Disclosure By Banks Of Business Lending Statistics How to Correct the Flaws in the Current System CCRC Position Paper #3 (November 1997)

"Small businesses play a fundamental and increasingly important role in our economy. Since 1992, they have created almost all net new jobs in Canada. . . The role of government is to create an environment of opportunity -- an environment where small businesses can thrive and prosper, and continue to drive the economic growth Canada needs. . .
. . . the government feels the banks have a special obligation to provide financing to small businesses, and will be working with the banks to establish benchmarks against which their performance in small business lending will be measured."

I. Background

(a) How and Why the Bank Business Lending Disclosure System Developed

It has long been the claim of certain regions in Canada (Atlantic and Western Canada) that Canada's financial institutions have existed to serve the needs of Central Canada. In the early 1990s, the complaint of regional bias with respect to the banks was supplanted by the view that the banks systematically discriminate against small businesses in their lending practices. However, comprehensive data to support or disprove either contention has not been available, and this situation has not changed.

Why has the information to prove or disprove claims regarding the bias of the banking system not been available? Essentially, requirements for banks to disclose detailed information about their lending practices have ranged from nonexistent five years ago to inadequate today. Despite the fact that the federal government has protected Canada's chartered banks from full-scale foreign competition since 1967, the government has never enacted in law measures such as disclosure requirements to ensure that our banks meet the legitimate credit needs of Canadians or Canadian businesses, especially small businesses.

Small business advocates have long complained about the lack of access to capital for Canadian small business as well as start-up ventures. Surveys by the Canadian Federation of Independent Business (CFIB) of its over 80,000 members have shown "access to capital" to be an ongoing problem, especially when compared to the U.S. It is consistently ranked in respondents' top 10 concerns, and the number of small businesses reporting problems with access to capital doubled from 20% in 1990 to 40% in 1996 (their June 1996 survey ranked "access to capital" as the 6th concern). In contrast, respondents to the U.S. National Federation of Independent Business (NFIB) surveys over the past 10 years have never ranked access to capital higher than 43rd (in their 1996 survey it ranked 63rd).

These surveys and complaints from many small businesses, when combined with Bank of Canada statistics showing that commercial loans of under $200,000 by chartered banks decreased from $21.7 billion in late 1989 to $17.9 billion in mid-1993, attracted the interest of several Members of Parliament at the time.

An important reason for the MPs' concern was that federal government studies pointed to small business as the engine of job creation in Canada. According to the Government of Canada, 98% of all businesses have less than 50 employees (88% have less than five employees), 53% of all Canadians working in the private sector are self-employed or employed by a business with less than 100 employees, small businesses created over 80% of all growth in employment in the past 15 years, and small businesses created 38% of Canada's gross domestic product in 1991.

The growing complaints by the small business sector prompted the House of Commons Industry Committee to take action in the spring of 1994. In October 1994, after a few months of hearings, the Committee issued a report entitled Taking Care of Small Business. Recommendation #2 of this report called on the banks to report statistics on small business lending, based on a quarterly compilation of data by the size (by employment and sales), type (major sector of operations), and location (municipality) of the business, and also the nature of the borrower, including the gender of the business owner.

Industry Committee hearings held in March 1995 gave individual banks an opportunity to comment on this recommendation. Following the hearing and further deliberations, on October 24, 1995 the Industry Committee released its report Performance Benchmarks for Small Business Financing by Banks. In this report, the Industry Committee proposed that business lending statistics be reported according to the following criteria:

