Commercial Loans & Economic Development

For several months Central 1 has sought a concession from the BC government on the capital required for a commercial loan portfolio if the portfolio exceeds 30% of a credit union’s total assets.  Currently, under the Capital Requirements Regulation, if the level of commercial lending breaches that threshold the excess amount requires twice the capital weighting.  This is a heavy capital penalty for exceeding the cap.  It is called a concentration risk adjustment.

Credit unions see market opportunities and want to lend to prospective good borrowers.

The new government has proposed to reduce the adjustment from 100% to 50%. This is a good response from Finance Minister Carole James.

The government perspective is not always well understood.  Fundamentally, savings institutions aggregate smaller transaction accounts and savings accounts to ensure consumers have a safe place to place their funds, with the benefit of a government deposit insurance program.  The intermediary is expected to invest or lend the funds in low risk ways.  Traditionally, credit unions made personal loans, where the individual loans were small and the risks distributed.  Subsequently they made personal mortgage loans, where they were well secured and the default rates were modest. Beyond that, investments were in government bonds, T-bills, bank deposits, and some high quality paper.

As credit unions have grown they have become small business lenders, real estate development lenders, and agricultural lenders.  These portfolios have different risk characteristics.  The concentration risk adjustment can be seen as a way to ensure that the credit union’s portfolio of loans is well diversified and more or less consistent with the role of a ‘savings institution’ in the world of finance.

Economists would note that financing for business purposes ‘should’ be facilitated through commercial banks, and other non deposit-taking entities, because these loans are more risky. This is consistent with distinctions between retail banking, commercial banking, investment banking, fund managers, and equity markets.  Such distinctions are meant to protect the savings institutions, keeping them low risk.

Institutions that take insured deposits and transform them into commercial credits are introducing risk.  Government has to have a good rationale for allowing that risk to be borne by the savings institution, especially if government guarantees the deposits.

Perhaps the biggest argument for a more limited ‘risk adjustment’ lies in rural BC where the availability of credit to small businesses may be more constrained than in urban centres.  Urban centres are well banked, and rural communities may often be classified as high risk by the national banks due to downturns in resource industry sectors.  Many reports have noted that the province has ‘two’ economies, the lower mainland and island and ‘the rest’.

I suggest that negotiations with the ministry focus upon how BC credit unions stimulate and support upcountry economic activity, and how this capital constraint limits that activity.   The focus can be on the communities that need access to credit.  Alternatively, there may be an opportunity for some of these loans to be separately guaranteed as part of a provincial economic development program.

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