Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 6 - Evidence - December 1, 2011
OTTAWA, Thursday, December 1, 2011
The Standing Senate Committee on Banking, Trade and Commerce met this day at 10:32 a.m. to examine the present state of the domestic and international financial system.
Senator Michael A. Meighen (Chair) in the chair.
[Translation]
The Chair: Good morning, everyone, and welcome to our meeting to discuss the domestic and international financial system. I am Senator Michael Meighen, from Ontario. I have the honour to chair this committee.
[English]
I will begin by introducing the senators present at this moment, although I am sure others are en route. To my immediate left is Senator Pierrette Ringuette from New Brunswick; to my right, Senator Larry Smith from Quebec; to the right of Senator Smith is Senator Stephen Greene from Nova Scotia; Senator Carolyn Stewart Olsen from New Brunswick; and Senator Donald Oliver from Nova Scotia. You can see we have a strong Maritime contingent.
Today, we are pursuing our special study regarding the financing of growth capital for small- and medium-sized enterprises. For our first session this morning, we are pleased to welcome Mr. David Phillips, the President and Chief Executive Officer of Credit Union Central of Canada; Mr. John Lahey, President and Chief Executive Officer of Alterna Savings; and Mr. James Gosselin, Vice President, Corporate Lending, Steinbach Credit Union.
Gentlemen, thank you for taking the time to be with us. We appreciate your assistance in our deliberations. Will you lead off, Mr. Phillips?
David Phillips, President and Chief Executive Officer, Credit Union Central of Canada: Yes, Mr. Chair, I have about 10 minutes of opening comments.
The Chair: We look forward to them, following which I hope you will all be amenable to answering questions.
Mr. Phillips: Very much so. Thank you for inviting us to share with you our thoughts on what the federal government might do to improve access to financing and growth capital for small- and medium-sized enterprises.
My name is David Phillips, and I am CEO at Canadian Central. I have with me today two representatives from the credit union system who will be pleased to share their experience as well. To my left is John Lahey, Chief Executive Officer of Alterna Savings, an Ontario-based credit union with branches in Ottawa, Toronto and areas around those two cities. Alterna is one of Ontario's largest credit unions and is active in the SME micro-lending sector. To my right is James Gosselin, Vice President of lending at Steinbach Credit Union in Manitoba. Steinbach is one of the 10 largest credit unions in Canada, with significant lending to agriculture and commercial businesses in Southern Manitoba.
Credit Union Central of Canada, my organization, is the national trade association for its member organizations, provincial centrals and through them, 378 Canadian credit unions.
Credit unions are full service, cooperative financial institutions that are owned by their members and their customers. Canada's credit unions hold about $136 billion in assets and operate a branch network of more than 1,700 locations outside of Quebec. Within Quebec, our friends in Caisse Desjardins operate there. We are substantially outside Quebec. These branches serve more than 5 million members and employ almost 26,000 people.
Credit unions are known for their community involvement. For example, credit unions operate the only brick-and- mortar financial institution in more than 380 communities across Canada. In 2010, credit unions contributed more than $37 million to their communities, equal to more than 4 per cent of their pre-tax revenue.
These ties to community create a natural affinity between credit unions and SMEs. Based on the most recently available data, credit unions account for approximately 18 per cent of the SME market. In this case, we are referring to SMEs as organizations with 50 or fewer employees. This market share is more than three times larger than the credit union system's overall weight in the financial services sector as measured by our share of total domestic financial assets.
Historically, credit unions have been important partners in federal programs aimed at supporting small businesses. Of particular note has been the credit union system's use and support of the federal government's small business financing program. According to Industry Canada data, credit unions and caisses populaires were the heaviest users of the program in 2010-11, accounting for 29 per cent of all active loans under the program.
Canadian Central recently held a webinar to further improve take-up of the small business financing program in the credit union system, and the webinar attracted a record 165 registrants from the system, a clear sign that the credit union system values this program.
The credit union system also expresses its commitment to SMEs through stand-alone activities. For example, Mr. Lahey's credit union, Alterna Savings, has a very active micro lending program to finance entrepreneurs. These micro loans are for a maximum of $15,000 although most loans are for amounts less than $10,000. Over a 10-year period, Alterna has lent more than $2 million to help more than 400 micro-business owners to start businesses and expand through the purchase of productive assets, the acquisition of workspace or the development of ecommerce applications.
Throughout Canada, we see similar evidence of credit union commitments to SMEs. In British Columbia, for instance, six credit unions along with some outside partners formed the Southern Interior Innovation Fund, the first private equity fund of its type, to focus on the southern interior of British Columbia.
In Nova Scotia, credit unions in partnership with the Nova Scotia Co-operative Council and the provincial government, offer various guarantee programs to higher risk small businesses, including those owned by new immigrants, fishers and forestry workers.
The deeper motivation behind all these credit union programs and funds is to finance the kind of innovation that the committee is interested in, whether we are talking about micro-enterprises or companies that find themselves in the in- between space where financing is hard to get.
In my remaining time, I would like to put forward two recommendations that we hope will be of assistance to the committee in its deliberations.
Our first recommendation touches upon the role of the Business Development Bank of Canada and Farm Credit Canada. Credit unions believe that BDC and FCC play an important role in supporting Canadian SMEs, and credit unions often partner with the Crown financial institutions to serve their members. However, we believe that BDC and FCC should behave in a way that complements the lending activities of private sector financial institutions. A strong complementarity mandate will ensure that the Crowns focus on filling financing gaps, partner with financial institutions on particular transactions and support credit union markets through difficult financial times.
We are concerned that some of the changes that BDC is seeking in its legislative framework could weaken its commitment to behave in a complementary fashion. We have recommended that BDC's complementarity mandate be strengthened. As you know, BDC's mandate is under review and we look forward to participating in the next phase of the process.
The Chair: Could I get a clarification? This committee did a study on BDC not so long ago.
Senator Ringuette: We had the same recommendation that you are giving now.
The Chair: Now you say "as you know," which I did not, "BDC's mandate is under review." I suppose it has not been dealt with subsequent to our report. Certainly, during the testimony we heard and evidence we took, it was clear that a complementary role was the one that BDC said that they played and that everybody agreed they should play.
Obviously, there is still a concern there.
Mr. Phillips: Mr. Chair, I believe the Senate was an important part of the review process.
The Chair: It does not seem to have come to an end yet.
Mr. Phillips: I think we are waiting. It has all gone within the federal government, and we are now waiting to hear what the results of that are.
The Chair: Thank you. We will follow up on that.
Mr. Phillips: You are right; we appeared before this committee and we were appreciative of that. We were appreciative of the committee's report and its support for that particular item. We have not yet seen how this ultimately will play out in the recommendations.
The Chair: I apologize for interrupting you.
Mr. Phillips: Not at all.
FCC is interesting. Our concerns with respect to FCC are the following: First, unlike other Crowns — EDC and BDC, for instance — there is no legislative requirement for Parliament to periodically review the FCC's legislative mandate. Second, there is no legislative requirement for FCC to behave in a complementary fashion. Third, since 1993, Farm Credit Canada has more than doubled its share of agricultural lending in that market to 28 per cent. Our concern is that they are able to expand their market share by virtue of special advantages they get from being a Crown institution. At the very least, the mandate of Farm Credit Canada should be subject to a legislative review, just like other Crowns, on a periodic basis.
Second, we are concerned that recent changes to the Survey of Suppliers of Business Financing — this is a StatsCan and Industry Canada product, a key source of information about SME financing — produce an incomplete picture of credit union lending activity. Due to budgetary pressures, the survey now samples 120 financial institutions rather than the 1,620 previously. With some 378 credit unions, this means that the survey necessarily misses a large number of credit unions.
From a policy-making perspective, this change could jeopardize the federal government's ability to accurately assess who is contributing to the success of its SME initiatives. This, in turn, could have an adverse effect on the design of government programs aimed at supporting the SME sector. We recommend that the government provide sufficient funding to the survey such that it can cover a more complete range of financial institutions, including credit unions.
To conclude, Canadian Central thanks the committee for the opportunity to contribute to its study into SME financing and innovation. Credit unions are community-based institutions that understand the needs of SMEs. We would be pleased to provide you with any additional information you may require. In particular, we look forward to your questions.
The Chair: Thank you very much, Mr. Phillips. I think I can speak for all members of the committee when I say that we appreciate briefs like this that are succinct, clear and deal with the mandate of the committee. Thank you for that. That will be very helpful to us.
Unless Mr. Gosselin or Mr. Lahey have any comments at this point, we will go right to our list of questioners.
Senator Stewart Olsen: Thank you for being here. I recently met with representatives of credit unions when they did their day on the Hill. One of the things they mentioned is that you are looking for a change in regulations and that you are overregulated in the same way that the major banks and financial institutions are regulated. Is that something that you are looking at as well?
Mr. Phillips: Yes, that is a concern. In a sense, credit unions are the SMEs of the financial services sector.
