The Canadian banking industry is setting itself up for a major shake up. In recent years, there have been several failed merger attempts by the major chartered banks. There is also the disturbing trend of bank branch consolidation throughout the country. In terms of public policy, the federal government has focused on developing merger review guidelines and is starting to examine the issue of allowing cross-pillar mergers (e.g., a merger between major banks and insurance companies). CFIB has, and continues, to follow closely such developments in the evolution of the financial sectorâ€”particularly as they relate to the small and medium-size enterprise (SME) segment of the economy. CFIB is not against change. In fact, a key trait among CFIB members is their ability to be flexible and innovative in reacting to change. However, CFIB is against any change that impedes access to business banking services and credit financing for SMEs.

Based on the findings of CFIB's nationwide survey, the major banks have not demonstrated their ability to better serve their small business clientele. To the contrary, business owners have not seen any improvement in banking competition during the past three years. While the banks have been active in providing services, the focus tends to be on increasing the number of ATMsâ€”at the expense of fewer full-service branchesâ€”and competing on wealth management products such as RRSPs, GICs and mutual funds. Business owners have stated very clearly that they require convenient access to full-service bank branches.

Listed below are the some other survey highlights:

Credit unions, HSBC and ATB Financial are the strongest in terms of servicing the small business market.

The performance of the banking industry in serving the needs of the small business market varies by banking institution. Credit unions, HSBC and ATB Financial continue to be the leaders in servicing the SME market, with Desjardins and National Bank trailing far behind in ninth and tenth place. The major banks fall in between, with CIBC and Royal Bank faring the poorest among the Big Five chartered banks.Highest Ranking

124*


	2000		2003

		="" Credit="Credit" unions	="" 1
		="" HSBC	="" 2
		="" ATB="ATB" Financial	="" 3
	4*	TD Canada Trust	*4
	7	Scotiabank	*4
	8*	Bank of Montreal	6
	8*	Royal Bank	*7
	6	CIBC	*7
	10*	Desjardins	9
	10*	National	10
Lowest Ranking
	A tie is indicated by an asterisk (*).

A very troublesome finding is the recent increase in the loan rejection rate, now at 16 per cent and up from 10.5 per cent in 2000. Most notable in this respect is the banks' inability to build on their small business client relationship: the higher the account manager turnover rate, the higher the loan rejection rate. The banking industry's adoption of automated credit scoring in the loan application process has made the manager-client relationship irrelevant in many instances.

The amount of small business debt financing remains flat. The level of bank loans has remained stable since the 1990s, with the median loan at $100,000. Financing amounts do vary by firm size, with the median loan amount for the smallest firms at $45,000 and the largest firms in the $2 million range. Bank of Canada data shows that small loan activity has remained stable while larger loan activity has increased since the late 1980s.

The demand for bank financing remains relatively low.

Compared to previous years, fewer and fewer small businesses are applying for financing. Only 60 per cent of business respondents applied for either a term loan, new line of credit or an increase in an existing line of credit in the previous three years. In 1987, the corresponding figure was significantly higher, at 73 per cent.

Bank market shares for the small business market have changed.

Key institutions such as CIBC and Royal Bank continue to lose market share. Poor service quality, low credit availability, and unfair service charge practices were the reasons cited most frequently by small business owners for switching banks.

The strength and confidence of Canada's entrepreneurs provides the foundation of a promising Canadian economy. Critical to the continued future success of the SME sector is the ability to access competitive banking services. CFIB offers a number of recommendations to help improve business owners' access to competitively priced banking services:

Federal and provincial government policy should focus more on increasing the level of competition in the financial services sector.
The federal government should not allow major chartered banks to merge with each other given the current level of competition in the banking industry.
The federal government should continue to establish a clear set of criteria and public process to assess merger proposals among major Canadian financial institutions.
Banks and other institutions should enhance the role of the account manager at the branch level.
Banks and other lending institutions should increase their participation in small business financing by adopting more flexible lending policies and practices.
The Code of Conduct for banks should be reviewed to ensure that, at a minimum, the existing measures are implemented and to develop additional standards designed to improve overall service levels to the small business community.
The federal government should collect and report publicly additional information specific to the banking sector's competitive status.
The federal and provincial governments should seek ways to rationalize their small business financing programs.

Introduction

In recent years, there have been several failed merger attempts by the major chartered banks. There is also the disturbing trend of bank branch consolidation throughout the country. In terms of public policy, the federal government has focused on developing merger review guidelines and is starting to examine issue of allowing cross-pillar mergers (e.g., a merger between major banks and insurance companies). CFIB has, and continues, to follow closely such major developments in the evolution of the financial sectorâ€”particularly as they relate to the small and medium-size enterprise (SME) segment of the economy. CFIB is not against change. In fact, a key trait among CFIB members is their ability to be flexible and innovative in reacting to change. However, CFIB is against any change that reduces access to business banking services and credit financing for small business.

A strong small and medium-sized enterprise (SME) sector is the key to a successful, prosperous economy. Estimates based on Statistics Canada data indicate that Canada's SME sector accounts for close to half (45 per cent) of the gross domestic product (GDP)â€”a clear indication that all segments of the economy and society are affected in one way or another by small business. Despite the constantly changing business environment, the focus of Canada's entrepreneurs has never wavered: to take the initiative of starting and growing their own businesses and make a solid contribution to their communities in the form of jobs and economic growth.

The achievement of small businesses goals, whether they are short or long term, is highly dependent on the services provided by their bank. In addition to requiring a source of financing for growth and expansion, small businesses also need a conveniently-located bank branch for various daily services. Cash and coin, account and deposit services, payroll processing, credit/debit cards, pension and savings, and various personal banking services are some examples from a long list of essential banking services. At a time when the client base is asking for full-service relationships, the banking sector appears to be turning their backs on this essential banking need.

