The Fraser Institute

The Fraser Institute

January 14, 2008 06:00 ET

The Fraser Institute: Ottawa Should Lift Restrictions on Foreign Banks to Increase Competition and Provide More Capital for Entrepreneurs and Small Businesses

VANCOUVER, BRITISH COLUMBIA--(Marketwire - Jan. 14, 2008) - Ottawa should lift restrictions on foreign banks entering Canada for the sole purpose of lending in order to increase competition and provide additional credit to entrepreneurs, concludes a new study released today by independent research organization The Fraser Institute.

"Access to readily available financing to start and expand a business is a barrier faced by many Canadian entrepreneurs and small businesses," said John Chant, author of Bank Lending and Entrepreneurial Finance: The Performance of Canadian Banks and Professor Emeritus of Economics at Simon Fraser University.

The study examines the performance of Canadian banks in financing entrepreneurship and compares their performance to that of banks in other industrialized nations.

"Bank loans, lines of credit and other banking products are among the most used external sources of finance for Canada's small and medium-sized businesses," Chant said.

"If the Canadian banking sector does not perform well in these areas, we are hobbling our entrepreneurs and erecting additional barriers for creative people who bring new ideas to the market. That in turn limits the potential of entrepreneurs to grow their businesses and create new jobs and employment opportunities."

The study found that while Canada performs reasonably well in terms of the overall health of its banking system, its performance in terms of financing entrepreneurs is weaker. International research shows that Canadian banks lag behind industry leaders in the two most important measures: the amount of bank lending (in terms of the quantity of funds) and the terms under which that lending is provided as measured by the spread between the banks' interest returns and costs.

In terms of private sector bank lending as a percentage of GDP, Canada ranks 20th out of 22 industrialized countries. This ranking increases to 16th when all private sector institutional lending such as credit unions is included.

The terms of financing indicate how efficient banks are in performing their role. If financing terms are onerous or costly, that has a direct impact on entrepreneurs by raising the costs of obtaining financing for their businesses. In this area, Canada ranks 10th out of 22 industrialized countries.

Chant points out that the weak performance of Canadian banks in private lending does not appear to result from Canada's relatively small banking market, the small size of its banks relative to the world's biggest banks, the level of banking concentration, or the level of foreign control of the Canadian economy.

Instead, he suggests a lack of competition in the Canadian banking system may be a cause and recommends that the federal government relax regulations that currently inhibit competition and limit the lending activities of foreign banks in Canada.

Data from the OECD show that while Canada has average barriers to entry into the banking market for domestic banks, it has above average barriers to entry for foreign banks, ranking 18th out of 21 industrialized countries in terms of the share of loans (in terms of total amount loaned) made by foreign banks.

"Openness to foreign competition is a common feature of countries whose banks show a strong performance in business lending," Chant said.

"Research has shown that the entry of foreign banks improves national banking markets by putting additional pressure on domestic banks to improve productivity and services as well as giving them access to foreign technologies and ideas that help improve efficiency."

Although foreign banks already have a presence in Canada, they currently can enter the banking market only through stand-alone subsidiaries or branches, both of which are subject to approval, supervision and regulation.

"Given the importance of foreign entry to bank performance, any obstacles to foreign banks wishing to participate solely in lending should be removed as this presence does not affect the safety and soundness of our banking system," Chant said.

"This should improve borrowing conditions for Canadian entrepreneurial businesses and help ensure that Canada's banking system best meets entrepreneurs' credit needs at competitive prices."

The Fraser Institute is an independent research and educational organization with offices in Calgary, Montreal, Tampa, Toronto, and Vancouver. Its mission is to measure, study, and communicate the impact of competitive markets and government intervention on the welfare of individuals. To protect the Institute's independence, it does not accept grants from governments or contracts for research. Visit www.fraserinstitute.org.

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