Senator Stewart Olsen: I apologize for bringing this up, but I think it is important we have this read into our record here. Being from New Brunswick, I know that sometimes, in certain areas, credit unions are the only place available for people to do their banking and their business. If you would not mind going through the regulation changes you would like to see and reading them into the record here, that might be helpful.
Mr. Phillips: I do not have specifics, but I think the way we were expressing it during our visits a few days ago is that we are the SMEs of the financial services sector. We find that many programs are designed with much larger institutions in mind. We are not against regulation, but what we suggest is that it should be tailored to different-sized institutions.
There is an expression that I think the CFIB uses — and it may come out of the Red Tape Reduction Commission Report — a reference to a small business lens; that in approaching regulation, one should apply to the regulation a small business lens, and what would the impact of this regulation be on a smaller-sized institution?
It is always a little dangerous to walk into this area because it can be misconstrued, but any money laundering, for instance, is an area where there are huge numbers of reports filed with the federal government, and the credit unions are under the same regulations as the banks. These reports have to go in, and we see that only a very small percentage of them are always acted upon.
That leads us to question whether it is possible that the definition of when a report should be filed is too broad, in which case, if it could be narrowed somewhat, maybe that reduces the burden on a credit union that would have to be filing these reports. That is just one instance, but there are others that we think need to be approached from the standpoint of not one-size-fits-all but that different regulatory regimes are appropriate to different sizes. That was, in the essence, our comment.
Senator Stewart Olsen: Thank you for that. I do know that in New Brunswick several credit unions are amalgamating or working together because they are small, and it behooves them to work together on things like this. In many instances, they are the only way that small businesses can get loans and be financed.
I am interested in being supportive, and thank you for helping me know how I can be supportive.
John Lahey, President and Chief Executive Officer, Alterna Savings: If I may, I will provide an example. In Ontario, where there are many small credit unions, the regulator has established two classes of credit union, class 1 and class 2. The class 1 credit unions, being the much smaller ones, I would say they have a lesser regulatory burden because the nature of their business is less expansive; and the larger credit unions have to meet the same standard as the bank.
At $2.5 billion, we have a lot more capacity to comply than credit unions that are $100 million or $10 million.
The Chair: For my clarification, does the anti-money laundering regulation kick in based on the dollar amount involved, or is it just a regular report dealing with all transactions?
James Gosselin, Vice President, Corporate Lending, Steinbach Credit Union: The reporting requirement is defined as any large or unusual cash transaction in excess of $10,000. Regardless of the size of the organization, you are required to comply with that reporting mechanism. Our information suggests that less than 600 instances were reported to the RCMP as a mechanism of moving that through the reporting regime. I think there were over 12 million reported instances of that definition being breached, but less than 600 of those ended up in an RCMP investigation discussion. It is a wide swath of reporting requirements that ends up in a small percentage of investigations that are as a result of that behaviour.
The Chair: I heard what Mr. Lahey said in terms of the size of the institution. Are you and Mr. Phillips making the same recommendation, or are you saying that if the reports will not be acted on, then let us cut down the reports?
Mr. Gosselin: I think what we are requesting is a scalable reporting mechanism that allows smaller institutions the ability to report that.
The other mechanism that is different is that the institutions are required to filter that information out and report, rather than simply provide the reports to the government, so the onus is on the institution to filter that information through to the government, not the other way around.
Mr. Phillips: I think what we are saying is that it is a general approach to regulation. One asks the question: What is the impact on a smaller institution? The example that Mr. Lahey cited is an example where that principle has been embodied in the regulation, where the regulator has actually said, "Yes, we agree that for smaller institutions, a different regime should apply."
His example was in the area of financial institutions regulation. I cited an anti-money laundering example. We could equally take other examples in the financial institutions area where that same principle would apply.
Senator Ringuette: It is nice to see you again, Mr. Phillips. Out of your $136 billion in assets, how much of that are loans to SMEs?
Mr. Phillips: I can give you the number for loans in general.
Senator Ringuette: Business loans in general?
Mr. Phillips: I would say that most of our loans would be in the area of residential and individual. This is a crude calculation, but the number I use is about 50 per cent for residential mortgages, 25 per cent for individual and then 25 per cent would be regarded as business oriented or in relation to business. Because of the size of our institutions, that component would tend to be in an SME area. We are not making any big corporate loans, let us put it that way, just by virtue of the size of the institution.
I will look to my colleagues for further detail.
Mr. Lahey: I think it will vary from credit union to credit union, but in the top 25, it is probably closer to an average of 40 per cent of their asset base that would be in commercial loans or loans to small business owners.
The other thing is a lot of small business owners do not actually borrow in the name of the company; they often borrow against their personal credit to use for business purposes. We know that is not inconsequential, but it is not tracked as such because it is secured with personal property or personal guarantees, usually with their home.
Mr. Gosselin: I would echo those comments. In our area specifically, given the fact we are also involved in the agricultural side of the business, 45 per cent of our total lending book would be on the commercial side, including agricultural. I would say of that book, 30 per cent of is probably agricultural-based lending, 60 per cent is corporate commercial and probably 80 per cent is SME-type institutions.
I echo the comment of Mr. Lahey in that a lot of the micro-commercial lending is done in a consumer-related environment, where those individual households have made a conscious decision to get into business for self, for example, and they will leverage household assets to get that seed money to get started. That is generally how those small businesses find the legs to get going in terms of what they are doing.
Senator Ringuette: I see you are stating the issue of Farm Credit Canada in that they have doubled their share of the agricultural lending market to 28 per cent. Coming from an agricultural-based region, we must understand there are two things happening. First, the six major Canadian chartered banks want to do less and less business with the farming community in Canada.
Second, with regard to assets, I have talked with the managers of our caisse populaire in Northwest New Brunswick, and they do not have the liquidity capability to supply the economic base of our agricultural component. Therefore, the farming community is in a bind because the caisse populaire does not have enough liquidity to supply them with their required cyclical loan simply because it is cyclical.
On the other hand, Canadian chartered banks are moving away from helping the farming industry, which leaves Farm Credit Canada as the key player. No wonder they had to increase their participation in that market by 28 per cent.
Maybe there is a secret that I do not know about with regard to that particular situation, but it seems to me that in New Brunswick, for instance, the farming community has an issue because credit unions do not have the lending capacity to provide them with their required loans.
Mr. Phillips: We are strong supporters of the idea of Farm Credit Canada for the very reasons that you cite. There are clearly gaps in the market that they need to address and should.
Our issue with Farm Credit Canada is they compete head on with credit unions. You are correct that the banks are reducing or have reduced their role in agricultural lending; that is clear from the statistics. We have maintained our market share, but we think that as a matter of principle, a public financial institution should not compete directly against private institutions like credit unions. The other fact is we feel they should be subject to a conversation about their mandate in a public forum like this at least once every 10 years.
I mentioned those 380 communities that had only one bricks-and-mortar institution, that being a credit union. I know Mr. Gosselin has worked at a couple of those. I know he has a perspective on that, and the committee may wish to hear it.
Mr. Gosselin: I certainly echo the statement that there are perhaps segments of the Canadian marketplace that are underserved in the agricultural sector, not only from a capital perspective but also from an expertise perspective. That is reality in our market, given the diversity of the agricultural sectors and how they perform.
To that point, however, in the communities where credit unions are the only financial institution in town, the behaviour of the FCC does not mimic market competitiveness in that particular region. They apply one logic, which is anything is fair game. Ultimately, for the markets that are underserved, I think FCC is the exact answer for that region of the country, but other markets are adequately served, and those are the markets that we see competitive behaviour within.
The other factor I will point out is that in the discussion of the agricultural sector, I agree that banks' behaviour has been sporadic in terms of the aggressiveness in one particular banking area, and perhaps they become almost an exit strategy in other areas of the sector, depending on how it is performing.
I would echo that the Canadian credit union system has been every bit as loyal to the regions that it serves over the course of the years they have existed. In other words, we do not abandon our backyards; we serve our communities and, ultimately, agricultural sectors are a strong component of those communities. Our behaviour has been consistent in terms of what we would do or not do for that sector.
There have been competitive situations that have arisen from FCC, and our request is that they simply be put under the same regulatory requirements we are in terms of cost of funds, regulatory requirements and lending behaviour so it is a level playing field in the smaller communities.
As Mr. Phillips pointed out, I have worked in three communities over the course of my career where I was the only institution in town and FCC was the only competitor. When you look at a small financial institution in a small community with a population of 1,500 to 2,500 people, you only have 20 or 30 large commercial accounts and of those, you can count that at least 12 or 14 of them are farming operations. If they are taking 90 per cent of their business to a local FCC office 75 miles down the road, it becomes difficult to manage that piece of business in your organization because, ultimately, those are the large corporate files that drive the margin and revenue sources for that institution to survive.
FCC does not provide banking services and so, ultimately, the community will get their chequing account from us, for example, but that is also the highest cost product that we offer. Even though there is some business going to the local community, it does not offset the large mortgage that ends up down the street.
