Canadian banks are pressured to improve their small business lending practices
Canadian banks are pressured to improve their small business lending practices
Lakefield, nestled on the banks of the Trent-Severn Waterway midway between Toronto and Ottawa, appears to be an idyllic small town. From the vine-covered verandas of the graceful old brick homes on its winding tree-lined streets to the neat grounds of Lakefield College School, the exclusive school that Prince Andrew attended in 1977, the town seems far removed from the ravages of the recession. But behind the pleasant facade, town businesses are facing the same kind of debilitating credit crunches that have wracked most other communities across the country. Lakefield’s two banks have slashed crucial small business creditlines and have refused to renew commercial mortgages— even for businesses that have never missed a bank payment. Rick Lyons, who operates several small tourism-related ventures in the area, including marinas and travel guides, says that last fall his banker, in Peterborough, flatly refused his request for a $15,000 operating credit line to buy desktop publishing equipment and to tide him over last winter. His credit request was refused even though he has a well-established track record and only $8,000 in other debt. Lyons, who is also general manager of the local chamber of com-
merce, was able to get the cash he needed from his family. “Unfortunately,” said Lyons, “some of our members just don’t have anyone else to turn to but a previously ‘friendly’ banker who shovelled out the money in the good days and then wrenched the tap shut when the recession hit.”
The problems of Lakefield’s businesses are typical of those in just about every community across Canada. When the recession began in 1990, bankers began tightening their lending. As the recession deepened they became even more aggressive about recovering money extended to businesses judged to be in jeopardy. They also began to take a much tougher look at the condition of those they were lending to: sometimes even minor problems were enough to warrant a credit crackdown. The banks will not say how many small business loans were cut during that period, but according to the most reliable, but still imperfect, statistics available from the Bank of Canada, banks reduced
their lending to independent business by more than $3 billion to $17.4 billion by the end of 1992 during the worst of the recession. Said Dennis Mills, Liberal MP for the Toronto riding of Broadview/Greenwood: “A lot of small business people got it in the neck from their banker, right at the time they needed help most.”
Mills is just one member of a Liberal government that promised to take a hard look at the banks’ small business lending practices. The Red Book, the Liberal Party’s campaign document, stated that there are about 900,000 small and medium-sized enterprises in Canada, which employ a total of 4.2 million people. Those businesses, furthermore, accounted for 85 per cent of the new jobs created in the 1980s. In the government’s first budget released in February, Finance Minister Paul Martin emphasized the role of independent business in kick-starting the domestic economy. And last month, the House of Commons industry committee began official hearings on small and medium-sized business financing. This week and next, the committee will hear from the banking community after weeks of affecting testimony from frustrated and angry small business owners. Susan Bel-
‘The only good banker I ever saw was in It’s a Wonderful Life, George Bailey.
But most of the bankers we have across this country are the Potters.7
John Gouett, president of Maple Leaf Ice Stadiums, testifying before the House of Commons industry committee
taken the time to understand our business,” she said. “It all comes down to whether they believe in what you’re doing. Business isn’t just about numbers on paper.” Lewis says that at times the bank goes out of its way for them. This month, for example, the bank is promoting personal loans for landscaping and invited Decora to mount a promotional display in the branch. But having heard horror stories from other business people in the community, Lewis knows that the company is vulnerable to its bank. “It seems that people either have a good relationship with their bank or a terrible one, there is no middle ground,” she said. “Accountants have told us that we should do I business with more than one I bank, just in case something goes 5 wrong. I’d be more comfortable if I there were other banks here providing the same level of service.”
5 The government’s emphasis on “ small business has certainly been noticed by the banking community, which is now scrambling to regain the confidence of clients like Lyons, Bellan and the Lewises. Helen Sinclair, president of the Canadian Bankers’ Association, says that the federal government has two budget committees, one parliamentary committee and about 20 other task forces and studies, all delving into small business financings. “Is that overkill or not?” asks Sinclair.
Certainly in recent months, the banks have lavished attention—or at least news releases—on the small and medium-sized business sector. In fact, two banks have just announced the creation of an internal ombudsman or an arbitration panel to review complaints from independent business customers. In addition, several new lending initiatives have recently been launched. Last week, the Royal Bank of Canada announced that it was creating a new venture capital fund with $125 million to invest in medium-sized businesses operating in key knowledge-based or export-oriented industries. The program is aimed at meeting the needs that many companies have for equity capital. At the same time, it addresses the bank’s problem of the high-risk, low-reward imbalance in their loan portfolios. Instead of using these funds to make loans to the companies as a traditional bank would, the venture capital fund will be used to buy an equity stake in various small companies. In this way, they will benefit from not having to make loan payments on these funds during the start-up period, while the bank will be entitled to a portion of any of the gains that the companies make if they succeed.
For the Royal, the announcement of the new program comes just two weeks before Charles Coffey, senior vice-president of business banking, is scheduled to appear before
and we do have money to lend.”