An important element of CFIB's work is to provide information how good or bad a job the banks are doing in serving the banking needs of small businesses. The survey findings also inform individual banks and other institutions as to how they are serving the small business market. The overall intent is to establish an information and knowledge base that can be used by business owners, bankers and government policymakers to improve the banking industry's ability to better serve the needs of business clients. This may mean more vigorous competition for the small business market; business owners shopping around for improved banking services or demanding improved service from their current bank; and the development of public policy that supports a competitive banking industry.

Canada's SME sector is strong. Canada's entrepreneurs are confident. Canada's future is brightâ€”but only if efforts are made to improve continuously the domestic market for small business banking services. CFIB believes the banks and other key players in the banking sector need to be continuously challenged on their performance for any improvements to be accomplished. Enhancing competition in the domestic banking market is more challenging today than it was in the recent past. Recent acquisitions and consolidations within the banking sector, as well as the trend towards fewer full-service bank branches, make additional competition in the banking industry more of a distant goal.

The CFIB Banking Survey was conducted between April 1 and May 26, 2003. A total of 9,565 owners of independently-owned and operated businesses participated in the survey. The survey data is representative of all regions and industry sectors throughout Canada. Overall results are accurate to within Â±1.0 percentage points, 19 times out of 20. The margin of error is larger within provinces, industry sectors and other sub-groupings of the survey data.

Ranking of Banking Institutions

Vital to the future success of the SME sector is the ability of the banking industry to support entrepreneurial activity and to constantly improve services provided to small business. To obtain a greater level of understanding of individual bank's performances in terms of serving their SME clients, CFIB has ranked the banks based on specific aspects of the business client-banking relationship. Nine performance indicators are used to rank the banks in terms of which is catering best to the needs of their small business clientele. The factors chosen for this analysis are as follows: (1) willingness to lend; (2) lending terms such as interest and collateral; (3) information requirements for financing; (4) service charges; (5) understanding of the client's business; (6) treatment by account manager; (7) travel distance to full-service branch; (8) branch hours of operation; and (9) on-line banking. This approach results in an overall ranking of the banks, as well as a specific ranking for each bank within each of these nine factors.

Table 1: Overall Ranking of Financial Institutions

Highest Ranking

124*


	2000		2003

		="" Credit="Credit" unions	="" 1
		="" HSBC	="" 2
		="" ATB="ATB" Financial	="" 3
	4*	TD Canada Trust	*4
	7	Scotiabank	*4
	8*	Bank of Montreal	6
	8*	Royal Bank	*7
	6	CIBC	*7
	10*	Desjardins	9
	10*	National	10
Lowest Ranking
	A tie is indicated by an asterisk (*).

Credit unions rank first in terms of overall satisfaction among business clients (see Tables 1 and 2). This is reflected by credit unions ranking first in seven out of the nine factors and second for the remaining two criteria. Given that credit unions ranked first in CFIB's 2000 survey, this provides further evidence that these locally based and managed institutions have an edge servicing their small business clientele. HSBC and the ATB Financial ranked second and third, respectively. TD Canada Trust and Scotiabank tied at fourth place, followed by Bank of Montreal at sixth place. Royal Bank and CIBC tied at seventh place. The Quebec-based institutions received the lowest rankings, with Desjardins ranking ninth and National Bank coming in tenth.

Credit unions rank first in terms of serving the small business market.

These rankings are similar to those found in CFIB's 2000 survey: Credit unions, HSBC and ATB Financial received the most favourable scores in terms of satisfied small business clients, while Desjardins and National received the least favourable results. In between lie the five biggest players in the Canadian banking industry. It is within this grouping where changes have occurred in the past three years. Among the Big Five banks, Scotiabank improved its overall ranking from seventh to fourth, tied with TD Canada Trust. The latter retains its fourth place ranking, which raises the question of why TD Bank's acquisition of Canada Trust in 2001 did not boost its ability to service the SME sector. The Bank of Montreal and Royal Bank improved slightly from their 2000 ranking, while CIBC is the only major bank to receive a lower overall ranking in 2003 than in 2000.

Table 2:
Ranking of Financial Institutions, based on Satisfaction of Service Quality

Overall Ranking		Willingness to lend	Lending terms	Information requirements for financing	Service charges	Under- standing of my business	Treatment by account manager	Travel distance to full- service branch	Branch hours of operation	On-line banking

2003

1	Credit unions	2	2	1*	1	1	1*	1*	1	1*
2	HSBC	1	1	1*	2	2	1*	8*	4	7
3	ATB Financial	3	3	3	3	3	1*	1*	2*	4*
4*	TD Canada Trust	7*	4*	6*	5*	7*	5*	3*	2*	1*
4*	Scotiabank	7*	4*	5	5*	4*	4	3*	5*	1*
6	BMO	4	4*	4	7	4*	5*	6*	5*	7*
7*	Royal Bank	5*	4*	6*	9*	7*	8	3*	8	4*
7*	CIBC	5*	4*	6*	8	7*	7	6*	5*	7*
9	Desjardins	7*	9	9*	4	4*	9	8*	10	9
10	National	10	10	9*	9*	7*	10	10	9	10

Notes: A tie is indicated by an asterisk (*). Overall 2003 ranking is based on an index using equal weights for all nine factors; eight factors were used for the overall 2000 ranking. The 2000 ranking differs from the 2003 ranking as follows: (1) the category "Trust Companies", which ranked 3^rd overall in 2000, is excluded from the 2003 rankings; (2) the 2000 ranking for TD does not reflect Canada Trust which was acquired by TD in 2001; (3) the 2000 factor "Level of financing" was replaced with "Willingness to lend"; and (4) the 2000 factor "Access to branch" was replaced by two new categoriesâ€”"Travel distance to full-service branch" and "Branch hours of operation".

