ARCHIVED—Study of the Economic Costs and Benefits of the Canada Small Business Financing Program

V. Estimated Net Program Benefits

In order to analyze the net impact of the Canada Small Business Financing Program on the economy it is necessary to compare the program costs to the benefits that accrue. The following section describes the estimated net benefits of the Canada Small Business Financing Program when all costs and benefits are analyzed.

A. Methodology

1. Assumptions on Discount Rate

Time-value-of-money has been accounted for in the calculation of the net present value of the program over time, using a blended risk-free-equivalent discount rate that is based on Bank of Canada 10-year bond rates over the time period analyzed.

Other rates typically regarded as 'social discount rates' were applied to the model as part of the sensitivity analysis. In particular, the Treasury Board Secretariat identified 8 per cent as the appropriate discount rate in the Canadian Cost-Benefit Analysis Guide. However, this rate is considered relatively high. There has been a trend toward the use of a lower social discount rate. For example, the British Treasury prescribes the discount rate at 3.5 per cent. A lower rate based on CPI or short-term GIC rates may also be used as a discount rate.

Table V-1
Discount Rates

Scenario	Discount Rate	Source
High	8%	Treasury Board Secretariat
Medium (Base Case)	5%	Bank of Canada 10-year bond rates (average between 1999/2000 to 2007/08)
Low	3%

2. Assumptions on Rate of Incrementality

For the purpose of the Cost-Benefit Study, the term 'rate of incrementality' refers to the percentage of full financial incrementality or partial financial incrementality.

A CSBF loan demonstrates full financial incrementality if no loan would have been granted to the borrower in the absence of the CSBF program. Therefore, the borrower would not have qualified for a loan if the CSBF program were not available^{Footnote 14}. Therefore, the rate of full financial incrementality refers to the percentage of CSBF borrowers that would not have qualified for a loan if the CSBF program were not available.

A CSBF loan demonstrates partial financial incrementality if a smaller loan would have been granted to a borrower if the absence of the CSBF. Therefore, the rate of partial financial incrementality refers to the percentage of CSBF borrowers that would have received a smaller loan if the CSBF program were not available. In the analysis of net benefits, it is assumed that a loan of half the size would have been granted in the absence of the CSBF program. Partial incrementality may include more favourable loan terms that would not have been received without the loan, also known as loan quality incrementality. For the purposes of this study, any differences in loan terms due to the CSBF program are not included due to the difficulty in accurately measuring the difference in loan terms.

Although there is some evidence that the rate of full and partial incrementality may have increased slightly in 2007^{Footnote 15}, it has been conservatively assumed that the rate of full and partial incrementality remains unchanged throughout the study period.

The rate of incrementality has been based on findings from existing incrementality studies. In particular, the Incrementality of CSBF Program Lending, Volumes 1, 2, 3. Equinox Management Consultants, Equinox Management Consultants Ltd. (2004), and Sources of Portfolio Risk and Revenue Generation of the Canada Small Business Financing Program, Phase 2, Equinox Management Consultants Ltd, December, 2008.

The rate of full and partial incrementality has been applied to benefits that were incremental to CSBF borrowers, i.e. these benefits would not have accrued if the CSBF program were not available. In particular, interest revenues on loans, increased salaries and wages paid by borrowers, growth in GDP resulting from payments to suppliers as a result of loans, and growth in GDP resulting from payments of suppliers to suppliers are adjusted for incrementality. Therefore, it is assumed that only a portion of measured benefits would truly be incremental to the program (e.g. 75% of additional salaries and wages were a result of financing obtained through the CSBF program, whereas 25% of loans would have been granted in the absence of CSBF and therefore the additional wages are not attributed as a benefit of the program).

Table V-2
Incrementality^{Footnote 16}

Scenario	Rate of Full Incrementality	Rate of Partial Incrementality
High	75%	0%
Base Case (Medium)	50%	25%
Low	25%	50%

3. Net Benefits and Cost Benefit Ratios

The net benefits and cost-benefit ratios for the CSBF Program have been assessed for the following time periods:

1. For each fiscal year in the study period; and
2. Over the nine year study period between 1999/2000 and 2007/08.
   1. Calculate the Net Present Value (NPV) of all costs and benefits. The NPV of each cost and benefit was calculated using a 5 per cent discount rate based on the average of Bank of Canada 10-yr bond rates over the study period.
   2. Adjust benefits for the rate of incrementality. All benefits, with the exception of administration and registration fees paid, are adjusted for the rate of incrementality of the loan since a portion of CSBF borrowers may have received all or part of the financing they required in the absence of the CSBF program.
   3. Calculate Net Benefits and Benefit-Cost ratios for each fiscal year. Net benefits are calculated as total benefits adjusted for incrementality less total costs for each fiscal year. The benefit-cost ratio for each year is calculated as the benefits adjusted for incrementality divided by total costs for that year.
   4. Determine the overall Net Benefits and Benefit-Cost ratios over the study period. Net benefits are calculated as the NPV of all benefits (adjusted for rate of incrementality) less the NPV of total costs between 1999/2000 and 2007/08. The benefit-cost ratio is calculated as the NPV of all benefits (adjusted for rate of incrementality) divided by the NPV of total costs between 1999/2000 and 2007/08.