Rachael and Randy Lewis who own Decora Landscaping Ltd., a landscaping and greenhouse company that also develops and sells seeds suited to the harsher northern climates, are happy with their bank. Rachael Lewis said their branch of the Bank of Montreal in Whitehorse has always been helpful, and that their bank manager, unlike others in the community, has been there for several years. “Our bank manager knows us and he’s
lan, who operates an import craft store in downtown Toronto, says that, to date, the banks simply passed their financial problems on to the government. “It was a double loss for government,” notes Bellan, a former economist. ‘Tax revenues fell and unemployment and welfare costs soared [as small businesses faltered]. If our social welfare system needs to be revised, so does our banking system.”
For their part, the banks are quick to defend themselves against charges of overly aggressive credit tightening. Said AÍ Cotton, vicepresident of independent business at the Toronto-Dominion Bank:
“Lending is a low-margin, high-risk business. We don’t share in the success of a business, but if it fails we can lose everything we’ve loaned.
We can’t afford a lot of losses.” Cotton says that banks generally make a spread of three percentage points on their loans to small business.
That means that for every dollar that they lend, they expect to get a return of three cents minus an expected loss ratio equal to about half of one cent during normal economic conditions. “Out of the remainder,” said Cotton, “we have to cover our operating expenses and generate a return for shareholders.” During the recession, average bank losses rose to a high of more than 1.3 cents for every dollar loaned. Bankers argue, furthermore, that for every small business that has a bad experience with its bank there are more that have good ones. “If something goes wrong in a business the bank is always the first to be blamed,” said Cotton. “But the vast majority of our relationships are solid
the industry committee’s hearing in Ottawa. But Coffey dismisses the timing as coincidence. “There have been a lot of announcements recently and I do wonder how real some of them are,” he said. “But this is a substantive program; the timing of the announcement is purely coincidental.”
So far, the Bank of Montreal seems to be leading the pack in appealing to small business accounts. One of its first initiatives was a lending program for small business at a special rate of one per cent below prime, launched in 1991. “No matter how you cut it, small business is Canada,” said Ron Rogers, senior executive vice-president of personal and commercial financial services. “It’s this bank’s No. 1 priority.” He noted that the bank’s share of the small business market has climbed six percentage points to 30 per
cent since 1989 as a result of the bank’s new attention to that market. In part, however, the Bank of Montreal was able to take such an aggressive lending approach because it had alienated parts of the small business market in the 1980s with some unpopular policy changes and as a result had a smaller proportion of the small business market when the recession began.
Meanwhile, the banks are also grappling with the question of lending to the emerging so-called knowledge-based industries, such as software design and computer services, in which the assets are people and ideas—not equipment and real estate.
Herman Turkstra, a lawyer in Hamilton who has represented many small and mediumsized businesses, believes that it is that rigid asset-based lending approach that largely contributed to the severity of credit crunch. Unlike many U.S. banks that are so-called venture lenders, basing their loans on a company’s business prospects, Canadian lending is traditionally based on hard asset values. Canadian banks prefer to reduce their risk as much as possible by making loans only if they are secured by tangible assets worth more than the money they lend. During the recession— when many assets, especially real estate, fell
‘Q: If you had to start all over again, what would you wish for?
A : If I had to begin again, I would become a bank.’
Toni Varone, president of Varone Group, testifying before the House of Commons industry committee
in value—banks came under pressure to reduce their loans proportionately. Head offices instructed their national network of branch managers and credit officers to either reduce the size of many outstanding business loans or to have their customers put up more assets as security for the loans.
Clearly, branch staff were under pressure from above. “There were times,” said Turkstra, “when we were dealing with bankers who were worried about losing their own jobs.” Bellan, whose own company suffered but managed to escape closure, adds: “I’d go in to see my account manager and I realized that he was terrified of me. When he looked at me all he could see was a big ‘RISK’ sign flashing over my head. Entrepreneurs are risk-takers and banks are risk-averse.”
Now, as the banks begin the process of
re-examining their entrenched asset-based approach to lending, they are starting with the industries that are expected to thrive in the economy of the information age. “They’re beginning to try some experimental things, especially in the Kitchener-Waterloo technology triangle,” said MP Mills. “It’s a good thing, too. Bill Gates wouldn’t have been financed by a Canadian bank.” Gates is the 38-year-old Wunderkind who became one of the richest men in the United States after founding software giant Microsoft Corp. in 1976.
However the banks redirect their efforts now, their record during the recession has left a bitter legacy. In Lakefield, Rick Lyons notes that other local business people have had an even harder time than he has weathering the storm. A few shops have already
closed and several more are teetering on the verge of failure. Relations with the banks in the town are so tense that when the owner of a video rental outlet suddenly committed suicide in his store in February, other shopkeepers immediately speculated that it was caused by the credit crunch. His family says that it does not have any other answer. Said his brother Mark Medland: “Business was slow. He had a bank loan. He had borrowed some money from me. I don’t have any proof, but all I can figure out is that he was under financial pressure.” But for others in the small business community, a growing awareness of such pressures and the government’s commitment to address them may bring some relief.
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