Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 28 - Evidence - May 6, 2015
OTTAWA, Wednesday, May 6, 2015
The Standing Senate Committee on Banking, Trade and Commerce, to which was referred Bill S-210, An Act to amend the Criminal Code (criminal interest rate), met this day at 4:16 p.m. to give consideration to the bill.
Senator Irving Gerstein (Chair) in the chair.
[English]
The Chair: Good afternoon and welcome to the Standing Senate Committee on Banking, Trade and Commerce.
Today is the second meeting on Bill S-210, An Act to amend the Criminal Code (criminal interest rate).
In our first meeting on this subject, the bill's sponsor and member of our committee, Senator Ringuette, appeared as a witness, to talk about her bill. The purpose of Bill S-210 is to amend section 347 of the Criminal Code to change the criminal interest rate, which is currently defined as interest rates exceeding 60 per cent per annum.
Today, our meeting will be split into two one-hour panels. Moving to our first panel, I am pleased to welcome Dr. Michael Bradfield, Professor of Economics (Ret'd), Dalhousie University. Additionally, Dr. Bradfield is a member of the anti-poverty association, Face of Poverty. I am also pleased to welcome from Option consommateurs, Ms. Dominique Gervais, Department Head, Legal and Budget Department. Option consommateurs is a not-for-profit association based out of Montreal. Their mission is to promote and defend the basic rights of consumers. One of their key areas of focus is financial services.
We will now proceed with opening statements by Dr. Bradfield, followed by Ms. Gervais.
Michael Bradfield, Professor of Economics (Ret'd), Dalhousie University, as an individual: Thank you very much for inviting me.
This bill is long overdue. It was inevitable that the original specified criminal interest rate, set when inflation and interest rates were at historic highs, would be made obsolete by changing financial and economic conditions over the years. Rather than setting a fixed rate, it is logical to set the criminal interest rate relative to a metric that reflects current conditions. The overnight rate of the Bank of Canada provides a reasonable reference point. A formula that sets the rate at a fixed amount or margin above the overnight rate is more sensible than using a multiple of the overnight rate.
The size of the margin is arbitrary. The proposed margin of 20 percentage points seems reasonable as the upper bound of acceptable, i.e., legal, interest rates as long as it operates as a ceiling rather than a target. But a law is only as good as its enforcement, especially against those who exploit the vulnerable. For this reason, this bill must also remove the exemption granted to payday loan companies so that the criminal interest rate applies to them.
The payday loans industry was granted an exemption to the criminal interest rate if the industry were regulated by the province in which it operated. A few provinces undertook regulation of the industry in the mid-2000s, with Nova Scotia introducing the first regulations in 2007, setting the maximum charge on a $100 loan at $31, i.e., an annualized rate of over 800 per cent. The Nova Scotia maximum was lowered in subsequent hearings to $25 and is now $22 in an industry in which loans are normally for two weeks. Subsequent regulation by other provinces sets the maximum as low as $17 per $100.
All of these provincial maximum interest rates violate the current federal criminal rate set at 60 per cent. To operate within this rate would allow a charge of at most, i.e. no compounding of the interest, $2.31 per $100. The provincial regulation process involves extensive lobbying by the Payday Loans Association and a few of the large firms. They argue that the standard mathematical formula for calculating interest rates, the interest payment divided by loan amount and adjusted for the time period of loan, should not apply to payday loans for several reasons. First, they argue that since the loans are small, usually under $400, and for short periods, usually two weeks, they must be constantly rebuilding their customer base, which generates administrative costs for them. In addition, they claim that the high default rates they have also drive up administrative costs.
Second, they argue that their customers have education and income levels above average. Therefore, they understand the effective rate of interest on the loans and do not expect it to be a hardship to repay the high interest and principle out of their next pay.
The third point is that their effective interest rates are accepted by the customers as a tolerable cost for the greater convenience in obtaining a loan relative to banks or other sources.
Finally, the industry argues that it were forced to charge less than the federal definition of criminal interest rate, payday lenders would go out of business and their customers would soon be in the clutches of loan sharks and suffer tremendous hardships, i.e., their customers are desperate. These arguments were contested on the basis of both logic and evidence, the latter primarily from academic research. Logically, if claim four is true — that their customers would then be the target of loan sharks — then claim two is refuted, that their customers can afford to pay the loans off.
People are borrowing out of desperation, not convenience, and are thus likely forced to roll over or refinance their loans. Thus the customer base is stronger and the administrative cost lower than claimed by the industry.
There are other reasons to reject the administrative cost argument. The lenders promote the speed with which they can make a loan, in part because they avoid the cost of a credit check on clients; some do not even search their own databases to determine if a borrower has outstanding loans or had difficulty repaying loans in the past. This suggests both minimal processing time and reduced administrative costs, but it also suggests a lack of due diligence. In addition, if claim two is correct, i.e., that their customers understand the terms of the loan and have an income high enough to repay it, then the default rate should be lower than institutions that have a broader spectrum of society, undercutting their arguments further.
Another logical argument against the claim of high administrative costs relative to funds is that firms, such as Cash Store, one of the largest firms — it was; it's now broke — acts as a broker for financial firms, processing claims and following up on collection. Unlike a bank or credit union, they do not have a pool of funds that requires constant recycling. They draw down the funds as they need them.
The evidence that the industry cites for the first two claims is based largely on surveys, which were soundly critiqued as statistically flawed by academics. Independent research contradicts the industry claim of having to continuously rebuild its customer base. A significant proportion of their clients are caught in a web of debt to payday lenders, borrowing from a new lender to repay their debt to another. The Consumer Financial Protection Bureau, in the United States, estimates that people who borrow one or two times a year represent only 13 per cent of the customers but a mere 2 per cent of the payday lenders' fees. People who borrow 20 or more times a year are 14 percent of the customer base — same size number of customers — but generate 32 per cent of their fee revenue. In other words, they take their money from the people who are most desperate. Cash Store's CEO has admitted that their typical client tends to borrow four to six times over a three-month period, in other words, renewing a bi-weekly loan up to six times before they can pay it off.
Recent industry data collected by Service Nova Scotia indicates that more than half of all the loans in Nova Scotia are repeat loans, with about 15 per cent of the borrowers taking out nine or more loans in one year. Thus, the evidence, including data from the firms' own databases, required by Service Nova Scotia, supports the conclusion that payday lenders' profits rely on repeat loans and that their interest rates make it difficult for low income borrowers to repay the loans. Convenience carries a high price.
Independent evidence contradicts their claim that, without payday loans, their customers would end up in debt to loan sharks. Schwartz and Robinson, in a study, cite the lack of any evidence showing any harm to consumers in Quebec and the 15 U.S. states, plus the District of Columbia, that set rates so low that all payday lending has ceased. North Carolina claims that its ban was actually beneficial to their consumers.
What alternative do low income people have? The answer depends on their level of numeracy, i.e., their ability to recognize how costly payday loans are relative to traditional sources, such as a line of credit, and on access to more traditional borrowing forms.
Credit unions and banks are developing financial literacy programs for their customers, but this issue needs courses in schools to provide extensive education about debt, credit and the impact of compound interest. The immediate issue of providing low-cost, short-term loans is being investigated by credit unions in Canada and has been done successfully in the U.S. The conclusion is, therefore, that applying the proposed revised definition of criminal interest rates is sensible and in the public interest. While the provinces should regulate many aspects of the payday loans industry, it should be within the framework of the federal definition of the criminal interest rate.
The Chair: Thank you very much, Dr. Bradfield.
[Translation]
Dominique Gervais, Department Head, Budget and Legal Department, Option consommateurs: Thank you for giving us the opportunity to share the concerns of consumers about interest rates charged on consumer loans.
Option consommateurs is a not-for-profit association whose mandate is to promote and defend the interests of consumers. The organization has been in existence since 1983, and it is also a family economics cooperative association. That means that we serve people in our offices who have debt problems. We are the equivalent of other debt counselling organizations elsewhere in Canada. We serve people with all sorts of income, low and high, of all ages and from all walks of life, who come into our offices very, very indebted. We are talking about car loans, maxed-out credit cards, lines of credit, personal loans, and alternative lending. We are real witnesses of what is going on the ground and what products exist on the ground, in Quebec in any case.
We know very well that interest rates are very high, with the exception of mortgage rates, which are at historically low levels at this time.
First of all, I would like to state that our organization supports and welcomes this bill. A criminal interest rate that fluctuates on the basis of the overnight rate is an excellent idea. We know that currently, there are credit cards with a 20 per cent or even 25 per cent interest rate, which can climb up to 30 per cent, and that is absurd. As Mr. Bradfield said, it is not logical because during the 1980s, when this provision of the Criminal Code was adopted, the Bank of Canada rates were at 21 per cent.
Overly high interest rates are a way of gauging the consumer, and I would like to draw a parallel with civil law to explain how we tackle these issues in Quebec. Quebec's Consumer Protection Act states that exploitation occurs when there is significant disproportionality between the respective benefits of the parties. The courts feel that interest rates above 38 per cent or 39 per cent on a credit agreement are abusive.
Furthermore, the Office de la protection du consommateur and the Quebec government have decided to not allow payday loans in Quebec. But more importantly, they have decided that they will not issue money-lender permits to companies that charge an interest rate greater than 35 per cent. It is important for criminal law to take an interest in this issue, because, above and beyond civil sanctions, there is a notion of criminal exploitation and extortion of the consumer that needs to be examined.
