider of products and services to small businesses in Canada. We want to respond to the specific questions posed by this committee to witnesses regarding the Small Business Loans Act and offer some general comments on a number of other issues.
CIBC is committed to serving small business and we are proud of our efforts to support this vital sector in our economy. These efforts have helped make CIBC one of the leading providers of small business services in Canada, serving more than 330,000 small businesses. CIBC has more than $12 billion of authorized credit to small businesses, with roughly $8.3 billion in outstandings. The average amount of credit outstanding to small business borrowers at the bank is $69,000. So the vast majority of our small business customers borrow relatively small amounts.
We continue to work to develop new ways to meet the needs of small business. Some recent examples include our Year 2000 initiative, which includes education, awareness and assessment of readiness and vulnerability, as well as discount offers with manufacturers and resellers of computer software and hardware.
On August 1, we will be launching a small business credit offer which vastly simplifies the credit approval process and requires limited security. CIBC's initiatives in support of small business customers are included in the information package that we distributed this morning.
We view the program established under the Small Business Loans Act as an integral part of the portfolio of services we provide to our clients. Credit is a foundation. It is a foundation need for small business, and without consistent access to it, the entrepreneurial spirit in Canada, as well as economic growth, will be in jeopardy.
The SBLA permits us to provide financing to clients who do not meet traditional lending criteria. As the SBLA Guideline for Lenders states, the program exists -- and I quote:
...to increase the availability of loans to proprietors of business enterprises for the purpose of the establishment, expansion, modernization and improvement of small business enterprises.
CIBC supports the SBLA and we believe that the program is meeting its goals to assist some small business owners with their fixed-asset financing needs. Our general view is that the program is working well for the sector it is serving. We have concerns that any changes to broaden the SBLA do not result in a more cumbersome program to administer or one that is less effective for the sector it currently serves.
These hearings provide a timely and an important review of the SBLA and the needs and concerns of small business. This committee has asked witnesses to provide specific comments on a number of issues. A summary of our recommendations is included in the information package we have distributed.
The first issue raised in the committee memorandum concerns expanding the SBLA to target knowledge-based businesses -- KBBs. For a small business in the traditional economy, fixed assets and leasehold improvements form a significant portion of its assets. For a KBB, there is little of that. That is what makes financing KBBs a challenge for lenders. In fact, in the early stages, KBBs need financing for non-tangible expenses such as market development, research and development, and hiring and prototype development. Financing requests from KBBs that prove to be a particular challenge often include research and development and precommercialization expenses.
This is why we have created a dedicated team specializing in lending to KBBs. Our experience has shown that access to patient capital is critically important to KBBs. Patient capital is essentially debt financing with far more flexible terms regarding repayment and security than has been typically provided by traditional borrowers.
So on the issue of whether the SBLA should provide debt financing to KBBs, we believe a gap exists in the pre-commercialization stage. Patient capital is the better solution for KBBs in the pre-commercialization stage than a loan under the SBLA.
The federal government has already started patient capital programs offered through its various development agencies such as the Western Economic Diversification Agency. Funds are supplied by financial institutions under a loan loss-sharing framework with these agencies.
The second issue raised in the committee memorandum concerns extension of the SBLA to include the voluntary sector. Some non-profit organizations currently receive debt financing from banks. The financial structure of these organizations, however, often prevents banks from fulfilling all of their financing needs. For example, some of these organizations do not have tangible assets or a reliable revenue stream that would facilitate financing.
Extension of the SBLA program, which currently supports the needs of proprietors, therefore, does not seem to be the most appropriate vehicle. If the government feels strongly that a credit program for the voluntary sector is needed, then that program should be separate from the SBLA, which is targeted at private enterprise.
On the issue of maximum loan size, currently 85 per cent of CIBC's business borrowers borrow less than $250,000. As mentioned earlier, our average small business loan is roughly $69,000. As such, the limit appears adequate, since the vast majority of small business borrowing requirements are below that ceiling.
With regard to personal guarantees, we believe that all stakeholders -- the owner, the bank and the government -- should share in the risk. For this reason, CIBC believes that business principals should provide a personal guarantee. We consider the provision of a 25 per cent personal guarantee to be a reflection of the small business owner's commitment to that enterprise.
While there is a demand for a working capital facility for the small business market, this type of financing is not the same as asset-based financing. It requires different security, different monitoring and different due diligence. These factors increase the cost of providing such a loan. For this reason, we have concerns about trying to expand the SBLA to include working capital. Working capital financing is provided by all the banks by a vast number of financial institutions, including the Business Development Bank and the Export Development Corporation. As such, we believe that there is an adequate supply of working capital financing within the marketplace.
Concerning administrative refinements to the SBLA, the administration of collection of invoices and cheques as well as the process of claims settlement are two areas that need to be revisited. The current system involves a great deal of administration, which increases the cost of the program to the government, to the lenders, and to the borrowers.
Mr. Chairman, since its introduction, the SBLA program has provided an important service to small business. Through regular reviews, such as this one today, we can all ensure that the SBLA continues to meet the needs of small business.
Thank you. We will be pleased to answer your questions.
Mr. Howden: Mr. Chairman, I wish to keep my comments brief.
The Hong Kong Bank is a supporter of the SBLA program. As a matter of interest, currently 85 per cent of our customers are small business, and they borrow less than $1 million. So we do have a fair number of small customers dealing with us. Of course, they are not all borrowing under the SBLA program.
You asked the question, "Should the SBLA be expanded to target knowledge-based enterprises?" The word "target" is probably not the right word. Currently, the SBLA program, as we know, focuses on financing hard assets. To include knowledge-based enterprises into the SBLA program would, to a greater extent, require a fundamental change in focus, away from hard assets to intangible assets such as financing R & D and, possibly, some of their cash flow requirements. Once we move away from financing hard assets, the SBLA guarantee essentially becomes an equity replacement for the small business.
The second question that was asked is: "Should the program be extended to the volunteer sector?" We agree with the concept that not-for-profit organizations could be included in the program. However, we believe that the maximum financing levels to those organizations could be reduced to compensate for the lack of guarantees that would be available which would limit the lending risk somewhat.
The third question that was asked is: "Should the current loan size of $250,000 per borrower be maintained or changed?" Statistics indicate that 85 per cent of borrowing customers within the banking network borrow less than $250,000. Increasing that limit to $500,000 would not only increase the target market by, say, 5 or 6 per cent but also increase the outstandings by a disproportionate amount, probably by a third. Hence, I would suggest that the $250,000 limit is probably where the program should stick; otherwise, there is a real risk that the cost of program could escalate substantially.
There is also resistance from higher-level borrowers paying a 2 per cent fee. They certainly have the ability to finance their operation at cheaper lending rates than what is generally offered under the SBLA program.
Again, we agree with respect to personal guarantees. It is our well ingrained lending philosophy that owners should stand behind their companies. To stand behind their companies means that they put up guarantees and other assets so that if the business suffers a cash-flow shortage, the sponsorship is there. Otherwise, without guarantees, once the stakeholders or their owners are out of the money, or if they have lost their initial equity, there is a tendency to walk away. So I believe the guarantee should stay.
The comment with respect to working capital is a difficult area. Again, the SBLA program is designed to finance fixed assets. Once we move into operating loans at relatively small levels, it becomes an issue of monitoring. The security is difficult to obtain; essentially, the SBLA would be financing unsecured loans. So if there were a program for working capital, I believe it should be a program set up separately, perhaps on the basis of a residual guarantee from the government.
With respect to extending the program to leasing equipment, small business is active in financing a business through leasing and we are in favour of extending the program to leasing equipment, although at this time we do not have a program for small ticket leasing.
With respect to the routine and the procedures related to the SBLA program, the program should be re-engineered to reduce as much of the paperwork and the technical compliance issues as we can out of the program, to make it both easier for the small owner to access the program and to encourage the lenders and the branch to promote the SBLA program.
Senator Callbeck: Recently, we held hearings in Prince Edward island and Nova Scotia regarding the Small Business Loans Act, and one of the comments that we heard over and over again was that there was a lack of financing for tourism businesses, including under the Small Business Loans Act. The Tourism Association of Nova Scotia, the Restaurant Association of Prince Edward Island, and in fact one witness, indicated that, unless banks change their thinking regarding businesses that are geared mainly to tourism, this whole industry will be in a crisis. Some indicated that it was getting harder and harder, that there had been a change of thinking on the part of some of the banks to lend money under the Small Business Loans Act to businesses geared to tourism.
I would like to get your comments on whether or not you agree with those witnesses.
Another concern was that a majority of small business owners are not aware of this program. As bankers, do you feel any responsibility in this area? Whose responsibility is it to make people that are in business, small business owners, aware of the program?
Mr. Shaughnessy: Your comments about the tourism industry and the SBLA reflect a difficulty in lending to the tourism industry. It is a very seasonal business, as the honourable member has said. It can be impacted by factors such as weather and things of this nature. So on the risk spectrum, if you look at industry risks, tourism is probably on the high end of the risk sector.
Having said that though, we as a bank lend to the tourism industry -- period. We lend to it. We probably have to do a little more due diligence for the tourism industry than an industry that operates 365 days a year and has a more predictable revenue flow.
In respect to the awareness of the program, if a client of ours or a potential client of ours had a particular need, we would attempt to serve that client outside the program first. I think Mr. Coffey cited what percentage of SBLAs form his portfolio. In our case also, it is somewhat less than 10 per cent; it is about 8 per cent in our portfolio. So we would attempt to serve the client outside of the program. If we could not, and if the transaction that is being considered is of a nature that, while it is above our normal risk tolerance but still is a make sense-type transaction, then we would offer this program to the client.
Mr. Jentsch: I would like to underscore and echo to a large degree what Mr. Shaughnessy said. The two primary things we look at when we put a credit together is stability of cash flow and the ability of cash flow to service the debt, as well as the management and credit characteristics of the management team. Hence, if the prospective client pay the loan back and has got a poor credit history, I do not think anyone around this table would support putting a loan out, government guaranteed or not.
Therefore, the fundamental premise when we look at credit is that, if they have a track record or a projected business plan that shows they can repay the loan, and if they have a fair credit history, we put the loan together.
If we believe that the equity in the business is not sufficient or the track record is not as long as we would perhaps want to have -- for example, a start-up operation -- we will then extend or reach for the SBLA program.
There will be instances, in the tourism industry, where $200,000 or $250,000 is not sufficient to meet their needs. Those are far and few between, but there will be situations -- as in any business -- where $250,000 is not sufficient. However, from our perspective, we will find a way to make the business viable, if there is an opportunity to do so.