These findings are troublesome for a number of reasons. First, there is not a single Big Five bank that seems to be taking a leadership role in serving the SME sector. The major banks are on record numerous times stating the importance of the SME market and yet none have been able to obtain more favourable ratings from their own small business clientele. The top three ranked institutionsâ€”credit unions, HSBC and ATB Financialâ€”have consistently ranked high in the past. However, these institutions are either regionally focused (ATB, credit unions), cater to a more established business clientele (HSBC) or are less likely to provide the full range of services as do the major chartered banks (credit unions).

Competitive Climate

It has been five years since the Task Force on the Future of the Canadian Financial Services Sector (the MacKay Task Force) made recommendations to increase competition in the financial marketplace. Of particular importance in this major federal government review was the focus on how to create more competition among banks and other providers of financial services to the small business sector. Some recommendations have been implemented that are designed to allow credit unions/caisses populaires and foreign-owned banks to increase their presence as major banking alternatives for small businesses.

(i) Overall Competition in Banking:

Figure 1:
Change in overall competition in banking industry during past 3 years

Figure 1: Change in overall competition in banking industry during past 3 years

Despite efforts to boost competition, not much has changed in the banking industry to better serve small business.

Despite these recent efforts made by the federal government to create a more dynamic, competitive banking sector, small business owners throughout the nation have not reaped much, if any, benefit. In fact, for the vast majority of independent business people, the overall level of competition in the financial services sector in their local community has not changed in the past three years. Overall, survey respondents stated competition has either stayed the same (69 per cent) or decreased (16 per cent); only 15 per cent of business owners have seen competition rise (see Figure 1). Businesses based in Alberta were most likely to indicate an increase in competition, while those in Ontario were the least likely to see a boost in competition. One partial explanation for these findings is TD Bank's purchase of Canada Trustâ€”the last major trust company that had a heavy focus on the Ontario market.

When it comes to specific services, banks have been much more active in establishing ATMs and focusing more on wealth management products such as GICs, RRSPs and mutual funds (see Figure A1 in Appendix). In contrast, banks are least active in boosting services directly related to operating a business, namely business account and deposit services. Some provincial variations exist, with business owners in Alberta seeing the greatest levels of increased bank activity.

(ii) Preferred Service Delivery:

Since the 1980s, the banking industry has placed a heavy emphasis on changing the ways consumers and businesses conduct their banking. Automated teller machines (ATMs), the telephone and the Internet have all been used by the banks to steer their clients away from their local branch. In a broad sense, the banking industry's overall objective was twofold: (i) to offer their clients greater convenience and constant availability of services; and (ii) to lower their costs in delivering services. The banks have lowered their costs through mostly electronic service delivery, but to the detriment of many of their clients.

Figure 2:
Importance of methods of accessing banking services

Figure 2: Importance of methods of accessing banking services

Access to a full-service local branch is by far the most preferred route to serving small businesses.

Business owners' preference in how they want to conduct their banking is straightforward: through a branch that is conveniently located and offers the full range of services essential to operating their business. Three-quarters of respondents (74 per cent) stated that a full-service local branch is very important to running their business, while 21 per cent indicated it is somewhat important (see Figure 2). Only 5 per cent said access to a branch is not important. There is little importance given to alternative banking methods, such as ATMs, the telephone and the Internet. This is because the range of services provided through these methods is restricted and do not allow access to basic banking services such as financing and cash management.

(iii) Role of Foreign Banks/Credit Unions:

Only one in five respondents (19 per cent) have noticed an increase in business banking services offered by foreign banks in the past three years (see Figure 3). This finding reflects the limited presence of foreign financial institutions currently servicing the Canadian small business market. Credit unions appear to have been more successful than foreign banks in attempting to become viable competitors in the SME market, with one in three (33 per cent) respondents noticing an increase in credit union activity. The increased presence of credit unions/caisses populaires varies significantly from province to province, the highest incidence being in Manitoba and the lowest in Ontario and Quebec.

Figure 3:
Increase in business banking services by foreign banks and credit unions/caisses populaires

"Foreign Banks"

Figure 3: "Foreign Banks"

"Credit Unions/Caisses Populaires"

Figure 3: "Credit Unions/Caisses Populaires"

Foreign banks and specialized niche players have made some strides in increasing their presence in the Canadian market during the past several years (see Figure 4). Many more small businesses have at one time or another used the services of institutions such as AMEX, GE Capital, MBNA, Capital One, ING Direct and Wells Fargo. It is important to stress that these players are not substitutes for the full service offerings of the major chartered banks. While the use of these specialized services is becoming more common, it does not as a whole represent a full banking alternative for small businesses.

Figure 4:
SMEs' use of major specialized financial institutions,
2003 versus 2000

Figure 4: SMEsâ€™ use of major specialized financial institutions, 2003 versus 2000

* AMEX was not included in the 2000 Banking Survey.

Use of specialized/foreign institutions has become more common, but it does not represent a full banking alternative for SMEs.

Bank Market Shares

Significant trends have appeared among the bank shares of the small business market since the late 1980s. The most disturbing trends are the falling market shares held by CIBC and Royal Bank. By a large margin, CIBC has lost the most ground when it comes to servicing the small business market based on the number of clients. In 2003, CIBC controlled just 12.6 per cent of the small business market, down substantially from 13.3 in 2000 and 19.3 per cent in 1989 (see Figure 5). While not nearly as dramatic, Royal Bank also has a looser grip on the small business market, with its share falling to 20.0 per cent in 2003, from 21.2 per cent in 2000 and 24.3 per cent in 1989.

Figure 5:
Small Business Market Share (client-based), 1989-2003

Figure 5: Small Business Market Share (client-based), 1989-2003

CIBC and Royal Bank continue to lose their share of the small business market.