Let us take the example of credit cards. For a number of years now, our organization has observed that consumers are increasingly directed towards credit cards. If we want to borrow a small amount or if we have modest income, we are directed towards credit cards with 20 per cent interest rates. It has become the norm for small loans. Twenty per cent interest rates no longer raise eyebrows. They have become the norm, even though the key interest rate has been set at 0.75 per cent. In the event of non-payment, for a consumer who has difficulty making payments, there are some financial institutions that impose an additional penalty and who charge them 5 per cent extra. So the rate rises from 19.9 per cent to 24.99 per cent, all the way up to 27.99 per cent. Therefore, these rates are excessively high.
In addition, there are a number of practices that hurt consumers even more and that encourage over-indebtedness. For example, there is the reduction of the minimum payment on credit cards. Currently, the minimum payment is roughly 2 per cent to 3 per cent of the balance. Allow me to give you an example. Let us say that I have a balance of $3,000 on my credit card, and I need to make a minimum payment of $90, which is 3 per cent of the balance. It would take me 24 years and 8 months to fully pay back the $3,000, and I would have paid $6,294 in interest alone. I would therefore pay twice, or more than twice the amount in interest. This is what happens with 20 per cent interest rates, and practices by financial institutions that encourage excessive debt.
Section 347 of the Criminal Code targets particularly this type of alternative lender, namely loan sharks, payday loans, and everything that is called alternative credit. In our offices, we are receiving more and more calls on this issue. However, practices are becoming more refined and there are more and more lenders.
Currently, loan brokers have become very common. They find you a loan and charge you brokerage fees. Brokerage fees are not exactly interest, but they get added to the fees, which results in credit rates that are absolutely exorbitant and astronomical. To date, there have been very few criminal prosecutions under section 347. Vulnerable consumers do not file complaints for a number of reasons, mainly out of fear of reprisals, but also because that is the only source of credit that they can obtain. Therefore, they do not want to cut themselves off from this source.
For this provision to have an impact, there will need to be greater surveillance of the activities of lenders, whom we call "predators.'' In Quebec, we have chosen to not allow payday loans, but we have also set out an alternative with Desjardins and the ACEF movement. An assistance fund has been established. Small loans of $200 to $800 are given to individuals who do not have access to traditional loans in order to prevent them from turning to alternative lenders. These are individuals who receive social assistance, who are unemployed, or who receive income from employment insurance or disability benefits. However, despite the fact that the clientele is quite vulnerable, the repayment rate is 85 per cent, and 0 per cent interest is charged.
It is therefore possible for a province to ban payday loans if the community mobilizes to offer credit and if the banks show a bit of goodwill.
In conclusion, our organization supports Bill S-210 and recommends its adoption. We also recommend increased monitoring of the industry. Finally, we recommend that the committee take an interest in other issues related to credit. There is still much work to be done to sufficiently protect consumers. Thank you.
[English]
The Chair: Thank you, Ms. Gervais. Ms. Gervais, I would just like you to clarify something. One talks about the interest rate that is actually charged, and then you referred to — conceivably — brokerage fees or other service charges that could be added to the loan. You related that to a percentage of the amount outstanding.
Is the amount of a brokerage fee or a service charge added to the percentage and viewed as being the effective rate, or are fees outside of the framework of interest rates?
[Translation]
Ms. Gervais: In Quebec, I know that, under the Consumer Protection Act, these fees are part of the credit rate. Under section 347, I am not certain whether these fees can be considered true interest, according to the definition, but I gave you the example of lenders who are able to get around the rules and add all sorts of fees to their loan to increase the bill. In Quebec, we call it the "credit rate,'' and it includes all other fees that are not capital. This can amount to 200 per cent, 300 per cent or 400 per cent rates per year.
[English]
The Chair: Thank you for that clarification. We will move to my list of senators.
Senator Black: Thank you both for being here. Insofar as you are agreeable, I'm hoping that you can educate me a little around this issue, because until Senator Ringuette brought this matter forward, I had no understanding whatsoever.
This is what I'd like to come to understand: Can you tell me, please, who is the target demographic of the firms that you are troubled by? Who are their clients?
Mr. Bradfield: What the target is and what the industry says it is are two quite different things. As I said, the industry claims that the people that they lend to are higher educated and have above-average income levels. The statistics that have been collected show that is not the case, and if you would like an example, drive down Richmond Road out by Lincoln Fields, near the big mall out there. Beyond Lincoln Fields, in three blocks, there are four payday loan outlets on Richmond Road, with public housing right behind it. They're after low-income people.
Senator Black: It must be more than low income; it must be low-income people with no credit ratings.
Mr. Bradfield: Yes, or low-income people who, for a variety of reasons, don't trust banks.
Senator Black: Well, that would be another problem.
Mr. Bradfield: They're referred to often as the "unbanked,'' even though most of the payday loan firms claim that you have to have a bank account to get a payday loan.
Senator Black: So your evidence in response to the question would be: low-income Canadians who, potentially, are unbankable.
Mr. Bradfield: Who are reluctant to get involved with banks.
The whole point of the repeat loans is that, if you've got a customer into the system and they can't pay off the next loan, you — well —
Senator Black: We can get to that. I just want to first understand the demographic from your point of view. Would you agree with that, Ms. Gervais?
[Translation]
Ms. Gervais: Yes, there are two categories. There are low-income people who do not have access to traditional credit. Even if they go to the bank and ask for a credit card, they will not have access to one. There are people who do business and also people who are very indebted, who receive traditional credit and who have reached the limit. In these cases, banks refuse their request. Perhaps they have lost their job or they have reached the limits of traditional credit. So they turn toward alternative credit. There are really two categories of people who turn to this type of lenders.
[English]
Senator Black: Thank you. For the loans in question, do the lenders take security?
[Translation]
Ms. Gervais: No. Based on what we have observed, they take a lot of personal information, the address of your mother, your father, your sister, your brother-in-law, and if you do not pay up, they are the ones who receive an unfriendly little visit.
[English]
Senator Black: Are you speculating on that?
Ms. Gervais: No.
Senator Black: Your evidence would be that tactics are used which —
[Translation]
Ms. Gervais: Yes. We provide services to people who have done business with this type of lender and who tell us what happened. We have seen contracts, and even signed contracts with "rent to own'' stores, which is alternative lending. You get asked for a long list of personal information and references, such as the name of your mother, your father, your sister, and you are told in veiled terms that you must pay, otherwise your family will receive a little visit. These are not rumours, this is what we have seen on the ground, and it is what people tell us.
[English]
Senator Black: Thank you. Anything to add to that, Mr. Bradfield?
Mr. Bradfield: On the payday loans side of it, many of them require that you sign a document giving them the right to draw out the interest and principal from your next paycheque, so that automatically comes out. So somebody who is strapped for cash and has to go to payday loan, the next pay they get, they're already going to lose off the top.
Senator Black: So they garnish your wages.
Mr. Bradfield: And then they have to do it again.
Senator Black: People could suggest — I wouldn't because I'm not at the point of having suggestions yet — that a lot of folks have lost control of their own credit situation, that it's not society's problem to deal with and that, indeed, high rates perhaps are a good thing because they act as a deterrent. I'm not arguing that, just wondering what you think about it.
[Translation]
Ms. Gervais: Up to a certain point, yes. People are responsible for their own situations, and easy credit is being dangled in front of their eyes. Just about anyone can get a credit card with an interest rate of 20 per cent. You work, you earn a small salary. It is necessary to earn a reasonable salary, but anyone can get a credit card at 20 per cent.
We are encouraged to accept credit. We live in a society based on credit. A few years ago, a new practice was developed. For example, a retailer sells an in-ground pool that costs $100 a month with payments spread out over 20 years. That is completely illogical. Financial corporations, banks and financial institutions encourage this practice among consumers.
Up to a certain point, the interest rate can allow a certain control of the market, but when a certain limit is reached, we end up in exploitation and vulnerability. Alternative lenders profit from this vulnerability, and that is the point at which there needs to be intervention. Financial institutions also profit from this vulnerability by issuing credit cards with an interest rate of 20 per cent.
[English]
Mr. Bradfield: The point that I would make is that the high interest rates may be a chicken and egg thing. The high interest rates make it impossible for them to pay off their loan. The second thing is that it's not necessarily a matter of people not handling their money well but a matter of people being so badly paid that they're just barely hanging on. Then, the car breaks down or they suddenly need pharmaceuticals or have a major expenditure that's not built into their tight budget, and that just knocks them off their feet for months. Those are things that normally one can't anticipate.
[Translation]
Senator Massicotte: I thank our two witnesses for their presence. We are all in agreement that a solution needs to be found with respect to abusive interest rates. However, when you look at the bill and the proposed solutions, things get more complicated.
There has been a lot of talk about payday loans, but the goal of the bill has nothing to do with payday loans, because the exemption was delegated to the provinces. Senator Ringuette referred to other payday loans. I am trying to understand if this is widespread. Are we talking about exploitative loans of 40 per cent or 50 per cent? Is this type of loan very widespread on the market, apart from payday loans?