• number and amount of loan authorizations between $0 and $24,999; $25,000 to $49,999; $50,000 to $99,999; $100,000 to $199,999; $200,000 to $499,999; $500,000 to $1,000,000; over $1,000,000;
• number and amount of authorizations to companies by the following number of employees: less than 5, 5-19 employees, 20-49 employees, 50-99 employees, 100-499 employees, and over 500 employees;
• number and amount of authorizations to companies who at the time of the loan application had recorded annual sales of: 0, $1-$249,999; $500,000-$999,999; $1,000,000- $4,999,999; and over $5,000,000;
• loan authorizations broken down into operating credits and term credits for firms by of employees and annual sales;
• number and amount of authorizations granted to new borrowing connections as per size of authorization, by number of employees, annual sales and a breakdown between operational and term credits;
• number and amount of loan authorizations by age of business as follows: start-ups (less than one year), 1 to 5 years, 5 to 10 years and more than 10 years;
• number and amount of loan authorizations by industry sector and gender;
• number and amount of loan authorizations by municipality broken down by size of authorization, number of employees, annual sales, by type of credit, age of business, and by industry sector and gender; and
• loan loss ratios by amount of authorization, number of employees, annual sales and age of business.

The Committee also recommended that the Banks develop an appropriate statistical method of tracking information regarding loan turndowns by amount requested, size of business by employees and sales, by industrial sector, by gender and by municipality no later than October 31, 1996.

The Industry Committee's detailed proposals led the Canadian Bankers Association (CBA) to develop a counter-proposal, and during a committee hearing in early November 1995 a lending disclosure system and schedule was negotiated.

The CBA's initial proposal was based on consultations between the banks and the Department of Finance. It initially called for SME credit statistics to be provided in three (3) categories of loans under $500,000, $500,000 to $1 million and $1 million to $5 million. Obviously, a minimum threshold of loans under $500,000 is of little use for analyzing bank business lending practices, as it combines into one grouping businesses of many different sizes, from those with credit limits of $450,000 to those with credit limits of $30,000. Consequently, under pressure from the Industry Committee, the loan size disclosure categories were expanded from three (3) to eight (8). The initial category is now loans under $25,000, and statistics using the eight loan size categories have been disclosed since the third quarter of 1995.

As a result of the negotiations between the CBA and the federal government, the current business lending disclosure system includes disclosure of the following information (with seven (7) banks participating in the system (Royal Bank, CIBC, Bank of Montreal, Scotiabank, Toronto Dominion, and HongKong Bank of Canada):

• loan authorizations by eight (8) dollar thresholds (between $0 and $24,999; $25,000 to $49,999; $50,000 to $99,999; $100,000 to $249,999; $250,000 to $499,999; $500,000 to $999,999; $1,000,000 to $5 million; over $5 million) along with total business credit;
• loan authorizations by 17 Standard Industry Classifications (SIC);
• loan authorizations broken down into eight (8) geographic regions (three (3) in Ontario and five regions of Canada) along with national totals;
• beginning with the fourth quarter of 1996, the banks provide loan loss provision information for all the above loan size categories;
• in addition, the following information is provided not by systematic collection and disclosure of statistics, but instead through CBA-commissioned surveys, including: loan application approval/turndown rates for firms by number of employees, sales and gender of loan recipient.

In essence, the Industry Committee, and the federal government as a whole, gave up its proposed requirement that banks be required to disclose loan authorizations by gender, municipality, age of business, annual sales, number of employees and by operational and term credits. Furthermore, the banks were not required to develop a reliable statistical method of tracking information regarding loan turndowns. As a result, the federal government effectively gave up on Industry Minister John Manley and Finance Minister Paul Martin's 1995 pledge (set out in the quotation at the beginning of this Position Paper) to establish benchmarks against which the banks' performance in small business lending can be measured.

(b) The U.S. Federal Lending Disclosure System: A More Effective System

In the United States since the mid-1970s, requirements to disclose statistics on mortgage lending have allowed citizens and governments to track financial institutions' lending performance very effectively. Under the federal Home Mortgage Disclosure Act (HMDA), almost all of the 10,000 U.S. banks and other financial institutions are required to disclose how many people apply for a mortgage loan, how many are approved and how many rejected, all categorized by the race, gender, income level and neighbourhood of the borrower. The financial institution also has the option of providing a reason why a loan application was rejected. Only the smallest companies, in terms of size of assets (under $10 million) and number of mortgages made each year (less than 100), are not required to disclose this information.

