No way to sugar-coat this. This is going to hurt.
The Bank of Canada’s recent interest rate hike to 4.75 per cent is the highest central bank rate in over 20 years. It is almost certain to lead to a recession.
The last time the bank pushed rates up this high was in 2000. Growth flatlined and unemployment increased. In the U.S. the tech bubble popped and the contraction was made worse by the impact of the attacks on the World Trade Centre and the Pentagon on September 11 of that year.
Apparently a recession is the medicine we need, according to . They also say more interest rate increases are likely.
Hard and fast rate increases are the way central banks dissuade home buyers from paying high prices, persuade employers not to hire workers, cause unemployment to deter unions from demanding wage increases and punish consumers carrying balances on their credit cards.
High rates also impact business investment, which in Canada had already been falling sharply since the pandemic.
According to OECD statistics, Canada is at the back of the pack in terms of productivity growth and financing conditions for small- and medium-sized enterprises or “SMEs”. Business investment by SMEs is critical to the future of the Canadian and BC economy.
High interest rates are certainly going to put the future in greater jeopardy.
The Bank of Canada has access to broad aggregate statistics for Canadian household debt and housing prices, both of which have been rising in the last decade. It gets advice directly from the major banks and has deep real time insight into what is happening on their balance sheets.g
A stable banking system has become a more prized feature of Canada's brand than the Mounties and is managed very closely by OFSI (Office of the Superintendent of Financial Institutions), which increased the ‘domestic stability buffer,’ requiring banks to have additional capital, before the most recent bank failures in the U.S.
Interest rates are a blunt policy instrument. While the intention may be to dampen consumer spending and real estate purchases, they also reduce lending that funds investments in productivity and growth by SMEs, which was already in decline.
Few economists, apart from a few notable exceptions who appear in Business In Vancouver, focus on SMEs and how they are key to Canada’s economic future.
Jock Finlayson, Ken Peacock and David Williams, in many articles in past issues of BIV, have described the serious, persistent and deeply structural problem that is Canada’s lagging productivity and GDP growth, and the consequences for the future of the Canadian and BC economies.
They have explained how GDP growth depends on increases in efficiency, expansion of capacity, and growth to scale primarily by SMEs. All of which is mainly funded by debt.
This is not growth for its own sake. This is the change and adaptation needed in order not to fall further behind. It is the growth that makes taxation possible and supports the Canadian dollar at a level where we can afford the imports we rely on.
The above-mentioned and others at the C.D. Howe Institute--the --have been sounding the alarm about declining productivity and appallingly low business investment for years as the Bank of Canada’s own data shows capital stock per Canadian worker has been declining since 2015.
SMEs in Canada do not have the same access to financing comparable in terms of volume and cost as peers and competitors in other OECD countries. It is a well-documented structural issue that has existed for over a decade.
Commentators, mainly from governments and banks, insist SMEs in Canada are not at a disadvantage. They base this on opinion surveys, not statistics, and point to a lack of equity capital or even a lack of ambition and risk-taking ability among Canadian entrepreneurs as the culprit.
This is victim blaming, and a bit rich coming from bureaucrats and bank executives.
The brute fact is that the availability and cost of debt is materially less favourable for SMEs in Canada than in almost every other comparable OECD country. The fact that in surveys by the federal government of SME owners and managers, financing is not at the top of the list of challenges, indicates how low their expectations are for getting it than anything else.
In the US, where Canadian governments are working hard to increase economic integration, SMEs are much better off in terms of access to financing.
Improving access to debt capital in Canada is the only practical route into this problem. Every financing discussion starts with it. "How much?" is followed by "what is the risk" and then "what return is needed to compensate for the risk." When the return is too high to be a cash obligation of the venture, that’s when the subject of equity will naturally come up.
These discussions are unlikely to take place with large banks, where commercial lending is no longer a favoured line of business and where AI is being implemented for all but the large lending transactions. Inside the big banks, lending to SMEs has to compete for attention with other business lines: capital markets, wealth management, retail banking and mortgage lending, all of which generate more reliable returns with less risk.
Business focused banks—like recently shuttered Silicon Valley Bank—are more liable to fail, but that would be worth the risk if it there could be a SME sector in Canada as robust, creative as exists in the US.
Credit unions could step up. They have been gradually increasing their share of SME business and have always been preferred as counterparties in surveys done by the Canadian Federation of Independent Business. However, they are far behind the major banks in terms of capability and capacity.
Artificial intelligence, fintechs, changes in the wholesale funding market, and the possibility regulators and governments will take the time to dig more deeply into this issue, can also give us hope.
We know Canada’s lagging productivity is a result of alarmingly weak business investment by SMEs. We know access to financing for Canadian SMEs has to be better than it is now.
It was a problem before the pandemic and before the interest rate shocks the Bank of Canada decided to inflict on the economy. The future is at risk. What are we going to do about it?
Guy Heywood, a former banker and CPA, is principal of Corporate Banking Advisory. He advises companies on financing strategies and technology.