Scotiabank was quite successful in gaining ground in 2003 with 14.2 per cent of the marketâ€”an increase of 3 per cent from 2000 and almost 5 per cent from 1989. TD Canada Trust's share came in at 13 per cent, a marginal improvement from previous years. Considering that the market share data for 2003 incorporates TD Bank's purchase of Canada Trust in 2001, it is surprising that this major institution did not post a stronger foothold in the small business market. The Bank of Montreal's share came in at 12.1 per cent, slightly below its 2000 level but 2 per cent higher than in 1989. National Bank's shares fell slightly to 4.4 per cent in 2003 from 5.0 per cent in 2000 and 6.1 per cent in 1989.

The level of SME clients remaining with the same bank in the past three years varies from bank to bank. By a wide margin, HSBC has the highest retention rate. Between 2000 and 2003, HSBC kept 95.2 per cent of its small business customers (see Figure 6). The next highest retention rates were among the credit unions and Desjardins, at 92.1 per cent and 91.9 per cent respectively. The major banks' retention rates ranged from 90 per cent for Scotiabank to 88 per cent for Bank of Montreal. ATB Financial's rate came in at 88.5 per cent, a significant change given that ATB had the highest level of retention for the 1997-2000 period. National Bank had by far the lowest retention rate, at 78.5 per cent.

Figure 6:
SME Clientele Retention Rates, 2000-2003

Figure 6: SME Clientele Retention Rates, 2000-2003

HSBC has the highest client retention level, while National Bank has the lowest.

Overall, these retention levels are quite high for all banks, with the exception of National Bank. One explanation is that small business clients are satisfied with the current level of service, as indicated by 55.4 per cent of respondents (see Table 3). The combination of a strong economy and SME sector in the past three years likely influence satisfaction levels. More than one third (36.1 per cent) of respondents stated that there is no real difference between the banks, while one in ten (9.6 per cent) feel that there is insufficient choice in banking. These finding are understandable given the limited choice of competitive banking alternatives in the Canadian market. The acquisition of the last major trust company, Canada Trust, is the most recent example of diminishing banking alternatives. One in five (20.5 per cent) business owners stated that they were too busy to shop around for a banking alternativeâ€”another indication that the high retention rates are not necessarily a reflection of high service quality.

Table 3:
Reasons for "not" switching banking institutions between 2000 and 2003


	Satisfied with current bank	Too busy to shop around	No real difference in banks	Insufficient choice in banks

	(% response)
Royal Bank	49.5	24.7	43.1	9.0
CIBC	50.6	22.7	40.0	10.9
Bank of Montreal	53.3	20.9	40.5	7.9
Scotiabank	53.5	21.1	37.6	9.5
TD Canada Trust	53.8	22.9	41.9	8.0
National Bank	51.7	18.1	39.3	12.4
HSBC	78.2	12.8	17.3	2.6
Desjardins	50.4	18.9	29.6	15.3
Credit union	77.9	10.9	15.2	8.0
ATB Financial	70.6	12.4	22.2	9.8
Overall	55.4	20.5	36.1	9.6

Poor service quality, lack of credit availability, and unfair service charge practices were the most frequently cited reasons by small business owners for switching banks (see Table 4). For one in five respondents, interest rates were a key reason for switching banks. The closure of a bank branch or acquisition of a branch by another institution was cited by 8.1 per cent and 6.7 per cent of respondents.

Table 4:
Reasons for switching financial institutions between 2000 and 2003, by bank used in 2000

Bank used in 2000	Service quality	Credit availability	Service charges	Interest rates	Branch closure	Acquisition of branch by another institution


	(% response)
Royal Bank	63.8	50.0	50.0	31.0	5.2	3.4
CIBC	62.2	40.0	44.4	28.9	11.1	6.7
Bank of Montreal	55.3	36.8	34.2	13.2	10.5	7.9
Scotiabank	32.1	57.1	39.3	25.0	17.9	14.3
TD Bank	45.5	42.4	42.4	15.2	3.0	12.1
Overall	53.7	42.1	40.2	22.1	8.1	6.7

Note: Figures by bank reflect the views of 2,829 business owners that participated in both the 2000 and 2003 Bank Surveys. Responses are only shown for the Big 5 banks; figures are available for other institutions but the number of responses is too small to be considered statistically significant. Total responses are based on 9,565 responses to the 2003 Bank survey. Sources: CFIB, Banking Survey, 2000 and 2003.

Types of Financing

Credit lines and term loans are the main forms of credit financing among small businesses. Three-quarters of respondents (74.3 per cent) have a line of credit to finance their business operations, while more than one-third (37.4 per cent) have a term loan (see Figure 7). While these types of financing are the mainstay for all types of business, they are a more popular financing means among larger and older businesses.

Figure 7:
Types of SME Credit Financing

Figure 7: Types of SME Credit Financing

Credit lines/loans are mainstay of credit financing, but 1 in 10 SMEs finance internally.

One in four business owners currently use mortgages and supplier credit, while one in five use credit cards, account overdraft protection and lease financing. Businesses that are larger or more capital intensive, such as manufacturers, are more likely to use lease financing. Conversely, among smaller less-established businesses, and those in retail and the services sectors, it is not uncommon to carry a credit card balance. The interest cost of credit card financing is expensive and begs the question why do so many businesses use this type of financing.

A loan from a family member or friend, sometimes referred to as "love money", is used by 11.8 per cent of business owners. The younger the business, the more likely it is to use this type of financing. For example, one in five businesses that have been in operation fewer than five years currently have a loan from a family member or close acquaintance. Factoring of receivables is also used by about one in nine businesses. Obtaining a loan from a Crown corporation, such as the Business Development Bank of Canada, is the least common form of financing.

Loan Amounts

The level of financing approved by banks and other lending institutions has remained relatively stable since the late 1990s, with the median amount of financing remaining at $100,000 (see Table 5). But financing amounts do vary according to firm size, with the median loan amount for the smallest firms at $45,000 and the largest firms in the $2 million range. The amount of financing approved also varies significantly by the lender.

