INDY Committee Meeting

STANDING COMMITTEE ON INDUSTRY

COMITÉ PERMANENT DE L'INDUSTRIE

EVIDENCE

[Recorded by Electronic Apparatus]

Tuesday, October 27, 1998

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[English]

The Chair (Ms. Susan Whelan (Essex, Lib.)): I call the meeting to order pursuant to an order of reference of the House dated Tuesday, October 6, 1998, consideration of Bill C-53, an act to increase the availability of financing for the establishment, expansion, modernization and improvement of small businesses.

We're very pleased to have with us several witnesses today. We'll be breaking our witnesses into two different groups, one at 3.30 p.m. and one at 4.30 p.m. Our first group of witnesses includes the Office of the Auditor General of Canada. We have Mr. Richard Flageole, assistant auditor general, Mr. Peter Simeoni, principal, audit operations branch, and Mr. Bryan DePape, director, audit operations branch. We also have, from Equinox Management Consultants Ltd., Dr. Allan Riding, a professor of Carleton University.

I'm very pleased to welcome you all here today. My proposal would be that we'd have opening statements by both parties and then proceed to questions. I would propose that we begin as identified on the witness list and that the Auditor General's office begin with their opening statement. Thank you.

Mr. Richard Flageole (Assistant Auditor General, Office of the Auditor General of Canada): Madam Chair, thank you for this opportunity to present our comments on Bill C-53, the Canada Small Business Financing Act. Our comments are structured along the following lines.

First, we will briefly review the main messages of our December 1997 report, chapter 29, on the management of the small business loans program. Next, for each of these messages we will present our views on whether Bill C-53 responds to our concerns as well as those expressed by the public accounts committee in its May 12, 1998, report to the House of Commons. Finally, we would like to offer suggestions to the committee on additional information it might consider requesting from the department.

I would like to mention that we have not reviewed the regulations that are to be made under the proposed legislation and that are being developed by Industry Canada.

The first message in our report was that the department needed to better define the results expected from the small business loans program and to be sure that it is designed in a way that maximizes its impact. Increasing the availability of loans to small businesses has been the objective of the program since 1961. This is a very broad objective indeed. We noted that Industry Canada monitoring of the program concentrates mainly on the level of activity such as the volume of loans, the characteristics of borrowers and lenders, and the number of jobs expected to be created. This, in our view, did not provide sufficient information on the results being achieved. To do so, the department needed to clarify expectations and develop indicators of the program's performance in establishing, expending, modernizing and improving small businesses.

The public accounts committee stated in its report that clearly defined performance criteria are a prerequisite for sound program design. Incrementality is also critical to the purpose of this program. That is, lending should be additional to lending that would have occurred anyway and should not merely replace it. A 1994 study indicated that between 30% and 40% of the guaranteed loans would have occurred without the program anyway. A 1996 study indicated that 54% of the loans, particularly those to newly created enterprises, could be considered incremental. We believe it is important for Industry Canada to define the level of incrementality it expects from these loans. Moreover, the public accounts committee recommended that clear target levels be established for the incrementality of SBLA loans.

Industry Canada has placed considerable emphasis on moving the program towards full cost recovery. We were concerned that under the existing fee structure and loss-sharing ratio it was uncertain whether cost recovery would be achieved. We suggested that in future assessments of the program the department carefully study the extent to which the objective of increasing the availability of loans at reasonable rates can be achieved simultaneously with the objective of cost recovery.

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Finally, although the Canadian economy has evolved significantly since 1961, the legislation governing the program has remained essentially unchanged with respect to the types of assets eligible for financing, namely the purchase or improvement of land, buildings and equipment. The service sector, and the knowledge and information sector, form a much greater part of the economy today, with the latter sector showing a high net employment growth. Furthermore, in recent years financial institutions have also introduced new services and new products for small businesses. The need for the program to meet any financing gaps in the market may therefore have changed significantly.

In our view these questions demanded careful consideration in future reviews of the program. The public accounts committee recommended that the department identify specific gaps in private financing available to small businesses and redesign the program to supplement existing financing and market areas where government assistance would be beneficial.

Does Bill C-53 address all of our concerns in that area? A clear statement of expected results is the foundation for the proper design, management and accountability of the program. Although Bill C-53 provides no further clarification of the government's performance expectations for the program, this is not unusual. Legislation is not usually the means by which performance expectations are defined. Nevertheless, without a pure statement of expected results it is difficult to assess whether the proposed design of the program will address our concerns.

The committee may wish to seek assurance from the department that the expected results of the program will be clarified as soon as possible.

There is also no reference to the level of incrementality expected for loans under the revised program. This is also a matter that can be presented in the department's report to Parliament on plans and on performance. The committee may wish to encourage the department to set a clear range of acceptable incrementality levels for the loans under the program and to monitor and report on its performance.

There is, however, one expected result about which the government has been very clear: that this program will recover its cost. In the absence of any other clear goals, this might be the one that will shape decisions on program management. The act provides the Governor in Council with authority to make regulations, to restrict access to the program to ensure that it remains on a cost recovery track. The department should be able to demonstrate to the committee how cost recovery will be reconciled with the purpose of the legislation, that is, increasing the availability of financing, particularly during downturns in the economic cycle.

We are encouraged that the legislation provides for pilot projects extending the program to cover capital leasing and including the members of the volunteer sector. However, without a proper definition of the expected results of the program it is difficult to determine whether this represents a reasonable response to gaps in available financing.

The committee may wish to ask the department what other specific gaps in financing were identified in their review and how they will be addressed.

[Translation]

Our second main message dealt with the urgent need to strengthen program management and loan-granting mechanisms.

We determined that the Department needed to develop better tools to better forecast losses on future loans and to more carefully monitor changes in its loan guarantee portfolio. We also questioned the relevance of monitoring mechanisms aimed at ensuring that financial institutions were prudent in granting loans and met the conditions of the program. For example, our audit of lenders' loan files revealed that the files did not always contain the information we needed to do a thorough assessment of credit risks. Moreover, we found a number of cases of non-compliance with the Act in which lenders charged administration fees for granting loans under the program. We concluded that it would be worthwhile for Industry Canada to examine the selected files in detail, using risk-based criteria, to ensure that lenders are complying with the Act and that they are using due diligence in granting loans. The Public Accounts Committee has made similar recommendations to the government.

We also found cases in which related borrowers were able to obtain numerous loans which, taken together, exceeded the $250,000 limit for loans to operate a given business. In one case, a group of 23 connected companies obtained more than $1 million in loans. We feel that these practices are not in keeping with the spirit of the legislation.

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The proposed Act includes measures which, if they are implemented in an appropriate manner, should improve program management and delivery. The bill appears to provide for regulations that would strengthen the requirement to exercise due diligence in setting minimum criteria to be met by lenders when approving loans. The minister will have the power to audit all loan files of lenders under the program to ensure compliance with the Act and regulations.

The bill also includes restrictions for loans granted to "the borrower and all borrowers related to that borrower," and regulations contain a definition of the word "related." This should address our concerns about the present legislation.

We continue to believe, however, that the Department needs more effective tools for predicting the future performance of the program. We also feel that such tools are indispensable for monitoring the inherent risk in the loan guarantee portfolio and for helping meet cost recovery objectives. The committee may wish to ask the department to indicate what measures have been taken to design this new tool and when it will be possible to provide performance forecasts.

In our report last year, we concluded that the Department should also provide Parliament with better information on results obtained under the program. A more rigorous assessment of the program's impact on job creation was needed, along with better financial information. The difficulty arises from the fact that the Department did not include any provision for loan losses in its annual report.

The Act calls for an in-depth program review in five years and then every five years after that. We feel that this is a valid provision. The value of this exercise, however, will be seriously jeopardized if there is no clear statement of expected results for the program. We are pleased to see that the Department has developed an evaluation framework for the program and we approve of the proposed performance indicators. What remains is for the Department to gather the necessary information to apply these criteria. If performance expectations are not clearly set out in advance, it will be difficult to say whether the program actually obtains the expected results.

In its 1997-98 report on the Small Business Loans Act, the Department indicated that it will close the gap between revenues and costs involved in loans granted over a given loan period and that it would present the results in its upcoming annual reports. Doing so will improve the quality of financial information provided to Parliament. Financial reporting could also be improved further if the Department included a provision for loan losses in its program reports.

The department agrees with us that more rigorous methods are needed to assess the impact on employment of the loan guarantees under the program. We recognize that it is difficult to obtain accurate figures and we encourage the Department to continue its efforts to improve its approach. More specifically, the Department should be sure to indicate the number of jobs created in its future reports to Parliament.

[English]

In summary, there are several issues the committee may wish to pursue with the department.

First, clear performance expectations have not yet been set for the small business loans program. These would provide the foundation for its design and management and for proper accountability to Parliament. In particular, the department has not yet set clear targets for the incrementality of SBLA loans.

Second, in our view it is still uncertain whether cost recovery will be achieved. The committee might also consider asking the departmental officials how they satisfied themselves that the purpose of the legislation—increasing availability of financing—can be reconciled with cost recovery, particularly during downturns in the economy.

