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The previous section reviewed financial service providers of three types of financing: commercial debt, leasing and factoring. This section builds on that analysis and presents key findings related to individual suppliers: domestic banks, other banks, credit unions and caisses populaires, and other market participants (e.g. finance companies).
Domestic banks remain the major suppliers of financing to all businesses in Canada. Combined, these institutions dominated the Canadian financial services sector, reporting $1080 billion in domestic assets in 2000, or over half of the sector's total assets in Canada. The five largest banks73 accounted for about 90 percent of total bank assets in 2000.74 In 2001, the top five domestic banks each had shareholders' equity of more than $11 billion and total assets in excess of $230 billion.
Commercial debt was the most common form of financing provided by domestic banks to all businesses in Canada. As of December 31, 2001:
Key findings about domestic banks:
Distribution of Commercial Debt Authorized by Domestic Banks as of December 31, 2001
These two observations indicate a decrease in the demand for debt; however, further analysis would be required to confirm the significance of this trend.
Nearly 50 percent of SMEs had outstanding loans or other forms of credit owed to domestic banks (see Table 11). Nonetheless, for domestic banks, smaller authorizations represented a marginal proportion of overall lending activity (12 percent — see Figure 36).
Domestic banks made 12 percent of their debt authorizations in amounts under $1 million, and tended to focus on the larger authorization amounts (88 percent) for commercial debt. As seen in Figure 37, the majority (9 percent) of the 12 percent of lending consisted of loans over $100 000.
Percentage of Total Commercial Debt Authorized by Domestic Banks Under $1 Million (by Size of Authorization) as of December 31, 2001
As seen earlier, domestic banks are key providers of debt to Canadian businesses, and are particularly important for debt authorizations under $1 million. However, it is important to analyze these institutions' risk of lending to better understand their lending practices. This section reviews the risk of lending (using loss rates as a proxy definition of risk) in 2000 and 2001, with a particular emphasis on debt under $1 million. For the purpose of this analysis, loss rates are defined as the amount of losses over the amounts outstanding in a given year. Although this approach has limitations (see text box), it does illustrate the risks associated with lending small authorization amounts.
Caveats On the Definition of Loss Rates:
The loss rate is typically defined as the amount of total losses (net of recoveries) divided by the original amount of the debt authorized. However, the Survey of Suppliers of Business Financing does not capture the original amount of the debt supplied. Therefore, the amount outstanding will be applied as a close proxy of the amount of debt borrowed. It should be noted that the amounts outstanding are cumulative so that loans from a number of years are included in this analysis.
Loss Rates on Commercial Debt of Domestic Banks by Size of Authorization in 2000 and 2001
As shown in Figure 38, the loss rates for domestic banks in 2000 and 2001 were as follows:
Further analysis reveals significant increases in loss rates for authorizations of less than $100 000:
These observations suggest that smaller authorization amounts incur higher risks than larger amounts. However, loss rates tend to be volatile and are heavily influenced by business cycles and other economic factors. Consequently, more data and analysis will be needed to determine what factors account for the higher loss rates in the smaller authorization categories.
Although domestic banks focussed mainly on commercial debt in 2000 and 2001, they also increased their stake in the leasing market (see Figure 35).77 These institutions operate in the leasing market either alone or in alliances with other suppliers who specialize in this form of financing (as is the case of the Bank of Montreal).
Key findings related to lease financing provided by domestic banks in 2000 and 2001 include:78
Leasing by Domestic Banks by authorization size: As of December 31, 2001:
Domestic banks in Quebec authorized 25 percent more lease contracts in 2001, compared with 2000: According to the Canadian Finance & Leasing Association (CFLA),81 chartered banks are becoming more selective in their consideration of new businesses. These institutions are shifting attention to due diligence and risk management and the large-ticket transaction market. The supply data do not distinguish between the amounts of leases authorized to SMEs and to larger businesses. However, given that only 11 percent of SMEs in Quebec used leasing to finance their operations in 2000, the increase in domestic banks' market share is likely related to their tendency to concentrate on larger businesses. Further data collection and analysis will be needed to better understand this market.