In terms of pure advertising of the program, per se, we go along with what the CIBC is saying: We will seek to do the business for the bank's risk first. In many cases, the interest rates are lower and benefit the customer, and that is what we try to put together.
Mr. Coffey: We at the Royal Bank are very aware of the comments made during your hearings in the Atlantic provinces. If you were to travel to parts of Ontario, beyond Toronto and elsewhere, you would hear similar concerns.
We are of the view at the Royal Bank that tourism is a strategic industry in this country and have worked very closely with the Canadian Tourism Commission to find ways to finance these operations.
As I said in my remarks -- and I want to explain very briefly what I mean by my statement that access to capital is not the real issue from my perspective. I would argue that transfer of knowledge is the real issue. What I mean by that is that banks and government organizations have a role to play in helping, whether it be in the tourism industry or other industries, their businesses grow and prosper, through sharing of ideas, and so on. With that foundation, understanding a business and cycles, and so on and so forth, there is an unlimited supply of capital. Access to capital is a subset of a much larger issue.
There is a lot of work to be done by the banks and other lenders -- you had another group here earlier and you will hear from others later on in the day -- in working with you and other institutions in finding a way to take tourism in this country to a whole new level.
Our percentage of tourism is slipping as a country in the industrialized world. Why is that? We now have an influx of Americans because of the dollar, but if you look at Canadian Tourism Commission numbers, there is in our minds cause for concern. Infrastructure upgrades are required.
So I accept the criticisms made in both PEI and Nova Scotia and we at Royal Bank will be focusing on solutions. I have not got exact solutions for you today, Senator Callbeck, but I would be willing to share with you on an ongoing basis what it is we are proposing to do.
Mr. Howden: We are not representative of PEI, but we do have a branch in Nova Scotia. However, generally, throughout Canada, we will lend to any business that presents a reasonable business plan and where the sponsors have a sufficient equity level to ensure the success of the business.
We do not believe it is a good idea to finance business where there is a high probability of failure. It is very disruptive to the sponsorships themselves. Bankruptcy is never an easy thing.
The tourism business is much like the hotel business -- you need a high level of equity to support the business through good times and bad times. Guarantees are not a substitution for equity.
Senator Callbeck: I take it then, from what you say, that the thinking of banks has not changed regarding industries or businesses geared mainly to tourism, because certainly that is what we have heard.
Mr. Coffey: The Royal Bank is not saying that. I am not saying that.
Senator Callbeck: I am glad to hear that. I certainly look forward to more money being lent to businesses geared to tourism because it is certainly important in Atlantic Canada.
Mr. Coffey: Every single creditworthy deal is financeable, every one. Every creditworthy deal is financeable.
Senator Meighen: As a part-time New Brunswicker though, I do not want you gentlemen to forget -- I know you forget tourism generally -- New Brunswick, if and when you do consider tourism. PEI and Nova Scotia are not the only places.
Mr. Coffey: Mr. Chairman, being born and raised in Woodstock, New Brunswick, I could never forget the province of New Brunswick.
Senator Meighen: You see, he is feeling guilty now because he did not mention New Brunswick.
Let us focus, for a minute, on those industries that are not a "slam-dunk"; those industries or business that do not have hard assets that you can take as security -- everybody likes to make a loan that will always get paid back. In other words, let us focus on knowledge-based industries and the volunteer sector.
Mr. Shaughnessy referred to patient capital in the pre-commercialization stage of knowledge-based industries. I guess that means before you have hard assets.
Mr. Shaughnessy: It means before you have a commercially viable business.
Senator Meighen: All right. What does patient capital mean? Does it mean a longer term? If that is so, one of the questions I think the committee asked you was whether you would be in favour of extending the 10-year term. I take it that you would be, in the case of at least the knowledge-based industries; correct?
Mr. Shaughnessy: Patient capital means more than just the term of repayment. Patient capital will frequently be subordinate to secure capital. Patient capital will frequently, recognizing the riskiness of that capital, take rights in future production and things of that nature.
So patient capital is not the same as a normal term loan that you and I would see. It may have an equity kicker, and things of that nature. It is the type of capital that you hear angels bringing to the table, and things of that nature.
Some of it though, such as the WED program that I cited before -- we are participating in two of them -- is such that the government is providing a loan loss reserve to a fund of loans. Once again, even in those programs, one can see the commercial viability of the enterprise.
In KBBs specifically, where somebody has a vision, somebody has an idea, the capital is needed when they are trying to, say, write software, build new hardware, and things of that nature. So the commercial value is not there until somebody comes along and buys it, until there is demand for it. So the people who are putting up the capital to finance that will insist on far more in the way of potential revenue streams, to mitigate that risk, than a traditional term loan bearing a rate of interest of prime-plus-X.
Senator Meighen: I think I am hearing from other sources -- and I hear what you are saying and it make sense to me -- that this is not available to the tourism industry, where there are considerable ups and downs, or to knowledge-based industries.
Mr. Shaughnessy: We were talking KBBs and precommercialization phase.
Senator Meighen: Would not the same apply?
Mr. Shaughnessy: No, not necessarily. The difficulty in lending to the tourism industry is the unpredictability of cash flow. Frequently, the asset is there. In Canada, frequently our tourism industries, with the exception of some of the more popular destinations, Banff and Vancouver, for example, are a one-season industry. Hence, you are carrying that debt for 12 months of the year but earning revenue for only three or four months of the year.
If you are involved in a ski resort, say, and there is a winter with little or no snow, you are carrying that debt for 24 months. That is a different issue from the patient capital that we are discussing in relation to KBBs, in that the risk profile of the tourism model is somewhat different.
Senator Tkachuk: Would that be like farming in Saskatchewan?
Mr. Shaughnessy: No. It has been my experience -- and I had the agricultural portfolio report to me -- that the farming sector in Canada today is a very stable sector.
Senator Tkachuk: Just as a supplementary. You said that if there is no snow, there is no revenue; but if there is no rain, there is no crop. The same thing happens to the people who sell the farm machinery. If there is no rain, there is no farm machinery. In our province, if there is no rain, the car dealers in the small towns cannot sell a car.
What is the difference between not having any snow at a ski resort, which is something that can happen, or not having any rain in Estevan and thus no crop?
Mr. Shaughnessy: The difference, from my perspective -- and my colleagues can jump in if they wish -- is that the tourism industry tends to be a very capital-intensive industry. There are very high debt loads related to hotels, and things of that nature, much more so than the debt load that I see Canadian farmers carrying today.
One might have argued differently 10 or 15 years ago, but the balance sheet of today's farmers has changed dramatically from what it was a decade or two ago.
Senator Meighen: Is there, or is there not, a consensus that it would be useful in some cases, call it patient capital or whatever, if the term were longer than 10 years?
Mr. Coffey: If I may respond, Senator Meighen. Our approach at the Royal Bank is to look at the life cycle of a business. Our intent is to get young entrepreneurs in early and move them through the life cycle, to stick with them through the good times and bad.
If you look at the agricultural sector, as the senator well knows from groups in the west, there have been ups and downs.
There are various programs available for pre-commercialization, and again it is not financing at the lab bench. It is bringing together a management structure to take advantage of the extensive research expertise that exists in this country.
Senator Meighen: Excuse me, when you say there are plenty of programs available, are you talking about Royal Bank programs or are you talking about government?
Mr. Coffey: I can only speak on behalf of Royal Bank, in partnership with others, including the Government of Canada, whether it be through FEDNOR or FORDQ or Western Economic Diversification. We have a number of alliances with the Business Development Bank of Canada. We have our programs with universities to provide a management structure. It is almost a "company in a box" or a "CFO in a box" for our research people. They are focusing on the research.
Yes, patient capital is part of it, and there are sources for that, but they also need a management structure to move that research and technology along a path that will take it into the commercial market. We, at Royal Bank, believe that we have a role to play in that, and that is in this transfer of knowledge issue that I spoke of earlier.
Mr. Jentsch: To comment on whether a 10-year term is satisfactory, in my own mind, the spirit of the SBLA program -- and we need to look at the loss or cost of extending a term. If we happen to look at amortization to ease cash flow, 15, 20 years may be appropriate. To say that it should be longer, in some cases that may be so, but there is a cost of doing that because in some cases the risk increases. I understand that the spirit of the program is to ensure that it is on a cost-recoverable basis.
If it is the tourism or the agricultural sector, we have an obligation, as lenders, to ensure that losses are kept at a minimum while at the same time trying to ensure that the business continues to operate in a viable manner.
In many cases, more flexibility is needed within the program to address situations that you may be referring to, to go beyond a 10- or 15-year amortization term. A term perhaps could be shorter, to make sure that it is reviewed in an appropriate time, but that needs to be reviewed in the context of potential loss and the impact of that loss on the overall program.
Mr. Coffey: If I may, Mr. Chairman -- and I apologize to my colleague for interrupting.
To your point, Senator Callbeck, in 1997, 18.7 per cent of all SBLAs were granted to the accommodation, food and beverage services industry. The next retail trade industries that may capture some tourism related 13.6 per cent.
Hence, any suggestion that the SBLA is not serving the accommodation, food and beverage services industry is not borne out by the stats that have been produced in the SBLA reports submitted to the Auditor General. I think what you are saying is that the banks must do more in understanding that industry, but I think the facts speak for themselves, with respect.
Senator Meighen: We heard from the Royal Bank and the CIBC that 5 per cent in one case and 8 per cent in another case were the percentage of loans under the SBLA made to SMEs.
Mr. Coffey: No. Of our outstanding portfolio, we have committed to the SME market $19.9 billion in financing. Our outstandings to SMEs total $13.6 billion. Of that, $1.14 billion represents loans under the SBLA, and that is the total today since 1961 outstanding.
Senator Meighen: Your billions are confusing me. What I am trying to find out in a very general way from all of you is: What per cent of your loans to SMEs are done under the SBLA. I heard 8 per cent in one case and I heard 5 per cent in another -- which does not amount to a very big cash difference.
Senator Tkachuk: Is that cash or is that individual companies and individuals? In other words, when you say 5 per cent -- I am interested in the same thing here because it is confusing. In 1997, 5 per cent of all loans were to small business. Is that in dollar amount?
Mr. Coffey: Dollar amount.
Senator Tkachuk: What does that translate into, in terms of number of applications?
Mr. Coffey: Just give me a moment, please. I do not have those figures on the top of my head.