Third, the committee may wish to ask the department what gaps in financing for small businesses it identified in the course of its review, and how they will be addressed. As I mentioned, this issue is closely tied to the question of what results are expected from the program.

In addition, there is still a need for proper tools to monitor portfolio risk, as well as for full reporting to Parliament on performance in relation to clearly stated expected results.

Madam Chair, this concludes our opening statement. We will be pleased to answer your committee's questions. Thank you.

The Chair: Thank you very much, Mr. Flageole.

Dr. Riding, your presentation please.

Dr. Allan Riding (Equinox Management Consultants Ltd.): Thank you for inviting me. This topic of small business financing is one that is of particular interest to me because it forms the basis of much of my research.

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I was very glad to see the Auditor General sharing the committee with me today, in the sense that they have stated that part of the problem being addressed by the bill is the need to help reduce barriers to financing for small businesses. I think we're focusing today on half that side, half that equation. We're looking at debt.

In my printed comments, I make reference to the fact that the problems we face are not just Canadian problems. Almost anywhere in the world you go, the problems of financing small businesses are with us and are being discussed.

A part of that problem relates to the formation of equity. That is also a need that perhaps this government needs to turn itself to.

That being said, we're here today to discuss loan guarantees. I don't profess to be an expert on that or, for that matter, on anything else. I do profess to be a student—a little older and balder than students I teach—and what I study, among other things, is loan guarantees.

My interest in this came about in 1994, when I went to the U.K. for a sabbatical. I had just completed an exploratory study of the effectiveness of the SBLA, and I left for the moors of Yorkshire convinced other countries were doing it better. I thought on my return to Canada I might be able to bring home some of this learning. I was so very sure other countries were doing a better job than we were.

To my surprise, I learned the SBLA compared very well with other implementations of loan guarantee programs. Our default experience compared favourably with the 40% default rate of the loan guarantee scheme of the United Kingdom. Even the U.S. small business administration loan guarantee program pales by comparison, with default rates in the order of 20% for loans made during the 1980s.

My learning continued with a round table discussion at the Inter-American Development Bank in Washington in 1996. More than 30 countries shared their experiences of loan guarantees, and the Canadian experience certainly stood out in terms of its relative success.

The lesson for me in all this is that it's easy to go wrong designing loan guarantee programs. A small change can make a big difference, and big changes can be disastrous. Our recommendation is that we proceed in small steps, and that changes to the program parameters be made infrequently and supported by sound research. Perhaps there's some merit in the idea that if it ain't broke, don't fix it.

So is the SBLA broken? What is its performance, and what are some of the issues involved in assessing its merits and shortcomings? Why do we need a loan guarantee scheme at all?

At that meeting in Washington of the Inter-American Development Bank, the topic of loan guarantee schemes and the need for them was discussed in considerable depth. Levitsky noted that part of what's happening is that the fear of loss, the undercollateralization of SME credit, is rightly perceived as an important element in bank decisions not to lend to SMEs.

A school of thought holds that unless we can identify a specific imperfection in the credit markets, intervention such as loan guarantees should not exist. They should be avoided.

Vogel and Adams argued in their paper to the Inter-American Development Bank that no imperfections had been identified, and therefore no government action was required. But they did notice two situations that may justify intervention such as loan guarantees.

The first situation is that lenders place substantial reliance on collateral, either as a means of securing the debt or as a means of signalling creditworthiness.

The second situation is where the fixed cost of the evaluating and monitoring of a loan application are disproportionate compared to the size of the loan. This, coupled with small lending balances, skews information asymmetry in favour of larger loans. That's an imperfection in the credit markets. And an imperfection generally requires some kind of intervention.

So these conditions suggest intervention may be required for loans to firms without sufficient collateral—such as knowledge-based businesses—and for relatively small loans. In the context of the SBLA, one-half of SBLA loans involve a principal amount of less than $40,000. If lenders are to profit from loans of that size, the loan account managers are required to administer over 100 accounts. This leaves them little time to conduct the due diligence to effectively make decisions about such small loan applications.

So given the need for intervention, how do we measure the effectiveness of loan guarantees, and what are the pitfalls in those elements? Typically, performance is measured by comparing the costs to the benefits. The easy part with loan guarantee programs is measuring the costs. As the Auditor General has pointed out, measurement of benefits is subject to some particular challenges.

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Let's begin with measuring costs. We've identified three categories of costs: the administrative costs and program infrastructure, transaction costs required of borrowers or lenders in working through their loan applications, and costs of honouring defaults.

In the context of the Small Business Loans Act—and I would suspect it's the same with the act before you as well—the lending volume of the SBLA the last couple of years has been in the order of $2 billion. For this volume of guarantees, the administrative budget for the SBLA in 1996-97 was $2.3 million. That's very small compared to the cost of claims, but it's also small compared to an external benchmark.

Consider the small business administration budget for 1984, a year in which a comparable amount of loan volume, $2.8 billion, was guaranteed by the SBA. Their administrative budget was $68.5 million, or 34 times ours, more or less. In part, the higher budget for the SBA reflects the fact that during the 1980s, the SBA reviewed each loan request after that request had been passed on to them by the bankers. Since then, small business administration in the U.S. has moved steadily to a model more like that of the Small Business Loans Act, wherein the borrower and the lender elect to invoke or not invoke a government guarantee, and where the role of the government guarantor is passive.

The SBA recognizes that bank loan account managers are more expert at loan assessment than government staff, and that the double review is costly. The double review process was not only costly in a financial sense, but added significantly to the time required for loan decisions. It also allowed bank lenders to ascribe bad lending decisions to government. This shielded lenders from responsibility for the 20% default rate. With the SBLA, we can compute decision rates on a lender-specific basis, and we can hold them directly accountable for too many bad decisions.

A second category of costs is that of transaction costs. These reflect the paper burden faced by borrowers and lenders in complying with the loan guarantee regulations. Historically, these have been low for the SBLA and have involved costs for registration and, by exception, those costs involved with submitting claims.

A compromise is involved in establishing those requirements. The invasiveness of the paper burden must be traded off against the completeness of the information provided to government. Requirements for additional information entail additional costs for lenders and borrowers, as well as the additional cost to government for processing such information.

If we accept that lender loan account managers are better qualified than government staff to make lending decisions, the question is begged as to how government might use additional information. Adding to transaction costs could increase the fixed cost of lending, conceivably defeating the purpose of the program.

In an international and Canadian context, those costs are certainly dwarfed by those of loan defaults. Historically, claims of the SBLA have been paid at a rate of 4.8%. With the 1993 and 1995 changes to the SBLA, there's reason to expect an increase in the rates of default and claim payments. There is reason to believe the risk profile has increased. On annual lending volumes of $2 billion, and much more in 1993-94, even 4.8% is a lot of money when compared to other cost categories.

Both of those costs are calculable. Measuring benefits is more difficult. The benefits come in three forms. The first is a direct benefit that arises from the fee incomes. Secondly, the loans allow for job-creating expansion of SMEs, thereby adding to the tax base. Typically, this benefit is measured using job creation estimates as a proxy. And third, businesses benefit with higher sales revenues, profits and viability. These benefits also add to the tax base. Nowhere has that been measured.

Compared to measuring costs of loan guarantees, the measurement of benefits is not at all straightforward. The main reason is the problem of incrementality—and incrementality is a problem. It has multiple definitions. The one used by the Auditor General defines incrementality as “the proportion of loans that would not have been made in [the SBLA's] absence”. That definition is very commonly used, but it's also a narrow definition.

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Richard Meyer and Raj Nagarajan state as follows:

The problem of evaluating a credit guarantee is further complicated by the need to identify and measure several dimensions of incrementality.

Skipping to the last sentence of that paragraph:

In fact, there may be several other dimensions of additionality that represent important benefits derived from a guarantee. They include:

· Larger loans. Targeted borrowers may be able loans of larger sizes because of guarantees.

We have not measured that.

· Longer term loans. Guarantees might encourage lenders to make longer term loans than they would otherwise make.

In the SBLA database, there is some evidence that this has happened.

· Reduced collateral. Lenders might reduce their normal collateral requirements for loans that are guaranteed.

As an example, the demand that lenders make for the family home to be put up at risk for the loan can very often be relaxed if there is a guarantee.

· Reduced interest rates.

That one's not really applicable in the Canadian context.

· Speedier loan processing.

This is an extremely important aspect. Research is showing that small business owners spend up to 10% of their time looking for capital. If a loan guarantee allows speedier transactions, that has very tangible benefits for business owners.

Finally, additionality must be thought of in terms of additional “good” loans...it would not be in the long-term interests of governments to stimulate lenders to make additional poor quality loans.

That last point is worth additional comment because it poses a real dilemma for program design. The goals of cost recovery and high incrementality are laudable when taken alone, but they are at odds. If we look at the Auditor General's report, we see this problem on two pages that come together as an illustration of why this is a dilemma.