Senator Ringuette: Mr. Gosselin, are you saying to us that in your experience, with the example that you gave of the community with a population of 1,500 to 2,500, which is your average rural community, your credit union would have had enough capital to supply the financial requirements of all the farmers in that community?
Mr. Gosselin: In the communities I served, the answer would be yes. In some cases, I was in a branch environment of a larger institution that did have the capital to serve that community. However, it is possible that the local credit union did not have the capital to service that but certainly would have been willing to participate in terms of a joint syndicated loan arrangement.
The other point I will make is that in the cases where capital is available, there was a time when FCC's mandate was simply to present support in the event that the conventional lender was not able to support it. The FCC was required to have proof of inability to secure conventional financing before individuals or businesses could approach FCC. That has gone by the wayside, so there is no mechanism in place for FCC to ask, "Have you explored local markets before entertaining the question?" Today, FCC bypasses that requirement and goes right to the farmer and provides capital whether or not the farmer could have found it locally.
Mr. Lahey: My credit union does not do farm lending. I had some exposure when I was at a bank, but my point is in the area of unintended consequences. Being for profit financial institutions, the government has to think about whether it wants to be the major lender to agricultural concerns in the country, because it has gone from 14 per cent to 28 per cent. Based on what we see, it could go higher. It could get 40 per cent or 50 per cent. However, in the private sector, people will disinvest in the skills and the capability to fill the gap if there is a review at some point and the government says that it does not want to be a 60 per cent lender or a 50 per cent lender.
We saw that with small business 20 years ago. When the banks receded from small business, the alternative lending institutions were not there the way they are today. Credit unions were not in the small business lending business 20 years ago. It was the bank receding from that business that caused credit unions to invest. It takes a number of years to invest and to build up the capability to replace someone who leaves the mark.
I think you have to ask yourself a policy question. I do not have an axe to grind because I do not do agricultural lending, but you must ask yourself what might be the unintended consequences if this market share continues to build and build.
Senator Tkachuk: Do we need a Farm Credit Canada?
Mr. Lahey: I think we do.
Mr. Gosselin: I would agree with that.
Mr. Lahey: There are enterprises and circumstances that private enterprise cannot always support because it does not have the capital or it has other issues going on inside its organization. We have seen that with BDC. There are many situations where it has been very appropriate for that to happen.
Mr. Gosselin: There are some markets in Canada that are under served by conventional banks and perhaps credit unions within the region. I think the issue there is whether or not FCC is taking on a complementary role or one as a competitor. I think FCC needs to exist as a complementary lender not only for the producer but also for the conventional financial institutions out there. As a direct competitor, I think they have gone beyond the functional use of that mandate.
Senator Ringuette: I do not see any problem with this committee recommending a periodic review of Farm Credit Canada. However, I maintain the concern about the network of credit unions. I think the capital is not there.
That brings me to the issue of the study of this committee. You have not mentioned that you are involved in venture funds. Have you ever considered under what conditions would you venture into venture capital?
Mr. Lahey: Speaking for Ontario, our regulator would probably not allow it. Technically, it is available. It is a power that we could undertake, but they would be skeptical in the current environment.
The reality is that it is a very different business and a very different set of skills and risks that you take. It would be like the credit unions, when they decided to go into small business in the late 1980s early 1990s. They would have to study the problem and invest in it over a period of time. It would be questionable whether they could raise the capital to do it in any meaningful way.
My particular credit union spends a lot of time on microfinance. We do that because a lot of small businesses do start off as just a simple idea. We brought copies of a study that we had done by Carleton University to quantify where the benefits of that might be. In the last 10 years, we financed 400 small enterprises; 95 per cent of them are still operating. In the city of Toronto, where it was primarily focused, 700 jobs were created. It sounds small, but I ask you to think about it if there were incentives or supports in place to get the major banks involved.
I spent 25 years at one of the big banks. The reality is that when they are looking at businesses, they are looking at what kind of return they can get. On your income statement, if you are really good at micro lending, you will break even. The benefits are in the community. That is why we invest in it, because we are a community financial institution. There are 700 jobs in the city of Toronto that would not exist if we needed to have a 15 per cent return on equity. You just would never do it.
Most of the candidates for our programs are people who are on social assistance or are unemployed. As you read through it, you will see that they build up the capability to get off social assistance and to get into a scenario where they are self-sufficient.
Unfortunately, in Canada, the micro loan program business is pretty small. In Ontario, there are no government guarantees on loan losses. While we might write-off 8, 10 or 15 basis points on our overall portfolio, in the micro loan business you are writing off 600. It is not for the faint of heart. That is one reason why our portfolio is relatively small. In the last few years, we have looked for partnering with organizations that would guarantee the loans, simply because the capacity of a small, community financial institution to finance the losses becomes a bit of a challenge as you get bigger. We have gone from financing 100 per cent of them to our own risk to about 25 per cent of them that are on our books at our risk. For the rest we work in partnership with organizations like the city of Toronto to create micro-loan programs.
It is not venture capital in the manner that you are suggesting, but it is job creation and enterprise creation. I personally have become a convert. We did this study because when I got to the credit union, I said — with my banker face on — "Why would I do this?" I knew enough about it to know that we did not make any money. That is why we did the study. I am quite convinced now that the social benefits of these things are quite meaningful.
I do not know exactly how the government can do it, but looking for ways to incent this kind of work to happen would be a good thing.
The Chair: Is that study available?
Mr. Lahey: Yes; I brought it here today. It is in the light green folder.
Senator Ringuette: I guess, Mr. Phillips, you could answer if the credit unions have looked into venture capital, yes or no. If so, what would be the premise that you would be looking for to really get on board?
Mr. Phillips: I cannot speak to the extent to which each of the 387 has looked at this. I mentioned the southern interior innovation funds in my opening remarks. We have six who have seen that they can participate in a regionally- directed fund. There are other examples. We would be pleased to provide the committee with others; however, as Mr. Lahey said, ultimately credit unions are deposit-taking regulated financial institutions and the regulations do not really allow for this. We are lenders, not equity investors. There is some of this participation as part of the community role, but it is very constrained by the regulatory environment in which they work. In some ways, a large role in venture capital would be inconsistent with being a regulated financial institution.
We do a lot on the lending side, supporting through lending, through the micro-lending program. We do not disregard that with some of these funds there might be some limited participation on the equity side. As I say, there are some others and we will provide you with more information about that for the assistance of the committee.
The Chair: Mr. Phillips, before turning to Senator Oliver, do I understand your position, which Mr. Lahey sort of expressed, that you studied the small business lending in the 1980s on early 1990s and concluded you should get into that and you have done so? If my memory serves me well, the caisse populaire in Quebec does do venture capital lending. Is it just a question of your movement considering this area and maybe eventually going in or not going in, or is there a particular reason why it is not on the table?
Mr. Lahey: Every credit union up until now is provincially regulated, so the rules are different in every province. The caisse in Quebec is $185 billion. My particular credit union is $2.4 billion, so even if the regulators would allow it, the capacity to do it in any meaningful way is quite limited. We would have to band together to entertainment that notion.
I cannot speak about Desjardins' venture capital, but I suspect a lot of it has to do with the fact that they have the size, and I would imagine their provincial regulation allows it.
Mr. Phillips: To build on that, it is important to understand the distinction between the Caisse populaire Desjardins system and ours. The Caisse Desjardins system is quite centralized in comparison to ours. They are able to make decisions on the basis of the whole entity.
Our system, with 387 credit unions, means there are 387 points of decision, 387 different strategies. The decision about whether to engage in a local equity fund would be made at that level of the 387 credit unions. The Caisse populaire Desjardins is able to mobilize their size to great benefit. That is why, no doubt, they have been able to devote some funds to a venture capital fund. The difference in the structure would explain some of that.
Senator Oliver: Our hands, therefore, are somewhat tied because of your provincial regulation. We are a Senate federal committee looking at public policy federally, so there are a number of things that will be restricted from even putting to you.
However, we are interested in developing good public policy. The theme that we are dealing with here in this committee today is financing growth capital for SMEs; so it is SMEs that we want to talk about, particularly those that are innovative.
All of you have indicated something about doing some micro-lending, which is $15,000, or maybe $10,000. Over and above that, there are some SMEs with 50 or less employees that are looking for seed capital; there are others that might be looking for funds for start-up, for early or late expansion or for turnaround.
Do you have categories within your various unions where you have people set aside to do that kind of work — to look at seed financing, early start-up and so on — or is that something that none of you do? That is what we are looking at here today, financing for small SMEs that have come up with something innovative and need seed capital or money for expansion. Are you doing any of that?
Mr. Phillips: I think much of that falls within the venture capital category or envelope. We would be doing a small amount through equity funds, as I mentioned, and we will provide you with more on that.
Again, we are on the lending side of the balance sheet here. Some of that lending would support some of that activity, but because we are regulated financial institutions, we do not have a lot of scope on the venture capital side.