Note on Assumptions:

The benefit cost ratio calculated for 1999/2000 – 2001/02 is not representative of true net program benefits since at the program inception benefits were disproportionately being accrued and few costs were incurred at that time (i.e. majority of claims paid against loans occur 2 to 4 years after loans are issued). The annual benefit-cost ratio calculation is representative of the true ratio between costs and benefits in the program steady state when costs and benefits accrue for multiple cohorts of loans.

As part of a cost-benefit study, cohort analysis can be conducted whereby the costs and benefits of loans provided in a given year are analyzed together (appropriately discounted) regardless of the fiscal year in which they accrued. Although the cohort analysis more closely relates the costs and benefits related to a given set of loans, it is difficult to attribute certain costs and benefits to a specific cohort. In addition, certain benefits of a cohort of loans are realized following a lag period of several years. This would necessitate a number of assumptions to be made to approximate/forecast future benefits that would accrue outside the evaluation period.

B. Net Program Benefits

1. Net Program Benefits by Fiscal Year

CSBF program costs between 1999/2000 and 2007/08 are summarized in Table V-3. Program costs grow from about $1.9M in 1999/2000 to $116.9M in 2007/08. The growth in CSBF program costs has largely been due to a continued growth in both claims paid and loan default costs to lenders. Program administration costs by Industry Canada (i.e. salaries and benefits, O&M, and capital expenditures) represent less than 4 per cent of total program costs (with the exception of 1999/2000 and 2000/01 when few claims were submitted).

Table V-3
Summary CSBF Program Costs (Current Dollars)

($M)	1999/ 2000	2000/01	2001/02	2002/03	2003/04	2004/05	2005/06	2006/07	2007/08
A. Salaries and Benefits of Program Staff	0.988	0.900	1.154	1.852	2.404	2.521	2.581	2.039	2.339
B. Direct operating Expenditures of CSBF Program	0.335	0.522	0.765	1.212	1.036	1.108	0.982	0.947	0.773
C. Capital Expenditures	-	-	-	-	-	-	0.330	0.360	0.390
D. Claims Paid on Loan Defaults	0.495	14.769	43.444	68.791	71.664	76.460	71.679	80.289	98.723
E. Loan Default Costs to Lenders	0.057	1.933	6.620	13.082	12.688	13.510	12.704	14.141	16.360
Total Costs (Current Dollars)	1.908	18.680	52.223	82.493	86.134	91.647	86.438	96.285	116.923
Discounted Costs (at 5% in 2007$)	2.820	26.285	69.984	105.284	104.697	106.092	95.298	101.099	116.923

CSBF program benefits are summarized in Table V-4. Total annual benefits range from a low of $415.9M in 1999/2000 and a high of $664.9M in 2006/07 due to benefits accruing both as a result of new loans being issued each year and loans that were issued to CSBF borrowers in previous years. The largest contributors to program benefits are expenditures by CSBF borrowers on suppliers for loan-eligible assets, and expenditures of suppliers on suppliers, which are directly related to the total volume of loans issued in a given year and the share of loans for new leasehold improvements, equipment, and software.

Although there are claims-related costs for the latest cohorts that have not yet been realized, there are also benefits, namely, future incremental wages that have not yet accrued. Over the study period, the incremental wages for each cohort have always been greater than the claims paid and related program administration costs.

Table V-4
Summary of CSBF Program Benefits (Current Dollars) (adjusted for incrementality)

($M)	1999/ 2000	2000/01	2001/02	2002/03	2003/04	2004/05	2005/06	2006/07	2007/08
C. Interest Revenues on Loans	13.060	35.860	21.499	21.345	39.030	29.520	48.166	62.330	63.331
E. Salaries and Wages Paid by Borrowers	-	49.214	117.288	81.015	149.494	180.539	227.233	255.382	165.411
F. Payments to Suppliers as a Result of Loans	217.615	188.991	146.423	155.642	162.741	169.535	177.979	171.319	167.668
G. Incremental Indirect Impacts from Expenditures of Suppliers to Suppliers	151.836	132.937	103.264	110.011	115.284	119.691	125.561	120.205	117.255
H. Administration and Registration Fees Paid	33.426	43.138	44.569	48.432	51.545	53.839	56.367	55.664	56.201
Total	415.936	450.140	433.043	416.444	518.093	553.124	635.306	664.900	569.867
Discounted Benefits (at 5% in 2007$)	614.527	633.392	580.319	531.500	629.746	640.310	700.425	698.145	569.867

Figure V-1 presents the net program benefits when they are discounted at a rate of 5  per cent. Net program benefits are at the highest in 1999/2000 as a result of few costs incurred due to claims paid. The decline observed in net program benefits in 2002/03 is mainly due to declines in total additional salaries and wages paid by CSBF borrowers that result from negative growth in average wages for the 2001/02 cohort of borrowers. The decrease in net program benefits in 2007/08 is due to both a decline in total additional salaries and wages paid by CSBF borrowers and a rise in claims paid by Industry Canada on loan defaults.