On page 29-14, the Auditor General discusses the issue of incrementality, reporting that 54% of SBLA loans are incremental, and notes that much of this additionality arises because of loans to newly created enterprises. If we then look at the next page, we see the dilemma. The Auditor General points out that the “1994-95...portfolio contains an increasing proportion of higher-risk loans [due] to an increase in loans to newly created enterprises.” Additionality was achieved, but so was higher risk. The consequence, though, is a higher rate of claims because “75% of claims against the Program guarantees were for loans that had been issued to start-up companies.”

It seems to me that we cannot have it both ways. Government must decide what it wants from a loan guarantee program. On the one hand, it appears that government truly wishes for high levels of additionality to help new businesses, among others, gain access to debt capital. If this is true, the risk of the portfolio is bound to increase, and we should not be surprised that there will be a higher price to pay in terms of higher rates of defaults and claims.

In my opinion, the way to go is to not demand that kind of additionality. It could be an error to view 54% as unduly low. As an example, I'll use health insurance. For a health insurance scheme to be viable, there has to be some minimum number of healthy people who buy insurance so that the claims of the unhealthy people who need the insurance get paid. I think that's also true in this instance, and that's where that different definition of incrementality may come into play. While the research that we have done shows that 54% of SBLA loans are additional in the narrow sense, 80% of those loans involve some kind of additional value, some additional benefit, that would not have been achieved otherwise. Among them are those listed by Meyer and Nagarajan.

Let's speak briefly about fee income. For the last few years, the SBLA has attempted to operate on the basis of full cost recovery, again narrowly defined as fee incomes that at least cover the costs of default and administrative infrastructure. To accomplish this, fees were increased to include an annual fee component.

Increasing fees is one of those small changes that can have potentially disastrous consequences. It can lead to a problem in capital markets that is known as adverse selection, the result of which is an increase in the risk profile of the portfolio. In my opinion, there is some evidence that this is happening.

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So what is the bottom line? After allowing for the three categories of costs and making adjustments as best we can for additionality, how do costs and benefits of the Canadian loan guarantee program compare?

Benefits are usually based on job creation. Several studies of SBLA-attributable job creation have been conducted. Let's select the most conservative of these, that carried out by Informetrica.

It is worth pointing out how that study was conducted, and, as I understand it—it's been some time since I read that report—Informetrica never actually asked any loan recipients how many jobs they created. My understanding is that they employed econometric models of the Canadian economy to calculate the rate of job creation per million dollars of new capital. This approach may be conservative if it ignores that small businesses create disproportionately more jobs than the average firm in the economy. I have other reasons to believe that this is a conservative study. Nonetheless, let's accept it.

Informetrica estimated the creation of seven jobs per million dollars of loans guaranteed. Let me state that a little differently. The historical cost of guaranteeing a million dollars of loans is 4.8%. That's $48,000, or about $7,000 a job. But let's again be conservative and suppose that because of changes to the legislation the claim rate increases to 7%. This would make the cost per job $10,000 before allowing for the increases to the tax base that arise from both the new employee and the employer firms.

In our own research, we went out and asked almost 700 Small Business Loan Act recipients how their firms' net levels of employment, sales, and profits compared before and after receiving their respective SBLA loans. In this survey, from which the Auditor General chose that 54% for incrementality, we report much higher rates of job creation. Even if our estimates are grossly in error, our findings remain consistent with cost per job created of much less than $10,000 per job.

In my view, the weight of evidence suggests costs per net new job of $4,000 to $7,000 before allowing for the increases to the tax base arising from both the new employee and the employer firm, and that seems like a good deal to me.

Thank you.

The Chair: Thank you very much, Dr. Riding.

I'm going to remind members of the committee that I would appreciate it if your questions are brief and the answers are brief, because we do have limited time.

That being said, Mr. Pankiw, are you ready to start?

Mr. Jim Pankiw (Saskatoon—Humboldt, Ref.): Yes.

Full cost recovery. Is that everything? Is that every bureaucrat who works at a desk doing whatever they do in administering the SBLA, paying their wages and stuff like that?

Mr. Richard Flageole: Madam Chairman, the big portion of the cost here is really the payment of the claims to the banks. The administration costs of that program are rather low. So I guess when the department talks about full cost recovery, they're talking about recovering all of the money they will have to pay out to financial institutions in claims. Again, the administrative part is a very minimal number.

Mr. Jim Pankiw: Don't you think it should be included in the equation?

Mr. Bryan DePape (Director, Audit Operations Branch, Office of the Auditor General of Canada): In most recent reports, the department talked about cost recovery. I'm not sure if it's clear if that is full cost recovery or not. The difference is the administrative costs, and I think Dr. Riding referred to a figure of a couple of million dollars as being the administrative cost of the program, compared to program costs in the order of several magnitudes higher. Still, they are there.

Mr. Richard Flageole: It isn't really clear to us whether those administrative fees would be included, but again, it's not going to make a big difference in the end because of the small size of the expense.

Mr. Jim Pankiw: Something strikes me as odd here, and that is that if this is going to be a full cost recovery program, we have businesses where banks outside of the program will say “No, this is too high of a risk venture, so we're not going to give you the financinc.” Effectively we're taking those ventures, we're applying administration fees and high interest rates to them, and you're saying those fees will more than offset any defaults of loans to those businesses.

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It just doesn't make sense to me. If that's the case, then why wouldn't banks just simply be charged...? They must analyse all the businesses that apply for loans. Wouldn't they be saying yes, we can charge higher interest rates to these higher-risk businesses and we'll be more than ahead? Do you follow what I'm saying?

I'll put it another way. How about if we say we have started an organization. If you've been rejected for a loan, come join the ABC group, a little cooperative here, and we'll guarantee the loan for you. You just pay us a fee and this will be a self-propagating thing.

That doesn't seem to make any sense to me, but that's what you're saying....

Mr. Richard Flageole: Madam Chair, I'd like to make it clear that the question of full cost recovery was not a recommendation of the Office of the Auditor General. That's a policy direction of the government.

I think the point you're making was one of the key messages in our report last year. Again, if the government wants to go to full cost recovery it is a policy decision of the government, and we cannot comment on that.

The message we brought to parliamentarians last year was that the basic objective of the program was to increase access to borrowers at reasonable rates. Again, we asked the department how they could balance the access with full cost recovery and incrementality. There's a very delicate balance between the three, and I think it's one of the key challenges for the department to see how they want to balance that. I think the point you're making is a very valid point.

Mr. Jim Pankiw: And you don't have any comments—

The Chair: Last question.

Mr. Jim Pankiw: Last question? All right. I'll have to skip that and go to Professor Riding.

Looking at the effectiveness of a loan guarantee scheme, you said we look at the costs and the benefits. One of the benefits, you said, was job creation. We had a presentation at this committee from the Fraser Institute, and they said the net job creation of a program like this is actually a negative amount because of the distortion of normal markets. In other words, applicants for loans, who normally would have got them, although their risk-benefit ratio was quite high, but still under the cutoff line, are now selectively chosen against, and the capital the bank is lending out is in favour of businesses with a higher risk that exceeded what the bank would have loaned, but the banks do it because of the taxpayer guarantee. The net effect of that is fewer jobs than if the program wasn't even in existence. Do you have any opinion or comment on that?

Dr. Allan Riding: I didn't have the privilege of seeing the Fraser Institute's presentation, so I'm making the assumption, as economists sometimes do, that that's a conceptual argument and not an empirical argument.

The empirical studies that have been formed, the ones we've done, the ones Informetrica did, are not consistent with the Fraser Institute's assertion.

Mr. Jim Pankiw: But did you even look at that? You're saying you looked at the businesses that applied for loans under the program and they created this many jobs, but have you tried to factor in at all the jobs that were never created because that program was in existence?

Dr. Allan Riding: It's pretty hard for any empiricist to measure something that didn't happen.

Mr. Jim Pankiw: But that's the point.

The Chair: Thank you, Mr. Pankiw.

Mr. Bellemare, please.

[Translation]

Mr. Eugène Bellemare (Carleton—Gloucester, Lib.): Mr. Flageole, in cases where borrowers have defaulted on loans, has anyone checked whether this has involved certain banks, or even certain branches of certain banks, more than others?

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Mr. Richard Flageole: As our last year's report indicated, there were defaults in almost all institutions. We looked into each institution's practices. There is no doubt that there were certain trends. Policies in some institutions were perhaps a little tighter, but this was not the most important issue that came out of our audit. I think that there were weaknesses almost everywhere with respect to institutions' practices, and these needed tightening.

As was mentioned earlier, the new legislation does tighten monitoring mechanisms for lending institutions, which should make it possible to better evaluate loan defaults.

Mr. Eugène Bellemare: In your opinion, were all the banks operating in a similar manner?

Mr. Richard Flageole: I do not have any specific figures. Some of them had claim rates that were a little higher than others.

Mr. Eugène Bellemare: Which banks?

Mr. Richard Flageole: I do not remember the names of specific institutions. But we have to be careful here. It is not because an institution has a higher claim rate that it is being less prudent. Perhaps it gives loans which would not have been given by other types of institutions. We did not want to make a judgement on the basis of the claim rate, since there are many factors at play.

Mr. Eugène Bellemare: Does the Small Business Loans Act favour the banks more than the small businesses?