Among the Big Five banks, the Bank of Montreal approved the highest loan amount at $150,000, while Scotiabank had the lowest amount at $80,000. Cooperative banks such as credit unions and the Caisse Populaire Desjardins approved the lowest loan amount, at $65,000 and $60,000 respectively. National Bank and ATB Financial approved loan amounts similar to those of the Big Five banks. The largest loans of more than $200,000 are found among HSBC clients. This is understandable given that HSBC is a niche market player that caters strictly to a larger and more established type of business clientele.

Table 5:
Median Amount of Financing* Approved

By size of business

Number of employees	1997	2000	2003


	$	$	$
0-4	30,000	40,000	45,000
5-19	100,000	100,000	100,000
20-49	350,000	307,500	350,000
50-99	650,000	1,000,000	750,000
100+	1,250,000	1,500,000	2,000,000
Total	97,000	100,000	100,000

* Includes the term loan amount and/or credit line limit approved by a financial institution during the past three years.

By banking institution


	2003

	$
Royal Bank	100,000
CIBC	110,000
Bank of Montreal	150,000
Scotiabank	80,000
TD Canada Trust	100,000
National Bank	150,000
HSBC	217,500
Desjardins	60,000
Credit unions	65,000
ATB Financial	100,000

Small-size loan activity remains stable while large-size loan activity has increased significantly. According to Bank of Canada data, loan activity for amounts under $200,000 has remained relatively stable but larger-loan activity of $200,000 or more has increased significantly (see Figure 8). Considering that the majority of small businesses that have loans/credit lines are for amounts under $200,000, aggregate bank loan activity for small businesses has not grown in the past few decades. In fact, adjusting the data for inflation shows that small-loan activity has actually declined since the 1980s, while larger-loan activity increased.

Figure 8:
Chartered Bank Lending to Business
(Authorized Loan Limits)

Figure 8: Chartered Bank Lending to Business (Authorized Loan Limits)

Source: Bank of Canada Review, quarterly data, 1988 to 2003

Small-size loan activity has remained stable while larger-loan activity has trended upwards.

Loan Applications

(i) Demand for Bank Loans

The demand for bank financing within the small business sector continues to fall. Compared to previous years, fewer and fewer small businesses are applying for financing. Survey data from 2000 and 2003 show only 60 per cent of business respondents applied for either a term loan, new line of credit or an increase in an existing line of credit during the previous three-year period (see Figure 9). In 1987, the corresponding figure was significantly higher at 73 per cent. The low demand for financing is even more evident among very small businesses and firms in the retail and services-related sectors.

Figure 9:
Share of SMEs that applied for financing in previous three-year period

Figure 9: Share of SMEs that applied for financing in previous three-year period

The demand for small business bank financing continues to decline.

The decline in bank financing for the small business sector has been steady, without interruption since the late 1980s. Most importantly, fluctuations in the overall Canadian economy during this period do not appear to be a factor. One would expect the overall demand for small business bank financing to rise during high economic growth periods and fall during times of low growth. But this relationship appears to be absent indicating that other factors are at play. One explanation is that during the recession in the early 1990s, the banks called in lines of credit to their small business clientele as a way to get their houses in order. As a result, those small business owners who were abandoned by their bank are reluctant to put themselves in that situation again. This explanation corresponds with the finding that one in ten business owners finance their business internally through retained earnings (see Figure 7).

(ii) Rejection Rates for Bank Loans

Loan applications are being rejected at a significantly higher rate. The overall loan rejection rate for the period 2000 to 2003 is 16 per cent, up from 10.5 per cent for the 1997 to 2000 period (see Figure 10). This dramatic increase in the proportion of loan applications being turned down by banks and other institutional lenders is a signal that this vital segment of the economy is unable to obtain the credit financing it requires to continue to fuel Canada's economy and provide jobs to more and more people. This finding is consistent with Statistics Canada survey data on SME financing that found 20 per cent of SMEs did not have their debt applications approved in 2000 and 2001 (the most recent year government data are available).^[1]

Figure 10:
Loan rejection rates, 2003 vs. 2000

Figure 10: Loan rejection rates, 2003 vs. 2000

Loan applications are being rejected at a higher rate; younger SMEs face higher loan rejection rates.

Businesses that have been in operation for 10 year or less are at the greatest risk of having their loan application turned down. Regardless of the age of the business, the incidence of loan applications being rejected has been more frequent during the past three years. One out of five clients of Scotiabank, TD Canada Trust and Royal Bank who applied for a loan in the past three years were turned down; conversely, HSBC clients were the least likely to have had their loan application rejected (see Figure 11).

Figure 11:
Loan rejection rates, by banking institution

Figure 11: Loan rejection rates, by banking institution

Scotiabank and TD Canada Trust clients face the higherst loan rejection rates, while HSBC clients have the lowest rate.

The client-bank relationship is of paramount importance when it comes to loan applications being accepted or rejected. Simply put, the higher the turnover rate of account managers at the same bank, the higher the loan rejection rate. For example, close to one third (31.7 per cent) of businesses with four or more account managers in the past three years had their loan application turned down by their bank (see Figure 12).

Figure 12:
Loan Rejection Rates

By number of account managers

Figure 12: Loan Rejection Rates (By number of account managers)

By size of firm

Figure 12: Loan Rejection Rates (By size of firm)

Previous CFIB survey data has consistently demonstrated the importance of the account manager to various aspects of a bank's relationship with the small business client, particularly the strong correlation to the loan rejection rate and overall higher costs of financing. Unfortunately the survey data show that the major banks are still not retaining account managers with their small business clientele long enough to continue to build on the client-bank relationship. More and more small business owners must deal with far too many new faces at their bank. This is primarily the result of career opportunities within the bank provided to account managers or the multi-staff approach adopted by some banks. New account managers are not fully aware of the track record of the owner, the history of the business, the dynamics of the industry sector, etc. As a result, banks are not capable of fully understanding the specific needs of the small business client in order to evaluate loan applications in a fair and informed manner. The implications of high account manager turnover are far reaching, affecting virtually every major aspect of the bank-client relationship. Whether it is a loan rejection, high service charges, or higher bank financing costs, a small business owner has nothing to gain and everything to lose when its own bank keeps replacing their account manager.