Other banks82 have been increasing their role in the debt marketplace. As noted earlier, changes in federal regulations have allowed a number of foreign banks to enter the Canadian financial services sector. Foreign banks, which have been operating in Canada since 1980 through regulated Canadian subsidiaries, have concentrated on providing wholesale financial services in urban markets.
Key findings about other banks in 2001:
Key findings regarding commercial debt authorized by other banks as of December 31, 2001 include:
As was the case with domestic banks, other banks have not focussed on the smaller authorization categories in terms of their overall debt portfolio. However, there has been a significant increase in the amount of debt authorized to SMEs (56 percent increase between 2000 and 2001), due in part to a coverage change of the supply sample. The survey coverage of federal and provincial government business enterprises was more extensive in 2001 than it was in 2000, which has resulted in higher estimates for some supplier types, particularly other banks.
Applying the same definition of loss rates used in the analysis of domestic banks (losses divided by amounts outstanding), leads to several conclusions about other banks' loss rates in 2001:
Other banks carried a riskier portfolio of commercial debt for all business in 2001 (compared with domestic banks), as the loss rate increased by 30 percent from 2000 (when the overall loss rate was 0.8 percent). While the data are insufficient to analyze each authorization category separately to determine the origin of the increase in loss rates, the data do indicate that loss rates on commercial debt authorized under $1 million fell between 2000 and 2001. In fact, compared with loss rates of other financial service providers to these enterprises, other banks' loss rates on commercial debt authorized to under $1 million were the second lowest among financial providers. Limitations in the data complicate firm conclusions on other banks' risk of lending to SMEs. However, continued data collection and reporting will determine the role of these institutions in supplying commercial debt to SMEs.
Canada's credit unions and caisses populaires play an important role in the Canadian financial services sector. They differ from banks in that they are co-operative financial institutions that are owned and controlled by their members. Their ownership and corporate governance are based on co-operative principles, and each individual credit union and caisse populaire maintains a separate identity. Given their autonomous local structure, credit unions and caisses populaires are generally much smaller than other deposit-taking institutions in terms of asset size.
Key findings about credit unions & caisses populaires:
Unlike domestic and other banks, credit unions and caisses populaires are provincially regulated, and as a result their activities remain primarily within provincial boundaries, although some of these suppliers of financing do provide financing outside of their home province.
As of 2001, Canada's credit union sector consisted of about 700 credit unions and almost 1100 caisses populaires, with more than 3600 locations and 3900 automated teller machines.83 The significance of the credit union movement varies substantially from province to province. Saskatchewan and Manitoba account for about 32 percent of all credit unions in Canada, whereas Atlantic Canada features a much lower rate of penetration (see Figure 39). In Quebec, the Mouvement Desjardins is a dominant market force, accounting for more than 36 percent of deposit-taking institutions' assets in Quebec and benefiting from a strong market position in many product lines.
Commercial debt authorized as of December 31, 2001 included:
Distribution of Credit Unions Across Canada
Unlike the larger institutions (domestic and other banks), credit unions and caisses populaires focussed on commercial debt authorizations under $1 million (69 percent of overall portfolio as of 2001 — see Figure 40). This was likely due to their smaller asset size and their community approach to banking. Furthermore, these institutions are concentrated in rural communities where businesses are typically small.
Distribution by Size of Authorization of Commercial Debt Authorized by Credit Unions and Caisses Populaires as of December 31, 2001
The percentage of commercial debt authorized to SMEs by credit unions and caisses populaires is consistent with the demand for debt seen in Part II. However, examining the number of clients (type of financing instrument used) served in this authorization category by these institutions, smaller authorizations represented the majority (50 percent, see Table 19). It seems that these institutions focussed on very small authorization amounts. While limitations to the data prevent a complete analysis of this market (as seen in the Note to Readers), the SME Financing Data Initiative will continue to monitor this situation.