Ms. Gervais: In Quebec, payday loans exist, but it is not a legal practice. Our province has not made any laws on the subject, but these loans exist, and the loan sharks do not make an effort to hide. It is like escort services, which are illegal, but run advertisements in the newspapers. It is a question of having the political will to stop them.
We have observed an increasingly common practice: offering a second or third chance at getting credit, like car loans for consumers who have declared bankruptcy, who are earning a low salary, or who have bad credit. These people end up with loans at 30 per cent, 40 per cent, 45 per cent or 50 per cent interest.
Senator Massicotte: Is this very common?
Ms. Gervais: Yes.
Senator Massicotte: Could you repeat that? You mentioned car loans?
Ms. Gervais: Yes, these people get a second and then a third chance at getting credit. This is a common practice which has become increasingly prevalent over the last 10 years. Before, we tended to talk about pawnbrokers, or "shylocks.''
Senator Massicotte: Are you referring to people who are turned down for credit applications in conventional institutions?
Ms. Gervais: Yes, that is right. These consumers' credit requests are turned down, but because they need a car to get around, they appeal to these loan sharks who target people who have declared bankruptcy, or who do not have good credit ratings. And the interest rates are calculated to reflect that.
Senator Massicotte: Very well.
Ms. Gervais: It is to be expected that someone who does not have a good credit rating would pay more, but after a certain point this really turns into exploitation. The courts in Quebec have confirmed this. Interest rates can reach 40 per cent or even 50 per cent. That is frequent.
Senator Massicotte: Do you have names, because you said this is being done?
Ms. Gervais: All you need to do is read the newspapers or listen to the radio.
Senator Massicotte: Do you have the names of companies that you could give us?
Ms. Gervais: Montréal Auto Prix and HGrégoire in Quebec. Almost all of the car dealerships have their own structure for first, second and third chances at obtaining credit. This is also a practice that is common in used car dealerships.
Senator Massicotte: You believe that, like the payday lenders, these practices should not exist. In other words, individuals should not have these services offered to them.
Ms. Gervais: We should set limits for these individuals. In fact, there is a real problem when this turns into exploitation, when it takes on huge proportions. I understand that a consumer who has more difficulty paying back a loan, who represents a higher risk, should pay higher interest rates. That is the goal of interest rates. But we need to inform consumers that, if they are borrowing beyond a certain interest rate limit, that is criminal. That is exploitation, extortion.
Senator Massicotte: Perhaps that is how the system is flawed. The market system works very well, but it is based on the important assumption of competitiveness. If competition is high, the rates will be proportional to the risks. However, is competition strong enough, or is the problem that consumers are not educated enough or do not understand the risks associated with interest rates?
Ms. Gervais: For high-risk loans, it is the credit card that determines the market. It is 20 per cent for a credit card. If you are refused a credit card, the interest rate will be higher.
Senator Massicotte: Are you referring to the credit cards that everyone offers? Are you talking about credit cards that have particular terms and conditions? Is this a widespread practice?
Ms. Gervais: I mentioned the example of a credit card to show you how the market works. A high-risk consumer does not have access to a credit card nor to a loan from a financial institution. He would have access to a first, second or third chance at credit. On a sliding scale, a personal loan would be around 8 per cent, 10 per cent, 12 per cent or 14 per cent.
Senator Massicotte: Is this reasonable in your opinion?
Ms. Gervais: For a personal loan, that is reasonable. But a credit card at 20 per cent is not reasonable. High-risk consumers are automatically put into the category of first, second or third chances at credit, so they face alternative loans and rates — Because credit card rates are 20 per cent, lenders will require a higher rate.
Senator Massicotte: Why would consumers accept credit cards at a rate of 20 per cent when they can obtain a rate of 12 per cent?
Ms. Gervais: In fact, the 12 per cent rate is not available to everyone. You need to be a good client. A consumer who has had problems paying off his credit card in a given year, because of illness or job loss, loses his right to get a lower rate.
[English]
Senator Tkachuk: I have a couple of questions for both of you. Thank you very much for your testimony today.
Mr. Bradfield, I want to spend a little time on the payday loan business. I know there has been a lot of research done on it. What kind of return on investment do these people get? What are their net profits at the end of the year? What kind of money do they make after they pay all their expenses?
Mr. Bradfield: It varies significantly between the different companies. DeLoitte Touche did a study for the industry several years ago. As I recall, the rates of return probably seven years ago were anywhere from 6 per cent to 17 per cent. You have to be careful with that because some of the companies have two companies, the finance company and the payday loan company as the front office. The payday loan company then borrows money from their own finance company to lend out. If they're making 10 per cent as a finance company and 6 per cent as the payday loan company, it's a matter of shifting the profits to the unregulated area. One could argue they were really making 16 per cent.
Senator Tkachuk: As far as we know, that is what they're making. Then they have to pay income tax on that. They're paying tax to the provincial government as well. Even if they're borrowing it from the finance company, the finance company is probably borrowing it from somebody else, the bank or investors. What I'm trying to get at is that it's not right necessarily to say that someone who borrows $200, is charged $35 and has to pay it back in two weeks is being charged an unheard of interest rate. When I buy a shirt, it costs me $100 but the retailer probably paid $50 for it. He didn't make $50 on it because he's got to pay rent, utilities, salaries and city property tax, et cetera. That's why the return on investment is much more important than what the individual product sells for in that two-week period.
Mr. Bradfield: There are a couple of issues. Return on investment has to be calculated on the actual money that the payday loan has invested of its own, but it could be just operating as a flow through. I would argue, without knowing the history of section 347, that a criminal rate is a criminal rate on the maximum you can charge, not a rate that says you get a certain rate of return. My argument as an economist would be: If you do something that is established as criminal or unethical or whatever word you want to put on that interest rate and try to charge that rate because you argue you need it to cover your costs, I would argue, as an economist, that society says, under the terms in the legislation, that this is not permitted and, therefore, if you can't make a reasonable rate of return by staying within the law, then you leave the market.
Senator Tkachuk: You're saying that people are exceeding the 60 per cent limit now and that they're breaking the law.
Mr. Bradfield: Yes, if you apply the federal law to the provincially regulated payday loans. That's the point. The issue is raised that they were specifically excluded from the federal criminal interest rate if they were provincially regulated. It was the industry that asked for that exemption. As far as I'm concerned, the reason they asked for that exemption was the divide and rule thing. The industry can go around with the same batch of data and the same experts and so on to argue in every provincial jurisdiction that this is unfair to them; and they bought that argument.
Senator Tkachuk: They're not breaking the provincial law.
Mr. Bradfield: They're breaking the federal law, but the federal law should be the constraint on the provincial operation.
Senator Tkachuk: What is Option consommateurs? What kind of organization is it? What is it exactly?
[Translation]
Ms. Gervais: We offer services equivalent to those offered by credit counselling agencies elsewhere in Canada. We deal with people who have debt problems. We are funded by United Way, so we are a not-for-profit organization which helps people with budget-related and financial problems.
These people come to our office and they are deeply in debt. They do not know what to do. Often they are being threatened by collection agencies or being taken to court. We sit down with them to look at their situation, to propose solutions, whether it be a consumer proposal, bankruptcy, reorganizing their budget; we also provide education about budgeting. That is the mission of our organization. In Quebec, this is credit counselling work, but we also have a broader mission, because we represent consumers, and we defend their rights as consumers.
In Quebec, we have a Consumer Protection Act. We work to improve the laws to better protect consumers.
[English]
Senator Tkachuk: Does all of your funding come from the United Appeal?
Ms. Gervais: No.
Senator Tkachuk: Where else does it come from?
[Translation]
Ms. Gervais: Industry Canada, through the Office of Consumer Affairs. We conduct research into consumer rights. We receive funding from the government to carry out periodic research. In certain cases, we also receive donations. So the public also funds us, as do the Government of Quebec and the Office de la protection du consommateur. We also receive money from fundraising initiatives that we lead. Often, there is money left over from class action lawsuits that we undertake. So those are some of the sources of our funding.
Senator Bellemare: Many of my questions have already been asked, but I have two questions. I will start with Dr. Bradfield. It would appear that you have studied the return on investments of alternative credit institutions a lot. The criminal rate which is currently at 60 per cent, from what I understand, was determined during the 1980s at a time when interest rates were very high.
In the history of the return on investments of alternative loan companies, did you determine that the rate of return, at the time, had increased following the lowering of the inflation rate, or did they remain more or less stable, that is around 16 per cent, as you stated earlier?
Have there been changes in the rate of return of these institutions over time, since the 1980s?
[English]
Mr. Bradfield: I'm not sure what's happened over time. That study was done in a particular period of time. Payday loans, in fact, have been operating more or less since the early 1990s, and they have grown rapidly. A few years ago in Canada, which is the last date I've seen, there were 2 million Canadians who borrowed $2 billion from the payday loan industry in one year. A large percentage of those people were borrowing more than seven times a year.
[Translation]
Senator Bellemare: Ms. Gervais, I would have two questions concerning Quebec's legislation.
First of all, the 35 per cent rate represents the maximum that an institution offering payday loans can impose in Quebec. Is that the case?