The information is required to be publicly available at each bank branch, and is aggregated nationally by federal regulators. In addition, recent changes to the U.S. federal Community Reinvestment Act (CRA) have extended some of these disclosure requirements to small business, small farm, and consumer loans, and several states have their own disclosure laws that, in some cases, extend the requirements to other areas as well. In all cases, information that would allow anyone to identify a loan applicant is not disclosed, to protect the privacy of borrowers.

The HMDA was enacted, as the law states, so that federal regulators would have information from banks, savings and loans, credit unions, other savings institutions and mortgage companies needed to:

• "help determine whether financial institutions are serving the needs of their communities";
• "assist public officials in distributing public-sector investments so as to attract private investment to areas where it is needed" and;
• "assist in identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes."

The CRA was amended to include disclosure in other lending areas for essentially the same reasons. The U.S. system has been effective because it tracks loan demand and rejection rates, and also tracks loans by other criteria. As a result, regulators have been able to determine that, nation-wide, if you are black you are twice as likely to be rejected when applying for a mortgage loan, even if you have the same income level and live in the same neighbourhood as other applicants. Regulators, along with citizens and community groups, are also able to track banks' performance in lending in specific neighbourhoods.

In contrast, under the current Canadian bank business lending disclosure system the federal government cannot determine: whether banks are meeting the demand for business loans; whether small business loan applicants are rejected at a higher rate than big business applicants; whether businesses in certain communities or industry sectors are rejected at a higher rate than others; or whether any bank's pattern of rejecting applicants is unjustifiable.

(c) Canadian Federal Party Policies and Platforms: Calling for More Detailed Disclosure

At the Liberal Party of Canada's national policy convention in October 1996 in Ottawa, priority resolutions proposed by three provincial party associations were passed by over 2,000 delegates from across Canada. Reinforcing the statement by Finance Minister Paul Martin and Industry Minister John Manley quoted at the beginning of this Position Paper, the resolutions proposed enacting legislation, based on existing U.S. legislation (detailed above), which would require banks, among other things:

• to disclose the number of loan applications received for business start-ups and expansions; and
• to disclose the rejection rate and loan-loss and loan-default rates for approved applications, all categorized by size and type and location of the business.

This information would allow Canadians and governments to know the actual risk of lending to specific business sectors and communities and therefore to judge whether the banks are meeting the legitimate demand for capital from these sectors and communities.

Aimed at addressing the same issue, the Conservatives' 1997 federal election platform pledged to require banks to publish detailed records on small business lending on a regional basis to "enable Canadians to compare the performance and commitment of their financial institutions to the creation of loan capital for new and small businesses." The NDP's and Bloc Québecois' election platforms also contained similar proposals concerning requiring disclosure of data on bank lending patterns and practices.

While some may wish to compliment the banks and the federal government for negotiating the current bank business lending disclosure system, it is more appropriate to ask whether the current system is sufficient to determine whether banks are meeting the credit needs of the businesses and communities they are purporting to serve. Our conclusion is that the current system is fatally flawed and inadequate in several ways, as follows:

(a) Voluntary System: Subject to Abuse

The first flaw with the disclosure system is that it is a voluntary system, with minimal standards concerning the form in which the statistics must be disclosed. As a result, the Canadian Bankers Association (CBA) discloses the data in quarterly reports, with their own summary presenting the banks' analysis of the statistics in the most positive light.

For example, the CBA's quarterly report summaries always contain an analysis of small and medium enterprise (SME) lending using the category of loans under $1 million, and always claiming an overall increase in lending in this category in each report. However, a simple analysis of the statistics reveal that customers with authorizations of $50,000 or less comprise 54% of business borrowers, with $100,0000 or less comprise 69% of the business customer base while 85% of business credit users have authorizations of under $250,000. These statistics make it clear that it is extremely rare for small businesses to need more than $250,000 in credit.