Mr. Gosselin: At a very micro level, there are some municipalities throughout the country that have these economic development initiatives, and they do fund the seed capital for these small start-ups. That cap is usually somewhere between $5,000 and $10,000. The local institutions would partner with that and provide the conventional lending for that seed capital.
Senator Oliver: Your local co-ops would?
Mr. Gosselin: Basically, local municipalities would have an economic development piece within the RM. They would have that seed program. For example, I sat on a credit committee of this local RM that ultimately provided seed capital loans to the region of the municipality.
The municipality funded $100,000 within the seed capital fund. They went out to the community and hired or appointed certain people who have some expertise in that area and created a seed capital fund for the financing. We came in behind those organizations and financed some the conventional support they needed, but the seed capital came at a municipal level.
The Province of Manitoba also has a loan program, which is more in line with perhaps something a little higher than the seed capital micro-lending. It is somewhere around a $200,000 or beneath cap. That is more in terms of helping the institution lend in a partnership way and providing a higher tolerance of risk. They would underwrite 80 per cent of the loan exposure, for example.
As a credit union, we could then finance at a higher risk point than we normally would because of the guarantee that sits in the back in terms of 80 per cent financing. It also enabled us to do lending that would perhaps be outside our scope — things like leasehold improvements, financing intangible assets instead of hard assets.
Those programs are available; but to speak to the system as a whole across the nation, these are fragmented grassroots initiatives that would be at various levels, depending on the credit unions' market and perhaps even the industry they serve. There is nothing at a national level that I am aware of.
Senator Oliver: Is there anything you would like to recommend to this committee that could be done to encourage more of your credit unions across the country to be able to assist small start-up SMEs who need some seed and other types of financing as they go? Say there is a mom-and-pop operation that has a great idea, and the next stage is to get enough money to build a small plant to start manufacturing. Are you able to come in for that, if they need $300,000 or $400,000?
Mr. Gosselin: The question is this: Is there a business case to support that? I think the logic is that there is, but it is in a complementary lending environment, where there is support to help the institution lend at a high risk point. That needs to be in the form of guarantees or some initiative that creates recourse to the lender to take the higher risk and at least maintain the current returns we have.
There are examples of programs that have worked well in the past. However, ultimately the structure of that program will dictate whether that credit union is able to participate or not. It will be dictated by the level of local expertise by that credit union as well.
Senator Oliver: I am hearing that the credit union movement, apart from Quebec perhaps, cannot really do much to assist in new financing for the small SMEs. That is what I am really hearing you say.
Mr. Gosselin: Some institutions can do a lot.
Senator Oliver: Apart from micro — the $10,000 to $15,000; that is not the kind of money that most start-ups would need.
Mr. Gosselin: I would say at this point that at a national level and in a consistent manner, probably not. In an isolated case, there are institutions that can and are doing a lot, but it is a regional strategy.
Senator Oliver: When you were talking about some of the small communities that you had worked in of up to 1,500 people, you said some of the big farmers would go up the road 60 or 70 kilometres and deal with a larger institution. What if one of those farmers had come to you in that small town and said I want to buy three new combines; will you finance them? Would you have had the capacity?
Mr. Gosselin: In my personal experience, the answer would be yes.
Senator Oliver: The second thing I wanted to comment on is a number of people were talking about anti-money laundering provisions, and you are saying one of the things we like is less regulation. It seems to me if someone came into a credit union that had total assets of $100 million and said I want to open an account and they had $40,000 in $20 bills, and they went to the same institution — say yours of $2.5 billion — and they wanted to open an account and they had $30,000 in $20 bills, you both should file a report so that we could check. Those rules were brought in for public policy reasons to protect Canadians, so we should not have a softening of those regulations.
Mr. Phillips: I totally agree with you, and that was not the intent of the comment. The intent was to cite an example of perhaps when you look at the numbers, there may be some issues in the reporting requirement that lead to so many reports and so little action.
We are not saying that we want less regulation; we are saying that regulation frequently is overregulation and regulation needs to be appropriate. The approach that many regulators take is that they do not ask themselves the question, how will this affect smaller institutions? That question needs to be asked. Perhaps the anti-money laundering area is a bad example, but there are many areas where regulation is laid on and there is no regard paid to how a smaller institution has to deal with that.
On the general subject of what can be done, the Small Business Financing Program is a very important program that credit unions support to a great extent. I know Mr. Gosselin has a perspective on that and it speaks to this issue.
Mr. Gosselin: Our organization looked at this program two or three years ago, and the conclusion we made is that the program has some value to it, but the challenge was we felt it was so cumbersome in terms of regulatory requirements that, as an organization, we could not invest the resources it would take to comply with all the provisions of the program and be assured that, at the point we made the lending decision, and you have to understand the program is you lend up front, the institution makes the decision, and it is a potential default that that triggers the need for a claim, and then the government decides at the end of that program whether or not you played by the rules. Ultimately, there is a risk up front that you take that, if you do not do everything absolutely right, that guarantee you have could be in jeopardy. To do it right is very cumbersome and costly, and you still never removed the risk until you actually placed your claim and found out whether or not you were in compliance. That was problematic for us, not to mention the fact that the program in and of itself is complicated in terms of the rules you need to follow. It is difficult for the proprietors and owners and business owners to understand, and it is difficult for small institutions to be in compliance because of the depth of that program.
I would say, on the other hand, the RED Program that we are in fact using is much more simplistic up front. The application process is far simpler, and the rules governing the program are far simpler, and the claim process is far quicker and easier to comply with. We are using that program.
The Chair: I was lost on the difference between the RED Program.
Mr. Gosselin: Rural Economic Development. It is a provincial initiative.
The Chair: The earlier program you were talking about was the federal government's Small Business Financing Program?
Mr. Gosselin: Correct.
The Chair: Notwithstanding, the movement as a whole accounts for 29 per cent of all the loans under that program.
Mr. Phillips: Arguably we could account for more if it were made more user-friendly to smaller institutions.
The Chair: Thank you.
Senator L. Smith: Over our study, and some of the folks have been in it longer than I have, we have heard about start-up seed, capital and commercialization. We have heard of partnerships, patient loans, innovation and mandates. Picture yourself as an entrepreneur trying to start off in a medium-sized market. It would appear there is a lot of confusion out there for people to be able to understand the road map. Should our government, and maybe this is a naive question, be trying to create the road map of identifying the various levels and who does what? You have talked about mandate clarification for the BCD and Farm Credit, which I understand you are in a competitive position, but should the government be an information provider as opposed to just listing a bunch of programs but setting up a road map outlining the various levels and who does what so that the average citizen who is trying to start up a business has access to that type of information?
Mr. Gosselin: Absolutely. I can speak positively about an experience that I had only a month ago. A young entrepreneur came in. He was expanding his business. He was an existing member of our credit union. He owed us about half a million dollars on his shop and land, and he was looking for working capital. The BDC presented him with an offer of $100,000 of what I consider to be patient money. We came in and increased our operating facility from 50 to $125,000 dollars. Today he is well capitalized. What I found very beneficial to this individual owner was that the BDC offered him part of their mentorship program and a training module within the loan application that was a requirement of his borrowing, so he now has the benefit of a 30-year-experience mentor helping him manage his business. That individual is giving him good advice on simple things like learning how to manage your accounts receivable, cash management services and structuring your balance sheet properly. He is going to now move from a proprietorship to an incorporated entity.
These are things that people need to learn and understand. I believe the accounting profession has to take some responsibility for that as well, but so too do these entrepreneurs need the training and the tools to make the right decisions. As conventional lenders, we can play a role there, but ultimately our role as a lender is to test the business case, not to create it for the proprietor. They need an avenue to create the business case and the business model to help them understand what is their road map for success. We want to support it, but we cannot create it for them.
Mr. Lahey: That is similar to our micro-loan program. We will not lend to people unless they have gone through government training on how to read a balance sheet, how to do a business plan and all of the kinds of fundamental things they need. They will not be entertained on a loan application unless they come back with a business plan that we can work our way through. We believe that that is a big part of why 95 per cent of the businesses that we finance are still operating, because they start on a solid footing. Most bankers will tell you that that is one of the biggest problems when small businesses get into difficulty. They were not as well prepared in the start-up as they could have been, and so they did not recognize necessarily the signs of when to act and sometimes they wait too long. We would, from our experience, say that some form of repository of information and guidance would be very helpful. I will tell you that most people who show up in our organization looking for start-up loans have done almost no research. We have to send them back. We have lists, and most are government, but CFIB has a lot of useful information on their site. I think it would be helpful for sure. You already do a lot of it.
Mr. Gosselin: Entrepreneurs do not lack excitement or good ideas; they lack a solid, well-balanced plan and, in some cases, cash.
