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SME Financing in Canada, 2002 — Part I: Debt Financing

Demand For Debt Financing: Contributing Factors

In 2000, a majority of businesses – 77 percent – made no request for new debt.^{Footnote 3} A recent survey conducted by the Canadian Federation of Independent Business (CFIB)^{Footnote 4} reports that debt instruments were the most common forms of financing used by SMEs. The most frequently used instruments reported were (in order of frequency): lines of credit (short-term debt), business loans (demand or short-term debt), commercial mortgages and personal loans/mortgages (long-term debt).

The Survey on Financing of Small and Medium-sized Enterprises found that 23 percent of SMEs requested some form of debt in 2000. The survey also found that there was a variable pattern of application for the various types of debt instruments across industries, size of businesses and regions. There may also be a changing pattern of loan authorizations^{Footnote 5}. The findings of this survey, which shows less than one-quarter of SMEs making a request for debt in 2000, corroborate other recent studies which report a decreasing demand for debt financing among SMEs. The CFIB report that there has been a "steady downward trend (1987 – 2000, in requests for debt financing , which) does not appear related to the business cycle".

The Conference Board of Canada study, A Changing Demand for Debt Financing^{Footnote 6}, reports that loans outstanding under $1 million accounted for 69 percent of authorized amounts in 1995, and 67 percent in 1999 and suggest that borrowers were likely more focussed on repaying loans during this economic upswing. Other factors which could be contributing to this phenomenon include:

• increased use of retained earnings;
• increased use of lease financing;
• a perceived or real barrier to access due to credit scoring practices of the major suppliers of debt; and
• larger institutions transferring their SME clients from commercial banking to their personal banking divisions.

The pattern of demand for debt is determined by a number of factors. In the sections that follow, the borrowing practices of Canadian SMEs will be reviewed in a number of different contexts by industrial sector, region, the demographic characteristics of the business owner and other characteristics. This report does not include the kind of detailed analysis that can precisely define the causal factors in the results that are presented. Further studies will look at these questions in more detail.

• Regional Economic Structures: The economic structure of Canada's regions varies considerably, with some regions more dependent on agriculture and primary industries and others more on manufacturing, services or knowledge-based firms. As these industrial sectors have significantly different financial services needs, the regional differences seen with respect to financial services may be linked primarily to the structure of the regional or provincial economy. For example, Manitoba and Saskatchewan have a greater reliance on agriculture than other provinces (Table 17 provides a breakdown of the contribution of a variety of industries in Canada's regions). Agriculture generally has a great need for debt and – because of the nature of the assets that are financed – a higher approval rate for debt applications. Thus the regional differences observed between Manitoba and Saskatchewan and other regions are likely not a result of factors specific to the behaviour of financial institutions in those provinces, or of all businesses in those provinces, but are a result of the importance of agriculture in their economies.
  
  
• Structure of the Financial Services Industry: There is a wide variety of firms providing financial services across Canada, and a considerable variation in their distribution. Part of this is explained by regional economic structure: some suppliers of financial products tend to specialize in certain business activities. For example, credit unions / caisses populaires are historically linked to agriculture and therefore agricultural regions. (This is not to say that these suppliers deal only with farms or are only found in agricultural regions, but that proportionately more of their business is done with this sector and in those regions.) The major chartered banks are most active in the urban markets, and particularly in Ontario and Atlantic Canada.
  
  
• Economic Performance: At any given time there is a degree of variation in the economic performance of regions and sectors of the economy. This can be a factor in explaining differences in the behaviours of both the users and suppliers of financial services across the country. Table 18 provides the recent GDP growth rates for Canada's regions.
  
  
• Changing Business Strategies and Other Sources of Financing: In Canada's dynamic economy and financial services sector, new business approaches and financial services are being tried all the time. This may be affecting historic patterns seen between, for example, the growth of small businesses and the amount of term debt outstanding. The knowledge-based sector with its relative lack of "hard" assets is a challenge for a financial system that has traditionally dealt with asset-backed financial products. Knowledge-based firms often need risk capital, in the form of equity investment, rather than debt. In recent years leases have become an increasingly popular form of financing, and this situation is likely cutting into the demand for other financial services. Credit cards and other short-term instruments are also increasingly being used by small businesses. These are complicated developments that likely advantage some firms and disadvantage others. One of the objectives of the SME Financing Data Initiative will be to document these trends so that conclusions on the impact of these changes can be made.

3. Statistics Canada's Survey on Financing of Small and Medium-Sized Enterprises, 2000 asked firms to report on their last request for debt in 2000. It is important to note that the statistics presented in this section do not include businesses that planned but failed to start up, or the ones that ceased operations, either during 2000 or after.

4. Canadian Federation of Independent Business, Banking on Entrepreneurship, March 2001. http://www.cfib.ca/

5. "Loan authorization" refers to the maximum amount of money a financial services supplier agrees to provide a client. This should not be confused with outstanding loans, which are the actual amount of debt owed to a supplier at any given time.

6. Conference Board of Canada, A Changing Demand for Debt Financing?, January 2001.

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