Mr. Richard Flageole: I think that the Act exists to provide for additional financing. When we look at the volume of activity, especially over the past two years, we see that billions of dollars in loans have been provided. To come back to what Dr. Riding said, even if we use the hypothesis that only half of the loans would not have been given, we are still talking about billions of dollars in additional money that has been injected into small businesses, which would not have been if the program did not exist.

Mr. Eugène Bellemare: If I remember rightly, you said that 30% of the businesses would have got loans outside the program. Is that correct?

Mr. Richard Flageole: Yes, between 30 and 40%.

Mr. Eugène Bellemare: Thirty to forty percent.

Mr. Richard Flageole: That comes from Industry Canada's studies. We did not carry out any detailed study of this aspect. We relied on studies carried out for the department.

[English]

Mr. Eugène Bellemare: My last question. Did you notice that there were repeat losers among the small business clients? For example, were certain types of industries or even certain specific companies repeat defaulters of loans? They made loans and went from bank to bank, if necessary.

Mr. Richard Flageole: We haven't looked at that specific point, no.

[Translation]

Mr. Eugène Bellemare: Thank you.

The Chair: Thank you very much.

Mr. Dubé.

Mr. Antoine Dubé (Lévis-et-Chutes-de-la-Chaudière, BQ): Here's my first question. Do you feel that the recommendations made by the Office of the Auditor General were enshrined in the bill?

Mr. Richard Flageole: Madam Chair, there are many good points in this bill, and we wanted to indicate in our opening remarks that certain shortcomings that we found last year required amendments to the Act. We listed quite a number of these. However, the changes to the legislation do not represent the end of the story. There are still a number of other issues that the department will have to deal with. Still, the bill does contain a number of amendments that deal directly with the issues we raised in our report last year.

Mr. Antoine Dubé: What do you think of the five-year limit proposed in the legislation?

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Mr. Richard Flageole: Madam Chair, I think that this is a reasonable period. If you make a loan in a given year, it takes some time to monitor developments in the file. I think that this is a reasonable period of time in which to carry out thorough assessments of a program such as this.

Ms. Francine Lalonde (Mercier, BQ): I am taking over from my colleague. I was not here for Mr. Riding's presentation. I was making a speech in the House.

I think that some effort was made in the bill to take into account the constraints that you indicated and that I feel are really accounting issues. What concerns me is that no one has measured the macro-economic impact of this program. I think that the program cannot be administered independently throughout the economic cycle. If we are headed toward a recession, as many people think we are, the availability of credit may play an important role even if, temporarily, more loans are not paid back. No one has examined whether the overall economic situation would be much better if a certain level of economic activity is supported, even if that means there are some losses. It seems to me that this dimension should be taken into account in administering the program.

[English]

The Chair: Any comments?

[Translation]

Mr. Richard Flageole: I would like to make a comment. One of the main points that we raised last year and that we are continuing to raise is that we are not in any way questioning the justification for a program such as this one. However, it might be useful to define more clearly what the expected results are. Without a doubt, economic cycles vary a great deal. Claims were much higher over the past two years. These two years, though, were good years, economically, for industrialized countries. It will be interesting to see how this will evolve in a downswing and to see how the cost-recovery objective can be reconciled with the goal of providing loans during periods when businesses need loans. This is a very important question.

[English]

Dr. Allan Riding: I think there are two comments to make. One is in terms of trying to deal with the cost recovery objective and the priority of that objective while at the same time trying to make sure the availability of loans remains constant over the period of the cycle. The statement of the objective of the program is not set in a cyclical context, and that's probably a good thing, because then you might do different things with the program parameters to try to have counter-cyclical effects. The problem will be that it will take a slice of time to measure whether or not cost recovery or economic impact has been achieved. If that includes a recession, we may get one picture; if it doesn't include a recession, we may get a different one. So certainly the future attempts to measure the effectiveness of the program are definitely going to have to take that into account.

The Chair: Thank you, Madame Lalonde. Ms. Barnes.

Mrs. Sue Barnes (London West, Lib.): Thank you, Madam Chairman.

Dr. Riding, there is an allowance for increased audit capability under the new bill, and that has not, to my knowledge, been mapped out as to who's going to do it and to what extent that should be done. First of all, I'd like your opinion on whether this is a necessary component and whether there should be internal auditors, external auditors, potentially auditors general, or inside.... I would like to see where you're going.

I have a number of questions, so just give me short answers.

Dr. Allan Riding: I'll try to be quick.

The devil is in the details. A comprehensive audit of all borrowers, I think, would be prohibitively expensive and just not on, particularly remembering that most bank loan files remain in paper form within the branches. At the same time, I believe a spot audit and checks would be very useful in terms of making sure lenders adhere to the regulations.

• 1620

Mrs. Sue Barnes: What is your comment, or have you an opinion, on who should be doing the auditing?

Dr. Allan Riding: I have no opinion on that.

Mrs. Sue Barnes: Okay.

In your studies, when you did your research, did you come across an amount sufficient to raise concern about related borrowers definitions or lack thereof under the act and any potential abuse because of that section?

Dr. Allan Riding: No. In my research I did not have the capability of assessing whether or not different loans were related to other loans. For confidentiality reasons, the amount of access I had to the data file was limited. I didn't need to know the identities.

Mrs. Sue Barnes: On another subject, when you're trying to do your measure of jobs, potential jobs out there being created, as I understand right now, the statistics are gathered under the act at the time of application. For the purposes of creating your number on actual jobs, how did you go about that? Did you do a sampling?

Dr. Allan Riding: Yes, we selected a random sample of 3,000 SBLA loan recipients and did a telephone interview of as many of those as we could reach in a particular timeframe. We reached about 700 of those recipients and queried them on a range of aspects related to the performance of the act.

Mrs. Sue Barnes: How statistically significant or how correct would your sampling be?

Dr. Allan Riding: Each number in our report has a different margin of error, and they are all reported in the report.

Mrs. Sue Barnes: I'll ask it a different way. Are you comfortable that your analysis of jobs created is statistically accurate?

Dr. Allan Riding: Yes, I am comfortable with that.

Mrs. Sue Barnes: Okay.

How did you measure jobs created outside the portfolio of those SBLA, on similar institutions, and how would you go about getting access to those numbers?

Dr. Allan Riding: That is one of the shortcomings of our research. We did not do that, and part of the problem in terms of mapping the effectiveness of any program is the need to do two things.

One is to do a longitudinal analysis, to follow businesses from the time they first receive the loan, into the future. That has never been done anywhere. You need to prepare for that up front.

The other thing is to have a control group of businesses matched, ideally, as to industry, sector and size, to do as you say, find out what jobs are being created.

Mrs. Sue Barnes: At present, is there anything in this bill or potential regulations that would set up that mechanism?

Dr. Allan Riding: I think the requirements for a review at the end of the five-year period have implicitly stated the need to do that rigorously.

Mrs. Sue Barnes: Okay, but is there any mechanism that you're aware of? It's all fine to say we're going to review it, but if the data hasn't been kept for five years, what are you going to review?

Dr. Allan Riding: Then we have a problem. That will have to be established up front.

Mrs. Sue Barnes: Thank you.

This is my last question. Your findings talked about the improved relationship with lenders, those using SBLA. Do you think that's because they don't sit in front of them as long, and have to do less paper for them?

Actually that's a facetious part; the real part is, is this a measurable difference, and do you think it's something that should be taken into account when we're developing the bill?

Dr. Allan Riding: I believe so. Part of that conclusion came from our finding that approximately 45% of the loans at the time we did the study were to brand-new businesses. A high proportion of those were businesses that had to be registered in order to receive the loan. They had previously never been, so the bank and the business owner were working together to create eligibility for the SBLA loan.

Another group of borrowers reported that the SBLA loan was part of a package that facilitated a wider loan facility.

Mrs. Sue Barnes: I'd like to follow up, but I'll let other people take their turns.

The Chair: Thank you very much, Mrs. Barnes.

Mr. Riis, please.

Mr. Nelson Riis (Kamloops, Thompson and Highland Valleys, NDP): Thank you, Madam Chair, and thank you for your excellent presentations.

Dr. Riding, I must say your net new jobs of 4,000 to 7,000 was an encouraging figure.

I'll pursue Mrs. Barnes' line of questioning. You feel confident in your methodology; that is to say, you targeted 3,000 SBLA loan recipients and got hold of 700. What are the other 2,100 doing? They haven't folded or anything, have they? When you say your methodology is accurate, do you feel confident?

Dr. Allan Riding: We used a telephone interview method, and because of—

Mr. Nelson Riis: Why couldn't you have reached 2,100 firms?

Dr. Allan Riding: Many of those companies were numbered companies. The main problem, a very small logistical problem, is that the SBLA loan registration data do not include phone numbers.

• 1625

Mr. Nelson Riis: Yes, I was surprised about that. Thank you very much.

With regard to your presentation, I really appreciated your comments. Going to point 14, I think we all recognize that some firms bundle up their corporate description in such a way that they can make a number of applications. Have you discovered this in your work, Dr. Riding, and to what extent do you think this is a significant problem, Richard?