Senator L. Smith: We had before us the Fonds de solidarité in recently, and they talked of an interesting concept I wanted to ask you a question about, and that is patient loans. They had loans extended out over 10 years plus, because of the ups and downs entrepreneurs had in starting their businesses. Do you have patient loans, or is it based on making sure that you get your money back within four to five years, or seven to eight years? What flexibility do you have? Do we need to make a recommendation from our committee in terms of the consideration of patients? I know that partnering was another idea that you have talked about, and other people have too, but what about the patient loan?
Mr. Lahey: We do not do it beyond five years, mostly because the funding for the loan is too volatile in term of cost. The interest rate risk is too substantial for a small institution to take on. We keep it within five years, but we do entertain patient-like features, where sometimes entrepreneurs want the first six months to be interest free, but not the kind of patient where it is interest only for five years or for three years. We just do not have the capacity and funding sources to do that.
Senator Moore: I want to pick up on the chair's question to Mr. Phillips with regard to your statement in connection with BDC and that they should behave in a way that complements activities of the private financial sector. I cannot remember. When was the credit union group last here? Was it earlier this year or last year?
Mr. Phillips: That would be about a year or 18 months ago.
Senator Moore: You are repeating that position, of course, which we understand, and it is good work and consistent. In the intervening year, have you paid attention to track BDC's activities vis-à-vis the credit unions to see whether or not they have been complementary, or have they been otherwise in their behaviour?
Mr. Phillips: In the intervening year, we have been in discussions with Industry Canada. We have participated further in the review process. We just did a survey of our members on their attitudes and experience with BDC and FCC. We do not have a benchmark to track that against. Through the survey, we learned that some credit unions are encountering competitive experience from Business Development Bank of Canada. They are also finding they have a good relationship with BDC in other files as well. I cannot say that is an increase because I do not have the benchmark, but we will do this occasionally.
We are also in the process of developing a liaison committee with Business Development Bank of Canada with the thought that representatives of the credit union system would sit down with BDC on a regular basis and share perceptions and experiences and look for opportunities to build partnerships. To be fair, we have also created a similar liaison committee with FCC.
That committee met in October and had a good meeting. We are in the process of setting this committee up with BDC. We are working on building that relationship. However we do feel in one of the recommendations that had been put forward — it must have been put forward by BDC — that there should be no cap when it is capital. We are concerned that eventually opens the door to more competitive behaviour. There is a constraint in the case of BDC because their statute does say they have to behave themselves in a complementary fashion.
That is an important constraint. It is not a constraint for FCC. On the scale of things, that is why we are more concerned about FCC than BDC.
Senator Moore: The complementary behaviour would be a central part of the discussions between the two of you. Would you get to the point of saying, "In this community in Nova Scotia we have a credit union, but you went in and cherry picked. You took the loan that we could have handled." Is this is sort of thing you would bring to the table?
Mr. Phillips: This is the sort thing that could be tabled. To be fair to BDC, they have indicated their willingness to entertain those complaints now. There is a person there who deals with these kinds of complaints. That avenue is open to raise those kinds of concerns with them.
Senator Moore: What about Farm Credit Canada? Like Senator Stewart Olsen, I had visits from the credit union people. One of the many complaints was that the FCC was in their communities picking up farm loans they easily could have handled. Are you hearing that?
Mr. Phillips: Yes.
Senator Moore: You obviously must because you are stating it.
Mr. Gosselin: I have experienced it.
Mr. Phillips: He has suffered the consequences.
Senator Moore: It is out there, so what will we do about it? I am concerned the FCC mandate does not require any parliamentary review. The money comes from the government.
Mr. Phillips: This is a publicly funded institution, so at a minimum we think there should be a public conversation about the role of FCC. It is time to do that. The last time this occurred was about 10 years ago, and it is time to do it again.
Senator Moore: BDC has a five-year review, but I do not think there is any such provision. That should be there.
Mr. Lahey, you are so right in your comment about the unintended consequences. Do we want government to be the main financier of community businesses in the agricultural sector? It has doubled in a short period of time. You have obviously been tracking this.
Mr. Gosselin: I would also point out that the FCC's business model today is not only to continue to maintain its growth market share in the primary producer category. They are also moving into secondary production. Things like financing equipment at the dealerships, financing feed mills and other entities is now starting to expand. They have strategically put things in place to expand that book of business. It is frankly obvious to me that the FCC and BDC are starting to intersect each other in certain market spaces, where they are starting to compete against themselves. It is ironic to have two Crown corporations competing.
Senator Moore: Is that not the role that the credit union would have in those communities?
Mr. Gosselin: We see that as our marketplace and our conventional support of those communities, absolutely.
I will point out one other thing about the Crown operations. We do not want to suggest there are not good things being done by these organizations. The FCC is working on a lot of producer-centric initiatives in terms of software being developed for farmers, and business planning. Those things are positive and they are making them available to all farmers. The challenge for me as a primary financier of producers is that I am not inclined to make a referral to the FCC for my producer to get access to those value-added products, because I see them as a competitor. Ultimately if you are going to develop these things within these Crown corporations for the greater good of the producer or business person, that is fine. If they are competing with me, I am not likely to refer them to those institutions.
It is almost like the government developed these programs for producers or business people that only deal with Crown corporations. That is a struggle for us.
Senator Hervieux-Payette: You consider that we are so knowledgeable that we could deal with all these matters. Personally I have some difficulty on this question. There is a decline in Canada for exportation, and I am talking about billions of dollars. We are less competitive and of course more than half of my own family are in the production of vegetables and cows. I must say they work very closely with agronomists and it is a more integrated situation. Financing is coming at the end. They do not have time to consult everybody, and very often it is the agronomist that is leading them to another production and more sophisticated products. Sometimes there is equipment and buying seeds. I would feel more comfortable if the Standing Senate Committee on Agriculture and Forestry would look at all of that globally, rather than us just at the end of the day. We need all the pieces to understand this question. I have mixed feelings about comparing BDC and Farm Credit. The government is mostly working with agriculture. In more than 10 years, I have never seen anyone in the agricultural field come before the Banking Committee, and I have been on this committee since I was appointed.
Do you have agronomists or people providing the technical support to move forward? For me, it is not just money. It is know-how and new markets. If you are a small farm with 10 cows it is one thing, but when we are talking about business we are talking about larger sizes. What would be your view? Would you mind going to the agriculture committee to deal with this question in the global manner as a complementary tool for them?
Mr. Phillips: Senator, I understand what you are saying, but our point is that Farm Credit Canada is a bank. It is the only bank in Canada whose mandate is not reviewed on a regular basis. The commercial banks have their mandates reviewed every five years, BDC every ten years and EDC every ten years. FCC is the only bank in Canada that does not have its mandate reviewed.
You are talking about the agronomists, and there is great capacity in the credit union system to provide that advice and support. Similarly there is great capacity in Farm Credit Canada. We appreciate the agricultural area is complex, but we are looking at a financial institution that is not regularly reviewed in a public forum as to its role and future in the marketplace.
The Chair: As you can see, Mr. Phillips, we are almost 10 minutes over time, meaning there is a great deal of interest from all members of the committee. Thank you for taking the time to be with us this morning.
Welcome to the second half of the meeting of the Standing Senate Committee on Banking, Trade and Commerce, in which we will carry on with our special study of the financing of growth capital for small- and medium-sized enterprises.
Appearing before us are representatives from Canada's banking sector: Marion Wrobel, Vice-President, Policy and Operations, Canadian Bankers Association; and Gail Cocker, Vice-President, Commercial Banking and Global Treasury Management, BMO Financial Group.
Marion Wrobel, Vice-President, Policy and Operations, Canadian Bankers Association: Thank you very much, senator. On behalf of the Canadian Bankers Association's 52 members and 267,000 employees, I would like to thank you very much for the invitation to speak to the committee on the subject of financing growth capital for SMEs.
I am here with Gail Cocker, Vice-President, Commercial Banking and Global Treasury Management, BMO Financial Group. Before we take your questions, we would like to take a couple of minutes to talk about how banks serve SMEs, how SMEs are financed, and how banks assist fast-growing SMEs to reach their business goals through credit and non-credit products in the early and growth stages of their life.
I will be providing you with the CBA submission — I will be reading that — and after that Ms. Cocker will give a few short comments.
Lending and providing products and services to SMEs is an important part of a bank's business portfolio. As of December 2010, Canada's domestic banks authorized around $87 billion in credit and had relationships with more than 1.5 million SMEs operating across Canada.
In lending to SMEs, Canadian banks have utilized prudent lending practices and excellent risk management systems that have led us to be ranked, four years in a row, as the most sound in the world by the World Economic Forum and first in the world for financial strength by Moody's Investor Service, for two years in a row. This is more than just patting ourselves on the back, honourable senators. As the Superintendent of Financial Institutions said last week when she appeared before this committee, "it is strong banks who can lend."
SMEs have benefited from this strength. Lending to SMEs has gradually increased and year-over-year growth has consistently remained positive over the last five years. Since the second quarter of 2009, when SME lending began to increase its base of growth, total authorized lending has increased by 6 per cent. In the last year, authorized lending has increased by 4 per cent.
