Canadian commercial lending rose in the second quarter, PayNet Inc said on Wednesday, in a report that showed smaller businesses we're expanding even as economic storm clouds gather in Europe and the United States.

PayNet, which tracks commercial financing to thousands of small and medium-sized companies, said its Canadian Business Lending Index rose 3 percent in the second quarter from the first three months of the year.

That was the largest rise in the index, which tracks the creation of new loans, since a 5 percent jump in the fourth quarter of 2007, before the global financial crisis knocked the economy into recession and companies retrenched.

It's good to see some solid growth return to Canadian small and medium-sized businesses, William Phelan, PayNet's president and founder, said in an interview.

The big question is can we stay on track? There is a lot of uncertainty out there still. With the credit crisis in Europe and with large substantial deficits in the U.S. there is a potential to fall off track and experience some new shocks to the financial system.

Lending activity was 2 percent above the same quarter last year, the index showed.

This is the first time the Canadian index has grown both year over year and quarter over quarter since 2007. So, for four years we've essentially been in some sort of falling pattern or uncertainty, and now finally we can say, as of the third quarter of 2010, we've hit the bottom and were starting to expand again, Phelan said.

Other PayNet data released on Wednesday showed that moderate loan delinquencies -- defined as those being behind by 30 days or more -- rose slightly to 1.76 percent in June, up from 1.49 percent three months earlier.

Severe loans in arrears, defined as behind more than 90 days, inched up to 0.54 percent in June from 0.47 percent in March.

Phelan said the increase in moderate delinquencies reflected a slight rise in risk-taking by companies but delinquencies remained far below the peak hit two years ago.

There has been a dramatic improvement in the financial health of these small and medium-sized enterprises in Canada, he said.

In the height of the recession, the moderate loan delinquency peaked at a much higher level, around 3.8 percent in 2009, so they've dramatically improved their financial stability and they are much more solvent than any time since August 2009.

PayNet's commercial lending index is considered a leading indicator for economic growth, and bodes well for positive Canadian GDP in the third quarter.

The Canadian economy shrank in the second quarter, its first quarterly fall since the 2008-09 recession, hurt by temporary factors such as the impact of Japan's earthquake and tsunami.

On Tuesday, the International Monetary Fund lowered its 2011 economic growth forecast for Canada to 2.1 percent from 2.9 percent, and to 1.9 percent in 2012 from 2.6 percent, but Canada remains among the stronger global economies.

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