Ms. Gervais: That is the case for any lender. In order to be a money lender in Quebec, except in the case of financial institutions and banks, one must hold a permit from the Office de la protection du consommateur. The latter, according to the guidelines, does not issue a permit if you charge — It will review your contracts and your practices, and if you charge over 35 per cent, it will not issue a permit. Therefore, looking at creditors overall, regardless of the type of loan concerned, in Quebec it is 35 per cent.
Senator Bellemare: Within recognized financial institutions, such as banks or cooperatives, is the maximum interest rate 20 per cent for credit cards?
Ms. Gervais: It can be as high as 27.99 per cent.
Senator Bellemare: In the traditional institutions?
Ms. Gervais: Yes, on credit cards.
Senator Bellemare: Up to 27 per cent?
Ms. Gervais: Yes, there are credit cards with a rate as high as 24.99 per cent, and if you miss one or two payments, the rate rises to 27.99 per cent. That is the highest rate we found.
Senator Bellemare: These institutions, therefore, would be affected by this bill.
Ms. Gervais: Some of them, yes.
Senator Bellemare: This is my other question. You spoke of other ways to promote consumption saying, for example, "You pay $100 per month, but over four or ten years.'' Would this kind of practice be covered by this bill?
Ms. Gervais: No. In fact, that was to give you an example of the kind of environment in which we operate at the moment. As far as lending is concerned, it is a bit unrealistic to think that a person can cope without any credit. Therefore, we also have to think about those who are the most vulnerable in our society who do not have access to traditional credit, who will go looking for loans on the alternative market and who must be protected.
It was an example to try and explain the environment in which we operate. Financial institutions and everyone else are pushing in that direction, and we must protect the most vulnerable in our society.
Senator Bellemare: Are the people who consult you always bankrupt?
Ms. Gervais: No, there are many other solutions. Some consult us before they go bankrupt and others when it is already too late.
Senator Maltais: Ms. Gervais, Mr. Bradfield, I would first like to tell you that you are doing great work for those who are most in need. You are almost like the missionaries of the finance world. My question follows upon the one asked by my colleague, Senator Massicotte, and has to do with the used car business.
It is all well known. At first, I noticed it, then I went to get a better look, and I did: there is a first chance at credit, a second and a third one. On some storefronts, you see the first, second and third chances advertised, and right underneath it reads "more.'' I did not dare go in to learn what "more'' meant, because I was afraid I would not get out of there in one piece.
These businesses have the loathsome habit of setting up shop in the most underprivileged neighborhoods, and that is when those youths who do not have enough money to buy a new car from a dealership get hoodwinked. They go to buy an old beater for $2,000, and by the end of it, they have paid the price of a new Maxima.
In a past life, I was an MLA in Quebec for many years. There are furniture stores who have also adopted the "Buy now and pay later'' scheme. Well, when it comes to paying later, you have the guy at retirement age still doling it out for furniture he bought when he was 21, without ever actually owning any of it! It is the vendors or the manufacturers — I do not know which — who sell credit to two, three, or four businesses that are nothing more than usurers.
Ms. Gervais: In fact, financial institutions are behind furniture financing. In Quebec, it is mainly Desjardins with their Accord D Financing, but certain banks do it as well.
There was a class action suit in Quebec against Brault & Martineau, a furniture store, and at some point we learned that 70 per cent of Brault & Martineau customers opted for financing their furniture, and 70 per cent of those people ended up paying interest, because they do not pay their furniture on time. So the market is huge, and the interest rates you have to pay when you are late are on the order of credit card interest rates of 19 per cent, 20 per cent and 21 per cent. Those numbers date back to 2007, so the situation has probably evolved since then. It is a huge market.
Senator Maltais: People told us that that the practice was that if one month —
[English]
The Chair: I'm going to have to ask for a concluding question, Senator Maltais, or we'll run out of time.
[Translation]
Senator Maltais: If one month you did not have enough money to make your instalment payment, they deferred it to the end, but still charge you daily interest. So if you had it deferred to 60 months later, your little $80 would have turned into $350.
Ms. Gervais: Yes, indeed, if you follow the rules.
Senator Maltais: We absolutely have to change that way of doing things. It is exploitation, and it is just shy of slavery.
[English]
Senator Ringuette: I guess I have to repeat this again for my colleagues. The payday loan legislative privilege that we gave to the provinces is specific to a financial product. It has to be a loan no more than $1,500 for a maximum period of 62 days. Whatever other financial product that payday loan provides comes under 347. We gave the provinces the ability to regulate that specific product. Whatever other product, their line of credit that they're now offering and so forth, is not within the jurisdictions of the provinces with regard to payday loans.
I certainly want to thank you for being here and, judging from your answers, sharing your knowledge on the issue.
Mr. Bradfield, you've indicated that Deloitte has found that payday loan companies or their mother financial institution make on average between 6 and 17 per cent profit. Is that what I understood?
Mr. Bradfield: That's my recollection, but you're asking me to pull a figure out my head from four years ago. A parallel thing in the United States that's relevant to the question about the rate of return: In the States they have found that some of the banks have set up separate financing organizations to finance payday loan lenders. So, if the big banks can make more money than their going rate of return by getting into the payday loan industry, I'd say we don't have to worry about the rate of return.
Senator Ringuette: We know, for instance, in the Canadian market, that a grocery store operator has a 4 per cent margin of profit. If you consider that in parallel to payday loans that make 6 to 17 per cent, they're in a relatively good profit situation.
[Translation]
As for car and furniture loans, since we now have the whole Easy Own network out there, has the Quebec government intervened to determine whether the 35 per cent interest rate indeed complies with the regulations governing loans?
Ms. Gervais: The Office de la protection du consommateur has investigated and has revoked certain lenders' licences. The problem we have with the Easy Owns of this world is that they are not actually lenders. They deal in leasing with option to buy. So it becomes a little harder to nail them with regulation currently in place. There was a bill tabled two or three years ago, but it went nowhere because of the election.
Senator Ringuette: The bill would have covered this whole new range of products.
Ms. Gervais: Exactly. These products did not exist back in 1978 when the law was passed. In Quebec, there was tremendous work done to figure out what new forms of credit there were so as to better regulate them. As I was telling you, there was a provision whereby a loan broker did not have the right to have a client pay in order to find him a loan. Instead, the financial institutions would have paid the broker when they granted the loan. Unfortunately, the bill has yet to be adopted.
[English]
Senator Ringuette: Mr. Bradfield, with regard to the payday loan industry's argument, the logic cannot be sustained, as you say. You also said that there is a problem with repeat loans. Could you elaborate a little on that? I suppose it's the payday loan industry and their 62-day limit.
Mr. Bradfield: The big issue around repeat loans is clearly that those people are so financially strapped they can't pay off their loan immediately, be restored and live off their budget. Those repeat borrowers are the very vulnerable, by and large, although there may be some scam artists in there but I doubt it. You're talking about a vulnerable part of society. The other part of the picture is the claim from the industry that because they don't have repeat loans, they have to keep getting new customers in and that's expensive and drives their administrative costs up.
The data show, and I cited some of it, that not only does a large percentage of customers borrow eight or more to 20 or more times a year, but also that a disproportionately large chunk of their fees come from that portion of their clientele. They argue that they don't have many repeat customers, yet the statistics show they depend heavily on getting, catching and keeping people as their customer base.
I'm a member of the Face of Poverty, which is a faith-based anti-poverty group. The point to us is that they are going after the most vulnerable people to make their profits so there is an ethical or moral question here besides the financial issue. I'm not sure if that answers your question.
Senator Ringuette: Yes.
Senator Greene: I want a sense of how large the industry is. How many companies are involved?
Mr. Bradfield: The total number of companies is nominally quite large. Some companies, for instance Cash Store, have more than one outlet with a different name. As part of their marketing strategy, when someone else comes along and locates a payday loan outlet, they will place one of each of their outlets on either side, assuming people coming from either direction will hit their place first.
What I can tell you from the studies is that in both the Nova Scotia case and the national case, three firms control 80 per cent of the market. The fact that you have a lot of small firms is irrelevant if three firms control 80 per cent of the market. In economics, that would be considered a market controlled by those three firms, and they have various ways of keeping the other firms in line. It looks like a competitive market because there might be 50 firms; but if 3 firms control 80 per cent, they control the market.
Senator Greene: Is the 80 per cent for Nova Scotia?
Mr. Bradfield: That's the national figure. I'm trying to think of what it was in 2010 when I did a lot of research on it. At the time as I recall, two firms controlled about 60 per cent of the market. That's still not a competitive market.
Senator Greene: How big is that market in terms of money?
Mr. Bradfield: Nationally, it was worth $2 billion on 2 million customers. In Nova Scotia, in a one-year period from July 1, 2013, to June 30, 2014, 200,000 payday loans were granted worth $89 million. The Service Nova Scotia data don't give you a breakdown as did the other study I gave you, but they state that a large portion of those people are multiple loan borrowers. It's a similar picture. My sense is the American data show a much more extreme picture than the Canadian data, but the Americans have faced payday loans longer so they have deeper roots or hooks into the marketplace.
Senator Greene: Does the ownership of these companies come from outside the industry?
Mr. Bradfield: I have no idea.