Table V-5 presents the benefit-cost ratio for the CSBF program for each year over the study period. The benefit-cost ratio identifies the dollar value of benefits that accrue for every dollar of costs related to the CSBF Program. The benefit-cost ratio is high between 1999/2000 and 2001/02 due to few claims paid during that time while much of the benefits for those cohorts have already been accrued.

Table V-5
Benefit-Cost Ratio

	1999/ 2000	2000/01	2001/02	2002/03	2003/04	2004/05	2005/06	2006/07	2007/08
Benefit-Cost Ratio	218.0	24.1	8.3	5.0	6.0	6.0	7.3	6.9	4.9

2. Total Program Benefits Between 1999/2000 – 2007/08

The benefits of the CSBF program to the economy exceed the costs by a significant margin. The net present value (NPV) of net program benefits is over $4.9B between 1999/2000 to 2007/08. For every dollar of costs incurred in relation to the program, $7.70 in benefits accrue to the Canadian economy.

Table V-6
Net Benefits and Benefit-Cost Ratio, 1999/2000 to 2007/08

NPV of Program Costs	$728.5M
NPV of Program Benefits	$5,598.2M
Net Program Benefits	$4,869.7M
Total Benefit-Cost Ratio	7.7

C. Sensitivity analysis

In order to test the potential variation in the results of the Cost-Benefit model, it is useful to assess the extent to which model results vary when key costs, benefits, and assumptions are varied.

As a result, a sensitivity analysis has been conducted that includes two additional scenarios (low and high scenarios) where the values of key benefits and assumptions are varied. The main Cost-Benefit analysis presented above constitutes the 'medium' scenario.

Actual data is available on the cost items that are included in the analysis and is subject to little variation (i.e. due to assumptions made). Therefore, the sensitivity analysis is based on varying selected benefits and assumptions applied to the model.

The methodology used to calculate net benefits and benefit-cost ratios, is the same as described in section A.

1. Methodology

Table V-7 summarizes the key benefits and assumptions that are varied for both the Low and High scenarios.

Table V-7
Assumptions for Sensitivity Analysis

	Low Scenario	High Scenario
Discount Rate	3%	8%
Incrementality	25% full incrementality 50% partial incrementality	75% full incrementality No partial incrementality
Net Interest Revenues on CSBF loans	The prime rate used to calculate the interest rate charged (Prime + 3%) on small business loans is assumed to be 50 basis points lower than Bank of Canada quoted business prime rates.	Cost of capital to lenders is assumed to be the 5-year GIC Interest Rate.
Salaries and Wages Paid by Borrowers	Total additional salaries and wages are 25% lower. The Statistics Canada Economic Impact Study (2004) indicated that the Atlantic Provinces, and Agricultural support industries and Information/Cultural Sectors failed to show employment growth. These borrowers account for about 12.5% of loans issued. In addition, it is assumed that borrowers in other geographic locations and sector may have realized lower employment growth and/or incremental wages for a total of 25%.	Total additional salaries and wages are 25% higher. Self-reported data on employment creation indicates that average incremental employment is about 25% per firm (see section VI-A).
Impacts from Expenditures on Suppliers	Only payments to suppliers for new leasehold improvements, equipment, and software (about 75% of loans issued) contributed to economic growth in the year the loan was issued). Growth in GDP for real property, and existing leasehold improvements purchased using CSBF loans was already accrued in the past.	Payments to suppliers for all asset types (100% of loans issued) contributed to economic growth in the year the loan was issued.
Incremental Indirect Impacts from Expenditures of Suppliers to Suppliers	Only payments to suppliers for new leasehold improvements, equipment, and software (about 75% of loans issued) contributed to economic growth in the year the loan was issued). Growth in GDP for real property, and existing leasehold improvements purchased using CSBF loans was already accrued in the past.	All payments to suppliers for all asset types (100% of loans issued) contributed to economic growth in the year the loan was issued.

2. Findings: High Scenario

As described in the section above, the following key assumptions were varied to arrive at the high scenario:

• Discount rate was increased;
• Rate of incrementality was increased;
• Costs of funds to lenders were decreased;
• Total additional salaries and wages were increased; and
• All loan expenditures contribute to direct and indirect GDP growth.