Based on these statistics, the banks' report summaries distort the true nature of their lending practices to small businesses because they combine the 85% of customers in under $250,000 loan category with the 10% of customers in the $250,000 to $1 million loan category.

An analysis of the CBA's statistics for the lower loan levels (comparing December 31, 1995 with the situation as of December 31, 1996 (released September 5, 1997)) reveals that, in contrast to the CBA's claims, support for small business in 1996 decreased, as follows:

• the percentage of customers with credit of under $25,000 dropped from 40.5% to 39.3% of total bank customers;
• total credit authorized in amounts of under $25,000 was reduced by 10% (from $2.5 billion to
  $2.2 billion);
• for credit authorizations of under $100,000, the share of the Big Seven's credit portfolio remained stagnant (at 3.04% of the total); and
• for credit authorizations of under $250,000, the share of credit also remained stagnant (at 6.9% of the total).

The CBA's report summaries also do not provide an analysis of changes in big business lending. Why not? One main reason could be that the changes counter the banks' claim that they are focussed on serving the small business sector's needs for capital. A simple analysis of the 1996 CBA statistics reveals that ending to big business increased during the year. Of the $18 billion increase in total business credit in 1996, $15 billion (83%) of the credit was loaned out in amounts in excess of $5 million (an increase in this loan category of 4.8%). However, during 1996 customers with credit in excess of $5 million declined by 13%. As a result, as of December 1996 customers with credit authorizations in excess of $5 million represented only 1.25% of total customers, but received 75% of extended credit (compared to 1.47% of total customers and 74% of total credit as of December 31,1995). In essence, the banks extended more credit to fewer big business clients in 1996.

In contrast to the current situation, if the disclosure system was enacted in law, the banks could be required to disclose lending statistics aggregated according to each loan size category, and by any other category the federal government sees as important for obtaining an accurate report of the bank's actual lending practices for policy-making purposes.

(b) Loan Size Categories: Too Broad to be Useful

The second flaw in the current lending disclosure system is that the lowest loan size category for which credit statistics are presently available is less than $25,000. However, this category comprises 40% of the banks' business customers. Clearly, this category is too broad to be statistically useful for analysing the different types of small businesses that have these small credit needs.

We believe that disclosure of lending of loans under $5,000 is needed to allow for analysis of bank lending to micro-enterprises, including home-based businesses and the self-employed. Demographers have predicted significant growth in this business category over the next decade, and knowing whether banks are meeting credit needs of these businesses will be more and more important for any federal government committed to creating an environment of opportunity, in which small businesses can thrive and prosper and continue to drive the economic growth that Canada needs.

(c) Demand for Credit Not Tracked: No Accountability As A Result

The third flaw with the current lending disclosure system is that CBA statistics reveal the supply of credit but not the demand, either by amount of customers or total credit requested. Knowing how much credit has been extended by the banks tells us very little unless we know how much businesses of different sizes demanded. For example, although we now know that only about 3% of total business credit extended by the banks goes out in loans of under $100,000 to 500,000 customers, we do not know whether banks have received applications from one million customers for 6% of total business credit.

As a result of this flaw, when faced with statistics showing stagnation in lending of loans under $100,000 through 1996, the banks can simply respond that demand must have remained constant, and that they just continued to meet the demand. The federal government cannot respond in any way to this claim because the banks are not required to disclose statistics either to prove or disprove the claim. The same situation will occur whenever bank lending to a particular business sector or region of Canada stagnates or decreases in the future.

The banks claim that they can't keep statistics on how many people apply for loans (and therefore they can't track approvals and rejections), because they cannot determine when someone actually applies for a loan, as opposed to just asking for information. This seems to be a valid problem, until you see the banks' claim that, according to their surveys, over 80% of small businesses that apply for loans are approved. If they can determine, for the purpose of a survey, whether someone has applied for a loan, then why can't they determine it in order to keep statistics on all loan applications, and whether they are accepted or rejected?