Our emphasis on serving SMEs is being recognized by the SMEs themselves. In a CBA survey taken in the midst of the financial crisis, 78 per cent of SMEs indicated that they have a positive relationship with their financial institution. Of those SMEs that have a credit relationship with their bank, 90 per cent reported that the relationship was positive.
Businesses rely on two main forms of financing — credit and equity.
Banks are institutions that provide credit financing to businesses. That is lending out funds with the promise to repay at a later time. When it comes to business credit, there are two main types of loans. One is secured loans where the business puts up collateral such as a building or a machine tool as guarantee. This is similar to a mortgage. The other type of loan is operating capital where the bank lends money based on expected cash flow or income.
The difficulty is that companies just starting out typically have no assets and no income to borrow against. That unfortunately means that a bank that would lend to that company would take on essentially the same risk as the equity financiers, with little of the same upside reward of equity investments.
Equity financing essentially provides investors with the opportunity to provide funds to a business in exchange for an ownership stake and a chance for that upside reward. The equity financing of new or growing private companies is often called venture capital. While the rewards of this type of financing can be very high if the company is ultimately successful, there is no guarantee that that will be the case.
As other witnesses have already pointed out, four out of five new companies never see their fifth birthday. The level of risk among new businesses is very high. As you have also heard, it is very difficult to make money by providing venture capital here in Canada.
Banks are not very active in providing financing to this area of the market. There are a number of reasons for this, but the main one is prudential risk. Banks are in the business of taking risks. However, as both the Governor of the Bank of Canada and the Superintendent of Financial Institutions recently said before this committee, there must be a limit on the amount of risk they are allowed to take. That makes sense if you consider what banks are and what they do. Banks operate large retail networks to take deposits, and then they invest those deposits, supported by shareholders' capital. This means that capital needs to be levered several times, not too much so as to create excessive risk, but enough to enable banks to operate efficiently and provide financing at low cost.
Venture capital, because of its inherent riskiness, cannot be funded this way. It cannot be levered the way bank activities are. That is why banks do only small amounts of venture capital financing and why venture capital firms look very different from banks. Banks are using depositors' money and, therefore, keep risks low. Venture capital firms employ shareholder funds and, therefore, can take bigger risks.
We have seen in other countries what happens when banks take too much risk or risks they do not fully understand. For the reasons I have just talked about, it is very difficult for banks to be active capital providers in the early stages of a company's growth. That does not mean, however, that banks do not have a role to play. In the early stages, banks are able to provide financing and services to support them as they seek out venture capital. As companies grow, banks can play an increasingly important role in financing their growth.
I would like to talk a little bit now about the stages of growth of fast-growing SMEs and to give you a sense as to what banks do.
In the start-up and early stages of business formation, entrepreneurs attempt to prove that an idea has a reasonable chance of success and then to bring the product or idea to commercialization. These stages often witness the fastest growth. In these early stages, SMEs require seed and start-up financing to cover marketing expenditures and organizational investments to begin to earn revenues. SMEs also require other products and services to help ensure their businesses are able to succeed and to help them acquire additional debt and equity financing.
Because owners of SMEs often have relationships with their banks through their personal banking, we encourage them to approach their banker for advice. When I am finished reading my remarks, Ms. Cocker will talk about the kind of advice they provide.
The banker can leverage their knowledge of the owner's personal situation to set up a number of small business financing solutions, such as introductions to potential customers, suppliers and sources of capital; economic trends and forecasts; specific information on special industries; export solutions; and bank short-term and long-term financing.
SMEs can rely on banks' short-term, day-to-day lending, which includes overdraft, credit cards and lines of credit. Solutions to address unique short-term needs can also be arranged through banks, these include: letters of credit to facilitate foreign transactions, bridge loans to close a purchase while permanent capital is sought, and bulge accounts to manage seasonal or cyclical requirements.
SMEs can also arrange a variety of longer term financing solutions through their banks, such as term loans, mortgages, leasing and factoring. Term loans provide the SME with the ability to purchase a new piece of equipment or technology or to acquire another company or operation, while mortgages allow the SME to expand their operations through the purchase of buildings or land. Leasing is a useful way to utilize equipment subject to depreciation, while factoring provides financing for accounts receivable, and, of course, banks provide access to loans through the Canada Small Business Financing Program operated through Industry Canada.
Banks also provide non-credit products and services, including chequing and savings accounts, both in Canadian and foreign dollar denominations, tax payment services; electronic funds transfers; payroll and filing services; and coaching through podcasts, booklets and seminars.
According to our customers, these non-credit products and services matter. In CBA surveys, a majority of business representatives consistently report that the selection of their main financial institution was driven by non-credit rather than credit products and services. The combination of these credit and non-credit related products and services bolster and add credibility to an SME's attempts at obtaining venture capital finance from friends, relatives, business contacts, suppliers and private investors. For instance, SME owners increase the likelihood of successfully attracting venture capital if they can illustrate cash flow in their business.
Banks provide the tools, resources and assistance to enable SMEs to manage their cash flow needs. We provide online banking to manage their expenses and monitor their accounts and transaction details in real time, initiating electronic payments, obtaining foreign exchange quotes and transferring funds between accounts. Tools such as online banking also help SME owners and advisers, including their banker, to identify efficiencies and potentially reduce the need for those additional venture capital funds and potential dilution of equity.
In closing, SMEs are integral parts of a bank's business portfolio. Our strength and stability allowed us to finance SMEs throughout the financial crisis at a time when banks in other countries could not. This ability to serve is reflected in business satisfaction with a wide range of credit and non-credit products and services. Banks provide these products and services all through an SME's life stages, while banks are not active capital providers in the early stages of a company's growth. We are able to provide debt financing and non-credit services to support them as they seek out venture capital from a variety of sources. As companies grow and mature, banks play an important role in financing their growth.
Thank you for your attention. We would be pleased to answer questions but before we do that, I would like to turn it over to Ms. Cocker to provide you with a bit of her perspective.
Gail Cocker, Vice-President, Commercial Banking and Global Treasury Management, BMO Financial Group, Canadian Bankers Association: Thank you for giving us an opportunity to speak to you here today.
I have been with the Bank of Montreal for 28 years. The last 17 of those have been spent in the personal and commercial area, so very much in the centre of the subject of the customer base you are talking about.
I learned the ropes in terms of lending to small business in the Halton Region in Ontario, and then I had the opportunity to work with business customers in three of our western provinces, so I have spent time in Saskatchewan, Manitoba and British Columbia.
Since 2004, I have been responsible for the Bank of Montreal's commercial banking strategy.
While I understand that these hearings are focused on growth and financing growth opportunities for SMEs, I do strongly believe that our customers are telling us that they are also looking for access to information. They are looking for expertise, experience and, often, just mentoring opportunities. Those are quite important to them; we hear that time and time again.
In my experience, small business owners are busy running their business. Typically, they do not have a lot of time to search out information, so they depend on their banker to be a source of education and advice for them. They are expecting us to provide meaningful insights to them to help them run their business better, to source new markets, and oftentimes just to provide solutions to problems that they might have. Certainly, at Bank of Montreal, our customers tell us it is not just financing that they are looking for. They are looking for someone they can trust who can give them advice on how to make sense of all the choices that they face in running their business.
In essence, we do not consider our bankers to be just gatekeepers of credit. Our bankers are there to be advisers, and we work hard to have our customers consider us as trusted allies in running their business.
It is our job to provide them with advice and guidance so they can grow and innovate their companies. That is really the message there.
In my opinion, customers choose Bank of Montreal because we have 1,000 bankers scattered across the country, many in communities where their businesses operate. Our customers know that their banker does not have to go to Toronto to approve their loan. We have local decision making in our marketplaces. Our bankers in the marketplaces have credit authorities that are able to approve loans.
Lastly, our bankers are knowledgeable and skilled, and that is one of the areas that I am proud of at Bank of Montreal. We have invested a lot of energy in our learning programs, making sure we train our bankers not just in credit financing and how to lend but also how to run a business and cash management solutions for our business customers.
On all those counts, we have worked very hard at it, and I think the testament to that is the fact that at Bank of Montreal, we are actually the second position in terms of market share in lending to small- and medium-sized enterprises. For the size of us, we are proud of that. It is a strong position that we have maintained for a long time.
I will take the opportunity, having listened to the previous discussion, to say that our message to small business is that we are open for business, we want your business and we compete very aggressively in the marketplace to get that business.
On the subject of agriculture, for Bank of Montreal, that is one of our most favourite industries. When we look at our lending to small businesses and medium-sized enterprises, the agriculture segment is our largest industry segment for lending.
Nothing makes our bankers feel greater satisfaction than feeling like they are making a difference in helping businesses grow and prosper. It is something that we almost live vicariously through our customers in terms of watching them grow and develop their business.
I wanted to give you a sense of what our strategy is about and what we are attempting to do with our customer segment. Thank you for the opportunity to share Bank of Montreal experiences with you, and I look forward to a good discussion.
