27 October 1998
Richard Flageole, FCA
Assistant Auditor General
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. 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 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 of 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’s 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, expanding, 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; 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 percent of guaranteed loans would have occurred without the Program anyway. A 1996 study indicated that 54 percent 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 for 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 toward 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.
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 PAC recommended that the Department identify specific gaps in private financing available to small business and redesign the Program to supplement existing financing in market areas where government assistance would be beneficial.
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 clear 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 for the loans under the SBLA 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 costs. 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 General 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 — 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.
Our second main message had to do with the pressing need to strengthen program management and delivery mechanisms.
We found that the Department needed better tools to properly forecast future loan losses and to monitor carefully any changes in its loan guarantee portfolio. We also raised concerns about the adequacy of controls to ensure that financial institutions exercise due care when making a loan and comply with the conditions of the Program. For example, our review of lenders’ loan files showed that they did not always contain the information necessary to perform a thorough credit risk analysis. In addition, we noted several cases where, contrary to the Act, lenders had charged administration fees for granting loans under the Program. We concluded that it would be cost-effective for Industry Canada to thoroughly review selected files, using risk-based criteria, to satisfy itself that lenders have complied with the Act and have exercised due care when making a loan. The PAC made similar recommendations to the government.
We also noted cases where related borrowers were able to obtain numerous loans whose total exceeded the $250,000 loan limit, to operate the same business. In one case, a group of 23 related corporations obtained more than $4 million in loans. We believe that these practices are contrary to the intent of the Small Business Loans Act.
The proposed legislation includes measures that, if carried out properly, should improve program management and delivery. The Bill appears to provide for regulations that would strengthen the due diligence requirement by setting out minimum criteria to be followed by lenders in approving loans. The Minister will have the authority to conduct audits of all lenders’ files on loans made under the program to ensure compliance with the Act and regulations.
The Bill also places restrictions on loans to “the borrower and all borrowers related to that borrower” and regulations include a provision for defining what related means. This should address our concerns about the existing legislation.
We remain concerned that the Department needs better tools to forecast future program performance. We believe that these tools are indispensable to monitoring the risk exposure of the loan guarantee portfolio and to support the objective of cost recovery. The Committee may wish to ask the Department what steps they are taking to develop this tool and how long it will be before reliable forecasts are available.
In last year’s report, we concluded that the Department should provide Parliament with better information on the results achieved by the Program. More rigour was needed in evaluating its job creation impact. Better financial information was also needed.
The legislation provides for a comprehensive review of the program in five years and then every five years after that. We believe that this represents a positive step. However, the usefulness of this review will be seriously undermined by the absence of a clear statement of expected results for the program. We are encouraged by the evaluation framework developed for the Program, and in particular, by the proposed indicators of performance. It is now up to the Department to collect the necessary data. Nevertheless, without clear performance expectations established in advance, it will be very difficult to say whether the program has actually been successful.
The Department has indicated in its 1997-98 report on the Small Business Loans Act that it will match revenue and costs relating to loans in a specific lending period, and will report results in future annual reports. This will be an improvement in the quality of financial reporting to Parliament. Financial reporting could be further improved if the Department were to include a provision for loan losses in reports on the Program.
The Department agrees that more rigorous methodology is needed in evaluating the job impacts of the loan guarantees under the Program. We acknowledge that accurate numbers are difficult to obtain and encourage the Department in its efforts to improve its approach. In particular, it should exercise care in the future in reporting job creation numbers to Parliament.
In summary, there are several issues that 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 business 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 would be pleased to answer your Committee's questions. Thank you.