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For small businesses, the banking system fails to impress

DEBORAH BAIC/THE GLOBE AND MAIL

Canada's biggest banks have spent nearly $40-billion (U.S.) on acquisitions since 2008, an impressive display of muscle-flexing at a time when many of their international rivals have struggled simply to remain solvent.

Jeff Lem wishes the banks showed similar bravado when it came to lending to their smaller business customers.

Mr. Lem leads qdata inc., a Markham, Ont.-based provider of bar coding equipment and wireless data systems for clients that range from United Parcel Service Inc. to Cargill Inc.

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A few years ago, Mr. Lem was putting together the money to buy out a partner. He asked his lender for $200,000 to round out a financing package, a request he described as "relatively small amount" given that his company churns out sales of about $14-million a year.

But the bank, which Mr. Lem declined to name because he still does business with the institution, refused. Eventually, the federal government's Business Development Bank of Canada (BDC) lent him the money, although at a higher rate. In the end, the financing problems added $100,000 to the cost of the buyout, a hit that forced Mr. Lem to slow his expansion into Alberta and robbed from his research and development budget. He abandoned what he called a "promising" iPad application.

"If it were not for BDC, the state of small-business loans would be in big trouble," Mr. Lem said.

This is the flip side of the "boring" banking model that Finance Minister Jim Flaherty has been trumpeting around the world since the financial crisis. Mr. Flaherty boasts about Ottawa's strict supervision and holds up the banks' conservative lending culture as a virtue. What he fails to mention to his audiences in places such as Istanbul, London and Washington is that Canada's entrepreneurs and smaller businesses are starved for cash.

Comparing banking systems across countries is no easy thing. Figures are not always consistent across countries. Lending depends on demand for loans, and as Royal Bank of Canada chief executive officer Gordon Nixon said earlier this year, he'd love to do more business lending, if only he could find more customers. Government programs, which differ across jurisdictions, also influence the willingness of lenders to lend and borrowers to borrow.

But the BDC can only do so much. According to the Organization for Economic Co-operation and Development, the outstanding debt of Canadian small and medium-sized enterprises (SMEs) essentially has been unchanged since 2000. Lending to smaller companies decreased 0.1 per cent in 2008, increased 3.7 per cent in 2009 and dropped 0.9 per cent in 2010, the 34-member OECD said earlier this year in its first annual scorecard of financing for SMEs and entrepreneurs.

It's fair, but too easy, to blame the lack of lending on the recession. In April, Mr. Flaherty told an audience in Washington that the Harper government intended to start comparing Canada's economic performance against the fast-growing economies of Asia and Latin America. According to the OECD, SME lending in Thailand increased 9.5 per cent in 2008, 7.4 per cent in 2009 and 7.2 per cent in 2010. Chile posted increases of 6.9 per cent or greater in each of those three years. SME lending also grew much faster in South Korea than in Canada.

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Ian Lee, an assistant professor at Carleton University's Sprott School of Business and a former commercial loan manager at Bank of Montreal, says the explanation is structural. From the writing of the original Bank Act in the 1930s, Canada's leaders put stability ahead of dynamism. While there is no longer an outright ban on international lenders setting up in Canada, the rules are structured in such a way that there is little incentive to do so. No investor can hold more than 20 per cent of the voting shares in a bank with equity of more than $12-billion and a majority of the directors must be Canadians.

So the lenders that are large enough to shake the Canadian banks' entrenched position – the Wells Fargos of the world – either stay small in Canada, or avoid the country altogether.

Canada's bank lobby disputes the notion that the industry is uncompetitive. The Canadian Bankers Association notes that there are more than 70 banks operating in Canada, 40 of which offer financial products and services such as credit cards and loans. There's no rule in Canada preventing someone from starting a small, regional bank. The ownership restrictions were endorsed by the Competition Policy Review Panel in 2008 as an important check against "self-dealing," or a dominant shareholder lending to him or herself, which increases the risk of insolvency.

"Canada's largest financial institutions are often criticized for their small-business lending practices," the panel concluded. "The evidence before the panel has not convinced us that competition is lacking in the supply of credit for small and medium-sized business."

Prof. Lee sees it differently. There are more than 7,000 banks in the United States insured by the Federal Deposit Insurance Corp. Most of those institutions are small, confining their lending to a specific community. The result is a more competitive credit market. SMEs accounted for 29 per cent of all business lending in the United States in 2010, compared with 18 per cent in Canada.

"If I turn down credit in Ottawa, I pick it up in Montreal or elsewhere," Prof. Lee said. "If you are First Bank of Wichita, Kansas, and operating only in Wichita, Kansas, you have to lend in Kansas. You have to lend to small business."

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