What is this metric and why is it important?
Debt financing, or loans, is a source of financing for existing firms who meet certain eligibility requirements. Although firms access debt for reasons other than innovation, the availability of funds is an important condition for a healthy innovation ecosystem. We measure here the interest rate on those loans for small and medium sized enterprises (SMEs) and large firms.
How is Canada doing?
- Borrowing costs for all types of Canadian firms are higher than they are for firms in most other countries, which could make funding innovation more difficult for Canadian firms.
- In 2017, only Mexico (17.0%), New Zealand (9.3%) and Chile (8.4%) recorded higher interest rates on loans for SMEs than Canada (tied with Australia at 5.2%).
- At 2.9%, Canada’s average interest rate for loans to large firms was lower than that in eight other countries (including the United States at 4.1%), but still in the bottom third of countries.
- Between 2007 and 2011, interest rates for SMEs and large firms in Canada fell; the average rate for SMEs declined from 7.5% in 2007 to 5.3% in 2011 and the average interest rate for large firm loans fell from 6.1% in 2007 to 3% in 2011.
The OECD defines the interest rate on loans for SMEs as the “average annual interest rate for all new small business terms loans and non-residential mortgage, base rate plus risk premium; excludes credit card” and the interest rate for large firms as the prime business interest rate (the interest rate charged to the most creditworthy borrowers).
Loans can enable firms to invest in new technologies that they know will improve efficiency and generate new revenue even though they do not have the cash on hand to purchase them outright. Additionally, debt financing can allow firms to spend on new research, development, and innovation projects that could lead to new and improved products, processes, and services. In both cases, the extra financing may also enable firms to hire more people and/or support other businesses through technology and equipment procurement. In short, loans allow firms to engage in innovative and productive activities that they might otherwise not be able to pursue given their limited cash reserves.