Mr. Jentsch: In our organization, given the heavy emphasis on start-ups, between 45 and 50 per cent of our portfolio to the SME market for lending tends to be about 60/40 split. Sixty per cent would be government guaranteed for term lending; 40 per cent would be the bank's risk. That is on the term fixed-asset side, not including of course working capital which is not applicable in this case. But from the term side, that would be the general split.
Therefore, it would be 60 for SBLA for term financing and 40 for the bank's own risk.
Mr. Shaughnessy: In our case, 8 per cent of the outstandings are under SBLA. I do not have the number of borrowers, but perhaps we could get that.
Mr. Jentsch: In terms of outstandings, our portfolio is less than 15 per cent. However, in terms of a dynamic marketplace, how it is handled by our lenders, that is the ratios.
Mr. Coffey: I think an important differentiation as well is that every SBLA client we have also has an extensive relationship. We are financing their working capital needs. I can tell you that small businesses entrust nearly $15 billion in deposits to our organization. They also use electronic commerce, cash management activities.
The SBLA is part of a holistic approach, if you will, to providing growth and value creation to small business.
Senator Meighen: I think we have a general idea of where it sits.
I thought I heard Mr. Jentsch say that availability, not price, is the essential criteria. Basing my question on that, Mr. Chairman, we have often heard in these hearings and others that small- and medium-sized businesses say that they need access. "We have got to have access to capital, and we would be willing to pay more, but the banks or the lenders refuse to give us the loan even at a higher rate."
In other jurisdictions -- and I am thinking of the United States principally; and I am not suggesting that we want a high interest rate policy here -- there are loans made at rates considerably higher than prime, what we would call prime. This seems to be the exception rather than the rule in Canada.
Mr. Coffey: I do not agree with that.
Senator Meighen: Why is it higher interest to cover risk?
Senator Kolber: The average cost for a small loan is prime-plus-4. The gentlemen who said 1 per cent just did not know what he was talking about.
Mr. Coffey: No, no, not prime-plus-4.
Senator Kolber: For small business.
Mr. Coffey: No, sir.
In a recent industry survey -- the other banks can speak to their own percentages -- 93 per cent of all applications for credit by small businesses were approved at Royal Bank.
Now, our detractors, as they have done in the past, will focus on the 7 per cent who did not get access. We have a pledge to small business. If we say no, we will honour our pledge to try to help them find credit.
Senator Oliver: And tell them why?
Mr. Coffey: Yes, sir, absolutely. And the spread for small business loans is not prime-plus-4.
Senator Kolber: What is it?
Mr. Coffey: You cannot charge small business those rates. They will simply walk across the street to the many hundreds of other competitors around. It depends on the risk profile of the borrower. If it is top-end, it is lower.
Senator Kolber: What is the average?
Mr. Coffey: Probably 1.5.
Senator Kolber: I have got to tell you, I made some phone calls this morning and received information diametrically opposed to what you say.
Senator Meighen: When you say "walk across the street", where are they walking to, foreign institutions?
Mr. Coffey: Banks, finance companies, AT&T, Newcourt. There are in excess of 2,500 lenders in this country. Banks only account for just under 50 per cent of the entire business financing market in Canada.
Senator Meighen: Did you say 15 or 50?
Mr. Coffey: Fifty; just under 50 per cent. Some have suggested a higher number, but I take great pride in managing my business by fact and that is the number.
Senator Meighen: I do not want to put words in your mouth. Are you saying that, if I am prepared to pay a higher interest rate, generally I can find an alternative source of financing?
Mr. Coffey: Senator, in my view, there is absolutely no shortage of capital in this country. Again, and with respect to Senator Kolber's comment about his motherhood statement, every creditworthy deal is financeable in Canada.
Mr. Shaughnessy: Mr. Coffey cited the industry survey, and our loan approval rates are right up there with the Royal Bank's. Some detractors say that that is a CBA survey; it is not a CBA survey. The survey was done by a company called Thompson Lightstone & Company. We financed it, but it is an independent survey. The results indicate, directionally, very similar as that with other organizations including CFIB.
The loans -- and these are term loans -- are granted under the SBLA. Their purpose is generally to assist a company with the acquisition of an asset. Mr. Powell and Mr. Simmons, who were in here earlier, are significant competitors to ourselves in that term loan market. They cited that they have vendor financing programs.
A client of the CIBC, or any other bank at this table, that wants to buy an asset frequently has an offer to finance that asset before we even know the client is out there looking at that piece of equipment. There is a ton of competition in this country for loans that come under the SBLA.
Senator Kolber: With respect to loans to knowledge-based businesses, it sounds like -- and this is not your problem, it is our problem -- like the government and yourselves are getting into the venture capital business. You say yourself that it is a very uncertain kind of lending to do.
Do you think that this committee and the Canadian government should discuss different approaches to what is basically a venture capital sort of operation?
I do not know all the rules that exist in the United States but I am told there is quite a difference. There is a lot of venture capital money down there that does not come from banks.
Even in the tourism industry -- I was in the investment business and I remember that about 30 years ago a group of us got together around the world and put up equity money. The result was Club Med. They could not have gotten four cents from the bank, yet it turned out to be a terrific proposition.
Do you not think that there are ways that we could encourage people to put up venture capital money, through the tax regime, say, or any one of probably a hundred ways to do it?
Mr. Coffey: Yes, on all counts, senator.
Senator Kolber: For example, if you are a taxpayer in Quebec and you take a risk and you make a profit, your tax rate is 42 per cent. The same taxpayer in New York will be taxed at 15 per cent. The difference is almost triple.
It would seem to me that that is a bit of an impediment to taking risks. It is also an impediment to moving money around. Should we be studying this? Should the banks be saying something about it?
Mr. Coffey: I think we have. In fact, the Royal Bank has been in the venture capital business since 1984. We presently have a $300 million portfolio focused on SMEs. Now, these are small transactions.
Mr. Jentsch: Is that outstanding?
Mr. Coffey: That is our commitment. We have a $300 million venture pool available.
Historically, the banks have been in the low-risk lending business, but there is money to be made, as you well know, in providing higher-risk or venture capital through a separate organization.
Senator Kolber: When you lend on what is basically a venture capital basis, you take back an equity kicker, which is what venture capitalists do; correct?
Mr. Coffey: You can. It is either pure equity or subordinated debt with an equity kicker. Royalty payments are becoming more and more popular. I agree with your point that the tax regime needs to be examined to encourage more higher-risk capital. Again, there is not a shortage of capital in Canada.
Senator Kolber: Of course not, but how do you encourage it to go to these places?
Mr. Coffey: I think we need to talk about that. That is beyond the SBLA focus, I would say. It may be an appropriate subject for another hearing.
Senator Kolber: What I am saying is that the SBLA is the wrong venue to do a lot of these things.
Mr. Coffey: I would agree.
Mr. Shaughnessy: Senator, from our point of view at CIBC, if you look at our handout, our third recommendation is that the government should review its existing taxation policy of capital gains to encourage financing of small businesses by angel investors and venture capitalists.
There is a lot of capital out there, but it has to be encouraged, as you have correctly pointed out; it has to be encouraged to participate in this market.
We are also in KBBs. Through very specialized bankers who are lending to that market, we are helping them arrange their balance sheets, and things of that nature -- and who are also participating, as I cited in my opening remarks, in patient capital funds. But Canada's capital gains taxation policy makes it much more worthwhile to investment in BCD than a small KBB.
Mr. Coffey: If I may, Mr. Chairman. We focused a lot on the downside; perhaps this committee is being driven by the fact that there have been some loan losses. I think we need to talk a little bit about the upside, in that, when an SBLA applicant applies to a lender, that applicant an average of five employees. Information provided by the entrepreneur and the lender would suggest that they create 2.4 additional jobs as a result of the support of the SBLA.
So how do we factor in the tremendous positive benefits to Canada, through wealth creation, job creation and economic well-being, through a program such as this? Yes, there have been some losses, and one might argue that they are too high and that we all need to take steps to take them down.
In terms of venture capital, large amounts of wealth are being created by young entrepreneurs who are investing in new ideas, and so on, whether it be Club Med or a disk, as others have done in the past.
I would like to hear some comments about the positive benefits of these partnerships involving the private sector and the public sector, in this case lenders under the SBLA program.
Senator Kenny: What difference would it make to the Canadian economy if the SBLA did not exist? More specifically, what difference would it make to small businesses if the SBLA did not exist?
The testimony of this panel started off with a series of commercials for the innovative programs that each bank was going ahead with. I accept that those programs are there. Why do you need the SBLA?
Mr. Jentsch: From my own perspective, 45, 50 per cent of new borrowers are start-ups, younger than a year, needing term financing; we would not be doing that term financing otherwise.
In other words, if the SBLA were not a reality, between 5,000 or 9,000 businesses would not have access to term financing.
Senator Kenny: But we have heard that there is no shortage of capital out there. We have heard that if you have a viable proposition, somebody will finance it.
Mr. Jentsch: The issue is that our profile risk and our start-up is higher. The maximum rate that we charge for the SBLA program is prime-plus-3, and it goes down from there. That is our general policy. We like to make sure the loans are repaid and within a fair spread above prime, that it does not exceed the prime-plus-3. Generally, we want to make sure that you put a loan on that will survive the tenure of the business.
So, yes, you can get a higher interest rate somewhere. Some organizations in Canada are charging prime-plus-8, but our organization has not done that.
Mr. Coffey: Mr. Chairman, to respond to Senator Kenny's point. I am just looking at the report submitted by the Director General in the period 1993 to 1995. Because of enrichments to the program, lending soared from $2.5 billion to $4.4. billion. As you know, changes were made in 1995 and the use of the program declined dramatically.
I think there was a role, to answer your question directly, for the private and public sector, through these types of programs, to join together to help small businesses grow and prosper.
To the point about access, to the point about capital, yes, there is a lot of capital out there, but people are not ready to invest it if they perceive a higher level of risk than they might get elsewhere or if the tax benefits are not conducive to them investing.
It was Willy Sutton who said, I think, in response to a question from the judge who sentenced him about why he robbed the bank, "Well that is where the money is." So a lot of people look to the banks. However, my point is that there are many other lenders and perhaps our role is to introduce the demand side to the supply side, so to speak.
Senator Kenny: It is sort of a subsidy, and you would like to have the security and the subsidy that the government gives you.
Mr. Coffey: I do not view it as a subsidy. I view this as a strategic partnership, to help small businesses grow and prosper.
Senator Kenny: Those are code words for subsidy, I think.
Mr. Coffey: Not in my mind.