The higher the account manager turnover rate, the higher the loan rejection rate.

The size of the business is also a major factor affecting the likelihood of a loan being rejected. In general, the smaller the firm, the higher the incidence of a loan application being rejected. For example, the loan rejection rate ranged from 23.3 per cent for the smallest businesses to 3 per cent for larger businesses (see Figure 12).

A significantly smaller portion of the small business community is applying for bank financing and those that do apply are more likely to be turned down by their bank. A troublesome finding, however, is that 26.9 per cent of business owners were not provided a reason by their financial institution for rejecting their loan application. To exacerbate the situation, the vast majority of respondents (83.1 per cent) stated their bank did not offer any information on alternative financing sources. These findings indicate that the chartered banks are not adhering to the banking industry's own Code of Conduct.

The implications of these findings are very significant. Why is a key segment of the economyâ€”the SME sectorâ€”not seeking or obtaining bank financing for growth and expansion? Not only do these findings compromise the growth potential of the SME sector, it will inevitably limit the overall performance of the Canadian economy.

Cost of Bank Financing

On average, small and medium-size businesses pay 1.58 percentage points above the Prime rate^[2] for credit financing from their main banking institution (see Table 6). The interest rate is slightly lower if the financing is either an increase or extension to an existing line of credit, at 1.48 per cent above Prime. Conversely, the cost of financing is slightly higher for term loans or new credit lines, at 1.63 and 1.66 percentage points above Prime respectively.

Table 6:
Interest rate over Prime, by type of financing and institution

Financial Institution	Term loans	New line of credit	Increase or extension in line of credit	Overall


Caisse populaire Desjardins	2.86	2.51	2.60	2.66
Credit union	1.56	1.61	1.57	1.58
National Bank	1.80	1.76	1.17	1.55
Royal Bank	1.51	1.63	1.52	1.54
TD Canada Trust	1.68	1.58	1.37	1.53
CIBC	1.70	1.57	1.29	1.48
ATB Financial	1.52	1.57	1.35	1.47
Scotiabank	1.46	1.71	1.12	1.42
Bank of Montreal	1.43	1.55	1.24	1.38
HSBC	0.99	1.32	1.14	1.15
TOTAL	1.63	1.66	1.48	*1.58*

The interest cost of financing varies by banking institution. HSBC provides the most competitive financing rates, at 1.15 per cent plus Prime, while Caisse Populaire Desjardins is least competitive, at 2.66 per cent plus Prime. The difference in rates is due primarily to the different type of clientele: HSBC typically caters to larger, more established businesses, while Desjardins services the smaller, less established businesses. Among the big chartered banks, Bank of Montreal offered the lowest rates; Royal Bank is least competitive in this respect.

The cost of bank financing also varies according to the size of business. The smallest businesses paid 1.88 per cent above Prime, while larger businesses paid 0.77 over Prime (see Figure 13).

Figure 13:
Interest rate over Prime, by size of firm

Figure 13: Interest rate over Prime, by size of firm

The smaller the business, the higher the cost of bank financing.

The amount of collateral a business owner has to pledge to secure the debt financing also varies according to many factors, such as years of business experience and the size of the business. TD Canada Trust clients had to pledge the highest level of collateral in relation to the loan amount, HSBC clients the lowest. For example, the collateral-to-loan ratio among TD Canada Trust clients is 1.70, meaning that for every $1 loaned, the borrower had to pledge $1.70 in assets. The corresponding ratio for HSBC customers is significantly lower, at 1.38 (see Appendix Table A1 for further details).

Service Charges

For the past few decades, the banks have honed their skills at raising more and more revenue by adopting a fee-for-service strategy. The banks started initially by charging a fee for a pre-determined package of services, shifting to pricing individual services by the early 1990s. Pricing policies for bank services varied throughout the past decade and today they include a combination of pricing for individual services or a package of services.

Figure 14:
SMEs' Satisfaction with Service Charges

By Province

Figure 14: SMEsâ€™ Satisfaction with Service Charges (By Province)

By banking institution

Figure 14: SMEsâ€™ Satisfaction with Service Charges (By banking institution)

Fifty-nine per cent of business owners are "not" satisfied with the level of bank service charges.

Satisfaction with service charges remains low. Overall, 59 per cent of business respondents are "not" satisfied with the level of service charges (see Figure 14). Significant variations in satisfaction level exist among provinces and financial institutions. Generally, the highest satisfaction levels are among firms in the four western provinces and those firms that are either clients of credit unions or HSBC. The level of satisfaction is also related to the size of the firm: the smaller the firm, the lower the level of satisfaction. Additionally, the higher the account manager turnover rate, the lower the level of satisfaction.

Conclusions and Recommendations

Based on these survey findings, the major banks have not yet demonstrated that they are better able to serve the SME market. The overall level of competition in the banking sector has not increased in the past three yearsâ€”at least not in terms of servicing the small business segment of the economy. Banks continue to focus their efforts on increasing the number of ATMsâ€”at the expense of fewer full-service branchesâ€”and competing on the wealth management products such as RRSPs, GICs and mutual funds. Despite the work of the MacKay Task Force, banks continue to engage in strategies that weaken competition in the banking industry. One recent example is the TD Canada Trust purchase of 57 Laurentian Bank branches outside of Quebec. The end result of such bank strategies can only be "less" not "more" competition.