The Chair: Thank you very much, Ms. Cocker. We will begin with Senator Oliver.
Senator Oliver: Thank you both for your presentations. The last thing you said in your last paragraph was that banks are not active capital providers in the early stage of a company's growth.
In other words, if we are looking for seed financing and start-up, all those other things, the bank will shake its head, and say, "No, I'm sorry. Go to your angels or someone else. We cannot take the risk because we have depositors' money and we cannot take that kind of risk with it."
There must be some things, because we have been told by a number of start-ups that there is not easy access to venture capital dollars in Canada. If you are small, there is no point in even thinking of going to California or somewhere in the States. We, as public policy-makers, have to find a better way of making this seed and start-up money available for Canadians.
Other witnesses have told us about angel investors. Look to people who have been successful in business and are prepared to come back in and take a risk. They will also perhaps join the board and be mentors and give the kind of practical advice that you were just talking about. Therefore, angels are a good thing.
Do you think that we, as a committee, public policy-makers, should look at increasing tax credits for angels to encourage more of them to come forward?
Next, I think that our Canadian big commercial banks could be doing a lot more regionally for the small SMEs. I do not know why you do not set up a series of regional advisory groups — or group it any way as you want, as a corporation — because all the regions of Canada are different. For instance the wheat and the large farming that you have in Saskatchewan, we do not have that anywhere in Atlantic Canada. Our small little potato farms do not compete with the 15,000- to 20,000-acre wheat farms. Therefore, set up a group of regional funds with $400 million for each, choose as your advisory board successful entrepreneurs in start-ups themselves and let them be the advisers. It seems to me this would be a very positive way that banks could help SMEs and encourage more venture capitalists to stay and be your partners. It would also strengthen the knowledge economy in Canada. I think it is time our large commercial banks put more back into the region. It seems to me that would be a wonderful way to do it, and I would love to hear your comments on that.
Mr. Wrobel: I will start with your second question on SMEs.
It is important to remember that if you look at the pattern of bank lending to SMEs over the last decade, it has grown fairly steadily. We have in the last five years gone through —
Senator Oliver: Is that lending in terms of start-up money?
Mr. Wrobel: I am talking in terms of SMEs, not necessarily start-ups, but that whole range.
Over the last five years, we have gone through a recession and a global financial crisis. If you look at the amount of money that banks have authorized to small businesses and to small- and medium-sized enterprises more generally, it has consistently grown. It has not grown by rapid amounts, but it has grown. If you look at those trends, you would almost conclude that there was no recession and no global financial crisis. It is very different than for some of the larger firms.
In terms of seed and very small businesses, we have also seen an increase in lending largely driven by an increase in customer accounts, which means that what is driving the growth in lending to that sector is the fact that we are bringing in new customers, and new customers are often new businesses starting up. They are getting funding.
The other thing we have observed is a very pronounced trend over the last 10 years, wherein these new customers are requiring smaller amounts of capital to start and they are utilizing a smaller proportion of the amount of money we have made available to them. Ten years ago, your typical small business was using 65 cents on every dollar of loans that were authorized to them. Today, they are only using about 50 per cent.
Therefore, the sense we have is that they have stronger balance sheets and do not need as much; they are getting the authorizations, but they are only using the money when they actually need it. Ms. Cocker could give you a better feel for that.
Ms. Cocker: Responding to your first question about angel incentives to encourage angel investors, we have talked about this and previous witnesses have talked about this in that it is not an area where banks will play a big role in terms of seed capital or venture capital. Anything we would do to encourage or to give a bit of a leg up for our small businesses, if they do not have the means to get started, is a good idea.
We are absolutely involved in helping them set their business plans and in linking them up with mentorship programs. We work very closely with BDC, and we get them hooked up with the right kind of experience or expertise. However, often it is at the very early stages, and if they do not have that base level of capital to make a strong business case and to increase their chances of success, any kind of program that would encourage that would be a good thing, as long as it leads to a traditional commercialization opportunity going forward.
Senator Oliver: What if there was commercial tax credits for banks who establish a venture capital fund of, say, $400 million? It would be a tax credit not just for angels but the corporation as well. Would that be an incentive?
Ms. Cocker: That might have some appeal because the returns in that business are very difficult, as we know. It is complex and high risk.
At the Bank of Montreal, I can speak to our company in that we currently have $300 million outstanding in venture capital through a special subsidiary to 50 companies across the country. It is very small because the level of risk, the level of due diligence required to run it and the hand-holding is a tough business proposition. We are in the business of banking, and the returns that we get reflect that, not this equity lending.
Senator Oliver: However, if your advisory board consisted of angels, who have been successful themselves, have been involved in these types of ventures and have built these enterprises from $100 to $200 million, surely they would help ease some of that pain. If there were tax credits as well, it might be a new way of making much more venture capital available to SMEs in Canada.
Mr. Wrobel: Governments always look at public policy measures to encourage certain types of activity, and this area is no different. If you can think of a good approach to either capital gains or some kind of tax credit, that is something we do not oppose.
However, if you think of it again from the point of view of venture capital being provided by banks, a tax credit will change to some degree the risk profile of venture capital, but it is still a very risky thing. Because it is very risky, that is one reason we do not do much of it, why the Bank Act has limits on the amount that is done, and why the prudential supervisor, who looks at the various activities of banks, may frown upon what we do to some extent.
I also want to point out that because we had this financial crisis five years ago, you read the newspapers, and it seems like we may be going through that again depending on what is happening in Europe. The regulators in Canada and around the world are very much tightening up the rules that apply to banks. Banks will have to carry much more capital than they have in the past. They will have to carry stronger capital, which means more expensive capital. They will have to be much more liquid on both their asset and liability side. Venture capital is not liquid; it is exactly the opposite of that.
If you look at where we are going in terms of that new regulatory regime, we started off by saying given the prudential constraints on banks, it is difficult to do venture capital. Going forward, it will probably be even more difficult.
We are not saying these new initiatives are bad; we know what is driving them. We know the concern of regulators and governments; they do not want to go through 2008 again. However, there will be consequences for what financial institutions can do and the cost at which they can do it.
I am simply saying that to the extent it was difficult to do venture capital in the past, it will probably be more difficult for a bank to do so in the future.
Senator Hervieux-Payette: For clarification, when I buy a share from your bank, I buy a share for banking, investment and insurance. Who covers that?
You are in the business of investment banking and you have a big boss at the bank who of course supervises all the activities, as well as a board. I hope so. You are talking about very narrow banking activities. Who do we talk to in order to hear about the investment banking side?
I understand everything you have said, and I was saying to the chair that you are very good at lending, providing we give you about five times the amount of guarantee, so I have no problem with that; it is very secure. However, when it comes to venture capital, who do we talk to?
I just saw Moody's report this morning in that banks have a lot of unsecured loans and credit cards. Ms. Cocker should be happy because hers is the best performing bank in that sector. Are these loans to small businesses part of these unsecured loans? Would you call it an unsecured loan when you ask for a guarantee using my house, my car, my inheritance and everything that goes with it, which is worth $10,000, yet you ask me for $100,000 in guarantee?
I would like the facts. You are not going to appear another day as an insurance company and, at the same time, make comments as an investment banker. You are the bank; you own all of these activities. Can we hear details about venture capital?
Mr. Wrobel: Because those subsidiaries are subsidiaries of the retail bank, it is the retail bank that owns the investment bank. It is the retail bank that owns the insurance company.
The Office of the Superintendent of Financial Institutions is concerned about the risks associated with the retail bank and because all of those things have an impact on the profitability, safety and soundness of the retail bank, the superintendent is effectively interested in all of those things. It is a conglomerate so it does not matter whether venture capital might be done through the bank proper or through some kind of subsidiary. It still has an impact on the bank, and we know that banks are different from a lot of other financial institutions because of the systemic risks associated with them. When banks fail, it can have negative consequences not only for the financial sector generally but also for the economy more broadly. Again, we saw what happened in 2008, and that is why there is that concern and that is why it does not really matter whether it is the bank proper or a subsidiary of the bank; it will have an impact on the risk, safety and soundness that of bank.
Senator Hervieux-Payette: You can answer our question about venture capital since it is under the umbrella of the bank. We know that. The superintendent was here last week and she reassured us by telling us that she is overlooking every activity of the bank, so I was more secure. At the same time, the mandate of the committee is to examine growth capital for SMEs. We know that you make loans to SMEs, and we want to know the whole picture. If an SME goes to one of your subsidiaries, it is still the bank. Of course, I have heard stories of people who were forced to issue shares on the market and become public companies because you wanted your loan to be repaid.
A start-up business with a proven concept needs money for commercialization. I think our colleague will agree that the toughest part is commercializing when you need more than $50,000, most of the time. What do the banks do for that business? We heard from a venture fund that told us they would go ahead and support that. Why do we not have the story of the banks, through their investment banking branch, about what they will do? We were told that they would be putting out $1 billion over a number of years. What is your forecast?