Mr. Shaughnessy: Senator, I think what the program does is permits the banks to move slightly up the risk curve, slightly higher than they would normally do. It is not a subsidy in my mind because, if we built the program, we would probably have to say an outright "no" to that borrower. So I think the beneficiary here is not the banks; the beneficiary is the borrower.
Senator Kenny: You would say an outright "no". You would not get out and compete?
Mr. Shaughnessy: Remember, the banks primarily are financial intermediaries. We take deposits in; we lend money out. We have to maintain an appropriate risk profile; otherwise, we will not get equity investors and we will not get depositors. So our loan losses have to be contained within a range that makes investors and depositors comfortable in depositing their money in the bank and investing in the bank. We cannot move up the risk curve. We cannot go out there and be a finance company or something of that nature because the Canadian public will not permit us to do it. They will not deposit their money in a bank like that.
So a risk profile is, frankly, a low-risk lender. What this program does -- Mr. Coffey has cited the percentage of his portfolio, I have cited the percentage of our portfolio; we are not throwing our entire SME book into this program.
Through a program such as this, we have been able to lend, in partnership with the Government of Canada, to small businesses that have a viable risk profile above which a low-risk lender like a bank can lend to.
Senator Kenny: But your security is restricted to chattel mortgages and collateral, stuff you folks can get your hands on. If you were wandering off into security that you could not get your hands on, I would be more understanding.
Mr. Shaughnessy: Some of the security that it permits us to do is things like leasehold improvements. In a situation where -- and we do not find it a very pleasant situation -- we have to realize our security, the realization value on a leasehold improvement is somewhere between nil and zero frequently.
Mr. Coffey: I would also argue that, in addition to the SBLA, we are, in fact, providing other forms of financing, that is, working capital which is an important part of a business, as you well know. So we are taking significant risks. This program is all about risk-sharing for the higher-risk profile transactions.
Senator Kenny: Mr. Coffey, the question of security has been dealt with in your remarks. There is some question in the committee's mind, however, as to why you are recommending that it be restricted or limited to chattel mortgages or collateral mortgages. I wonder if you could comment briefly on that.
As well, Mr. Coffey, you said that receipts to prove the utilization of funds should be eliminated, and I am not certain why. Would you also comment on that, please.
Mr. Shaughnessy, point 4 of the "CIBC Summary of Recommendations for SBLA Program," says:
More should be done by government and lenders to better inform small business owners about non-traditional sources of financing.
What have you got in mind, and could you be more specific?
And then point 7, bullet three, says:
Large invoices paid for by cash (over $500) should be disallowed as this leads to many abuses within the program.
Could you give us some indication as to the kinds of abuses this refers to?
Mr. Coffey: Let me deal quickly with the issue of receipts. If, for example, we were financing, under the SBLA, a large piece of equipment, we would assure ourselves that it is lien-free and take a chattel mortgage on it. Why is it necessary to go through the additional burdensome and costly process of getting receipts to prove that the individual actually bought that piece of equipment when it is there and we have a chattel mortgage on it and the registration shows no other liens? It is reasonable to assume from that, recognizing honesty and integrity amongst small business people, that the money was used to purchase that equipment.
We are finding that the providing of receipts in the $5 and $10 range is extraordinarily costly and burdensome, which ties in with your first question about taking fixed charges over the equipment or the property and registering them under the appropriate jurisdictions.
We are looking at productivity and efficiency improvements in the system, and I do not believe that the provision of receipts, among other things, has contributed to that. In fact, it would have the effect of increasing costs.
Mr. Shaughnessy: In our code of conduct, as it relates to small business clients, we have an obligation to inform borrowers who we cannot serve of alternate means of financing. In other words, "While we at the bank cannot help you, these are sources of financing that you should go and see."
Surveys tell us that our account managers believe that they are communicating that, but the borrowers are not getting the message. So, obviously, we have to get out there and publicize alternate means of financing. We as a bank are doing it. We as an industry are doing it. We are doing it through the print media. We are doing it through websites and distribution to industry groups, and things of that nature, but we can still do a better job, as borrowers have been telling us.
Senator Kenny: This gets back to my previous question to the other panel, where I asked them to elaborate further on the credit scoring model. If a borrower knew up front the credit scoring model of your institution, he or she would not waste time at your institution if they knew beforehand that they did not fit the profile. What is your comment with respect to that?
Mr. Shaughnessy: As Charlie and I pointed out earlier, our loan approval rates are well over 90 per cent -- and that is not an internal statistic.
Senator Kenny: So you think most people do know?
Mr. Shaughnessy: No, no; I am saying that the vast majority of loans are getting approved.
What I am saying is that we have to do a better job of communicating alternate sources of funding to those borrowers whose loans do not get approved.
Senator Kenny: I am assuming that if you have a 90 per cent approval rate then most people who will ask for a loan already know what factors are necessary to obtain a loan from you; consequently, a lot of people do not go and ask for a loan if they understand what your model is.
Mr. Shaughnessy: Credit scores are used in small business lending but not the only thing that is used in small business lending. There is subjective risk assessment. What I would say to most small business clients is that if you have a good, viable business plan and an appropriate capital structure within your company, you will probably get approved. Statistically, that is borne out.
Mr. Jentsch: To build on Mr. Shaughnessy"s point, in terms of an organization's actual scoring technology, and the underlying weighting and statistical analysis that goes with it, not one individual organization wants to share it with another. The credit scoring model represents a competitive advantage. It takes an organization a lot of time, energy and resources to achieve satisfactory weightings of the variables in such a way that it is comfortable with its own risk profile that is generated out of this.
Having said that, there are general characteristics that go into these things -- for example, personal credit history -- which we explain to our customers as being important variables in the approval process. In terms of the actual weighting of those in a statistical analysis, often we do not even know because we buy the scoring models from another vendor as well. So there is a proprietary interest in the actual statistical makeup of credit scoring. However, as an industry, we need to better convey to our customers the variables involved in approving a loan, because scoring is only one small part of it. It is one of the tools we use. As an industry we must do a better job of communicating those variables.
Mr. Coffey: Senator, just very briefly, in terms of credit scoring, I was very interested in the dialogue you had with your guests earlier.
I worry from time to time that credit scoring is viewed as a panacea. Dealing with entrepreneurs, it is not only high-tech but it is also high-touch. I am not interested in a one-product relationship with any client. A loan is a product. They deposit with us. They need all these other things I shared with your colleagues earlier. Credit scoring, as my colleagues have said, is one tool. Some people use it exclusively; as you heard earlier, if you are a start-up business or have been in business for less than two years, you may get "credit scored out". That is not where we are coming from.
It is the young entrepreneurs, the start-ups, who, if we stick with them through the life cycle, will provide the returns that will reward us over the longer term.
Mr. Shaughnessy: With your permission, Mr. Chairman, I will ask Mr. Paterson to respond, since he has more expertise in that area.
Mr. Paterson: Senator, when we have completed our due diligence requirements through the claims process we find that, in this category, there tends to be some falsified information, so we tend to go through the figures to validate the market values given. That is the reason for including that component as a recommendation.
We support Mr. Coffey's point about some of the lower-end transactions. We drew the threshold at $50 and under, which is in line with the amount of administrative time taken to validate those types of transactions.
Senator Tkachuk: The banks are the administrators of this program so your comments will be most helpful.
When you refer to 5 per cent of the loans granted in the Royal Bank brief, does that refer to individuals or the dollar amount?
Mr. Coffey: If I granted, in 1997, for example, $100 million to the SME market, $5 million of that would be under the SBLA program and $95 million would be for my own risk.
Senator Tkachuk: How does that relate to the application stage?
Mr. Coffey: Do you mean the numbers of accounts?
Senator Tkachuk: Yes.
Mr. Coffey: It is significantly less than that.
Senator Tkachuk: How much less?
Mr. Coffey: As I said, the average loan in 1997 was $75,000. There were 5,527 loans in 1997 against $415 million which I think is around $75,000. It is less than 5 per cent by volume and by numbers of accounts.
Senator Tkachuk: Is it 3 per cent, 2 per cent?
Mr. Coffey: It is under 5 per cent. I can get you the exact figure.
Senator Tkachuk: It would be important for us to know that number.
Mr. Coffey: I am sorry, I am not clear on the point. Is it too low or too high?
Mr. Tkachuk: What I am trying to find out is the number of applications because I think it is important to know how many customers make use of the program as compared to how many customers you have in the small business enterprise section of your marketplace.
Mr. Coffey: If you require a precise number, I will get back to you, Mr. Chairman. However, it is under 5 per cent by numbers of accounts, and about 5 per cent by volume. The point I want to make is that 95 per cent or 96 per cent by volume and by numbers of accounts are for our book.
Senator Tkachuk: Within that 5 per cent of loans granted for small business under this program, if you take the government out of the picture, what is the dollar value of the assets you hold against those loans? Unless it is a very good customer of the bank, you take a 25-per-cent personal guarantee on the loan, plus the value of the assets. What is the value of the assets you hold against those loans? How much risk are you assuming?
Mr. Coffey: We would take security as per the guidelines established under the act.
Senator Tkachuk: How much security?
Mr. Coffey: We take security according to the regulations. If you are asking me to give you a market value of the security we hold in support of outstanding SBLA loans, I do not have that information. Guarantees up to that percentage are optional. In certain cases guarantees are taken.
As I said earlier, in addition to the SBLA, in virtually 100 per cent of our cases, we have an extended borrowing relationship with the client and, as you said, most are good customers. I would argue that all are good customers.
Senator Tkachuk: The banks are providing us with information they want us to know, but I want information that is important for us as legislators to have. I have asked you two questions, the responses to which I think you should know.
What would be your average security against all of your small business loans?
Mr. Jentsch: We do not have that information. We have the information in every loan file but we do not have the consolidated information on an MIS, management information system, from which we could draw. It is not part of our initial consolidation of information on our information systems.
We do know how many customers we have at any point in time. We know the loan repayment requirements, the expiry dates, and we have all the accounting information. However, traditionally, we have not consolidated the management information on collateral values. Our systems have not been set up to do that. An individual file will record that, but we do not have consolidated information on our, say, 1,200 business units across Canada.
Mr. Tkachuk: Why does the customer pay the administration fee?
Mr. Jentsch: The administration fee goes to the government.
Mr. Tkachuk: Do you charge an administration fee as well?
Mr. Jentsch: No.
Mr. Tkachuk: Do you not deduct a fee?
Mr. Jentsch: No. No fees are allowed under the program.