The role of public policy on banking competition is now more important than ever. If bank shareholders' interests prevail and the major banks receive the green light to merge, the Canadian banking industry of the 21^st century will be one characterized by less choice and competition for banking services and business financing. This is clearly not the path that will lead to more competition among banks and better serve the needs of Canada's entrepreneurs. Rather, public policy must be aimed at improving conditions in the access to and provision of banking services to small business.

The strength and confidence of small business owners are the foundation to a thriving economy. Critical to the continued future success of the SME sector is access to competitive banking services. Serious actions must be made if the domestic market for small business banking services is to improve. CFIB believes that there are many ways to help improve business owners' access to conveniently-located and competitively-priced banking services. The following recommendations, if acted upon by the banking community and government policymakers, would help in this respect:

Federal and provincial government policy should focus more on increasing the level of competition in the financial services sector.
The next policy steps must be based on more recent evidence than that contained in the 1998 MacKay Task Force. Some of the recommendations of the MacKay Task Force have been implemented. The survey findings outlined in the report, however, are a clear signal that much more needs to be done to enhance competition in the banking sector. Efforts must be made to encourage the development of competitive alternatives to the major chartered banks. This can be achieved by continuing to remove legislative and other regulatory barriers that impede the development of credit unions and foreign banks in the Canadian market.
The federal government should not allow major chartered banks to merge with each other given the current level of competition in the banking industry.
There is currently insufficient competition in the banking industry and allowing bank mergers would only exacerbate the situation. The loss of the major trust companies, most recently Canada Trust, is a clear sign that mergers will only reduce the overall level of competition in the banking industry. (Please refer to CFIB survey question on bank mergers in the Appendix.)
The federal government should continue the process of establishing a clear set of criteria and public process to assess merger proposals among major Canadian financial institutions.
A key component of any merger review process should be the ability of small business to access competitive banking services. Without additional competition among the banks, mergers among the major chartered banks must not be allowed.
Banks and other institutions should enhance the role of the account manager at the branch level.
The survey data provides concrete evidence that the business client-banking relationship is linked directly to the number of times the key contact person at the bankâ€”the account managerâ€”is changed. Every major aspect of the client-bank relationship is affected. The banks must address the role of their account managers and how it can be enhanced to better serve their small business clientele. This can be achieved by: (i) reducing the turnover of account managers; (ii) ensuring that account managers are adequately versed in the needs of small businesses and risk assessment; and (iii) providing account managers greater decision-making authority.
Banks and other lending institutions should increase their participation in small business financing by adopting more flexible lending policies and practices.
Banks and other lenders should place less emphasis on automated credit scoring models and focus on the relationship between account managers and small business clients.
The Code of Conduct for banks should be consistently enforced to ensure that, at a minimum, the existing measures are implemented and to develop additional standards designed to improve overall service levels to the small business community.
The survey data indicate that one in four small businesses that are rejected for credit financing are "not" informed of the reasons for the decision and are not provided with information on financing alternatives. The Code of Conduct for banks stipulates that these two actions must be carried out in cases of credit turndowns. The banking industry, in conjunction with government and CFIB, should work together to ensure the Code is being fully implemented and to develop additional banking standards to better serve the small business market.
The federal government should collect and report publicly additional information specific to the banking sector's competitive status.
While Statistics Canada and Industry Canada currently collect and report survey data on SME financing issues to the House Industry Committee on an annual basis, there currently exists a wide gap in pertinent information relating to competition and concentration levels within the bank sector. Examples include: the number and location of bank branches; types of service offerings on a branch basis; and the accessibility of banking services offered in various communities.
The federal and provincial governments should seek ways to rationalize their small business financing programs.
The role of government should be centered on collecting and reporting small business financing data on a regular basis.

Appendix

Additional Survey Findings

A. Figure A1: Change in banking services in local community

B. SME Debt Financing Indicators:

Table A1: by financial institution
Table A2: by industry
Table A3: by province
Table A4: by age of firm
Table A5: by size of firm

C. Merger Survey Question: Should additional competition in the banking industry be a prerequisite for allowing major Canadian banks to merge with each other?

Figure A1:
Change in banking services in local community

"Business loans/credit lines"

Figure A1: "Business loans/credit lines"

"Business account and deposit services"

Figure A1: "Business account and deposit services"

"Personal banking services"

"Wealth Management"

Figure A1: "Wealth Management"

"ATMs"

Figure A1: "ATMs"

Table A1:
Selected SME Debt Financing Indicators, by Financial Institution


	Median financing approved	*Market share (loan value)**	*Market share (customers)**	Collateral- to-loan ratio	Interest rate over Prime	Loan rejection rate	Firms with 3 or more account mgrs.

	$	%	%	ratio	%	%	%
Royal Bank	100,000	19.7	20.0	1.56	1.54	18.8	22.6
CIBC	110,000	12.1	12.6	1.57	1.48	15.5	24.4
Bank of Montreal	150,000	14.9	12.1	1.54	1.38	13.4	18.4
Scotiabank	80,000	12.5	14.2	1.45	1.42	21.8	18.4
TD Canada Trust	100,000	10.2	13.0	1.70	1.53	21.2	24.8
National Bank	150,000	6.5	4.4	1.25	1.55	14.1	23.8
HSBC	217,500	8.9	2.2	1.38	1.15	6.5	22.5
Caisse pop. Desjardins	60,000	5.1	8.1	1.44	2.66	9.4	17.8
Credit unions	65,000	5.7	9.9	1.51	1.58	12.2	10.3
ATB Financial	100,000	1.3	1.9	1.53	1.47	11.5	17.9
Other institutions	137,500	3.1	1.6	1.46	1.63	12.7	18.7
TOTAL	100,000	100.0	100.0	1.52	1.58	16.0	20.4

* Market share figures differ significantly from province to province. In Quebec, for example, Desjardins accounts for 44.0 per cent of the small business market in 2003, while National Bank has 20.1 per cent of the market. In Alberta, ATB Financial accounts for 19.3 per cent of the small business market. * Some CFIB members may have been participating in a merchant services plans offered by Scotiabank and Moneris.