Senator Wallace: Mr. Bradfield, you stated in your presentation you believe that tying the non-business commercial lending rate, or at least this maximum criminal rate, to the overnight rate of the Bank of Canada would be reasonable. You also said that having to propose a margin of 20 points above that bank rate seems reasonable to you. We're being asked, if we approve this bill, to establish that as a criminal rate. Obviously, it's a significant matter. Do you know of any studies that would support the Bank of Canada rate plus 20 points being that appropriate level? Should it be plus 15 or 25 or 35? Why 20? Do you know of any studies?
Mr. Bradfield: The academic literature I tend to look at hasn't looked at that question. Normally it has been focused on the existing situation, whereas this bill proposes setting up a new situation. I can't think of anybody off the top of my head who has looked at this.
Senator Wallace: Certainly, compared to 60 per cent it is far more reasonable; but why 20?
Mr. Bradfield: If I could take a personal view, since you have heard the discussion of credit cards, it would seem to me that the 20 per cent is something that the credit card industry isn't going to be too up in arms about; so it reduces the political pressure.
Senator Wallace: But it would be less than 2 per cent compounded monthly, which is 26.89 per cent.
The bill would also create a criminal rate for loans for business or commercial purposes, which could not exceed of 60 per cent. Does either of you have any comment on that? I'm thinking that there are many vulnerable Canadians who have small businesses, such as a backyard car repair operation or a small plumbing and electrical business, need lines of credit to do their business. Do you have any concerns that a 60 per cent rate applied to those businesses would be reasonable and could impact those who are vulnerable?
[Translation]
Ms. Gervais: I have focused mainly on the issue from the consumer's point of view. It is true that some small businesses could be affected, but I could not tell you more. I have not looked at it from that angle.
[English]
Senator Campbell: Is there no responsibility on the part of the person getting this loan? I understand that they get into problems and that they are marginalized because of their economic situation. How do we stop them from having to do this? How do we educate them? How do we help them to understand finances? How do we understand all of this? If they were educated, we wouldn't be here talking about this bill.
As much as I have huge sympathy, there is a responsibility on the part of both the people who take the loans and us to try to help them get out of that situation. Is there anything available to be done? I see on television at three o'clock in the morning things like, "Phone us and we'll get you out of debt.'' But don't phone it, it doesn't work, okay? Other than that, what options do we have to get to the people who basically are forced to use this system for whatever reason?
[Translation]
Ms. Gervais: There is certainly room to educate. That is what we at Option consommateurs do with the workshops on budgeting, credit and debt held with neighbourhood community groups. We meet people who are looking for jobs, who are on welfare or who are unemployed. We educate them and offer advice.
[English]
Senator Campbell: What's your success rate? I know that you can't have this, but what is your sense? Is your sense that after somebody takes this all in and sees ways of avoiding this here, do you see that happening or does it just continue?
[Translation]
Ms. Gervais: We hope our efforts bear fruit. I cannot measure the scope of our work in that regard, but Option consommateurs does offer a small loans program with Desjardins, all across Quebec. You must also understand that you cannot live without credit today. And that even those who are struggling need credit.
Initiatives like the one set up by Option consommateurs that offer small, interest-free loans between $200 and $800 for essential needs — we do not lend for trifles, we lend for the purchase of a fridge or glasses — allow these people to go on living, buying a fridge, without falling prey to these lenders.
How can we stop these lenders? Not only do we have the responsibility to educate people, but also to stop these lenders from exploiting the vulnerable. And that is where this bill comes in.
[English]
Senator Campbell: I very much appreciate what your group is doing.
The Chair: We have three senators with questions on round two. I would ask them to get those on the record. If you can answer quickly please do, otherwise please send them in writing.
[Translation]
Senator Massicotte: Let me sum up my area of concern. Of course, there are always consumers who are not well informed, and there are always people who want to benefit from that lack of understanding.
I know that Option consommateurs gives out loans; and you made reference to Desjardins. But that is more like a subsidized social program, and I am not convinced that it is a long-term structural solution.
[English]
The problem I have with all of these suggestions is there are some loans, but it just takes a certain amount of time, a certain amount of paper. If you're going to lend a hundred bucks out of a pay loan and pay it back two or four weeks from now, it's going to cost at least —
The Chair: I'm going to have to ask you to put the question.
Senator Massicotte: How do you cover the fixed cost of doing a transaction? How do you make sure it's fair to the borrower when you have a fixed cost for that transaction?
Mr. Bradfield: In the case of payday loans, the companies often establish a number of fixed charges that are separate from the stated interest rate. In Nova Scotia, for instance, even though it was stated that the second setting of $25 per hundred was the maximum for all charges, some payday lenders still found the capacity to add a fixed charge to it.
Senator Massicotte: That's a fixed charge, but in legislation what do you do here?
Mr. Bradfield: You do what supposedly the Nova Scotia law does. You say the "maximum interest rate plus any other charges shall be.''
Senator Tkachuk: Ms. Gervais, I want to follow up on that line of questioning. You're funded by province, feds, charities, donations, maybe others, I don't know, but when you give out a loan of $200 up to $800, what does it cost?
[Translation]
Ms. Gervais: The Quebec financial institution called Desjardins finances these loans for us. Centraide also gives us a small sum. We receive about $60,000 per year overall to pay a resource that takes care of those loans.
The capital is loaned to us by Desjardins. We have not had to invest money, because it was Desjardins that gave us the money to manage the program. It is really philanthropy on the part of the financial institution. Desjardins no longer offers small loans to consumers and does not have the expertise to do our work, so it has outsourced small loans to us.
[English]
Senator Tkachuk: They give you the money as a revolving loan, interest-free from Desjardins.
Ms. Gervais: Yes.
Senator Tkachuk: Is that $60,000 part of your overhead or just to pay employees to administer these loans? What is the cost per loan?
[Translation]
Ms. Gervais: I could not tell you that, because we do not calculate it in that way.
[English]
Senator Tkachuk: You have to calculate it that way. I'm saying a loan is not free. I'm just trying to make a point here.
Senator Ringuette: By the way, the U.K. government is doing the exact same thing in all its communities that Desjardins is doing in Quebec.
My recent research suggests that there is a growing slate of online lenders at rates that are extremely high. What are your customers/study indicating in regard to these online companies?
[Translation]
Ms. Gervais: Online loan companies generally offer rates that are similar to payday lenders' rates. In Quebec, these are payday lenders under another name, because they do not have the right to use the term payday lenders. That is what we often see in Quebec, but I cannot speak for the rest of Canada.
Our clientele does not do business with online loan companies, but rather with companies that have storefronts or that advertise in the classifieds and have a somewhat sordid little office. What we are looking at is more alternative loans or high interest loans.
[English]
The Chair: Ms. Gervais, Mr. Bradfield, I think I can speak on behalf of all members of the committee to indicate that you have been marvelous witnesses. We thank you very much for appearing before the Standing Senate Committee on Banking, Trade and Commerce.
In the second hour of our meeting, we have two more witnesses to discuss Bill S-210. I am pleased to welcome from the Sprott School of Business at Carleton University, Dr. Ian Lee. Dr. Lee teaches strategic management, and he previously worked in the financial services sector as a loan manager in consumer, mortgage and commercial credit for an American multi-national and was subsequently at the Bank of Montreal.
I am also pleased to welcome, representing the Uniform Law Conference of Canada, Ms. Jennifer Babe, Partner, Miller Thomson LLP. Her practice based out of Toronto emphasizes commercial law, focusing on secured transactions, the securing of sales and leases of significant products and the purchases of business assets and shares.
We will proceed now with opening statements from Dr. Lee.
Ian Lee, Assistant Professor, Sprott School of Business, Carleton University, as an individual: I'd like to thank the august Senate Banking Committee for inviting me to appear to discuss Bill S-210. First, I will go through my disclosures. I don't consult to anyone or anything, anywhere — not corporations, not unions, not NGOs, not governments, not persons. I'm reading my notes because I'm a digital person, not a paper person. Second, I have zero financial investments in any corporation or investment vehicle, except my share of the Carleton University pension fund, so I'm in the no conflict of interest before this committee.
Third, I have published op-eds with Philip Cross, the retired chief of the Economic Statistics Division of Statistics Canada and separately with Chancellor/Professor Vijay Jog on the savings, assets, debts and net worth of Canadians in The Globe and Mail and The Financial Post.
Fourth, I was formerly employed in financial services in Ottawa in the 1970s and early 1980s. I was a branch manager for four and a half years with AVCO Financial Services, as it was then called, and then I changed to the Bank of Montreal.
The Chair: Could I ask you to slow down a little? We're having a little trouble on the translation.
Mr. Lee: I'll slow down.
Then I went to the BMO Bank of Montreal as a consumer loan manager and then a mortgage manager in the fourth-largest branch in Canada. In fact, it's 100 metres down this street at 144 Wellington. I understand that it's been appropriated by Parliament for the House of Commons Finance Committee.
I simply want to point out that I lent millions and millions of dollars over those nine years. I didn't do anything else. I wasn't in foreign exchange or deposits. All I did was lend money — loans, personal loans, mortgages and so forth.
While employed in 1970s, I granted numerous loans — thousands — under the Small Loans Act of Canada. Due to inflation in the 1970s, because that was a high-inflation period — the act became less important as more and more loans were granted over the threshold of the $1,500. Indeed, there was a lot of pressure on lenders to up-sell customers to get them over the $1,500 because the rates were higher. It was perfectly legal. It was called up-selling and cross- selling.
