Small and Medium-sized Enterprise Financing in Canada — Part III: Financial Services Sector — Providers of Business Financing

2. Overview of Financial Institutions' Services

This section provides a general overview of the different types of financing supplied by the various financial service providers and explains how their presence within each market segment differs (e. g. domestic banks focus on lending while specialized finance companies focus on leasing). This section covers commercial debt, leasing and factoring. Risk capital financing, which is used by less than 5 percent of SMEs, is addressed in Part IV.

2.1 Commercial Debt

Commercial debt was the most common type of financing sought by SMEs in 2001 (49 percent) (see Table 11). As noted earlier, the proxy definition of SMEs is loan authorizations of less than $1 million. Figure 33 illustrates the market share of commercial debt authorized under $1 million by key institutions as of December 31, 2000 and 2001.

Figure 33
Market Share of Commercial Debt Authorized, Under $1 million, by Financial Suppliers as of December 31, 2001

Some key findings include:

• Smaller authorization (less than $1 million) amounts of commercial debt⁶⁴ from all sources increased by 6 percent, from $137 billion to $146 billion during the 2000–2001 period
• Domestic banks were an important supplier of commercial debt for smaller authorization amounts, representing half of the market in 2000 and 2001
• Other banks have nearly doubled their market share of smaller authorization amounts⁶⁵
• Credit unions and caisses populaires authorized nearly one fifth (18 percent) of commercial debt in smaller authorization amounts. Although these institutions are not evenly distributed across Canada, their financing activity in the smaller authorization marketplace is significant, constituting $27 billion to businesses in these categories in 2001, compared with $25 billion in authorizations in 2000
• Insurance companies were not key suppliers of small authorization amounts: As of December 31, 2001, insurance companies authorized $2.6 billion of commercial debt under $1 million, representing 4 percent of their overall commercial debt portfolio

The market for commercial debt changes for even smaller authorization amounts (less than $250,000). As illustrated in Figure 34, credit unions and caisses populaires' market share increased significantly for authorizations of less than $250 000, from 18 to 25 percent. These institutions' market share increased to 30 percent for debt authorized under $50,000. Conversely, financial providers such as other banks and finance companies tended not to focus on the smaller (less than $250 000) amounts, as evident in their decreasing market share. Domestic banks, however, continued to play an important role.

Figure 34
Commercial Debt Authorized, Under $250 000, by Financial Suppliers as of December 31, 2001

Some key findings as of December 31, 2001 include:

• Domestic banks: led the market for authorizations for:
  • less than $250 000: $33 billion (46 percent of all debt in this authorization category)
  • less than $50 000: $7 billion (45 percent of all debt in this authorization category)
• Credit unions and caisses populaires:
  • less than $250 000: $18 billion (25 percent of all debt in this authorization category)
  • less than $50 000: $4 billion (26 percent of all debt in this authorization category)
• Finance companies focussed on larger authorization amounts more than credit unions and caisses populaires
  • less than $250 000: $15 billion (21 percent of all debt in this authorization category)
  • less than $50 000: $3 billion (19 percent of all debt in this authorization category)

2.2 Lease Financing in Canada⁶⁶

As of December 31, 2001, the total value of leases authorized to all businesses amounted to $32.4 billion, a 20-percent increase from 2000 (see Table 22).⁶⁷ According to the Conference Board of Canada, the growth in the leasing market may reflect businesses' use of leasing rather than borrowing.⁶⁸ While data limitations preclude accurate consludions about this issue, the SME Financing Data Initiative will continue to monitor this situation.

The Canadian Finance and Leasing Association⁶⁹ suggests that lessors, especially larger institutions (e.g. domestic banks), are becoming more selective in their considerations of certain types of new businesses and are focussing on serving large ticket transactions. This change in behaviour by large lessors could account for the significant increase in the amount of leases authorized in 2001.

Figure 35
Market Share of Commercial Leases Authorized by Financial Suppliers as of December 31, 2001

Amounts of leasing authorized to all businesses in Canada by key financial service providers as of December 31, 2001 were composed of (see Figure 35):

Finance companies: $15 billion (20-percent increase from 2000)
Domestic banks: $9 billion (13-percent increase from 2000)
Leasing companies: $6 billion (18-percent increase from 2000)
Other suppliers: $2 billion (16-percent increase from 2000)

As shown in Figure 35, finance and leasing companies accounted for two thirds (66 percent) of the leasing market in 2001, and domestic banks maintained approximately one quarter of the market. The lower participation by the domestic banks may be connected to the restrictions imposed by the Bank Act,⁷⁰ which prevent banks from leasing automobiles and light-duty vehicles — the kind of equipment that accounted for the most leasing requests by SMEs in 2000.⁷¹

As a result of these factors, domestic banks have been less involved in supplying leasing for the smaller authorization categories. As illustrated in Figure 35:

• domestic banks' market share for leases authorized under $1 million was 15 percent lower than their share for leases over $1 million; and
• finance and leasing companies' market share for leases under $1 million was 15 percent higher than their share for leases under $1 million, with leasing companies accounting for the majority of the difference (10 percent).

Other Leasing Highlights⁷²

Firms in the transportation and warehousing sector were authorized 30 percent — $9.8 billion of leases by all suppliers as of December 31, 2001 (see Table 19). Manufacturers captured the second-highest proportion, with $7.5 billion authorized. This is consistent with the findings from Part II — that these two sectors were the highest users of lease financing. For example, 25 percent of manufacturing SMEs used leasing to finance their operations in 2000 (the highest of all sectors).

2.3 Factoring

As of December 31, 2001, $127 million in factoring was provided to all businesses in Canada, slightly less than the total for 2000 ($131 million). Factoring is not often used by all businesses, and this is particularly true for SMEs. Generally, this type of financing is used by larger firms in manufacturing, wholesale/retail and knowledge-based industries. Factoring is obviously a marginal type of financing (as seen in Part II, factoring constituted approximately 1 percent of SME financing in 2000).

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64. The Survey of Suppliers of Business Financing defines the total amount authorized as the maximum a client is allowed to borrow, aggregated over all clients falling into the particular size instrument, industrial or geographic category. This may or may not be the amount that a client actually borrowed.

65. The change in market share is a result of coverage change that occurred during the 2000 and 2001 surveys. Some institutions were included in the “other banks” category in the 2001 survey that were not included in the 2000 survey.

66. The Survey of Suppliers of Business Financing categories do not differentiate between capital and operating leases. The definition includes leases on assets such as cars, trucks, machinery, equipment, computers and office equipment (fax machines, photocopiers, printers, etc.). It excludes leases on real estate and office space and short-term rentals (i.e. less than one year). Future surveys will include clear distinctions between operating and capital leases.

67. Since lease authorization size is tied to the value of the asset being leased, rather than to the borrowing capacity of the borrower, it is not possible to apply the same definition of an SME (under $1 million in authorization) to leases as was applied for commercial debt.

68. Conference Board of Canada, A Changing Demand for SME Debt Financing, January 2001.

69. David Powell. Asset-based Financing and Leasing in Canada: An Overview, Canadian Finance & Leasing Association, 2003.

70. Bank Act, section 417 which states "Restriction on leasing – A bank shall not engage in Canada in any personal property leasing activity in which a financial leasing entity, as defined in subsection 464(1) is not permitted to engage." Section 464(1) is a list of definitions under the investment powers in the Bank Act.

71. Industry Canada, Small and Medium-sized Enterprise (SME) Financing in Canada, 2002.

72. There are insufficient data to support an analysis of lease financing loss rates.