Requiring banks to track demand and approvals / rejections is also equivalent to the disclosure required under the U.S. federal Home Mortgage Disclosure Act (HMDA) and Community Reinvestment Act, with which thousands of banks, many much smaller than our chartered banks, comply (as described above in section I(b)).

With their own actions, Canada's big banks contradict their claim concerning the difficulty of tracking demand. Two of Canada's chartered banks (the Bank of Montreal and Toronto Dominion Bank) own subsidiaries in the U.S. both of which are able to comply with the U.S. requirements while maintaining profitable operations.

(d) Geographical Breakdown: Too Broad to be Useful

The fourth flaw with the current lending disclosure system is that Canada is divided into only eight (8) regions for reporting purposes. This is clearly not sufficient for analyzing whether banks are serving the credit needs of communities (or even some provinces) from which they accept deposits. A more detailed breakdown is required to track banks' lending performance in communities across the country.

What would be an appropriate breakdown? It seems appropriate to require banks to report data for each census tract, with aggregate statistics for each federal electoral ridings, province, and region. By requiring banks to disclose credit information by Parliamentary ridings it would allow individual Members of Parliament (MPs) to determine how well their constituencies are being served by the banks in their community.

The banks have argued that such a detailed breakdown is too complicated for them to produce. However, as above, it is equivalent to the disclosure required under the U.S. federal Home Mortgage Disclosure Act (HMDA) and Community Reinvestment Act. As mentioned above, two of Canada's chartered banks (the Bank of Montreal and Toronto Dominion Bank) own subsidiaries in the U.S. both of which are able to comply with the U.S. requirements while maintaining profitable operations.

(e) Key Information: Tracked Only by Flawed Surveys

The fifth flaw with the current lending disclosure system is that key information, such as loan application approval / rejection rates (categorized by number of employees, sales and gender of loan recipient) is not collected systematically, but instead through CBA-commissioned surveys. These surveys, conducted by Thompson, Lightstone and Company of Toronto on behalf of the CBA in 1995 and 1996, have proven to be flawed in several ways.

First, the CBA surveyed businesses which have sales of less than $50 million and fewer than 500 employees, a definition that extends far beyond the small or even medium-sized business sector in Canada (less than one percent of Canadian businesses have more than 500 employees). Second, the survey sample size is very small, weighted to larger businesses, and statistically insignificant in the category of start-up businesses. Specifically, results were based on responses of mostly larger existing businesses (more than 50 employees) and at most 200 start-up businesses that had approached banks for financing. This represents a very small portion of the 720,000 business credit customers of the Big Seven Canadian banks. Third, in 1996 the survey was conducted in conjunction with the Canadian Chamber of Commerce, whose membership includes banks, as opposed to an organization representative of small business interests.

The 1997 survey also exaggerates the banks service level to small business, disclosing a high level of small business financing by personal (41%) as well as business (24%) credit cards. The survey concludes that this level of credit card utilization is for reasons of "convenience" to business owners. However, convenience is not defined. Given, that credit cards are an expensive method of financing, it is arguable that "convenience" in this case refers to avoiding the hassle of trying to secure a loan with a more reasonable interest rate from a bank.

Overall, from the past two years of CBA surveys, it has become clear that a CBA-commissioned survey is an inadequate and invalid means of tracking small business demand for capital, and loan approvals and rejections. Surveys cannot be as complete as full data disclosure, and in particular cannot in any way detail banks actual lending patterns and practices concerning business start-ups applying for their first bank loan (particularly if the loan application is rejected). It is, therefore, a grave mistake to rely upon the CBA survey data for the purpose of policy development.

