The Impact of the Recent Financial Crisis on Bank Lending to SMEs in Canada

Abstract

This study investigates the magnitude of credit contraction encountered by Canadian Small-and-Medium-Sized-Enterprises (SMEs) during the recent financial crisis of 2007-2008. These firms account for an important source of job creation and economic welfare (Haltiwanger et al., 2010); therefore, to ensure the creation and growth of SMEs through a smooth flow of capital is crucial for a healthy economic recovery from the crisis. The empirical observation obtained in this study is contrary to what the theory suggests, as well as what many of the existing studies witnessed (i.e., a financial crisis has a negative impact on SME loan circulations). Using binary probit regression and structural break testing, this work finds that Canadian SME loan approval and application rates were higher during the crisis period. This somewhat counterintuitive result prompts the researcher to search for the possible factors enabling SME credit lending in Canada to retain its health during the time of financial distress, which include: (1) the stability of Canadian banks evidenced by the relatively constant Capital Tier I ratio during the crisis; (2) initiatives the Canadian government implemented as a response to the crisis. This result also raises a question whether the five billion dollars the federal government injected in the SME lending market under the Business Capital Availability Program (BCAP), a measure designed to insulate Canadian SMEs from the liquidity shock, could be justified. This research question will be investigated as a future area of research.