Table A2:
Selected SME Debt Financing Indicators, by Industry


	Median financing approved	Market share (loan value)	Market share (customers)	Collateral- to-loan ratio	Interest rate over Prime	Loan rejection rate	Firms with 3 or more account mgrs.

	$	%	%	ratio	%	%	%
Agriculture	150,000	12.1	6.8	1.80	1.18	8.4	13.5
Primary	200,000	4.3	2.0	1.48	1.69	8.3	17.2
Manufacturing	165,000	22.4	14.0	1.44	1.38	13.7	24.0
Construction	100,000	9.1	10.9	1.47	1.62	10.5	17.9
Trans./communications	122,500	7.4	4.5	1.57	2.26	15.9	19.7
Wholesale	160,000	16.8	8.9	1.47	1.50	15.2	23.6
Retail	63,350	15.2	25.0	1.68	1.63	20.8	19.3
Finance, ins., real. est.	100,000	2.5	4.8	1.26	1.42	14.5	20.2
Business services	50,000	4.2	9.4	1.35	1.65	19.4	27.3
Community services	60,000	1.7	3.3	1.12	1.40	17.4	16.2
Hospitality/pers. services	60,000	4.3	10.4	1.51	1.80	19.7	19.8
TOTAL	100,000	100.0	100.0	1.52	1.58	16.0	20.4

Table A3:
Selected SME Financing Indicators, by Province


	Median financing approved	Collateral-to-loan ratio	Interest rate over Prime	Loan rejection rate	Firms with 3 or more account mgrs.

	$	ratio	%	%	%
British Columbia	100,000	1.72	1.47	15.5	18.3
Alberta	105,000	1.63	1.38	17.6	22.5
Saskatchewan	80,000	1.31	1.51	17.0	12.6
Manitoba	100,000	1.72	1.71	9.9	17.8
Ontario	100,000	1.67	1.40	17.8	21.6
Quebec	100,000	1.31	2.00	11.2	21.7
New Brunswick	75,000	1.35	1.62	19.3	15.3
Nova Scotia	60,000	1.16	1.82	21.6	24.1
Prince Edward Island	90,000	1.47	1.50	12.6	13.8
Newfoundland & Labrador	100,000	1.06	1.54	23.3	13.4
CANADA	100,000	1.52	1.58	16.0	20.4

Table A4:
Selected SME Debt Financing Indicators, by Age of Firm

Number of years in business	Median financing approved	Collateral-to-loan ratio	Interest rate over Prime	Loan rejection rate	Firms with 3 or more account mgrs.


	$	ratio	%	%	%
1-4	50,000	1.35	1.84	32.2	21.9
5-10	65,000	1.34	1.81	21.2	25.2
1-10	60,000	1.34	1.82	25.3	24.2
11 or more	110,000	1.59	1.49	11.6	19.1
Young, high performers*	75,000	1.27	1.64	27.3	27.9
TOTAL	100,000	1.52	1.58	16.0	20.4

Table A5:
Selected SME Debt Financing Indicators, by Size of Firm

Number of employees	Median financing approved	Collateral-to-loan ratio	Interest rate over Prime	Loan rejection rate	Firms with 3 or more account mgrs.


	$	ratio	%	%	%
0 – 4	45,000	1.44	1.88	23.3	20.5
5 – 19	100,000	1.66	1.60	14.8	21.3
20 – 49	350,000	1.42	1.20	8.2	19.8
50 – 99	750,000	1.30	1.34	5.0	18.5
100 +	2,000,000	1.12	0.77	3.0	11.2
TOTAL	100,000	1.52	1.58	16.0	20.4

additional competition in the banking industry be a prerequisite for allowing major Canadian banks to merge with each other?

(select one)

Background:

Last fall, Scotiabank discussed a possible merger with the Bank of Montreal and, in 1998, there were two merger attemptsâ€”the Royal Bank with Bank of Montreal, and CIBC with TD Bank. To date, the federal government has rejected all proposed bank mergers, citing competition issues as a concern. The federal government did approve the merger between TD Bank and Canada Trust in 2000 and between Scotiabank and National Trust in 1997. There is a process in place to review proposed bank mergers through the Competition Bureau and the Office of the Superintendent of Financial Institutions. The final decision over bank mergers rests with the Minister of Finance based on public interest considerations that includes the costs and benefits to individual consumers and small business owners, as well as regional impacts and employment.

Supporters

say there is currently insufficient competition in the banking industry and allowing bank mergers would only worsen the situation. The loss of the major trust companies has not been replaced by other competitive entities and foreign banks are not viable alternatives for most small businesses. Ensuring that competition in Canada's highly concentrated banking industry has increased before allowing bank mergers would be responsible public policy.

Opponents

say the Canadian banking industry is competitive, but to protect consumers and small business in the long run, banks need to increase in size and pool their resources to offer the full range of banking services at competitive prices. A bank merger is simply a business strategy and Ottawa should not interfere in deciding what a bank's business strategy should be. Many other countries allow bank mergers as a way to strengthen their banking industry.

Results of Web Survey (n = 1,943)

Results of Web Survey (n = 1,943)

The above survey question was conducted by e-mail on January 23-27, 2003. A total of 1,943 responses were received from small and medium-sized independently-owned and operated businesses located in all regions and sectors throughout Canada. The results are accurate to within Â±2.2 percentage points, 19 times out of 20.

Notes:

^[1] see Statistics Canada, The Daily, June 30, 2003: Small and medium-size enterprise financing in Canada. [Return]

^[2] The Prime rate charged by the major chartered banks during the survey period April-May 2003 was 5 per cent. [Return]

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