That act was replaced in 1981, I will argue, very naively by an amendment to the Criminal Code, which criminalized a portion of lending, notwithstanding that in the literature since then there have been very few prosecutions.
I want to give a big-picture overview, because I think that's lacking in the debate. This is empirical data from Statistics Canada's National Balance Sheet Accounts, which is published quarterly. This is personal, excluding corporations and governments; this is just individual Canadians, in aggregate. We've all heard that we owe $1.7 trillion, a mind-boggling number, and people really get their knickers in a knot over the fact that we owe $1.7 trillion but almost everyone forgets to note that we own $9.5 trillion in gross assets, or $8 trillion in net worth, or approximately $250,000 per person. Younger people, of course, don't have that; older people have more than that. It averages out.
Here are a few other big-picture numbers: Seventy per cent of all household debt in Canada is residential mortgage debt. That is about $1.2 trillion of the $1.7 trillion, and that's secured by real estate. Twenty per cent of that $1.7 trillion debt is personal lines of credit, and only 5 per cent is credit card. Sixty per cent of Canadians pay off their credit card in full each month.
Finally, I want to review the hierarchy of credit, and then I'll be open to questions. I don't know if anybody has said this to you committee. I hope somebody has, but if not, I will. There is a hierarchy of credit. Mortgages are the cheapest form of credit in Canada and the United States, bar none, because they have the lowest average delinquencies. As we speak, one third of 1 per cent of mortgage dollars outstanding count as delinquent. It is extraordinarily low. Therefore, the losses are much lower on mortgage credit.
Second in the hierarchy: Consumer or personal loans are more expensive than mortgages, with higher rates of delinquency, depending on the bank or region. It is from 2 per cent to 5 per cent, with much high charge-offs to bad debt.
Third in the hierarchy: Credit cards — Visa and MasterCard, principally — are much more expensive, with higher interest rates — around 18 per cent. Some go into the 20s, some go down into the 10s, but I'm using around 18 per cent as my benchmark.
The fourth level in this hierarchy of credit is department store credit. Most people focus on the bank cards, not realizing that the Home Depots, the Canadian Tires, Sears and all those clothing stores charge 28 per cent. They're much higher than the Visas, and they're much higher risk, again, with higher delinquencies than personal loans, higher charge-offs to bad debt and more expenses.
The fifth one in the hierarchy is payday loans, which are even higher risk.
Quick summary takeaway: Credit, risk, interest rates and bad debt are profoundly correlated. The data is very clear, if you can get it from the lenders, though the lenders tend to guard it in a proprietary manner. When I was in the bank, I had that data and there is absolutely no question. There is not a theory; this is not ideology. I was there as a mortgage manager for almost four years. I had zero dollars of charge-off on mortgages, whereas we charged off several hundreds of thousands a years in personal loans. There is almost no risk in mortgage lending, because you have the house. If you don't pay, we take your house. It's really clear.
I understand I'm running short on time, so I'll be quick.
Let me come to my concerns about this legislation. First, I don't believe there is a crisis in Canada, as I just showed you with these numbers. I don't believe we have a lending or abuse crisis. My problem is that because the act includes fees, some creative lawyers are using that. We saw that where there was a class action against the banks, charging that they were criminally violating the law because of the way they calculated the delinquent fees. This could be — and I think it can be and will be — used as a back door for those who have an ideological agenda against banks. I've already told you that I have no investments of any kind in the banks, but I worked there and I know how the system works, as do the almost 300,000 Canadians who work in the chartered banks and the 1.1 million Canadians who work in the financial services sector. That's Statistics Canada data.
While I believe there is a consensus in Canada that we must protect borrowers from abusive lending practices, I simply do not believe that the Criminal Code is the proper tool to regulate commerce or to regulate credit and lending. Indeed, it's not clear to me whether the bill is trying to address credit cards or bank overdrafts, which are federally regulated, or payday loan lenders, which are regulated provincially.
However, as I tell my students every term, every year, the financial services sector, and especially the chartered banks, is the single most heavily regulated sector of any sector in all Canada. I'm saying that after 40 years of working both as a professor and in the financial sector.
The implicit notion that federally regulated financial institutions are inadequately regulated is so wrong in so many ways, I'm almost at a loss as to where to start. Bill S-210 attempts to further criminalize lending.
There is no crisis. Indeed, Stats Canada, which collects the data on just about everything under the sun in this country — because I spend most of my daytime, seven days a week, studying Statistics Canada data — they don't have good data on this fifth tier, suggesting it is that small or unimportant.
In conclusion, using the Criminal Code to regulate interest rates and lending is the wrong tool and the wrong agency; i.e., the police and the courts trying to regulate what is, in fact, a misdiagnosed problem.
Thank you.
Jennifer Babe, Partner, Miller Thomson LLP, Uniform Law Conference of Canada: Thank you for allowing the Uniform Law Conference of Canada to participate again on this issue on section 347.
The Uniform Law Conference of Canada is over 100 years old. It was started by the Canadian Bar Association and it has been for some time a gathering place for lawyers in-house at the 10 provinces, three territories and the federal government, sitting in two sections: one, on criminal law, and one referred to as civil law, being everything else that is not criminal.
The ULCC did, for about 10 years, a major project on commercial law issues in Canadian law. The issues about 347 do not come from the criminal side of the ULCC. They come from the civil side for the impact of this statute on business law in Canada.
Section 346 of the Criminal Code deals with extortion. Section 347 deals with those who contract for or receive interest at a criminal rate. If, as my friend has said, you actually look in the reported decisions that are out there in the cases that are cited as criminal prosecutions, last time I checked, since about the early 1950s, there were only three or four. The Crown does not go after loan sharks using section 347. Section 346 for extortion? Probably. I didn't check the stats on that.
The Criminal Code, in 347, triggers civil litigation where parties to contracts declare that portions of their contracts are illegal and, therefore, not enforceable. In the materials handed out to you, from the last time the ULCC appeared before this committee, about the predecessor bill, Bill S-19, there are citations to three Supreme Court of Canada decisions about section 347. All of them are about contract law. One of them is a telling one, and it's a class action result against Consumers Gas. Consumers Gas's regulator said it would be good for the utility if people pay their gas bills on time. If you paid on the date, your fee was X. If you paid one day after that, a 5 per cent penalty of your bill was assessed.
The problem with section 347, at contract law, is that the Criminal Code requires that it's not the annual rate of interest that's charged but the effective rate of interest as charged, which must be calculated by an actuary. If you look at the Consumers Gas case, if, for example, your gas bill was $50 and you paid one day late, the actual amount of your 5 per cent per annum discount would be about 3 or $4, somewhere in there. On the actuarial method of calculating criminal interest rate, it exceeds 2,000 per cent per annum. The shorter the denominator of the time period, the higher the effective rate, hence why payday loans, to even exist, have to be regulated outside the Criminal Code under a separate regime.
The other cases that went to the Supreme Court dealt with commercial parties represented by counsel, but, because of various circumstances to the parties, there was a default of some kind and a short payment between loan advance and default and calculation of interest.
The Supreme Court of Canada does not spend much time on commercial law at all, 347 issues getting to the Supreme Court three times in about eight years. That was why the ULCC and the Canadian Bar Association, over the last number of years — and the handout has some of that material — have come here, because, for business parties, 347 is a real pain. In my private practice, I have people engaged in legitimate business, arm's length transactions. Bill S- 210 will give over $1 million: "We think you're sophisticated. You're big people; you'll be outside.'' That helps, but not all of my clients who are engaged in arm's length business, be they regulated financial institutions or other parties, will be freed from 347, making their contracts criminal, therefore, unlawful and unenforceable provisions. The Supreme Court said that, in those situations, in the Degelder case, "You owe the principal, and you owe the interest reduced to the efftective 60 per cent. But you don't have to pay the amount above.''
But people shouldn't, in doing business deals, have to pay me fees to figure out how to deal with their contract terms when they are sophisticated parties.
There are, in the materials, the recommendations from the Uniform Law Conference of Canada and other people about how to deal with section 347. Critical is one of the things that was discussed before; interest is defined to include all charges the borrower must pay to get a loan. So, if you were now talking a high-tech startup, the kids coming out of university today, all of whom have an app, who are doing crowdfunding, if they are doing equity kickers, mezzanine higher risk financing, those charges they're going to pay in terms of royalties on patents or higher rate preferred share outcomes will be interest, and it will trigger 347.
One of the recommendations is carving out. If you are going to carve out certain business practices, the suggestion was that, if you're a regulated financial institution lender of any kind, provincial or federal, you should be outside of 347. If you're above $1 million, S-19 previously set $100,000. It's a contract law problem. With respect, as noble as it is to try to regulate consumer protection, the Criminal Code is not the place to do it.
[Translation]
Senator Bellemare: If we adopt Bill S-210 and reduce the criminal interest rate to 20 per cent more than the Bank of Canada's rate, what will be the known repercussions on the industry?
[English]
Ms. Babe: In consumer transactions, you will trigger more class actions. Because this is used to make provisions unlawful, then, like Consumers Gas and a number of other consumer protection matters, they become class actions relative to the unlawful charges in contracts.