Mr. Richard Flageole: Madam Chair, we reviewed a sample of loans, and we found a certain number, including some in the States, where 23 corporations got a package together. I was reviewing the response of the Department of Industry to the public accounts committee. They had Ernst & Young do some reviews, and they also found some of those cases.

It's very difficult to determine if it's a pervasive problem. I think the key here is that the door is open, but the proposed legislation is very clear, a lot clearer than the previous legislation on—

Mr. Nelson Riis: That would militate against this happening in the future.

Mr. Richard Flageole: Yes, and we really hope that the way it is now will fix the problem.

Mr. Nelson Riis: Excellent.

Dr. Riding, do you feel the same way?

Dr. Allan Riding: As I mentioned to Ms. Barnes, in my research I didn't have access to the identities of borrowers, so I am unable to comment on that.

Mr. Nelson Riis: The other issue that came up repeatedly in your report is the financing gaps that exist and the issue as to whether or not the present legislation as we see it would provide an opportunity to adequately finance the kinds of new businesses that are coming on stream. Is there anything in the legislation that would be helpful in ensuring that this gap was minimized, if not closed?

Mr. Peter Simeoni (Principal, Audit Operations Branch, Office of the Auditor General of Canada): You're probably aware that there are two pilot projects, one for the volunteer sector and the other for capital leasing. But apart from that, there aren't any real changes in the parameters for the program coming from the legislation. We understand that's because the department has conducted a thorough review of the existing financing available for small and medium-sized enterprises, has identified gaps, and has satisfied itself that other lending agencies have covered those gaps appropriately or that the program simply isn't designed to meet their needs and they'll have to find their financing somewhere else.

We would encourage the committee to ask the department for the details of their work and who's going to cover off those gaps and why it isn't going to be them.

Mr. Nelson Riis: This is my last question, and I'm not sure to whom I'm directing this.

With regard to the issue of leasing and the pilot study that will look into this, have you determined where this initiative originated? We heard from other witnesses that they're curious about where this came from and who called for this.

Mr. Peter Simeoni: I couldn't give you a specific source. The way I remember it is that this was something that had been suggested to the PAC as a result of their departmental consultations. I'm sorry I can't give you the specific source, and I'm not sure it's in the PAC document. That may well be something you would want to ask them, where that came from.

Dr. Allan Riding: The 1994 meetings of this committee included a discussion of the extension of the SBLA to leasing. I don't remember precisely who was involved as the witness, but there were some references in, I think, April or May 1994.

The Chair: We are quickly running out of time and we have other witnesses to hear from, so I'll ask Mr. Lastewka to be brief, and then Mr. Jones, and then we'll move on.

Mr. Walt Lastewka (St. Catharines, Lib.): Thank you, Madam Chair. I'll be brief.

I'll go directly to the Auditor General's office. You say that a clear statement of expected results is the foundation for the proper design, management, and accountability of the program. What did you mean by that, and what would you want as expected results?

Mr. Peter Simeoni: As it stands now, the purpose of the program is defined by legislation to increase availability of financing. We think this program, like every other program of the government, deserves to have more specific expected results established for it. Now, that need not be in the legislation or in the regulations. In fact, that would be unusual. There are other mechanisms, such as reports to Parliament, for example, or it could be done as an annual report for the SBLA. That would suffice.

• 1630

We wanted to recognize the quality of the work done by the department in establishing an evaluation framework that has all sorts of performance measures built into it, the kinds of things this program should be achieving. For example, they're going to measure net increases in employment and the small and medium-sized enterprise revenues, income, and success of business. But with the absence of any kind of notion of what they're expecting to do with the program, it would be very difficult for anyone to say this was successful or unsuccessful. We'll simply know that x number of jobs were created, and revenue has increased by x percent. We would like them to contemplate establishing some ranges perhaps or, with a little bit of experience, something more precise by way of expected results in jobs or any of the other things they propose to measure down the road. Otherwise, the information is interesting, but it doesn't provide a basis for good accountability to assist Parliament in assessing this lending.

Mr. Walt Lastewka: But isn't the purpose of the bill spelled out very clearly, that is, to increase the availability of financing for the establishment, expansion, modernization, and improvement of small businesses? You can look at year-after-year results. If you make small changes in a system and those items are improved upon, you know you've made the right changes. If you have decreasing, you know that somehow the system is interfering. Isn't there the danger of saying we don't know how many people are going to apply or how many types, but we think it should be in this range? Isn't there the danger of doing that? It takes away from what was intended. The intention is to help more small businesses get started and become larger.

Mr. Peter Simeoni: I couldn't agree more. On the other hand, I don't think there's a danger in being clear about what results you're trying to achieve in any particular government program. Being foolishly precise may be counterproductive. I can see that point. On the other hand, simply saying we are going to increase the availability of financing means that if you increased it by $1, you've achieved your objective, and I don't think that's what they have in mind as well. So we think they can do a little better in identifying exactly what this program is trying to achieve.

Mr. Walt Lastewka: But you're agreeing it shouldn't be in the legislation.

Mr. Peter Simeoni: Of course not, and I wouldn't want to imply that's where it ought to be. There are better ways of articulating program results that would allow for their change from year to year.

Mr. Walt Lastewka: Dr. Riding, I appreciate your report and your comments. Could you give me an example of how other countries may be giving out clear expected results?

Dr. Allan Riding: I think Canada's ahead of the game, and I hope that was something I communicated in my statement. We're leading most other countries in this regard.

Mr. Walt Lastewka: Thank you.

The Chair: Thank you very much, Mr. Lastewka.

I want to thank the representatives from the Office of the Auditor General of Canada not only for their presentation today but also for their report that was issued last December and for their participation throughout the hearings on the SBLA changes and the new legislation.

I want to thank Dr. Riding as well for his study and for his participation today.

The committee members have lots of questions, and we could go on for a long time. I apologize for the shortness of our meeting today, but we do have other witnesses to hear from. So thank you for being with us, and we'll ask you to exchange places with our next witnesses.

We have two groups of witnesses joining us, the Digby Network and the Canadian Restaurant and Foodservices Association.

• 1635

I apologize to our new witnesses. We are under very tight time constraints. We'll be having bells at approximately 5.15 p.m., which means that I would ask you to be brief in your presentation. We do have it in front of us. If you could summarize it and maybe not read it all into the record, that would allow for more time for questions.

I propose that we'll begin with Digby Network. We have Mr. Glenn Stansfield and Ms. Flo Frank. Then we'll go over to the Canadian Restaurant and Foodservices Association to hear from Mr. Michael Ferrabee. I welcome you here, and I turn it over to Digby Network.

Ms. Flo Frank (Digby Network): Thank you very much. We'll be doing our presentation in English,

[Translation]

but I would like to say a few words in French. I speak French, but not very well. I live in a small town in Saskatchewan where it is difficult to practise French. I will try if necessary, but for the moment, I will continue in English.

[English]

My colleague Glenn and I are here for one clause and one part of Bill C-53 only. There's something that we want to support in our presentation. We will be very brief because our points are very brief.

We work in the field of community economic development, which is part of the community sector, which has been referred to here as the volunteer sector. For me, this conjures up all sorts of notions. I've worked in the volunteer sector, and often these are not businesses that you and I might recognize as businesses. So we're here to speak about the one part that recommends a pilot be done for the volunteer sector or the community sector to access the Small Business Loans Act.

Digby Network is a fairly new association in Canada. We've been in existence for three years, but here's who we are. We are best-practice models of community economic development, which is something that many people don't really fully understand. I'm going to simplify it, but not because I assume you don't know. Glenn and I had the pleasure of presenting in front of the banking committee. At the end of it, they said they understood what we were talking about.

We're familiar with the public sector and private sector, but there's a third sector, the community sector. Within that are voluntary organizations and community-owned enterprises. There's a whole range of organizations.

As a national network of 17 organizations, who in turn represent hundreds of best-practice models in Canada, we work with enterprises, straight-ahead businesses, that have not had access to the Small Business Loans Act simply because they are owned by the community. The difference between a CED initiative and any other initiative comes from who owns it and where the profits go. In every other way, they're businesses. They're set up to create jobs, do training, and generate profit and revenue.

So we want to state, very simply, our support for the pilot. We offer this committee and the Department of Industry an opportunity to work with the Digby Network to develop a pilot that would support and, for all of us having a vested interest in its success, demonstrate the importance of having the third sector, the community sector, involved in having access to these loans.

So that's our purpose for being here today. Community economic development is not new at all in Canada; we just don't often call it that. Cooperatives are community economic development.

The little community I live in now in Saskatchewan had an agricultural base until the last ten years. Although it didn't collapse recently, it certainly was in default. We now have several community economic initiatives that have generated jobs.

Now, this may not sound like a lot, but 14 jobs were created in this town, which has a population of 89 people. This is a significant impact.

• 1640

Glenn will give you some other examples, but before he does that I want to stress that this isn't necessarily small business we're talking about. We might think about the volunteer sector, day care or theatre—there's nothing wrong with any of those things—but not all day cares and theatres and cooperatives are designed to make money. Some of them are not enterprise-based. But many of them, the ones we represent that we're talking about today, are designed and created as enterprises. They create jobs, they make money, they deal with banks.