(f) Report Format: Hard to Digest

A final flaw with the current disclosure system is that the statistics collected and disclosed by the banks to the federal government, and the CBA's raw survey data and survey summaries, are not made available in electronic format so that they can be easily analyzed by the federal government or other interested parties.

III. CCRC Recommendations

The CCRC recommends that the federal government take the following steps to ensure a higher level of transparency concerning banks' business lending practices in accordance with the recommendations of the House of Commons Standing Committee on Industry in its report of October 1995, and to ensure that Canadians and Canadian governments know the actual risk of lending to specific business sectors and communities and can therefore judge whether the banks are meeting the legitimate demand for capital from these sectors and communities:

1. Each chartered bank in Canada, should be required by law (as in the U.S., and instead of under the current negotiated, voluntary agreement) to collect and disclose to the federal government the following information about business lending for each branch of the bank (some of the following information is disclosed under the current agreement, our proposed additions are highlighted in recommendations set out below):
• the number of loan applicants in each loan category;
• the number of loan applicants the bank accepts and rejects in each loan category;
• the loan default and loan loss rate for each loan category;
• the number of loans in each loan category the bank calls each quarter;
• all of the above categorized by size of loan (under $5,000; $5,000 to $25,000; $25,000 to $50,000; $50,000 to $100,000; $100,000 to $250,000; $250,000 to $500,000; $500,000 to $1 million; $1 million to $5 million; over $5 million);
• all of the above also categorized by size (by sales and number of employees), type, and location of the business (by census tract), and also by the gender of the business-owner; and
• financial institutions should also be required to provide reasons for loan rejections.
2. As set out in recommendation #1 above (and as in the U.S.), for each loan category loan demand (number of applicants), approval / rejection rate, and number of called loans should be added to the current disclosure system so that Canadians and governments can track whether banks are meeting demand for credit across the country. The patterns of reasons for rejections (which the banks should be required to disclose) will give the federal government indications as to problems that need to be solved (e.g. if a large number of applicants in a particular region have not prepared a proper business plan, it will indicate that training and educational programs in that area could be increased).
3. As set out in recommendation #1 above, each small business loan category should be tracked for each census tract in Canada, and by the gender of the business owner (following Statistics Canada guidelines to ensure that the privacy of borrowers is protected).
4. As set out in recommendation #1 above, an additional loan size category, credit allocations of under $5,000, should be added to the current disclosure system in order to allow Canadians and Canadian governments to determine if banks are supporting micro-business initiatives across the country.
5. The federal government should designate a government agency (such as Statistics Canada) to aggregate the above data (as in the U.S.), with the mandatory assistance of the banks, for each federal electoral riding, province, and region and nationally and to make all the data publicly available in hard copy and electronic format.
6. The House of Commons Industry Committee should hold annual hearings to evaluate the data submitted by the banks as well as determine if additional data needs to be disclosed for public policy purposes.
7. As promised by federal Industry Minister John Manley on July 31, 1996 before the Senate Committee on Banking, Trade and Commerce, Crown financial institutions (e.g. regional development agencies, Farm Credit Corporation, Business Development Bank of Canada) should be required by law to disclose statistics on their financing practices similar to the banks.
8. Other domestic deposit-taking financial institutions should also be required by law, by the government which regulates their activities, to disclose statistics on their financing practices similar to the banks. The time it may take to enact these requirements should not in any way delay enacting requirements for Canada's chartered banks, which have a basic disclosure system in place already.
9. Should the ongoing multilateral negotiations taking place in Geneva under the auspices of the World Trade Organization lead to greater liberalization of the Canadian market in financial services, the government should adjust the requirements concerning disclosure of lending patterns and practices to ensure that foreign banks and their customers are covered by the system.
10. A financial institution's record in meeting the legitimate credit needs of businesses across Canada should be assessed as one part of an overall system of requirements and monitoring of financial institutions' performance in serving the needs of their customers, including penalties for not meeting requirements. The CCRC will set out a detailed proposal for such a system in a subsequent CCRC Position Paper.