Ms. Cocker: Moving beyond venture capital, which we have talked a little bit about, the Bank of Montreal is actively providing loans to small businesses. The answer that I would give you is that the Bank of Montreal currently has over $29 billion in loans outstanding to what we define as SMEs. Over 200,000 small customers across the country come to us to get financing, advice and solutions on how to manage their cash more efficiently and effectively. For example, sometimes you can figure out how to collect your receivables faster and lessen your dependence on your line of credit. You can actually improve your situation in that way.
We spend a lot of time educating our business customers and exposing them to other solutions. BMO has a whole series of business learning sessions for owners to learn everything from how to set a marketing plan to how to develop a business case to how to do a cash flow. There is a whole element around education. When someone is starting up a business, they might not know where to go to get this information. We have pod casts on a variety of topics, which we get from our customers who ask about this and that. Some of it simply refers them to government agencies.
There is a whole piece around advice and solutions beyond financing that we provide to our customers; and financing is definitely a piece of the puzzle. If people are interested, I have all kinds of tips on what we have available. I am sure many of you might have seen this in terms of the podcasts of regional economic briefings across the country and all kinds of information. People need access to information to know how to solve their problems.
Mr. Wrobel: We have these broad relationships with our customers. We have a very good sense of the services available both internally at an individual bank and in the marketplace. In trying to help their customers, if there is something they cannot provide, bankers will try to find an outside source and make referral elsewhere. The banks have relationships with various institutions that provide patient capital, patient loans and venture capital. They make those kinds of referrals. It is not as if they are giving away business because it is something they do not do. Helping customers, to whom we provide a host of services, is particularly valuable. An example might be the Business Development Bank of Canada, which provides some venture capital financing.
The Chair: In your presentation, you said that banks provide access to loans through the Canada Small Business Financing Program. What does "access to loans" mean? The testimony of the previous witness indicated that it is a very complicated process with a lot of red tape.
Mr. Wrobel: We do offer them.
The Chair: Do you help businesses to navigate through the red tape? Do you provide guarantees? Do you provide matching finance?
Mr. Wrobel: The Canada Small Business Financing Act is a federal government program that provides a guarantee to lenders. Credit unions are lenders and banks are authorized lenders. We offer those. Also, we have been working with government to streamline the regulations surrounding the CSBF act. Historically, at the same time that our lending to small businesses has gone up, our use of the Canada Small Business Financing Program has gone down. In part, that is because it is too cumbersome, paper-based and different from the way that banks make loans. We do things very quickly now, often electronically. The CSBFP is sort of paper-based. We have been working with the government to make the program more efficient so that it operates more like the banks and other lenders operate so that the process can be done quickly and efficiently. We are awaiting the new regulations, which are in process with the government right now.
The Chair: That may be something we can help with. If we agree to move that forward, we could so recommend, I presume.
You have already decided what improvements are needed, have made recommendations to the government and are awaiting to hear. Is that correct?
Mr. Wrobel: We understand that the regulations have been written and are in process at the department.
Senator Ringuette: My first intervention will be in the form of a comment as a follow-up to the superintendent of OSFI, who appeared before us, with regard to your amalgamated operation of commercial, investment and insurance banking. All of your operations are subject to OSFI as a commercial only entity. That removes the ability to increase your investment risk in Canadian businesses. Maybe one of the recommendations that this committee should make is to have the Bank Act look at separating these three entities because, in reality, they should be subject to three different pieces of legislation and supporting regulations. That is a comment.
Please remind the members of this committee about the Industry Canada Small Business Loan, of which there are two types. There is a certain percentage of guarantee that the federal government provides you for the first loan, and then another percentage of guarantee for the second loan to the same business. What are those percentages? Could you remind the members of our committee?
Mr. Wrobel: We cannot answer that question right now. We will provide you with that information. My understanding is that it is something like 85 per cent guarantee.
Senator Ringuette: Exactly. So the Government of Canada, through Industry Canada, provides 85 per cent on the first loan application from that SME to the banking institution. Therefore, in reality, you only have 15 per cent risk, and you charge the small SMEs a premium so that you would get that guarantee from the federal government. Am I right or am I wrong?
Mr. Wrobel: There are limits as to what can be charged on a loan like that. At the same time, when a bank has a loan under that program, it pays an administration fee to the federal government of 1.25 per cent.
Senator Ringuette: That you charge back to the SME?
Mr. Wrobel: No, because there is a limit on the amount that can be charged, and it might be something like prime plus 3. I said earlier on that one of the trends we have seen over the last little while is that at the same time that banks have been increasing their lending to SMEs, they have been reducing their use of the Canada Small Business Financing Act.
In some cases the banks, despite the guarantee, have found that the administrative burden is such that a loan where they might have used the Canada Small Business Financing Act, they do it outside of that, and they are able to deliver it to the customer at a price that the customer is willing to accept.
You asked the question about the two types of guarantees. One thing you should also understand about the Canada Small Business Financing Act is that although on a particular loan there is a guarantee of 85 per cent, there is also something called the minister's total liability with respect to those loans, which I believe is something like 10 per cent of the portfolio.
Banks have to use the same prudent requirements, the same criteria for making those loans. They cannot just do shoddy risk adjudication; and if they do, and if they are not acting prudently, they will find that they will actually be incurring a lot of those losses on their own, despite the 85 per cent guarantee, because if they go beyond that 10 per cent minister's liability, they are responsible for all losses beyond that.
There is an element of guarantee; that is true.
Senator Ringuette: Eighty-five per cent.
Mr. Wrobel: We do not deny it. It is 85 per cent. However, on your small business portfolio that is under that program, effectively, on that entire portfolio, the guarantee is only 10 per cent.
Senator Ringuette: First, I do not agree with the amalgamation of investment, commercial and insurance under the same roof, as one entity. I also find it disturbing that with regard to small- and medium-sized businesses, these entities of our chartered Canadian banks receive, and have the ability to receive, an 85 per cent guarantee from the taxpayers of Canada, on the one hand; however, with regard to the high-risk venture capital from the workers' fund, there is only 15 per cent credit. There is a great imbalance with regard to lending to SMEs and the risk factor involved.
I want my colleagues to remember that yesterday, and in our meeting prior to that, one of the recommendations was that the federal tax credit for the workers' fund would be increased from 15 to 20 per cent. I think that if the Canadian chartered banks can have 85 per cent guarantee from the federal government for loans to SMEs at a stage in their growth that is a lot less risky than the start-up phase, then I think that certainly justifies their recommendation.
Mr. Wrobel: We find, for example, that the Canada Small Business Financing Act is most useful for start-ups because these are precisely those firms that tend to have no assets, and they do not have a track record of income, of revenue. That is precisely where we are using that program.
Ms. Cocker: The difference is that the returns are capped. The risk is similar, but the returns to the venture capitalist are much higher because they are taking an equity position and they get an ownership in the company, versus this is a solution for some business owners, where they retain the ownership of their company, and it is a way for banks to participate and help them to get started.
It is certainly an area that we try to tap into. If we cannot make the loan based on the risks that we see in the business because it is a start-up, the cap is pretty small.
Mr. Wrobel: I think it is $250,000.
Ms. Cocker: My experience is that often it is at the smaller end. It is a big administrative burden, not only on the bank — so we have to staff up to ensure we submit all the paperwork — but also for the customer. As soon as we can see that we have a commercially viable risk, we want to move it into a regular lending program. We will move it into a loan as fast as we can. It is a particular niche market that this works for.
Mr. Wrobel: To make one thing clear, the vast majority of lending to small- and medium-sized enterprises is done outside of that program, without any government guarantee.
The Chair: What would be the result if your recommendations and the regulations you say are now being rewritten came into being? Would that change?
Mr. Wrobel: I think it might reverse the decline in the usage of it, but it has never constituted the majority of lending to small businesses, and I do not envisage that it ever would.
Senator Ringuette: You said that it was a small percentage. What would be the percentage that you are referring to?
Mr. Wrobel: I would not be surprised if it would not be more than 10 per cent, something in that neighbourhood. We can provide the numbers.
Senator Moore: Ms. Cocker, you answered Senator Ringuette by saying that you have $29 billion in loans outstanding to SMEs. What percentage of that would be under the Canada Small Business Financing Program?
Senator Ringuette: It is not a yearly thing; it is a total.
Ms. Cocker: The $29 billion we have is authorized to small business enterprises. I do not know the exact number that would be under that small business financing program. I am pretty sure it is under 10 per cent, but I will come back to you with those numbers. It is pretty small.
The Chair: Colleagues, that brings us to the end of our session. Thank you very much, Mr. Wrobel and Ms. Cocker. Your presence has been helpful.
Colleagues, next week, hopefully after we have been enlightened by Senator Hervieux-Payette's speech on Bill S-5 in the chamber, we will be turning to the study of that bill. The clerk is in the midst of lining up the witnesses for us. It should be an interesting week.
(The committee adjourned.)