Mr. Coffey: We are not allowed to charge fees under the SBLA.
Mr. Jentsch: It goes to the SBLA administration, and they do the day-to-day administration in the event of default claims. We deal with the initial application, but the fees are forwarded to the government.
Mr. Coffey: When a loan is granted, Senator, we take security that we believe will ensure repayment of the loan in the event we have to realize on that. As you well know, the value of that underlying security can go up or go down, depending on general economic conditions.
I hear your request for additional information, so I will reflect and consult with my colleagues on that to see what we can do to answer your very serious and very important question.
Mr. Shaughnessy: First, for loans granted under the SBLA, in general, the security would be the assets acquired by the proceeds of that loan.
Senator Tkachuk: It is not a personal guarantee?
Mr. Shaughnessy: As we said in our submission, we recommend that a personal guarantee up to 25 per cent be taken, but that is not tangible security. That is not hard security. We are not taking, for example, a collateral mortgage over somebody's.
Second, you asked a more general question about small business lending. There is a movement within the industry to do lending to the smaller end of the market, in our case up to $100,000. I believe Mr. Coffey cited his card-based product where we are lending against personal guarantees. We are not taking any tangible form of security for many of the loans. The reason for that is that the application process for the client is a very simple process. It is almost like applying for a credit card
Senator Kolber: How can you say you are not getting a lien on his house?
Senator Meighen: He did not say that.
Senator Kolber: If a client guarantees 25 per cent of the loan, and part of his assets are a house, you have an interest in his house.
Mr. Shaughnessy: No, I do not. I am an unsecured creditor to an individual.
Senator Kolber: You may not have a piece of paper that gives you a specific lien on the house but you certainly have access to it.
Mr. Shaughnessy: I am an unsecured creditor.
Senator Kolber: You are playing with terminology. The fact is you have got the house.
Mr. Shaughnessy: That person may have a first mortgage on that house.
Senator Kolber: You could a second mortgage.
Mr. Shaughnessy: I accept your point, but I am an unsecured creditor.
Senator Tkachuk: You could secure the loan on a promissory note.
Mr. Shaughnessy: As I said, generally, when we take the 25-per-cent personal guarantee for an SBLA loan, we do not have collateral security behind that guarantee.
Senator Tkachuk: Unless you need it.
Mr. Shaughnessy: No. We would not take it under the SBLA.
Mr. Jentsch: In many cases in the small business market, the individual does not differentiate from the business. They intermingle their affairs. In some cases no guarantee is required because the business is solid and stands alone. In other cases, given the individual circumstances, they choose to run their operation in such a manner that the assets and profits are, in fact, in their personal name. It depends on the circumstance.
To state that we must eliminate all guarantees or make all guarantees mandatory, we must first look at the structure of the SME market and we would have to conclude that it is unstructured. No organizational structure fits the small business market. It depends on the circumstances and how an individual runs his business.
Senator Tkachuk: What percentage of loans under the program do not have a 25-per-cent personal guarantee?
Mr. Jentsch: I do not understand your question.
Senator Tkachuk: You said that sometimes you have a 25-per-cent personal guarantee and sometimes you do not. On what percentage do you not have the 25-per-cent guarantee?
Mr. Jentsch: I do not have access to that consolidated information. As a general rule of thumb, in our organization, there is a personal covenant of some magnitude, whether it be 5 per cent, 10 per cent, and whether it is a government guaranteed loan or not a government guaranteed loan.
I keep hearing that the program is cost recoverable; its purpose is to ensure that businesses have access to financing, that perhaps would not normally be available, at fair rates; and that an inundated program can repay itself from the loan losses.
Some might say that we should eliminate the personal guarantee from the SBLA. However, that would mean the loan losses would be driven up and the whole cost recoverable equation would need to be reviewed.
Senator Tkachuk: That is not the purpose of my question. You have made the statement that these are not necessarily required. I then asked you what percentage of the loans do not require them.
Mr. Jentsch: I do not know the answer to that question.
Senator Tkachuk: How can you make the statement if you have no information?
The Chairman: In fairness, I think the witness was saying that there are some loans, the percentage of which is unknown, to which they have not required the 25-per-cent guarantee. He can make that statement. You asked him if they knew that percentage. I inferred from your answer that there were at least some that do not require the 25 per cent.
Mr. Jentsch: Absolutely.
The Chairman: You just do not know the percentage.
Mr. Jentsch: That is correct.
Mr. Coffey: With respect to that point, in 1994, Industry Canada commissioned Allan Riding, George Haines and Carleton University to do a detailed study of this program. They did surveys on collateral supporting and so on. I suspect the trend lines that were identified remain the same today. With your permission I will table this with the clerk for senators' review. Perhaps it is time for Mr. Riding and others to update this material.
Senator Tkachuk: Do you support voluntary associations making use of the SBLA?
Mr. Jentsch: Generally, I support them making use of the SBLA. With a view to keeping the program simple to deal with the mass market, I would want the voluntary sector handled differently because you need to consider them differently. You would take different security, have different rules and make a different analysis. If you add that to the SBLA it would become a monstrous program.
While I support the concept of the use of the SBLA by the voluntary sector, to put it into action, and in the interests of simplicity, I would recommend that you do it outside of the SBLA program.
Senator Tkachuk: Should there be personal guarantees in those cases?
Mr. Jentsch: You would be unable to obtain personal guarantees which would mean you would be looking at the analysis and the due diligence requirements differently.
Senator Tkachuk: Unless you took them from directors.
Mr. Jentsch: That would be an option. I do not know how practical that would be.
Senator Tkachuk: Is this a profitable program for the banks?
Mr. Jentsch: The SBLA program and the total SME banking is profitable to the organizations. The SBLA program is an important component which allows us to participate in the market in a meaningful way.
Senator Tkachuk: Do we need this program?
Mr. Jentsch: Yes.
Senator Tkachuk: If it did not exist, would there be any real difference in the economy? Would the world be any different today?
Mr. Coffey: I believe so. In my submission I noted that this program hasa very useful purpose in supporting Canadian small businesses to grow and prosper. Can changes be made? Yes, and that is what we are suggesting.
Senator Tkachuk: We heard a number of witnesses in Calgary and Vancouver. In the Vancouver area we heard from, I believe, seven companies representing manufacturers, importers and exporters. They are a new alliance. They were all start-up entrepreneurs but they were not aware of the program and had never used it. They became aware of the program when they received our letter. This seems very strange to me.
Mr. Coffey: In 1997, 9 per cent of manufacturing industries availed themselves of loans under the SBLA to the tune of about $179 million. That is not a big percentage but it is relatively significant. Perhaps I would argue with a 93 per cent approval rate. Banks are finding other ways to help those types of companies without relying on the SBLA program.
Senator Tkachuk: That is my point. Do we need the SBLA?
Mr. Coffey: I believe we need it for the immediate future. If you want to come back in five years' time and have another discussion on this point, as I am sure the Senate might, our response might be different. However, we at the Royal Bank see this as a strategically important program for the foreseeable future.
Senator Kolber: Earlier I asked you about the average cost of loans. You may have misunderstood my question. You told me the average cost of loans under the SBLA, but I would like to know the average cost of loans to the small business sector.
Mr. Coffey: With respect, sir, I am not sure that is within the mandate of this committee.
Senator Kolber: That information would give us some perspective of what the government is doing. You do not have to answer. I believe I already have the answer.
Mr. Coffey: I believe this morning you said that you had conducted a telephone poll. I am glad you came back to that question because I gave you a number which applied only to the SBLA. I am not, with respect, comfortable about sharing my spreads on this market.
The Chairman: You may well wish to argue that that is proprietary information and you do not want to release it. I have no problem with Senator Kolber asking you the question. If you do not want to release that information, that is your call.
Senator Eyton: Is the small business market a competitive market? Is it business that banks and other financial institutions want and pursue? You may have a range of answers to that question. Perhaps you are not really enthusiastic about it but you do it because it is a public service, it is a service you provide in the community, and it is part of your overall business. It may be a business that you pursue aggressively and it fits nicely into your business strategies in the overall fortunes of your institutions.
The test, it seems to me, is market share. My question is twofold. I am not particularly asking about the bank's market share relative to that of other financial institutions who deal in that marketplace. I am curious about the individual market shares. I would like to know, for example, what BNS is doing, as opposed to what the Royal Bank is doing, as opposed to what the CIBC is doing in this whole area. I am talking about small business loans. It seems to me that some banks are probably more enthusiastic about this business and are pursuing it more aggressively than others.
If some banks are more aggressive and doing a better job in that sector, what can we recommend that will encourage not only banks but other institutions to be more aggressive in pursuing lending to that sector? How can we broaden their perspectives?
Mr. Coffey: Over 98 per cent of all businesses in Canada are SMEs. This is what Canada is all about. This is what the Royal Bank has in mind when responding to this question. We believe in small business with a passion. It is an important creator of wealth, jobs and taxes. In our case we do more than lend money to that sector, we have a holistic relationship with it.
In the fall of 1994, the Government of Canada established a House of Commons Industry Committee to investigate the relationship between banks and small business. Many of us here today appeared before that committee as recently as two months ago. Clearly, we have shown tremendous progress. We have divulged our market share to that committee, so that is publicly available information.
Senator Eyton: I would be interested in that.
My question was related to the segment of the small business sector who use the SBLA. According to your testimony and that of Mr. Shaughnessy, it was quite small. Who is competitive in that area? What are your respective shares of the market? What are the trends?
Mr. Coffey: Our share of the SBLA program is less than our share of the SME market in Canada. We are taking more small business risks for our own book as opposed to relying on the SBLA. In 1997, 21 per cent of all loans under the SBLA program were granted by the Royal Bank. My colleagues can speak to their market share.
Mr. Jentsch: Of the banks or of the program?
Mr. Coffey: Of the program. It is a tool we have to help small businesses. Last year 5 per cent of all of my lending was through SBLA.
Senator Eyton: Is that going up or down? I am looking for trend lines.
Mr. Coffey: It is stable. Over the last four or five years we have improved our market share of SBLA, but not to the same degree we have improved our market share of the broader SME market, both in volume of dollar commitments and number of accounts.
Mr. Shaughnessy: The small business market in Canada is intensely competitive. As my two colleagues have articulated, we consider it on a holistic basis. We do not want to go in and just make stand-alone small business loans to small business people. We want to be able to meet all of their needs. We want to be able to meet their personal needs as well as their commercial needs.
When you look at it from that point of view, the sweep of products or services that a small business person needs, it is a very competitive market and a very profitable market.