Our organizations represent $50 million worth of assets, just within our little group. It's pretty significant. We create hundreds of jobs across the country. We're suggesting today that the department, this committee and the Digby Network work together cooperatively to design a pilot that would satisfy all our needs. That's it.

Glenn will give you an example. He's a businessman—a hard-edged banking kind of guy—so he will talk to you about his perspective on that, briefly.

Mr. Glenn Stansfield (Chief Executive Officer, Niagara Enterprise Agency; Digby Network): The Niagara Enterprise Agency is a six-year-old not-for-profit organization whose area of facilitation encompasses the entire Niagara region, with a population base of approximately half a million people. We also act as sponsor for the Niagara Canada Community Investment Plan, and under that plan we have gained great knowledge and understanding of access to risk capital on behalf of our companies located in the Niagara region.

We also sit on the policy advisory committee for small business and tourism in the province of Ontario, and are currently in the process of facilitating with the provincial government in Ontario recommendations for private investor tax credits under the Community Small Business Investment Funds Act.

In Niagara we have worked with a group of 19 partnering organizations that we refer to as partners in enterprise. Each and every one of these not-for-profit organizations at some point has received assistance from the federal government through different ministries, and in many cases from the provincial government. Our job through the Canada Community Investment Plan has led us to form strategic partnerships and relationships with all 5 chartered banks and 19 other community partners that have also made financial contributions to the administration process, in partnership with Industry Canada and the federal government, for us to open up a bridge to risk capital.

As part of that whole facilitative process, we deal very closely with small businesses looking to access capital through the Small Business Loans Act. I will suggest to you, if our experience is representative on a larger scale of the national experience in non-main financial centres such as Toronto, Vancouver and Montreal, there is a tremendous need both within the small business community for-profit sector and in the not-for-profit sector, for the Small Business Loans Act.

We are very much supporters of meeting all of the criteria under the legislation, including the loan guarantees at 25% and a process of due diligence which we believe we could work through Digby and promote in a national network to screen investments under the legislation and work very directly with the financial institutions that will grant the loans.

In our case we would work with our 19 partners in enterprise and would not facilitate loans under the legislation without tremendous due diligence assistance in developing business plans. We would help partner with other organizations that could offer loan guarantees, and all of the organizations that would be facilitated under the legislation would have to meet the criteria of repayment of the loans, of course.

In the United States we don't have similar figures that we can track in Canada. If the not-for-profit sector were taken as a national economy, it would form the third-largest country in the world. Canada, I would imagine, has very similar trends in its not-for-profit sector. I may suggest to Allan Riding that he do some research into this. But the not-for-profit sector is an extremely important part of our local economies.

We see tremendous benefit to working with certain best-practice organizations that can meet the very strict criteria of the legislation. Working directly with the financial institutions and the Canada Community Investment Plan in communities that possess programs is one suggested way of doing that.

• 1645

Ms. Flo Frank: I'd like to summarize by saying we really welcome the opportunity to come here and speak with you. This piece of legislation is very important. It's particularly important to the communities that have had industry shift, for the individuals who have lost their jobs where there doesn't appear to be any potential for them to get employment.

Community economic development is fairly well known around the world. As a matter of fact, I just came back from an international conference in Sherbrooke, where 850 people from 85 countries talked about community economic development, and each and every one of them brought models and examples. I brought books, which you won't have time to look at, but there are models all over the country.

The issue here isn't whether or not community economic development is viable; it's whether we can work together to do a pilot to show that this is a way to increase access for Canadians to develop businesses and access the resources they need. We wanted to actually allow you to see some of the faces of the people who work in this sector and introduce you to the Digby Network and who we are.

I brought some information. I'm not sure if this is allowed because this also....

[Translation]

I'm sorry, but it is not in French.

[English]

Our partner Nancy Neamtam from RESO in Quebec is very active. She and her organization have created many jobs across Quebec, and there are others.

I would like to provide this for you to let you know who we are in Digby Network, aside from Flo Frank and Glenn Stansfield, and thank you very much for your consideration of supporting that pilot.

The Chair: Thank you very much.

[Translation]

Ms. Flo Frank: That is all. Thank you very much.

[English]

The Chair: Thank you, Ms. Frank.

The clerk will be happy to receive that information and distribute it to the committee members, but she'll have to make copies for all of the committee members first.

I'm now going to turn to Mr. Ferrabee. I want to let the committee members know they have different...on the bill but in slightly different capacities. We had difficulty fitting Mr. Ferrabee into our schedule, due to our late notice in contacting him and him getting back to us. I apologize, Mr. Ferrabee. We would like to hear from you today, in any event.

Mr. Michael Ferrabee (Vice-President, Government Affairs, Canadian Restaurant and Foodservices Association): Thank you very much.

First of all, I would like to thank the committee and the clerk for readjusting their schedule in order to hear me. I very much appreciate it.

I think my remarks will perhaps go some way toward explaining why there isn't a prepared text for you of my remarks. I wrote them on the plane on the way up here as a result of some recent news we had on the regulatory front. But if I can seek your indulgence, I'll quickly run through my presentation. I don't expect it will take terribly long and then we'll have an opportunity for some questions.

I'm here to talk to you about small business in our industry, the restaurant and food service business. The companies you may think of when you think of quick services, as we like to call it, or fast food, as other people call it in our industry—the big international players in the food service business—do not use the Small Business Loans Act. They often have finance arrangements with the big banks that would make small business in our industry green with envy.

I'm here to talk to you about small business—the vast majority of owners and operators in our industry who are independent businesses or franchisees of mid-sized, Canadian-owned, usually regional chains. To these small operators, the Small Business Loans Act has been critical to their success and critical to their being able to do what they do, which is provide important economic activity in their communities and, even more important, provide jobs.

Our industry employs 867,000 people in Canada. That's a full 6.1% of the workforce. A full 46% of the jobs we provide in Canada are to people under the age of 25. With the youth unemployment rate at near tragic proportions, these jobs are critical and all the more critical for those who have never held a job and need first-time work experience.

The Small Business Loans Act works for our industry because it provides access to capital that the banks, frankly, won't provide. We have been supportive of the SBLA for this reason. As recently as this past summer, we made presentations to another parliamentary committee in both Alberta and Prince Edward Island, supporting the program and encouraging the government not to tinker unduly with the basic structure.

Our small business people traditionally use the SBLA to finance start-ups, expand their businesses or purchase existing restaurants. Often these will be branded Canadian-owned regional franchises. When they go to visit their bankers they're looking for capital to fund equipment but also, in large measure, something called leasehold improvements.

• 1650

I want to spend a little bit of time on leasehold improvements to explain to you what I've learned over the last couple of years, because, frankly, it's complicated. I want to make sure you understand it. What I'll do is just give you an example.

When a restaurant agrees to rent a space, they have to do a lot with the square box they begin with. Just imagine a space in a mall. They may start by configuring and ventilating their kitchen area, building in work space and shelves in this kitchen, and creating a place for all the equipment—a service station, a counter, a sink, etc. For the public part of the restaurant, they have to put down floor tiles or carpet, install fancy fixtures, have wallpaper or a mural, maybe build seating along the walls, have dividers from one section to the next, and provide his and her washrooms. They have to hang drapes and paint windows. Finally, they buy the equipment: stoves, ovens, grills, point-of-sale terminals, and software.

In most cases the intangibles, called leasehold improvements, will equal or exceed the tangibles of equipment and hard assets.

A restaurant is a public place. It's a place where the public meets and eats. Very strict rules and building regulations, as we all know, govern safety, hygiene, smoking and cleanliness.

In order to attract customers, a restaurateur has to invest a considerable amount in what we call leasehold improvements. Without basic and prescribed leasehold improvements, no restaurant could operate in Canada. Without an ongoing investment in decor, upgrades, repairs and improvements, no restaurant would stay open in Canada for long.

It is for this reason that we objected when, two years ago, the government indicated they were considering removing “existing leasehold improvements” from the criteria that banks could lend under the Small Business Loans Act.

At that time, we pointed out that removing existing leasehold improvements from the criteria for lending under the program would punish anyone who now owns a business they may want to sell, and would effectively exclude anyone who wants to buy an existing business from using the Small Business Loans Act. In effect, it would ensure that the only people with enough capital to buy a small business in our sector would be big business. We know that big business, even in our sector, already has access to bank financing.

I thought our arguments at the time were compelling. The government changed its policy, and not only allowed the practice to continue under the old program but explicitly recognized existing leasehold improvements in the guidelines to lenders.

Earlier this year, we appeared on two occasions in front of another parliamentary committee looking into the SBLA. We made presentations, generally lauding the government for the program. We raised concerns about raising the lending limit and about abolishing the personal guarantee. We were guided by the principle that the program was working well and that it should not be tampered with.

We expressed our support for the program, and made it clear we did not want a handout but rather the very effective hand up that the SBLA provides. We said that the program was fulfilling its mandate of providing needed capital to small businesses in Canada. For our industry, with all its concerns about other government programs and expenditures, this was one program, and one of the few, that we could support and endorse.