Percentage of Commercial Debt Authorized by Credit Unions and Caisses Populaires to SMEs (by Size of Authorization) as of December 31, 2001
Loss rates for credit unions and caisses populaires as of December 31, 2001 include:
Unlike the larger institutions (domestic and other banks), loss rates on commercial debt authorized by credit unions and caisses populaires dropped significantly (24 percent) in 2001 (see Figure 42). The fall in loss rates was most significant in the lower authorization categories, particularly loans of less than $100,000. The amounts of outstanding loans authorized in the under $100,000 category remained relatively stable (on a percentage basis) between 2000 and 2001. Accordingly, the significant decrease in loss rates for credit unions and caisses populaires could indicate that they have been more diligent in their assessment of risks. Moreover, as indicated in Parts I and II, credit unions and caisses populaires tend to focus on agricultural businesses, which tend to have a high asset base to pledge as security for other loans. This tendency may be related to the trend toward industry consolidation; credit unions and caisses populaires are now better able to assess price and manage risk. Limitations in the supply data preclude a more conclusive explanation. Further data collection and analysis on loss rates by sector will clarify the potential impact of debt authorized to agricultural firms and how this affects these suppliers' overall loss rates.
A number of other participants in the sector, such as specialized finance companies, offer financing to SMEs; most of these operate beyond the scope of federal regulation.84 Among these are security dealers, specialized financing companies, money managers and advisers. Some of the institutions in these sectors are among the most innovative and successful in the Canadian financial services marketplace (e.g. General Electric Capital Corporation [GE Capital]). These specialized finance companies have carved out an important market niche that includes business financing (typically in leasing) and commercial debt financing (typically in secured loans and conditional sales agreements). Specialized finance companies serve as another financing alternative for SMEs.Other financial suppliers include factorers, however, as noted earlier and in Part II, only 1 percent of SMEs reported using this type of financing in 2000. Accordingly, these suppliers are included in the "other supplier" category and will not be a focus of discussion in this section.
The Conference Board of Canada reports that business financing from specialized finance companies, such as GE Capital, has increased substantially in recent years, reflecting the rapid growth of these financial services intermediaries. While many finance companies are subsidiaries of manufacturers, or "captives," the number of independent companies that have become major alternative sources of credit for large and small businesses has grown substantially in recent years.86
Loss Rates of Commercial Debt Authorized by Credit Unions and Caisses Populaires to SMEs (by Size of Authorization) in 2000 and 2001
Commercial debt authorized as of December 31, 2001:
As noted earlier, finance companies are becoming important suppliers of commercial debt to Canadian businesses. As seen in Figure 33, these financial service providers represented one quarter (24 percent) of the commercial debt market in 2000 and 2001. In terms of the distribution of commercial debt, nearly half of their overall portfolio was for authorizations under $1 million. However, unlike credit unions and caisses populaires, whose lending peaked in the $100 000–$249 000 range, most of the debt authorized under $1 million by finance companies (55 percent or $35 billion) came in authorizations of between $250 000 and $1 million.
Key findings for finance companies:
Percentage of Commercial Debt Authorized by Finance Companies to SMEs (by Size of Client Authorization) as of December 31, 2001
Loss rates for finance companies as of December 31, 2001:
Commercial debt loss rates by finance companies dropped significantly (24 percent) in 2001. However, following the pattern for domestic banks, there were significant increases in the loss rates in the lower authorization categories (less than $250,000), while loss rates fell in the larger authorization categories. Supply data limitations preclude a more thorough analysis of loss rates: for example, determining how factors such as sector or size of business influence the loss rates in these authorization categories. Further data collection and analysis will be required to better understand the risks that finance companies assume in lending to SMEs.
While finance companies do authorize debt, they are also major players in the leasing industry. Some key findings related to institutions' leasing activities include (as of December 31, 2001):
As seen earlier (see Figure 35), finance companies led the industry in lease authorizations as of December 31, 2001, concentrating on mid-sized authorizations. In this category, leases were used primarily to finance automobiles and light-duty vehicles — activities that accounted for the most leasing requests by SMEs in 2000. Since domestic banks are restricted from leasing these types of assets, it is not surprising that finance companies focus primarily on this segment of the market.