Table V-8
Annual Net CSBF Benefits and Benefit-Cost Ratios

	1999/ 2000	2000/01	2001/02	2002/03	2003/04	2004/05	2005/06	2006/07	2007/08
Net Benefits ($M)	491	513	459	408	525	561	665	690	556
Benefit-Cost Ratio	258.0	28.5	9.8	5.9	7.1	7.1	8.7	8.2	5.8
Discounted Net Benefits (at 8% in 2007$)	908	879	728	599	715	707	775	746	556

Table V-9
Net Benefits and Benefit-Cost Ratio, 1999/2000 to 2007/08

NPV of Program Costs	$794.0M
NPV of Program Benefits	$7,405.7M
Net Program Benefits	$6,611.7M
Total Benefit-Cost Ratio	9.3

In the high scenario, the benefit-cost ratio is $9.30 of benefit for every dollar of costs incurred in relation to the program, an increase of $1.60. The observed increase is predominantly due to a rise in the amount of direct and indirect GDP that has been attributed to the CSBF program. In addition, about a third of the increase in the net program benefits can be attributed to the change in the time value of money (i.e. discount rate). A decrease in the cost of capital to lenders had little impact on the overall benefit-cost ratio.

3. Findings: Low Scenario

As described in Section 1 above, the following key assumptions were varied to arrive at the high scenario:

• Discount rate was decreased;
• Rate of incrementality was decreased;
• A lower business prime rate is charged for small businesses;
• Total additional salaries and wages were decreased; and
• Only loan expenditures on equipment, new leasehold improvement, and software purchases contributed to direct and indirect GDP growth.

Table V-10
Annual Net CSBF Benefits and Benefit-Cost Ratios

	1999/ 2000	2000/01	2001/02	2002/03	2003/04	2004/05	2005/06	2006/07	2007/08
Net Benefits ($M)	338	350	303	260	339	362	433	447	350
Benefit-Cost Ratio	160.4	17.4	6.0	3.6	4.3	4.4	5.4	5.1	3.5
Discounted Net Benefits (at 3% in 2007$)	428	431	362	302	381	395	459	460	350

Table V-11
Net Benefits and Benefit-Cost Ratio, 1999/2000 to 2007/08

NPV of Program Costs	$688.3M
NPV of Program Benefits	$4,256.3M
Net Program Benefits	$3,568.0M
Total Benefit-Cost Ratio	6.2

In the low scenario, the benefit-cost ratio is $6.20 of benefit for every dollar of costs incurred in relation to the program, a decrease of $1.50. The observed decrease is largely due to a decrease in the amount of direct GDP that has been attributed to loan expenditures made by CSBFP borrowers and a change in the time value of money (i.e. discount rate), which account for 26.3 and 29.9 per cent of the net benefit decrease respectively. In addition, about 20 per cent of the decrease in the net program benefits can be attributed to the change in indirect GDP resulting from expenditures of suppliers on suppliers. A decrease in the prime rate charged to borrowers had little impact on the overall benefit-cost ratio.

4. Comparison of the three scenarios

The sensitivity analysis has shown that program benefits significantly exceed program costs even when benefit-cost model assumptions are varied. In 2007/08, the difference between the high and low scenarios varied by about $200M mainly due to the differing assumptions on additional wages paid by borrowers and loan and the impact of loan expenditures on suppliers. In 1999/2000, net program benefits between the three scenarios vary to a greater extent than in 2007/08 largely due to the assumptions made about the time-value of money (i.e. discount rate).

D. Conclusions

The benefit-cost analysis of the Canada Small Business Financing Program focussed on costs to administer the program including salaries and benefits of Industry Canada staff, direct operating expenditures and capital costs, costs of loan defaults to both lenders and Industry Canada, and benefits accruing from the program including additional salaries, wages and expenditures in the economy made by lenders, CSBF borrowers, and suppliers to borrowers, and registration and administration fees paid.

The analysis of costs and benefits of the CSBF Program indicates the presence of significant net benefits to Canadian society. The estimate of net benefits is based on a nine-year timeframe, 1999/2000 to 2007/08, using a 5% discount rate to calculate the present values of both costs and benefits. The total net present value of costs of the program are $728.5M whereas the total net present value of benefits of the program are $5,598.2M, resulting in total net benefits of $4,869.7M.

The estimates of costs and benefits were also tested under a number of alternative assumptions and outcome scenarios. Variations were made in the discount rate, rate of incrementality, net interest revenues on loans, additional salaries and wages paid by borrowers, impacts from expenditures on suppliers, and indirect impacts from expenditures of suppliers to suppliers. Variations in these estimates led to the same conclusion, namely that CSBF program benefits significantly outweigh the costs.

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Footnotes