The banker who chooses to ignore the small business market will not have the same results as the banker who does not.
To directly address the SBLA question, the foundation product for a small business person, whether they borrow or not, is the loan product. They want to deal with the financial institution that they know is there today and will be there tomorrow if the need for a loan need arises. It is somewhat different from personal products. They know that they will need a loan at some point in time, and the FI they want to deal with is that FI that they know is in the marketplace. You have got to be there, one; and you are there, two, because it makes sense to be there.
Mr. Howden: In the case of the Hongkong Bank, a high percentage of our small business customers do not actually borrow money from us. A high proportion of our small business customers are actually net depositors. We use the SBLA program to satisfy that customer base for their operating requirements when they decide to expand their business. We do not necessarily go out looking for SBLA accounts, but we service our existing clientele. Hopefully, customers will migrate from our competitors to our institution, and we can serve them.
The SBLA program is the same at our bank as it is at our competitors. The rules are the same.
Senator Eyton: I might have an answer. I am not sure.
The Chairman: Our next witness is Mr. Brien Gray from CFIB, the Canadian Federation of Independent Business. Some of you may remember that Mr. Gray appeared before our committee previously when we were studying Crown financial institutions. As you will recall, this committee recommended certain organizational changes, including doing away with the regional agencies for which we took a significant amount of abuse from many of our colleagues. In any event, Mr. Gray, you were very helpful to us in that study.
We very much appreciate you taking the time to be with us today. You have provided us with a brief. Perhaps you would make some opening comments and then we will proceed to questions.
Mr. Brien Gray, Senior Vice-President, Policy and Legislation, Canadian Federation of Independent Business: I will highlight certain aspects of my statement and then I will be prepared to answer any questions you may have.
CFIB is very pleased to respond to the Senate Banking Committee's request for input on certain aspects of the Small Business Loans Act. We come with what we feel is a unique perspective. Our organization represents about 90,000 small- and medium-sized enterprises across the country. These firms are in every sector and in every corner of this vast geography. We have been watching, monitoring and assessing the Small Business Loans Act for better than 25 years and, as such, we feel that we have become knowledgeable about the program from the perspective of the users, the tens of thousands -- or hundreds of thousands now -- of small business that may have used it.
Historically, our surveys and independent research have pointed to the SBLA as being one of the most effective programs of its kind. According to our members, it is the best known, the best understood, and the most used program of its type at the federal level or at the provincial level.
There are several reasons for this. It has remained relatively constant in its purpose as a program to assist young and small firms in obtaining debt capital because of gaps in equity and capital for this end of the market. The program is accountable. It has been reviewed regularly to ensure that it operates efficiently. The problems are addressed, and new appropriate needs are entertained. Finally, the program has worked in no small measure because the politics have been kept out of an independent and inherently good program.
In spite of our support for the SBLA and its role for the small business community, we are concerned that the program stick to its fundamental principles in order to sustain itself. Efforts to steer it away from those fundamentals have and will put the entire program at risk. We do not believe, for example, that is a risk worth taking. As one reads through the consultation paper, one is struck by the range of new applications being suggested for the program, and CFIB would remind the government to stick to its knitting with respect to this program.
We have long been on record as saying that working capital needs should not come under the SBLA because it is our experience in other countries that it could ruin the program. Lending for working capital purposes is a very different type of game, and if the government is determined to go in this direction, it should test the program on its own measures and see whether it works.
At the end of the day, we worry about the long-term sustainability of the SBLA. We believe that it is dangerous to park every conceivable need under this program.
Finally, the government must reject the suggestion that the only way banks will lend to export firms, KBIs, micro firms, the voluntary sector, is to do so under a credit guarantee scheme. As useful as the SBLA is, it should in no way be used by the banks as their response to the broad financing problems experienced by the majority of small firms in this country.
I think it is important to talk about a number of specific issues and I have outlined a few.
On program numbers, CFIB has been concerned for some years about the number of loans being made under the program. Throughout most of the 1980s, the number of loans under the program each year was in the 16,000 to 17,000 range. Following the changes to the program in 1993, those numbers rose quickly to peak at 68,000 in 1994-1995. Since that time the numbers have fallen due in some measure to the changes in 1995 to about 30,000, and I believe it is below that now.
In 1994, we wrote to Minister Manley to register our concerns with aspects of the SBLA that we felt needed attention. We were particularly concerned that up to 16 per cent of total small business term lending had been financed under the SBLA since the 1993 reforms. CFIB believes that the numbers are still too high and risk going even higher if the some of the present proposals for expansion of the program are accepted.
With regard to program parameters, CFIB is of the view that the overly generous parameters of the program resulted in larger than anticipated up-take column shifting and the need for the department to go back to further funding allocations during the five-year term.
We have in the past called for these parameters to be tightened. In 1994, CFIB members had a median loan size of about $50,000. That figure increased to $90,000 in 1997. The average size loan under SBLA today is about $65,000. Further, the higher limit may be creating problems related to larger firms trying to beat the system.
For several years CFIB called on the government to lower the SBLA loan threshold from $250,000 to $150,000. In view of the present deliberations, we felt that it was important to again ask our members for their views on this. I should report to you today that 49 per cent said that it should be left at $250,000. However, the narrow margin of the vote would suggest that we think it would be wrong to increase that threshold. If, as some people have suggested, it were increased to $500,000, it would put enormous pressure on the program and the government coffers which could well jeopardize the program. Remember, the average loan size is well under $100,000.
We also believe that the sales volume threshold is set too high.
The Chairman: Mr. Gray, may I interrupt you with one question? What is the current sales volume threshold?
Mr. Gray: It is currently $5 million, but I would report that 7 per cent of our members are at $5 million in sales, and up; and 18 per cent are at more than $2 million in sales. Statistics Canada figures would support that. Those who would argue that we need to keep larger firms and larger loans in the program to subsidize the program are, in our estimation, wrong-headed. The issues is whether these firms need SBLA-type credit guarantees, and the CFIB submits that loans of this size are beyond the fundamental scope of the program.
Another issue that relates to the program, its numbers and sustainability, is that of the types of enterprises that qualify under the program. It would be difficult to argue the case of need for major franchisees, fleet operators, dentists and the like. Further, we would argue that, if there is a need for assistance for the voluntary sector or CFOs, those needs should be dealt with outside of this program, and it is questionable whether the banks should be made program deliverers for every conceivable idea under the sun.
Senator Meighen: What is "CFO"?
Mr. Gray: Canadian financing operations.
On micro loans, CFIB is concerned that some lenders may be treating the majority of their micro loans under the program. In effect, if you want a micro loan, you can get one, but it must be under a credit guaranteed scheme. In our view, statistics should be kept and analyzed to determine whether or not the numbers are disproportionate.
On the subject of column shifting, the CFIB continues to be concerned about the phenomenon of banks shifting lending that should be done outside of the program onto the SBLA program, effectively moving the risk off of their books. We have raised these concerns with ministers responsible for the program and the numbers in the 1980s versus the 1990s seem to be an indicator that there is something to it. Earlier, Mr. Coffey mentioned Mr. Riding's report. He also deals with that in his report. We feel that there ought to be program evaluation criteria set up to monitor, on an ongoing basis, the levels of incremental lending under the program, including analysis by institution.
Transparency: CFIB believes that those who received funds under the SBLA must be aware of that fact. Several sources have indicated that many loan applicants do not know they are receiving money under a government guaranteed program for which they pay a premium. As a result, they may not be making an informed business decision to proceed under the program or to remain in it.
The SBLA application form must be fully transparent and loans officers must be required to fully explain the opportunities and the costs of this form of financing. The government should get some credit for the program it is delivering.
Data collection and monitoring is a serious issue. The methods of assessing the program are critical. In the past, the program had the weakness of not keeping relevant statistics. Tighter monitoring and program evaluation is a must. For example, to what extent do we know today which elements of the 1993 and 1995 changes bore fruit? To what extent can we measure the effects?
On another note, judging the SBLA by jobs produced is, in our estimation, more of a political measure than a true measure of this program's success. Measure, instead, firms that graduate from the SBLA program, their growth rates, their financing needs, and the like.
As to regulatory flexibility, CFIB understands the need for governments to be able to move quickly when problems need correction under the program. An example would be where abuses of related companies occurred. In such cases, a regulatory approach makes some sense, however, for those issues that are fundamental to the program, for example, structural changes to the program such as lenders permitted, loan thresholds, qualifying loan recipients, these things should be dealt with under legislation, not regulation, in order to ensure accountability and transparency under the program.
As we understand it, some lenders have asked to be able to charge service charges beyond the charges inherent in the program. The rationale for this proposal is that such policy would be more in keeping with normal banking procedures. CFIB rejects the notion of adding these fees to the SBLA program. Our members have consistently complained about service charges, the arbitrariness of their application and the levels charged, and the lack of correlation between the service charge and the value of the service. We do not think it is appropriate that the federal government program add these types of charges to the SBLA program.
Finally, as we pointed out in the section under "Transparency", we feel that it is important to differentiate loans under the SBLA from the so-called "normal" loans.
With regard to capital leasing, CFIB, frankly, has not had loud cries for this form of financing to be available under the program. The need has not been clearly established, and we suggest that Industry Canada determine the levels of need and then test out options before determining that the appropriate policy response is to incorporate these types of loans under the SBLA.
I will briefly turn to the provision of equity capital because, after all, the SBLA was set up in part because of equity capital gaps in the marketplace. One cannot discuss these issues without also discussing adequate access to capital. In the last 20 years, far too little attention has been paid, in Canada, to the equity issue as it affects small firms. The hangover effect from the recession on small-business equity levels continues. In the face of weakening market conditions and often massive cutbacks on small-firm lending, many firms were forced to draw from their equity bases to survive. As the economy has strengthened, a different tax mix has made it difficult for small firms to reestablish their equity base, and reduced equity levels make it difficult for many firms to lever more credit financing. In our view, the consequent effect is sub-optimal job creation.
The present range of tools to address this issue is seriously insufficient. A survey of our members in 1997 identified personal savings, 56 per cent, and reduced taxes or higher retention of earnings, 45 per cent, as the most appropriate sources of equity financing for small business.
In contrast, there was low support for passive investor angels, 5.2 per cent, venture capital companies, 4.1 per cent, and labour-sponsored venture capital firms, 1.1 per cent, as appropriate sources of equity.