Frankly, we felt good doing it. We believed it was a good program and one that met our criteria for operating on a cost recovery basis, to the benefit of those who used it. It balanced needs with costs and was generally very helpful to our sector.

When I was first solicited by the clerk of this committee to come and speak to the legislation, I sent a copy of our brief from the other presentation. I also had a copy of a letter from the minister assuring us that “all major program perameters will remain in place”. I told my board of directors only 10 days ago that all was good. The new act would reflect the old act. There was nothing to be worried about.

Then last Thursday I received a copy of the regulations. I was wrong. The new regulations not only explicitly exclude existing leasehold improvements, thus excluding anyone who wants to buy an existing business in our industry. They also demand a “buyback agreement” from franchisors of any business where the franchisee wants to access funds for leasehold improvements. Effectively, this would mean that any franchisee who wanted to buy a new franchise or any owner who wanted to do renovations to their existing store would have to have the parent franchisor secure that expenditure.

Not only is this an unprecedented intrusion into the relationship between franchisors and franchisees, it is also totally unworkable.

• 1655

Franchise relations run the gamut from very tightly controlled franchise agreements to much looser arrangements between the parent company that owns a brand and those licensed to use it. This type of cookie-cutter approach would not satisfy any of the franchise companies that I have spoken to thus far. I have spoken to five important Canadian-owned regional franchisors across Canada, and not one company would be willing to provide such an agreement.

So what are we left with? Without an agreement from the parent company, no franchisee would be able to finance the bulk of the cost of their business under the Small Business Loans Act. No franchisee would be able to fund the purchase of an existing business because of the exclusion of the existing leasehold improvements. In short, the SBLA will be of little use to small business in our business.

The only major area left for funding under the Small Business Loans Act would be equipment, and frankly the big banks are already inclined to finance tangible assets. The SBLA was useful to our sector—the largest user of the program, I might add—because it freed up capital for leasehold improvements. It explicitly told the banks that our business was different, that we needed capital for what was a key component of our operations—leasehold improvements.

We thought it existed within a cost recovery system that allowed this to happen. With these new regulations, our industry will likely go from being the biggest single user of the program to no user at all. It will be effectively shut out of the new program. It will encourage big business with access to capital to gobble up small business that has nowhere to turn.

I would encourage you as a committee to send a message to the minister that you want existing leasehold improvements included in the regulations and that you want the 50% buyback agreement scrapped for all other leasehold improvements. Only with these changes will the regulations, as presented to you and to our industry, keep, to quote the minister, “all major program parameters in place”. Only these changes will accomplish what the program set out to do and provide small business with access to capital they need.

Finally, normally when we appear before parliamentary committees we get barraged with questions, and in conclusion I have one for you. As the chair of the committee, or perhaps as committee members, would you normally as a matter of course review the regulations in this committee before the legislation was passed, or is that something you would consider doing? It's really a procedural question as much as anything.

The Chair: Mr. Ferrabee, in fact what you have seen are draft regulations and when they are gazetted there will possibly be other changes. We had asked for the draft regulations because we had concerns from several witnesses and committee members that certain things would be contained in the regulations that may affect the workings of the act.

Your presentation here today solidifies that fact for a number of members who had concerns. And there is actually a committee, scrutiny of regulations, that would review regulations as well. It's not policy itself, but regulations go before the scrutiny of regulations committee.

Mr. Michael Ferrabee: My understanding of that committee is that it doesn't really have the opportunity to get into policy matters.

The Chair: There is a gazetting process as well for the regulations. This is a preview and there'll be a gazetting process, so your comments were heard today by department officials who are here and by committee members. We had asked for the draft regulations so we could hear from the witnesses. There'll be another gazetting of them. You'll have a second chance to air your opinions.

Mr. Michael Ferrabee: So you will then be looking at them after this?

The Chair: No. We won't be looking at them, but there's a gazetting process where you are entitled to make comments once it is gazetted.

Mr. Michael Ferrabee: There's not a public process of any kind?

The Chair: It's a written process. It's a discussion with the department. There is this hearing and there will be hearings before the Senate.

I'm going to let committee members know we have extremely limited time because the bells are going to begin at 5.15 p.m. To ensure that everyone has adequate or some time to ask questions, I'm going to try to limit everyone to about three minutes each, which means two questions possibly if you're brief. If we get into long diatribes, obviously that won't happen.

Mr. Pankiw.

Mr. Jim Pankiw: Actually, what Mr. Ferrabee raises is a very good question. If the policy that these regulations affect doesn't come before this committee, who's going to...? It's quite possible that the minister had no intention...correct me if I'm wrong, but did he make these regulation changes? Maybe some bureaucrat did that, and it's not his intention or the advice of this committee that they should be made.

Mr. Michael Ferrabee: I think you misunderstood. I don't think there was any intention by the department deliberately to squirrel this away.

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The Chair: Mr. Ferrabee, to clarify for Mr. Pankiw, we had requested the draft regulations as a committee. We have the right as a committee to do that. There was some discussion during the committee meeting that we would like to see the draft regulations, and that's what we're doing. So there is policy vetting, I guess you could say, of the regulations through this process now.

Mr. Jim Pankiw: But if it's the collective wisdom of this committee, the question is raised—

The Chair: This is your second question.

Mr. Jim Pankiw: Fine. If it's the collective wisdom of this committee that those regulation changes were not advisable, then what procedure or what avenues does this committee have to try to effect a change in those regulations?

The Chair: It's part of our report when we finalize the legislation. We can make recommendations in that report when it's tabled in the House.

Mr. Jim Pankiw: To change regulations?

The Chair: We can have a separate report. Yes, we can make recommendations to the minister.

The idea is not to vet, word for word, the regulations here. However, the idea is to get an understanding of what those regulations could possibly be or what the thinking was, and the banks, as well as other witnesses, have requested that we have them before us. So that's why the department hurriedly prepared them and there has not been a full vetting with all parties.

Mr. Jim Pankiw: My only question to Mr. Ferrabee then would be, again, could you clarify your suggestions to this committee or what you would like this committee to recommend in that report with respect to these regulations that you referred to?

Mr. Michael Ferrabee: Yes, there are two specific parts of the bill, and I can give you the specific references later on, if you'd like.

One is the exclusion for existing leasehold improvements, which I believe is subsection 5(4), where it says “A loan referred to in paragraph (1)(b) may not be made to finance the purchase by a tenant of existing leasehold improvements”, that in fact that be changed to say that the program “can” be used, as the guidelines previous to the publishing of these regulations explicitly said that they “could” be used for existing leasehold improvements. That would be the first.

The second large one is paragraph 12(7)(a), which deals with the 50% buyback provision relating to franchisors and franchisees.

Thank you.

The Chair: Thank you.

Thank you very much, Mr. Pankiw.

Madame Jennings, please.

Ms. Marlene Jennings (Notre-Dame-de-Grâce—Lachine, Lib.): Hello. That was a good presentation.

I appreciate your comment concerning the regulations, and I'm sure the committee will follow up. As the chair mentioned, the scrutiny of regulations committee, which is a joint House-Senate committee, does have a mandate to look into regulations and to determine whether or not they conform to the legislation and have followed the constitutional process, and so on.

I have a question, and it's not going to touch on the regulations, because the point you've made is very clear.

The proposed legislation would create pilot projects in order to provide loans to the community volunteer not-for-profit sector. We had the Canadian Federation of Independent Business here saying don't do it under SBLA; we think it might be a good idea, but it doesn't at all meet the requirements. They had a real fear that, by tinkering too much, we could actually destroy the good that SBLA is doing. They suggested that it come under separate legislation completely. Does your association have a view on that?

Mr. Michael Ferrabee: We spent a great deal of time talking about it, and thinking it through, and talking about it to people in the business.

I share many of the CFIB's concerns. This is a good program. It works. It's working for our sector, regulations notwithstanding. Up until March 31, it has been a good program to our sector.

My concern, and if I understand the concerns of the CFIB, is that you have a great thing here, and when you have something that works the tendency is to load it up with all kinds of other stuff. I spoke to my people about the various aspects of the changes that were suggested, the voluntary sector and everyone else, and frankly, we don't have nor would we express an opinion on that. It's not our business to do it. I'm not sure I'd like it if they started talking about the restaurant business, and I'm sure they wouldn't want me to start commenting on their business.

Ms. Marlene Jennings: It's a case in point.

Mr. Michael Ferrabee: Yes, exactly. But I do share their concern that it's all being put into the same big tent of something that works, so let's just sort of shove everything into it.

I think the program may be useful, and if it is, I think the suggestion that it be set up as a separate entity is probably a very good one. I would be concerned about diluting the program.

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Ms. Marlene Jennings: Okay, my second—

The Chair: Just a second, I think Mr. Stansfield has something to say.

Ms. Marlene Jennings: Well, I wanted to ask you a question.

The Chair: Okay.

Mr. Glenn Stansfield: Could I respond to that, please?

The Chair: Yes.

Mr. Glenn Stansfield: My organization has been instrumental in facilitating over the last six years a number of loans to the particular sector that's being addressed here.