Mr. Lee: I won't deal with the legal consequences. People with good credit ratings can get credit. It's just that simple. That is to say, they don't get kicked out of the market. They're not pushed out of the market. Who gets pushed out of the credit market because credit is a market also? It's those people who are marginal. That famous phrase is: "The road to hell is paved with the best of intentions.'' In this instance, what it will do is, if it causes the banks to tighten up, which I expect it will, they'll just become very much more cautious. They'll make the rules tighter and they'll make it more difficult to get credit. That's just going to drive the really marginal people who are desperate underground, into the really bad actors' arms.
That's what I mean by "the road to hell is paved with good intentions.'' I think the impact of this bill could be exactly the opposite of what you're trying to achieve.
Senator Massicotte: Thank you for your presentation. It's very useful.
Ms. Babe, I'm trying to understand. I think I understood what you're saying, but what would you do with the bill? You'd reduce the million bucks to probably 100,000, and you would increase the 60 per cent to a hundred per cent? How do you get around this, or do you just abolish the paragraph completely.
Ms. Babe: I'd take out the effective requirement on the calculation of the effective annualized rate.
Senator Massicotte: Make it a nominal rate?
Ms. Babe: Just the straight annual rate, the straight, linear per annum calculation. It's the effective rate calculation that causes a lot of these problems and class actions.
Senator Massicotte: So what percentage would you choose?
Ms. Babe: Sixty per cent is fine. The industry is used to it.
Senator Massicotte: You would take out the word "effective,'' and you would say what again?
Ms. Babe: I would take out the effective annual rate. I would make a carve-out from the definition of interest for things like equity kickers and royalties on intellectual property. Those are not considered interest, so businesses can use those assets as a way of leveraging money. I would also take out any regulated financial institution as a lender.
Senator Massicotte: You touched $ 1 million.
Ms. Babe: I would go down to $100,000 again. It will not solve all the problems, but for business-purpose loans, it would be highly helpful.
Senator Massicotte: Basically you're referring to a nominal annual posted rate, and you would exclude fixed costs or fees that are calculate separately.
Ms. Babe: Yes, if they are paid to a third party. Say in a real estate loan if you have to have an appraisal done and pay a fee to a third party to get the loan, that's legitimate. I have been hearing is that you pay and a related party is a loan broker — if you pay a legitimate third party, such as a surveyor or an insurance policy cost — things that you would expect to be paid as part of the creation of a commercial loan.
Senator Massicotte: The objective, I think, of Senator Ringuette is quasi-payday loans — replacements of those regulated by provinces — where somebody borrows $100 basically for two weeks and provides a credit card or a postdated cheque or something. So, no one gets offended by the 60 per cent or maybe 40 per cent, but 20 per cent gets tight because most credit cards are above that. How do you deal with the fact that just to create that paper — have somebody come in your office and do business for $100 — you're probably going to spend 10 or 15 minutes filling out a form and asking a couple of questions about the person. There is a fixed cost to that. The interest rate is a rent on the loan of money. It's a rental — you can't look in the absolute. How do you deal with that issue? Say $100 for two weeks will cost $8 to do the paper and you want to be paid 15 per cent to 20 per cent for the risk. Immediately you're up to 1oo per cent. How do you deal with that issue?
Ms. Babe: I don't know how you deal with overhead. If you're going to regulate costs down, it's going to be a challenge; and you will drive some parties out of the marketplace.
Mr. Lee: First, and I'm being very serious, not flippant, I would defeat the bill. Get it out. It's a bad bill.
Senator Massicotte: I'm surprised you said that.
Mr. Lee: If you're going forward, I would certainly remove any institution that is regulated by OSFI or the credit union equivalent. I'm less familiar but credit unions are certainly well regulated. Remove all the institutions, the banks and similar institutions regulated by OSFI. If we are going to start regulating interest rates, the instrument is OSFI. They have the expertise, the people who understand banking and understand the financial sector. Whereas, using the Criminal Code to try to get at nefarious behaviour is something that's straight out of the 19th century.
Senator Massicotte: OSFI.
Mr. Lee: Office of the Superintendent of Financial Institutions.
Senator Massicotte: A lot of this payday loan doesn't come from the major institutions.
Mr. Lee: That's true and that's why I said the institutions that come under OSFI, and the payday loans are regulated provincially. Let me go beyond that. I'm not so certain that there is a crisis or a problem. I've spent quite a bit of time, I assure you, in the last five days looking for data; and I'm really good at finding data because that's all I do all day long. That's the luxury of being a professor: You don't have to go to work. I can spend my time wandering through picking up the phone to call people I know at Statistics Canada to ask if I'm missing a database. It's not there; and yet they measure just about everything in this country.
I want to get to your question on the overhead. This problem happened at Avco in the 1970s. They got around the overhead problem and the cost of small loans by simply up-selling the people to loans over $1500. You did that by paying off other companies, such as the Sears credit card and so on. The problem went away partly through inflation and partly through the strategies of the loan companies.
How did the banks deal with it, and I was there when it was happening. Banks originally, for those older people who remember this, weren't big on consumer loans back in the 1970s. Banks couldn't make a consumer loan under the Bank Act until 1967. It was illegal in Canada for a bank to make a personal loan. The banks were given that right in 1967. They sat stupefied for five years because they didn't know what to do. I'm serious. The Bank of Nova Scotia, as it was known, got into it first. They realized they didn't have any expertise in consumer credit so they started to raid Household Finance, Beneficial and AVCO because they had the expertise in credit and collections for consumer loans.
The other banks started to get big on doing consumer and car loans and dealer floor plans; but they ran into the same problem. There were customers who wanted a loan for $300 or $400 but the banks wanted to do loans for $2,000, $5,000 and $10,000. Clearly, there are economies of scale in credit. It costs as much to check out a loan for $10,000 as it does for $200. That's when VISA came into the market in the mid- to late-1970s.
Increasingly, the banks, in a very clear and clever strategy, began to issue credit cards to young people without a credit check. They worked on the law of large numbers — 98 per cent or 99 per cent of the customers would pay on time and 1 per cent wouldn't, which they charged off to bad debt. So who cares — you found a whole bunch of good customers for the price of writing off one bad customer. They're using credit cards as the small loans. The people who can't get a credit card have very bad credit. That's why they're going to the payday industry. You're talking about people who have serious credit problems, and I don't think you can regulate that.
[Translation]
Senator Maltais: Mr. Lee, you spoke a great deal of Avco. Since we both have white hair, I would like to remind you that they had the Avco World Trophy in the World Hockey Association. Three quarters of the teams in that league went bankrupt. It is a bad example.
Ms. Babe, I am trying to understand what you said. In your presentation, you said you have always won your cases before the Supreme Court. Is that correct?
[English]
Ms. Babe: No, sir, I'm not a litigator. Those are just reported decisions. It's rare that the Supreme Court does commercial law. It has three decisions in 10 years on section 347, none about crime but about contract enforcement.
[Translation]
Senator Maltais: So why should we be afraid of Bill S-210 if the Supreme Court is giving us that guarantee?
[English]
Ms. Babe: There was no guarantee. The lenders lost. The problem is for lenders and businesses.
[Translation]
Senator Maltais: You said that the lender lost. That is a first in Canada, and even throughout the world, right?
[English]
Ms. Babe: No, sir. The real thing that you're going to have a problem with if this goes forward is: When Bill S-19 was put forward in 2005, six or seven of the provinces intervened relative to the constitutionality of trying to regulate in the area of civil and property rights. This is contract law matter between borrowers and lenders and business people. It's not about crime.
[Translation]
Senator Maltais: Do you work in Quebec?
[English]
Ms. Babe: No, sir, I practice in the Province of Ontario.
[Translation]
Senator Maltais: Do you work for a gas company?
[English]
Ms. Babe: No, sir. I work for a law firm.
Senator Wallace: I think you're both saying the same thing. At least I get the message loud and clear you believe that in regulating consumer and commercial lending, the Criminal Code is not the place to do it. It's an antiquated idea that arose from the 1970s, and that is not where we should be going.
Do I take it that if we were going forward to alleviate a lot of the lending issues out there, both commercial and for consumer lending, that section 347 should be removed from the Criminal Code and be replaced with other regulated requirements that are not criminal. Is that where you are coming from?
Ms. Babe: Yes.
Mr. Lee: I think you have to separate, and I'm saying this as someone who was a collector many years ago. Even in those days they were worried about ethical issues. You have to distinguish between the rate you're charging the customer and the means whereby you collect the money. In other words, if you threaten to break their head with a baseball bat, it's illegal. If you're going to keep something in the Criminal Code, it should be the means by which they're trying to collect the debt, which is completely independent of the interest rate.
It shouldn't be in the Criminal Code. So yes, in terms of the rate, that should not be in section 347.
Senator Wallace: Certainly as far as the method of collection goes, whether you're collecting interest, money or a ball glove, the fact is that it's the criminal act of enforcement.
Mr. Lee: I know you understand that, but what I think happened over the years is that the two have become concatenated. We tend to correlate in our heads high interest rates with people who collect in a very aggressive and possibly illegal manner. We have to unpack and separate out those two issues.
Senator Wallace: Having said that, there seems to be an issue that Senator Ringuette has tapped into and I think we all agree something is there that should be addressed. Do you see anything on balance, anything beneficial that would come from the enactment of Bill S-210? I ask both of you.
Mr. Lee: I don't.