Clearly, programmatic solutions and LSVCCs are not the solution for our sector. The issue was identified by the Small Business Working Group's "Breaking Through Barriers" report which was produced in 1994. This group, which was appointed by Ministers Martin and Manley, suggested the use of instruments of fiscal policy to resolve the equity gaps for small firms. Solutions practical to small firms must be pursued with more vigour. Better solutions to the equity issue for small firms will do much to build not only the financial health of the firm but also its ability to grow and contribute to the economy in terms of jobs and wealth creation. Another outcome would be less reliance on government subsidized credit-guarantee programs such as the SBLA.
I would be remiss if I did not make some reference to our concerns about the proposed mergers and their effects on this program. It is difficult to review a financing program, one that is delivered in large part by Canada's major chartered banks to small business, without some consideration of the implications of the proposed bank mergers.
CFIB has taken a look at some recent SBLA numbers and has observed that in Ontario, for example, if the four banks were reduced to two, those two banks would account for more than 75 per cent of the number of SBLA loans and more than 75 per cent of the dollar value. Of course, these figures will be higher in some communities. Inasmuch as this program and the loans under it are aimed at young and small firms, and given that small, young firms are providing the majority of the net new jobs in the economy, the vast majority of SBLA loans would be monopolized by two mega institutions.
As part of your review exercise, we believe that it is critical to gather data from the banks to assess the impacts of possible bank mergers on the SBLA program.
CFIB has outlined our views and concerns about the SBLA program and we have reiterated several as well. We encourage you to read the previous letters that we have written to ministers. Some of the parts are outdated but some are still relevant. We believe that many of the concerns that we have expressed are still valid.
Finally, we believe the SBLA program, tightly defined and administered, will continue to play a very important role in the development and growth of the small-firm sector in Canada as it has for many years. However, we recommend that you proceed with extreme caution when contemplating major structural changes to the way in which SBLA operates. In effect, if it works, do not fix it. Thank you very much.
[Translation]
Senator Hervieux-Payette: In terms of debt-equity ratio, has the situation of small and medium-sized businesses improved or has it remained the same? After all, that is in a way the foundation for the whole future of small and medium-sized businesses.
Over the past five years, has the situation improved, in your opinion? When dealing with this program and other government measures, we want to proceed in a balanced manner. Often what threatens a business's future is too large a debt load. If getting into debt is encouraged and the entrepreneur does not have the means to balance his debt-equity ratio, do you think we have all the tools we need at the present time to help small businesses and assure not just their growth but their very survival?
Mr. Grey: That is what I was just talking about; in other words, the equity financing situation for small businesses everywhere in Canada is a problem. You hear a lot about what in English are called "sponsor venture capital corporations" and "angel investors". But the statistics have shown us recently that these are really a very small part of the market.
In our opinion the most useful approach -- and this is reiterated in the report entitled "Breaking the Barriers", on tax instruments -- is to promote protection of the equity within the enterprise, in other words to reduce the tax burden on these enterprises. They are so small that they have no opportunity to raise money on the public markets like the "venture capital corporations" or from "angels". So it is difficult for them to get access to alternative sources of financing, as far as equity is concerned, and that is why I mention it. It has been years since there were any changes. There are plenty of incentives to invest in IBM Canada or companies like that but there is practically nothing encouraging Canadians to invest in small business. That is precisely the problem.
Senator Hervieux-Payette: You are not speaking necessarily of the owner or the entrepreneur, but of Canadians who would put money into a fund, which could result in a tax benefit, and this money would be directed toward small business?
Mr. Grey: The informal equity markets in Canada are much bigger than the formal markets. The tax system must be changed to encourage Canadians to invest in small businesses. Small businesses are creating jobs in all regions of Canada. The problem is that, especially since the 1980s, taxation as a whole in Canada has changed a great deal. Before that we had a system based largely on a progressive income tax; now it tends to be regressive. In other words, the focus is on payroll taxes and other similar taxes that basically erode the amount of the profit that a company can keep, and that is the problem. We have to change the incentives to invest in equity funding for small businesses.
Senator Meighen: Does the capital gains tax have an unfavourable effect on equity investment in small business, in your opinion?
Mr. Grey: It does, senator, but I have to say that it is only one part of the bigger picture. There are a number of elements to consider. You have to have the capacity to retain money within the enterprise from one year to the next. So if I was in difficulties during the recession and I had to use up the equity portion of my company, today's problem, in comparison with the 1980s, is changes in taxation as whole. Now I have less ability to retain funds in my enterprise, funds that I could use to expand it. This means much greater pressure on me to get into debt in order to fund my enterprise. Capital gains are important but they are only a small portion of the whole thing.
Senator Hervieux-Payette: I think it is important that we have to look at these measures as a elements of a whole rather than on an individual basis, because businesses need all these tools if they are to grow.
I know that your membership covers a very wide spectrum. Earlier you heard witnesses telling us that certain sectors are much harder to find financing for, including one in particular. The minister has of course asked us to consult the knowledge-based enterprises. Let us take biotechnology and computer technology. Do companies in these sectors tend to belong to associations like yours or do you have closer ties to the manufacturing sector?
Mr. Grey: No, they are members of our association. We have many members from both those sectors. We have 90,000 members across Canada. Just about every sector is represented in our membership, but I should point out that the reason why it was suggested, if you look at this sector in particular -- the banks themselves will admit that it was only recently they began to understand how to make loans in this market. It is an extremely unusual market. Loan financing becomes a little like working capital for these enterprises. It is a style of lending that is very very different from the one envisaged by this program. A pilot test under the SBLA was suggested, and it should be done, but not as part of this program. Otherwise, I have the impression that the program, which currently is working extremely well, might be put at risk.
Senator Hervieux-Payette: The banks have little experience with the sectors we mentioned, including the knowledge-based industries, and I would tend to think, like you, that this situation does not necessarily exist everywhere in the country. Expertise is not uniform everywhere, in all small cities and towns across Canada. The major urban centres are certainly better equipped to assess risk and give a fairly rapid response. If a company is located in a small town and it has to go to the head office or somewhere else for the analysis to be done, that involves travelling, changes and so forth. The assessment process costs too much and so it does not really help these enterprises, which in my opinion are the enterprises of future.
So when it comes to our making recommendations to the minister, your preference would be that the knowledge-based industries be given a temporary experimental program until such time as we can determine what measures or what kind of program would be best to introduce that would not affect the other enterprises in the regular program. The existing program does, in your opinion, respond to the needs of the traditional sector?
Mr Grey: Yes, but we really have to be clear on the fact that making loans to the knowledge-based sector is very different from making normal loans. That being the case, as you just said, the banks have centres that specialize in the knowledge-based sector but you don't find those centres just anywhere. Perhaps we should be looking at a program that allows for this. That is why we are suggesting that it should be tested separately. If a unique solution can be found for this sector, it should be. I would like to add that the equity aspect is extremely important for this sector.
Senator Hervieux-Payette: In my humble opinion, the risk capital funds may in some cases be more specialized and have the expertise to do a better analysis in this area. But there again, they are not necessarily represented in every small community in Canada; they are found in the major urban centres and are perhaps less accessible.
My colleague was speaking of tourism. I know the Canadian government is making a massive effort to coordinate its efforts with those of the provinces and the private sector to bring new vitality to this area. I think Canada's tourism potential is really underdeveloped. On the other hand, despite this it is apparent that more efforts could perhaps be made. Is your federation in contact with the association representing the tourism industry and with the governments that are responsible for investigating how to help these industries, which call for as much investment as the knowledge-based sector? Have you worked with them? What are your suggestions for achieving progress in this sector?
Mr. Grey: We often have dealings with the tourism sector and a number of tourism companies belong to our organization. When I was with Philip O'Brien, who co-chaired the report "Breaking the Barriers", there were a great many tourism enterprises that insisted that the Business Development Bank of Canada had to be maintained because in their opinion it was the only source of debt financing for those enterprises in the 1990s. So there you have one component that so far has been extremely effective for the tourism industry. I do not have figures on the availability of SBLA funding for the tourism sector, so I cannot really answer you on that.
I would like to revert to the theme of equity. If as a Canadian I see an opportunity in the market of helping a tourism business in my own community, why should there not be some incentive for me to assist that local business? That is basically what I am saying: Canadians across the country should be encouraged to invest in support of businesses that they know well.
Senator Hervieux-Payette: Could I interpret your comments to mean that a program like Quebec's Régime d'épargne-actions, which provides a certain tax benefit, could set up investment funds for these sectors, whether high tech or tourism, and thereby enable investors to go into higher-risk sectors and also to benefit from growth in the sector generally? Not all enterprises will necessarily run into difficulties, after all.
Mr. Grey: I agree that it is important to look at the Régime d'épargne-actions as a tool. The government should make an in-depth examination of equity access for all small and medium-sized businesses in Canada through the Régime and other mechanisms, in other words offer an incentive to invest in funds outside the Régime, so that investment funds can be oriented towards small- and medium-sized businesses in Canada. They are the ones that are creating jobs, and we ought to help them.
[English]
Senator Callbeck: I should like clarification of the statement on your first page where it is stated that working capital needs should not come under this program. Is that because the program is self-supporting and you believe that, if working capital is included, the fees would have to be increased?
Mr. Gray: My thinking behind that is based on our examination of programs in other countries that have credit guarantee schemes and that have tried to include working capital assistance in them. The programs have, effectively, blown up. That is because the risk inherent in working capital lending is quite different from the risk inherent in term lending.
The advice from our organization, and I believe the banking community, has consistently been: Do not include working capital because you may blow it up. If you want to test that, do a pilot test outside of the program to determine if it is doable because, frankly, the evaluation of that will have to come from a different perspective.
Senator Callbeck: I see no mention of the current provision related to the personal guarantee of up to 25 per cent.
Mr. Gray: It is not in the presentation. Historically, the federation has argued that there ought to be no personal guarantee. The reason for that is that, if the government is providing a full credit, then presumably the bank's positions are covered and there is no need for a personal guarantee.
The "compromise", if I could call it that, from those negotiations was the 25 per cent level. In the early days after that, some institutions -- and I do not know if malice was intended -- as a means of covering themselves, were asking for 25 per cent coverage from each of four partners in a firm so they would have a 100-per-cent personal collateral guarantee. We blew the whistle on that and that has been clarified and rectified.
I believe that the intention of the ministers responsible for the program -- and I guess the banks convinced them -- was that there should be some proof that a borrower would be serious about repaying the loan and, to that extent, there should be some personal participation.
Senator Kenny: Your organization now accept this as an important feature. Your organization does not quibble with the 25 per cent.