For the purposes of statistical reporting, the category of finance companies includes some Government Business Enterprises (GBEs), defined as Crown corporations (e.g. the BDC) and federal or provincial agencies that offer financing (e.g. ABT Financial Inc.). The other banks category included those GBEs with deposit-taking capabilities. These institutions contributed considerably to the supply of financing. In fact, as seen in Part II of this report, nearly 7 percent of SMEs secured financing from government loans and grants in 2000. These institutions and government programs are important, since they allow SMEs to access financing that would normally be unavailable.
Distribution of Commercial Debt Authorized by Size of Authorization by GBEs as of December 31, 2001
Some key findings concerning GBEs as of December 31, 2001 include:
Of the $35 billion in commercial debt authorized by GBEs as of December 31, 2001, approximately half ($17 billion) was authorized to SMEs (under $1 million in authorizations). A closer examination of their distribution of commercial debt authorized by the various authorization categories (see Figure 44) reveals that GBEs focussed on larger authorizations. Nearly half (43 percent) of this debt came in authorizations under $500,000. This trend is supported by Crown Corporation financial reports. For example, the BDC reported that the average loan size in 2001 amounted to approximately $324 000.
Due to the confidentiality requirements of the Statisitcs Act, more detailed data are not yet available.88 However, the SME Financing Data Initiative is conducting research on GBEs' amount of financing and target population (in terms of sector and region). More precise conclusions on GBEs' financing of SMEs will be included in future reports.
73. The top five domestic banks include BMO Financial Group, CIBC, RBC Financial Group, Scotiabank and TD Bank Financial Group.
74. The Canadian Financial Services Sector, Department of Finance, June 2002.
75. Although the Canadian Bankers Association previously collected authorization amounts of domestic banks, the Survey of Suppliers of Business Financing defines the category of domestic banks differently. Therefore, comparisons with the CBA data are not feasible and consequently there is no consistent measure of the activities of domestic banks over time. However, efforts are being made to resolve this issue so that future results can provide valid comparisons.
76. The Survey of Suppliers of Business Financing categorizes 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.
77. As noted earlier, domestic banks are restricted from leasing certain assets, such as automobiles and light-duty vehicles.
78. Unlike commercial debt, there are insufficient data to support an analysis on loss rates for lease financing.
79. The Survey of Suppliers of Business Financing defines the total value of leases authorized as the original value of the lease, aggregated over all clients falling into the particular size instrument, industrial or geographic category.
80. Unlike debt, there is no accepted proxy for linking lease authorization size to size of business.
81. David Powell, Asset-based Financing and Leasing in Canada: An Overview, Canadian Finance & Leasing Association, 2003.
82. Other banks include foreign banks, trust companies and all other deposit-accepting institutions except credit unions and caisses populaires.
83. The Canadian Financial Services Sector, Department of Finance, June 2002.
84. Finance and leasing companies are not regulated as financial institutions, since they do not carry out certain "core activities" such as fiduciary activities, underwriting insurance, dealing in securities and deposit taking (Department of Finance, June 2002). The difference is that they are subject to market rather than regulatory discipline. However, as they make use of public markets and typically secure their assets with regulated institutions, they are often subject to similarly rigorous scrutiny of their assets and practices as are fully regulated institutions.
85. For the purpose of the Survey of Suppliers of Business Financing, and for this report, finance companies include enterprises that provide financing to businesses, often for the purchase of goods and services, but do not accept deposits. Debt financing is commonly provided, but companies that purchase accounts receivable, or provide both debt and lease financing, are also included. Examples include the acceptance companies of vehicle and equipment manufacturers, factoring companies and several Crown financial institutions. Enterprises providing only lease financing are usually classified as leasing companies.
86. A Changing Demand for SME Debt Financing, Conference Board of Canada, January, 2001.
87. These figures represe nt finance companies, which include Government Business Enterprises (GBEs).
88. For example, data on losses was not available because of confidentiality constraints or poor quality.