The Small Business Loans Act is an extremely important piece of legislation. It's viewed by the chartered banks as almost a form of quasi-equity in start-ups in a very, very sensitive sector. With first-hand knowledge of that sector, I can suggest to you the pilot project, meeting all of the criteria of the legislation, will not affect that sector one little bit.

Ms. Flo Frank: I have one quick comment about that. We're not talking here about redesign, particularly. We're talking about access and increasing access.

Ms. Marlene Jennings: That's why I'm asking you the question.

The Chair: Ms. Jennings, one last question.

Ms. Marlene Jennings: My second question was this. I've looked at this and I see the founding members, but I don't see anyone from Quebec. It seems to me I caught you mentioning there's somebody from Quebec who's a member of Digby. You do know there is a strong community economic development sector in Quebec, not-for-profit—whether they're cooperatives or not-for-profit organizations that do job training or job creation, whatever. So I'd like to know what the participation is in Digby.

Ms. Flo Frank: There's significant participation of Quebec in the Digby Network. Nancy Neamtam from IFDEQ has been working with a national policy group.

Ms. Marlene Jennings: I'm sorry, could you repeat that?

Ms. Flo Frank: It's Nancy Neamtam.

Ms. Marlene Jennings: Oh, Neamtam. Yes, okay. I know very well who you're talking about.

Ms. Flo Frank: And all of her good work. When these brochures were printed there hadn't been agreement on her part that she would have the time to put into this. However, we spent the weekend at a conference with her and many, many others from Quebec who are very interested.

We're opening up the Digby Network in the next three months. This has been our formative few years. We will have 40 associates; 4 of those will be from Quebec. So there's significant involvement.

Ms. Marlene Jennings: Thank you very much.

[Translation]

The Chair: Ms. Lalonde, briefly, please.

Ms. Francine Lalonde: I know Nancy Neamtam well. I was with her at the start-up of what is now the RESO in Saint-Henri, where I ran twice.

I understand how important this bill is to the social economy. Mr. Stansfield, if I understood correctly, you said that community organizations would have to provide guarantees at the 25% level. Is that right? Could you tell me why and how? We know that community organizations take a different approach.

[English]

The Chair: Mr. Stansfield.

Mr. Glenn Stansfield: Yes. When we appeared before the Senate banking committee on this issue, I was fairly vocal in my comments associated with the guarantees. I just started with a general comment.

In my opinion, there was a mistake made when the guarantees were reduced in the legislation at all, from what was previously in place. The reduction in the guarantees to business placed the prime financial institutions in a preferential position in loans that were offered that weren't covered under the act, in businesses that were financed with a portion of the loans being covered under the act. We feel very strongly some level of personal guarantee is necessary.

The type of best-practice organizations we work with and represent have a number of mechanisms in their operations to offer these guarantees. In my own organization, I would go to a community partner—it may even be a chartered financial institution—and ask them to offer the guarantee. But I think in negating the need for the guarantee at the 25% level, you're putting the government in a very, very delicate position. There has to be a strong commitment by anyone receiving loans under the Small Business Loans Act. I believe that guarantee at the 25% level is an essential component of commitment to the loan, which I would certainly not advocate being taken out for the community economic development sector.

[Translation]

Ms. Francine Lalonde: You did not answer my question. How would this be done?

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Mr. Ferrabee, do you believe that the regulations no longer contain the provision on leasehold improvements? Do you think this has had a negative impact?

Mr. Michael Ferrabee: Ms. Lalonde, I think that the government has made an effort

[English]

to mitigate the risk factor associated with our sector. Accommodation is a rather curious category. The accommodation and food services sector—they lump us together—is the largest user of the program. I do not yet have—I've requested this from the department and they agreed to follow up—numbers from them that talk about failure rates relative to either leasehold improvements or existing leasehold improvements. I don't have a good reason to believe that they're any higher than the average. Certainly, in the case of a franchise or a franchisee—there's a curious insertion for one of them about the buyback agreement—information suggested that those businesses do better than ordinary start-ups.

I think it was a legitimate attempt, perhaps, by the department to try to put some parameters around the lending. The point I was trying to make is that the minute you exclude those from our industry, you're excluding our industry. That's what we use the SBLA for. It's enormously important to us as an industry, and it has been very successful to date.

Ms. Francine Lalonde: Thank you.

The Chair: Merci, Madame Lalonde.

Mr. Riis, please.

Mr. Nelson Riis: I have a couple of quick questions, Mr. Ferrabee. If it were the will of the committee, is there an amendment to the legislation that could be considered in terms of your concern?

The second question is to Ms. Frank. Presumably, part of the problem we may be having in terms of the volunteer pilot study is what people think about when they hear the term “volunteer”. I think you've been of immeasurable value by giving a long list—it's not limited to this—of, in a sense, profit-motivated operations that are not necessarily for profit in their bottom line. Would you agree that this is the definition? I think that maybe when we think of a volunteer association, we think about the Scouts or the SPCA.

I guess that would be a bad one.

Voices: Hear, hear!

A voice: Be careful.

Mr. Nelson Riis: Anyway, I'll just leave it at that, Madam Chair.

The Chair: Thank you.

Ms. Frank.

Ms. Flo Frank: Thank you very much for the question. I think that's exactly the point. There's not a lot of understanding about the enterprise base in the community sector. When we think “volunteer”, we often do think of the social end or the end that's not traditionally associated with hard-edged business and making money.

There are many of them out there. One little example is an organization in Ontario that one would think is a volunteer organization. It does good works, and there are 280 volunteers, but there are also 55 paid staff. They generate over a thousand jobs and have a budget of $9 million. For any of you who live in Ontario, you may know of the Opportunity 2000 initiative. That's a CED initiative. So two thousand people are going to be moved out of poverty based on the profits generated within enterprise in that organization.

So you're right, it's a perception problem. The community sector, as our third sector in the country, needs to be better understood by all of us. The opportunity we're presenting is to invite you to work with us in Digby, if you would, to move that from looking at the public and private sector feeding the volunteer sector, which is how we see it, to letting the volunteer and community sector continue and increase its ability to feed itself.

That's it. Thank you.

The Chair: Thank you. Mr. Ferrabee.

Mr. Michael Ferrabee: Mr. Riis, you asked about amendments to the legislation. I'm not a procedural expert, although in terms of whether it would be appropriate as a question procedurally for the committee, I don't think it would hurt in a piece of legislation. Keep in mind that my understanding of legislation is that, when it's given second reading and it's passed by both houses of Parliament, it's supposed to encompass the basic understanding of the functions and outlines of a program.

Taking that definition, I don't think it would be at all out of line to explicitly detail in the legislation that one of the principal areas for capital would be through the financing of existing leasehold improvements, and leasehold improvements generally. That is an area that this legislation is explicitly intending to address.

The Chair: Thank you very much.

Mr. Jones, we didn't get to you in the first round. Did you have any questions? No? Thank you.

Mrs. Barnes, briefly.

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Mrs. Sue Barnes: With respect to the leasehold improvements, at the very least I think we can assure that we can ask the right questions in order to get the rationale for why it's there and for what is not there. Rather than assuring you that an amendment will be made, I think we can at least assure you that we'll make the inquiry to understand how this came out in a draft regulation.

The other thing I would like to turn to is with respect to the other presenters. I just want to clarify something from your opening comments. You talked about being willing to do due diligence. You were not alluding to a second tier, to a self-vetting system of diligence before going into an SBLA system, were you? That could be interpreted from your words, so I just want to clarify that for the record.

Mr. Glenn Stansfield: No.

Mrs. Sue Barnes: Okay, then what you're really after is equal access.

Ms. Flo Frank: Yes, exactly.

Mrs. Sue Barnes: Having clarified that, going back to the last Parliament, my recollection is that the BDC network was put in place and utilized especially in rural Canada even though it's not available in the urban centres—at least, not to my knowledge. That was done to give a lot of the economic development community and economic fledgling organizations some access that wasn't as accessible. Just as a factual matter, is that still utilized heavily by your organizations?

Ms. Flo Frank: Yes, it is.

Mrs. Sue Barnes: If so, what limitations are there? Do you see this as complementary, or are you finding that the one system isn't sufficient for your needs?

Mr. Glenn Stansfield: We have three business development centres in the Niagara region. I'm not aware of them becoming directly involved in the not-for-profit sector. In terms of their loans, 99% are on the debt side of for-profit businesses, all of which are of a higher-risk level and have been turned away by traditional financial institutions.

The Chair: Thank you.

Mrs. Barnes, I have to stop you. The bell has started. It's a fifteen-minute bell, and we have to go across the street.

Mrs. Sue Barnes: No problem. Thank you.

The Chair: I do want to thank the witnesses for being with us. In fact, there was a fit-in in there earlier on, and you kind of worked in together, actually. I appreciate that.

Mr. Stansfield, Ms. Frank, Mr. Ferrabee, we do appreciate your comments. When I read the draft regulations word for word yesterday, I was very concerned. When I heard that you wanted to be here today, I said we should definitely have you.

We do appreciate the volunteer sector being here as well. We have been looking for people to comment specifically on it.

The meeting is adjourned until tomorrow.