Mr. Gray: Our preference would be not to have it, but we are not hearing a hue and cry that it is an unfair requirement.
Senator Kenny: If you were lending money, you would probably like to know that the individual would have some sense of personal involvement.
Mr. Gray: That is probably so.
The Chairman: I might add for the record that a number of the business witnesses both in Atlantic Canada and in the west made the argument Senator Kenny just made, which is that it shows a degree of personal commitment to the business by requiring an element of a personal guarantee and, in fact, they encouraged us not to drop this requirement. These were people who were actually borrowing under the program.
Mr. Gray: Well, I think one of the reasons we did not put it in the brief itself was because we felt that it was effectively an element that will not change under the program.
Senator Kolber: Has anyone in this room ever gone to the bank and not been asked for a personal guarantee? If you want money, you sign for it.
Senator Callbeck: Some witnesses we heard in Atlantic Canada expressed a desire for a longer term. Do you have any thoughts on that?
Mr. Gray: We have not asked that specific question of our membership, but it is a good point.
Senator Angus: You have made some very interesting comments, Mr. Gray. Were you in the room when the first witnesses were here from the leasing asset division?
Mr. Gray: No. I was not for the leasing folks.
Senator Angus: The thrust of one of their comments was that this is a very outmoded piece of legislation, that it has failed to keep up with modern technology as it applies in the financial services industry generally, and more particularly, it has failed to adapt to some of the sophisticated financing methods available today in the marketplace.
I am trying to reconcile those comments with what I understand to be your bottom line which is: If it ain't broke, don't fix it. Tone it down a bit; shrink it. The SBLA is fine with you. There is no great hue and cry from your members. Is that a fair comment?
Mr. Gray: In a nutshell, our position on the SBLA would be that the vast majority of lending in this country must and should come from the banking and other financial institutions that serve small business. However, if we believed that everything under the sun ought to be credit guaranteed, then we would be in big trouble.
Our response generally has been a reflection of our members' views which are generally conservative: make it work, make it work effectively, but let private markets work in the normal way.
Our membership have not told us that they have trouble with leasing and that they need a credit guarantee scheme to access leasing.
Representatives of the industry have told me that, because credit scoring is used, firms in their first couple of years of development cannot be adequately assessed as being a safe risk, so companies will not lease to them in those circumstances. My response has been to ask if their proposal is related to firms of two years and younger. If that is where the need lies in the marketplace, then their proposal should be restricted to meet that need.We must establish the nature of the need in the marketplace, understand it, and then figure out the appropriate solution.
Senator Angus: A couple years ago this committee conducted a study of several government financing organizations such as ACOA, and the general guidelines upon which we addressed the subject was that these organizations were established at a time when a credit gap existed in certain sectors of the economy and it was appropriate to set up some kind of a help mechanisms, but not with a view that they would become a permanent fixture in the bigger scheme of things in this country.
I was intrigued by your comment that one of the main reasons for setting up the SBLA in the first place back in the early 1960s was that there did exist at that time a credit gap for equity capital for small business, and that the private sector financial marketplace was unable to fully respond to those needs. Do you perceive that such a gap still exists?
Mr. Gray: As I mentioned earlier to Senator Hervieux-Payette, our estimation is that this equity issue for small firms is a very serious one. To my recollection, this issue has not been examined in any meaningful way by anybody in government, and I have been representing small business for close to 20 years.
As I tried to explain in French, hopefully eloquently, there is a change in the product mix. Prior to the 1980s when we had a lot of tax reform in this country, we had a system that was predicated more or less on a progressive form of taxation. Corporate taxes were higher, but there was far less reliance on other, what I would call, "regressive" taxes, payroll tax. In the last several years, you have seen CPP going up by a great deal. The province of Quebec health tax has more than doubled in the last 10 years.
Your ability to come out of rough economic times requires compromise. Formerly, you would rob your bottom line, your equity base. Then you would plow your earnings back into your firm and create a solid equity base so that you would have an easier time with the bankers. The situation today is much different from what it was then.
In 1994 when Phil O'Brien made recommendations to the government we were still on a deficit objective, and I believe we still should be.
I think this is an appropriate time to examine in great detail the levels of equity in small firms in this country. Most small entrepreneurs in this country are far from rich. They are making a huge contribution to this country but they are not making a lot of money. In fact, some are marginally viable, but they keep at it. We owe it to them to consider this equity capital issue to help them to continue to provide the jobs and wealth in this country that we need.
Senator Angus: Perhaps one result of our study will be to scrap the SBLA and recommend some other type of small, government-backed vehicle. How would you view such a recommendation?
Mr. Gray: I think the SBLA has got to remain as long as that gap exists and, for the foreseeable future, I think it will exist. That is not to say we ought not to complete this examination.
Small firms cannot go to public markets. As I mentioned in my remarks, venture capital corporations, LSVCCs, angels even, form a very narrow, little band. Although it is trendy to mention these sources, these are not a realistic, practical source for our constituency. We have argued that the tax system is the best way for firms to retain earnings and to plow it back themselves, and to encourage other Canadians to invest their savings in developing companies.
The Chairman: I gather from your answer to Senator Angus and your presentation that, while you do not want leasing to be included in the program, you would have no objection to a pilot program designed to meet that need. That being the case, how should that need be met?
Mr. Gray: The government is constantly examining the different ways to go about understanding changes in the economic environment. I think it would be responsible to test this out before you initiate a program.
The Chairman: That is what I meant by "pilot program".
As to your question about lowering the sales volume, can you give us any idea as to what it should be? You said that $5 million was too high, but you did not suggest a reasonable alternative.
Mr. Gray: If 25 per cent of firms are $2 million and over in sales, then it begs the question: What is the correlation between sales volumes and need under the SBLA program? If there is any inclination to increase that sales threshold, I would suggest you resist it.I think you could probably retain that and still be fine under the program.
The Chairman: By "fine" do you mean "not too risky"?
Mr. Gray: I do not think it would change the program a whole lot, but you might find that you have less difficulty with larger firms trying to break down loans in order to get into the system.
The Chairman: I was not surprised by your position: If it ain't broke, don't fix it, but I would have thought that a fair number of your members would be in knowledge-based industries only because there has been an enormous growth in the number of small, knowledge-based industries. First, are they part of your organization?
Second, assuming you have some information on them, are there things that need to be done differently for knowledge-based industries that do not have some of the hard assets held by other industries?
Mr. Gray: To answer your first question, yes, they are in our membership and, yes, we try, when we do banking surveys, to break out their experience as much as we can. I will be glad to send our most recent ones to your committee.
However, with regard to this program and knowledge-based industries, lending to the knowledge-based industry is very specific-skilled. It is not available outside of the SBLA throughout the system of banks. They will admit they have only recently understood how to go about lending to this industry. To the extent they do, it is done largely by only a few commercial banking centres in specific areas.
This program is predicated on broad distribution to a broad number of firms, but the risk inherent in those kinds of firms is different.
The Chairman: It is different because you are, basically, betting on an individual and an idea which is not a tangible asset. There is no hard asset which could be seized if things go bad.
Mr. Gray: That is right. One of our recommendations to the Berger Committee was that we should encourage, for example, the CICA to have what I call an "IT" section. The Canadian Bar Association has such a section. These folks are very knowledgeable about specific elements of this type of lending activity and, I think, could bring a lot of brain power to understanding how to assess, how to deal, and how to provide the appropriate funding mechanism to that industry. I doubt whether it would be aligned along the lines of the SBLA. For that reason we think you should consider a different design.
The Chairman: It is clearly an important sector of the Canadian small-business economy and it may require a different type of program.
Mr. Gray: Absolutely. Equity is critically important to that industry.
Senator Tkachuk: I agreed with your comments about the overall problem of how we, as a nation, can ensure that there is financing for small business. I recognize that we have a problem in the tax system that acts as a deterrent for small businesses to accumulate retained earnings. Small business people tell us that they want this program, not because they think it is a good program but, considering the problems we have in other areas, it is the only alternative for them.
Mr. Gray: This program was initiated to assist small, young firms, and often "young" was more important than "small". Historically, small firms have run into problems accessing equity capital. At the outset, they are often under financed and the banking community, to some extent justifiably, will not make a loan to them if they have insufficient equity. The guarantee program helps them overcome that gap in the early years.
One would hope that, as a firm grows, it will have the ability to retain earnings, plow them back into the business, and exit the program. That was the original intent of this program. We think that there is still a need in the marketplace for that gap to be filled, and that is why we continue to support the program. In a perfect world, you would not need this program.
Senator Tkachuk: In Saskatchewan some businesses have a 37-per-cent or even a 50-per-cent tax rate. Any amount over $200,000 is taxed at 50 per cent, and under $200,000 is taxed at 37 per cent. Small business people take any cash over $200,000 out of the business because there is no incentive to maintain cash in the business. That also prevents small business from lending to other small businesses, and that is what entrepreneurs like to do. That market no longer exists. People used to start up in business with assistance from their friends, associates, and other business people, and not necessarily the banks.
If we increased the threshold to half-a-million dollars from $250,000, there would be a demand. We have created the supply of cash and credit.
My point is that I do not think this program is a good program. There are other ways to do this that would not involve the taxpayer as the risk-taker. We want to know how we can solve that problem.
Do small business people like the program because they believe it is necessary to the economy of the country, or because the options outside of it are so unappealing that that is the only program that they can use?
Mr. Gray: I think those two go together. Without it there would be a problem for the economy.
Small firms compete for investment dollars. There are now so many competing tax incentives for my dollar that it would pay me, as an investor, to invest somewhere other than in a small business. Investing in a small company is not trendy, it is not sexy, it is not glamourous, whereas investing in other areas is.
Frankly, small businesses are the worker bees, the worker ants, of this country and we must start supporting them in a more coherent way on the equity side. I think that would result in a huge improvement in economic activity in this country. The large firms are shedding jobs, they are rationalizing. The future of this country will be dependent on providing equity sources to the small firm sector to encourage it to grow again and to get back to the kind of historical investing you mentioned.
Senator Oliver: You told us that there are certain normal banking practices that support fees for loan applications, renewals and other fees. You also told us that your members have consistently complained about service charges, the arbitrariness of their application and levels, and the lack of correlation between the service charges and the value for those services. Do you have any letters, documents or statistics to prove those fairly strong statements?
Mr. Gray: Yes, I do. We have issued a myriad of reports on this issue, the most recent of which was earlier in the year. I would be happy to give you a copy.
The Chairman: Mr. Gray, thank you very much for your assistance.
The committee adjourned.