Ms. Babe: If this section is not going to be repealed, the $1 million cap will help business deals but it's not the solution for business deals. It will remain a problem and 347 goes back to the early 1950s; it was meant for loansharking. The police asked for a rate to put in to twig a clear line in evidence, but having put in the effective annual rate as calculated by an actuary has led to the contract law problem of unenforceable contracts by reason of illegality.
Senator Ringuette: Ms. Babe, I read the three Supreme Court decisions before putting forth the bill and that is why, in regard to bridge financing and so forth, for the big companies, the million-dollar and more deals, that it's completely removed from the Criminal Code.
However, that being said, I've also read the Uniform Law Conference of Canada report of 2008 with regard to all the issues. There are seven sections.
On page 17, as a recommendation, the group that you are part of says:
In light of the issues and discussion contained in this paper, the Criminal Section of the Uniform Law Conference of Canada recommends that the Department of Justice, in consultation with the provinces and territories, immediately conduct an examination of s.347 with a view to reform and present the results of its examination on an expeditious basis.
It is now seven years later. Nothing has been done with your recommendation.
Ms. Babe: That is correct.
Senator Ringuette: It is very unfortunate because I agree with the seventh section in the document. By the way, I'm not ideologically against banks. I'm against abusers.
That is why the entire section of Bill S-210 for loans of $1 million or more is completely taken out, in order to give the financial situations the flexibility they require, whether it's venture capital for a year or less and so forth. It is because of those three Supreme Court judgments.
Barring that, for seven years your organization has called on the government to consult the provinces, the institutions and so forth in order to correct a situation that needs to be corrected. Since then we've seen the result of payday loans and Internet loans.
In what other way can we bring some attention to all of these issues so that people don't have to wait another seven years to to get it corrected? I think, more or less, we all agree that the situation is not acceptable. Maybe there is a place other than the Criminal Code to deal with such an issue. The Department of Finance and the current government has not put up any other solutions or alternatives, and the current Criminal Code has been in effect for 34 years. Highlight the issue, bring some solutions. I think that Bill S-210 is bringing some solutions or at least bringing some attention.
Ms. Babe: I understand. Unfortunately, in 2008 I worked with my colleagues on the criminal section of the ULCC, and the Crown attorneys aren't using the section so they didn't see much of a problem. The commercial law people on the civil side did, but we had had our shots between those years leading up to 2008 and handed it to our criminal law colleagues hoping they would do something with the Minister of Justice. That has, as you know, not happened.
In the meantime, the payday loan industry got regulated by an exception and —
Senator Ringuette: For one product.
Ms. Babe: The "payday loan'' is defined, absolutely true. I go back to the fact that the Criminal Code, as seen by people who have to deal with business lawyers, is not the right place. There is the federal Interest Act. It's nine sections long and hasn't been touched since about 1904, but it's still there.
However, I think you have a constitutional problem in terms of trying to regulate in the sphere of property and civil rights. That goes back to consumer protection statutes provincially, and cost of credit disclosure rules are much better than they were. Quebec unfortunately does not have cost of credit disclosures for leases or you would see more disclosure in Quebec on leases.
Senator Ringuette: I have another question for you. What if I were to amend my bill to remove the entire section with regard to business? Right now the 60 per cent still applies for loans that are less than $1 million for the small- and medium-sized businesses.
If I would amend my bill and remove that clause, in regard to contracts and so forth, would that be proper in lieu of doing nothing?
Ms. Babe: Having the million-dollar cap in is beneficial to businesses. I think you're going to start having people play fast and loose with what a business is if they want to get around that. But, for legitimate business people, arm's length transactions, the million dollars helps. For business people, it would also help with other things inside the definition of interest.
You mentioned bridge loans. That isn't usually businesses. That is usually consumers in Canada who buy the new house before they sell the old house, and those bridge loans can indeed be criminal by just having to pay off your loan after two days. That's a very legitimate transaction, and with that short denominator with the effective annualized rate, most of those loans will be made by regulated financial institutions. So to Mr. Lee's point, if you take out regulated financial institutions as another carve-out, that will assist as well, from a business perspective.
[Translation]
Senator Bellemare: I will ask just one question. The previous speakers told us about what is done by the Mouvement Desjardins in Quebec. It helps to finance a fund to help those who have been exploited by the financial system, because there is a relationship between risk and interest rates, and often it is the poorest among us who pay the most. There is a fund administered by a community group. It helps the poorest and most disadvantaged to get out of a tight spot. If we did something similar, if the government encouraged financial institutions — given that they discriminate a great deal between their clients — to finance such a fund to prevent people from getting deeply into debt, do you thing that would be a good way to help the most disadvantaged?
[English]
Mr. Lee: No, and I'll explain why. Immediately, you're creating a problem of moral hazard. Moral hazard is where you're encouraging people to do that which you're setting out to try to mitigate. If there is a fund to not pay your loan, my goodness, I'll probably apply too. I can get a free loan is what you're saying. I'm being a little bit flippant to make my point.
The second problem is you have a profound measurement — I would call it a methodological problem. That is to say, how do you determine whether it's really a hardship case? I assure you — I have already said this; I am repeating myself — I was in credit for nine years. We dealt with these issues every day of the week. We were evaluating because some customers don't tell you the truth. They're like students. The odd student lies. Believe it or not, they do. Most of them don't, but some do. So my point is that you have to filter and ask which person who said, "I can't make my loan payment,'' is really legitimate. Did they really lose their job? Is it a hardship case? Then, you're almost becoming a psychological counsellor and evaluating, so I think that that would be very difficult.
My third point for you: This is why the Bankruptcy Act was passed by Parliament. If you cannot pay your bills as they become due, you have the full legal right to go bankrupt. It's not complicated or difficult. I dealt with thousands of bankruptcies over the nine years. I wasn't going bankrupt. I was getting notices every day in the mail from the bankruptcy office of Gingras and Associates telling me one of my customers had just gone bankrupt. There is an outlet is what I'm trying to say; there's a legal mechanism for people who are overburdened and cannot pay. It's called bankruptcy.
Senator Massicotte: What is interesting is that there is a serious problem with the legislation as it is, regarding the 60 per cent. If you look at the court process, it's usually sour grapes, where things didn't work out as planned so then they used legislation, the arbitrary number of 60 to try to get down their loan costs and so on. To do nothing is not a solution. A stupid question: Why hasn't the government done something? A lot of time is spent on the court process today — and your example of Consumers Gas is a good example — which is obviously manipulative. Why don't they do something? Why don't they correct the problem?
Ms. Babe: I wish they had, but it hasn't happened. I applaud this group for trying to do something. We're talking here about crimes. When the Department of Justice isn't prosecuting the crime of loansharking, it's not an issue to them. Since it's the bailiwick of the Minister of Justice, that's where it stays.
Senator Massicotte: You're looking for a solution to a different problem than the objective of Senator Ringuette, who is trying to protect the consumers who need protection, if you wish. Maybe the solution would be to reduce the million bucks to 100,000 bucks. You get the exceptions for regulated lenders and so on. That largely achieves that. I have a problem — and I guess we discussed earlier — re: the quantum, the numerical calculation of a certain number. Why not just drop that number and do like the U.K. and like the U.S. is looking at, to simply say that a lender can only provide a loan where there is reasonable expectation of getting repaid. There has to be something in front of us showing us that. Because what you constantly have in the pay loan industry is repetitive lending, and it becomes abusive. So, as you know, the U.S, last month, recommended that wording. When you make a loan, you have a reasonable expectation of getting paid in a time provided. Therefore, it is less manipulative. Wouldn't that be an easy solution to resolve the pay loan or the abusive lending issue, on the consumer side? At the same time, we're trying to resolve your issue, which is all kinds of business loans, which, numerically, may exceed the 60 per cent. You remove that completely.
Ms. Babe: If you went to that sort of test, it shouldn't be in the Criminal Code.
Senator Massicotte: I know, but you're stuck with it. You're trying to resolve your problem.
Ms. Babe: I think you would have a very hard time having the police remove the 60 per cent because, when they go to court on those rare times, they need a bright line test. So I think we're stuck with the 60 per cent. How it's calculated is a different issue, and that's what triggers business problems.
Mr. Lee: I'm sympathetic. Even though I don't agree with you, I understand that you have an issue, Senator Ringuette, and you want to address it. May I suggest, very respectfully, that you work with Statistics Canada to get a hard number? I think the reason the government is not paying attention is that there is no agreed-upon, empirical data. Is the problem 10,000 people a year and $100 million of indebtedness, or is it billions and hundreds of thousands of Canadians? Nobody knows. We don't have data, seriously reliable, good, hard, quality data. Everybody is literally groping around in the dark.
Senator Ringuette: Statistics Canada was cut with regard to the quantity of study and data that they could collect.
The Chair: Dr. Lee, on behalf of all members of the committee, I would like to express our great appreciation to you. You have been before us on a number of occasions. It is always a pleasure, sir.
To you, Ms. Babe, I don't believe I am aware that you have been before our committee before. It has been an absolute pleasure.
Ms. Babe: In 2005, on Bill 347.
The Chair: It was before my time. It was an absolute pleasure having you. We express our great appreciation to both of you for appearing before us.
Mr. Lee: Thank you.
Ms. Babe: Thank you.
The Chair: This meeting is concluded.
(The committee adjourned.)