Private or Public? Financing Japan’s SMEs

Ford Foundation Conference on Finance, Business Models, and Sustainable Prosperity

Kay ShimizuColumbia UniversityDecember 7, 2012

Puzzles about Japan

Source: OECD i-Library

Puzzles about Japan

• Low unemployment despite a major financial crisis in 1990 (Reinhart and Rogoff 2008)

• Continued domestic (and overseas) demand for Japanese government debt (Greenspan)

• Continued deflation despite financial easing (Krugman, Posen 2012)

• Middle risk gap (Schaede 2004)

Private bank loans outstanding, by interest rate (Dec 2002)

Bank and Non-bank loans outstanding, by interest rates, Dec 1998

Risk averse by design

• In the US or UK, markets used to price risk• Japan’s financial institutions designed to

mitigate risk• No market for pricing risk– Local government bonds– SME finance

Small and Medium Enterprises (SMEs) are high risk

• Lack of information• Small by definition• More vulnerable

Perceived credit accessLarge enterprises vs SMEs

SMEs depend on debt financing

• Average SME gets over 50% of capital in loans from financial institutions

• Decline in loans from government affiliated financial institutions

• The smaller (and more risky) the firm, the more it depends on borrowing

• In 2001, firms with less than 20 employees received 66.9% of capital in loans

• Firms with more than 300 employees received 24.2% of capital in loans

Private banks finance SMEs in Japan

• Private banks play a vital role (90.5% of loans)• In 1965, 41% of bank loans to SMEs• In 1997, 70% of bank loans to SMEs• In 2012, 68% of bank loans to SMEs• Regional banks dominate and also depend on

SME loans for revenue• BUT, proper loans only to the most profitable

SMEs (25.4% of SMEs in 2011)

How do weaker SMEs access funds?

• Credit guarantees use public funds to guarantee private bank loans

• Not unique to Japan• Japan’s program features:– 100% coverage– Widespread use

• 63.7% of SMEs have used CGs• 39.8% of SMEs using CGs in 2003• 21.1% of all loans in Japan covered in 2010

Credit guarantees make risk disappear

Credit guarantees support the community

Why do SMEs get protection?

• Over 99% of Japan’s firms are SMEs• SMEs employ ~70% of workers• Japan has long systematically protected SMEs

(Calder 1988)• In 1982, Japan’s public loans to SMEs 17.5

times that of the US• Effective organization– Vertical organization with access to national policy– Local mobilization influencing local policy

Why do regional banks participate?

• Regional banks depend on SMEs as main source of income

• Regional banks have monopoly over local information– Relationship banking– Designated financial institution of local

governments• Growing burdens for regional banks

Credit guarantees disperse and postpone risk

• Pools risk at the national level• Postpones risk to future generations• Politically viable though less effective– Decreased accountability– But multiplies funds while minimizing costs

Default rate of Credit Gurantees

Private money as public funds?

• Credit guarantees release private money as public funds

• Depositors shoulder the risk– Low returns

• Which SMEs qualify for credit guarantees?• Analogous to welfare programs?• Unintended recipients?

How institutional design deals with risk

• Local government bonds– Spread on interest rates extremely narrow– Interest rates cannot reflect levels of risk– Emphasis on treating all localities equally

May help explain puzzles about Japan

• Why we observe a middle risk gap• Why unemployment remains low• Why start-ups and venture capital remain

underdeveloped• Why risk capital is scarce