Research Paper: Sustaining Growth of Japan’s SMEs
Current Prospects and Future Financial Ecosystem
Preliminary analysis of interviews with various private, semi-private, and public support
groups/financial institutions in assessing Japan’s current and future financial support
system for small and medium-sized enterprises

Author:Rachel Gayle Olanoff
GraSPP MPP/IP 2015
Research Advisor:
Professor Toshiro Nishizawa

Table of Contents

The Current Climate for SME Financing _________________________________________________________________1
Public Support to SMES–Moral Hazard vs. Safety Net _________________________________________________3
Efforts to Nurture VC-Limits of High-Risk/High Return Focus ________________________________________6
Private Support for the "Middle Risk" Financing Gap __________________________________________________6
Conclusion _________________________________________________________________________________________________8
Appendix __________________________________________________________________________________________________9
References _______________________________________________________________________________________________ 12
Acknowledgements _____________________________________________________________________________________ 13

Interview with selected SME support agencies/financial and public institutions

THE CURRENT CLIMATE FOR SME FINANCING
The importance of supporting Japanese small and medium-sized enterprises (SMEs) in economic growthpolicies continues to be a politically popular issue, particularly considering the large share of SMEs in theJapanese economy in terms of number of businesses (comprising 99% of total number of business) andemployment numbers (comprising nearly 70% of total employees). Nevertheless, compared to larger
enterprises, SME finance generally faces the following difficulties: 1) Larger credit risks 2) Lower reliabilityof financial statements 3) Lack of collateral that can be provided by SMEs for traditional lending1 4) Larger
monitoring costs and 5) Difficulty of performing business transfers due to the burdensome personal
guarantee system2. Thus, private sector financial institutions tend to prioritize lending to large enterprises interms of efficiencies and relatively lower credit risks, a situation worsened further by a reduction in risk
appetite after several decades of economic stagnation following the bubble burst as well as other setbacks
such as the global financial crisis.
In particular, SMEs may have difficulty securing long-term loans due to the increase in risk and information
asymmetries between banks and SMEs, where SMEs have higher-quality information on their own
management and business performance than banks. Banks in turn seek to prevent problems of adverse
selection and moral hazard—lack of reliable risk measures and credit information may lead to higher risk
ventures being supported than could be assessed at the time of contract formation, resulting in risky behavior
after the loan on the part of businesses. Adding to institutional risk aversion towards SMEs, Japanese SMEs
also suffer from low profitability and rank lower in terms of ease of credit than other Asian countries
including India, Vietnam, China, Thailand, Philippines, and Indonesia. 3
The difficulty of accessing finance and lack of proper monitoring to incentivize growth has arguably stunted
the growth of the SME sector. Especially after the global financial crisis, in addition to profitability andinvestment in Japanese SMEs declining significantly, business registration of SMEs (in net terms) has
remained stagnant. Some note that this can be due to nonviable SMEs being kept afloat with public support
polices—this would lead to resource misallocation and create distortions in the competitive market. In
addition, although not covered specifically in this paper, various regulatory barriers and lack of market
development activities have hindered the creation of new business. 4

PUBLIC FINANCIAL SUPPORT MEASURES AND RELATIONSHIP LENDING
Considering these challenges, two major approaches by Japanese public and private financial institutions to
supply loans to SMEs are 1) the use of publicly supported SME focused lending institutions/credit guarantees
and 2) a focus on relationship lending—borrowers repay loans as agreed upon in contracts in order to secureaccess to finance in the future; through this on-going relationship, lenders then accumulate borrowers’
information including borrowers’ clients, cash flow, and management capacity. In regards to public support

1 Traditional bank lending that is collateral or asset-based requires capital and many SMEs may not have enough security forconventional based loans. Alternatives are then information based (credit scoring, relationship lending, financial statement lending) but
many companies may additionally have difficulty supplying this information. Also companies may have intangible assets (not all theseassets can be offered as tangible collateral such as ‘rice fields’ or property)
2 Although attempts have been made to reform the system, those interviewed repeatedly mentioned the personal guarantee system(limited liability subject to a maximum amount and duration) as a formidable financial barrier towards further SME growth/expansion
since business owners must absorb all of the risk upon bankruptcy
3 Finance to SMEs in Japan and Asia (JFSA-ADBI-IMF joint conference January 27,2014)
http://www.fsa.go.jp/frtc/kenkyu/event/20140312/s2_2.pdf
4 W. Raphael Lam and Jongshoon Lim “What Role can Financial Policies Play in Revitalizing SMEs in Japan,” IMF Working Paper

Page 1Interview with selected SME support agencies/financial and public institutions

systems to increase financial access to SMEs, Japan’s system of Credit Guarantee Corporations (CGCs)
allows for the spreading of risk burden across society with taxpayer money—private banks are encouraged tolend to SMEs if loans are backed by publicly supported CGC issued guarantees which are in turn backed ininsurance by the government supported Japan Finance Corporation (JFC). In addition to this, the publicly
affiliated financial institutions JFC and Shoko Chukin Bank supply long-term and low interest money to SMEs
to further compliment private sector banks.5 However public support measures also bear various costs,
introducing economic inefficiencies through government market distortions. For example, such actions cancreate moral hazard by weakening incentive for proper credit risk assessment by lenders—this may in turnunderstate credit risk, limiting incentives to restructure inefficient SMEs and leading to the misallocation of
resources, ultimately undermining the healthy dynamism of SMEs.

POTENTIAL RISK CAPITAL AND EQUITY/INVESTMENT BASED FINANCING FOR JAPANESE SMES
It would appear that a reliance on financing through relationship lending and credit guarantee models is
insufficient to sustainably support the continued growth of SMEs in Japan. For example, some experts draw acorrelation between SMEs that use credit guarantees and lengthened periods for repaying debt with a higher
likelihood to incur losses. Additionally, the smaller size of shinkin banks and regional banks supporting local
SMEs means that although these banks are close enough to individual enterprises to perform relationshiplending, they lack larger scale business restructuring experience and may not have enough capital adequacythemselves to be able to absorb the shock of non-performing loans.6
Thus, the alternative of ‘equity finance’ as opposed to direct lending models, where investors makecontributions to a company (sometimes by directly purchasing ownership shares) in exchange for potential
return on profits (rather than interest accumulated payback), has been cited as an important incentivizing
tool for SMEs to expand their businesses or improve business performance (either in regards to financials orsocial impact) to attract investors. This is in contrast to loans, where firms incur debt and the expectation is
to pay back money over time, regardless of business performance. SMEs supported by risk capital or equity
finance are normally classified as having higher potential returns than typical SMEs but lower risk than
traditional venture capital (VC). Accordingly, recently Prime Minister Abe and his cabinet have initiatedreforms to strengthen the provision of risk capital and several public/private initiatives have shifted towards
fund creation to supplement VC investment in Japan. 7 Nevertheless, even with the greater provision ofventure capital and better mechanisms to promote the success of potentially viable but high risk enterprises,
the lack of timely credit information8 has a created a financing gap for “middle-risk” enterprises, since VC andthe CGS system supported bank-lending mechanisms service high-risk customers, while larger banks continue
to support low-risk customers. Additionally, risk appetite in Japan remains low as exhibited by the slow paceof business restructuring, banks’ heavy reliance on collateral, and preference for burdensome personal
guarantees. Lacking early stage “angel” investors to supply initial capital, even venture-oriented SMEs may
still be dependent on bank lending credit, and continued survival of non-viable, high-leverage low-

5 Finance to SMEs in Japan and Asia (JFSA-ADBI-IMF joint conference January 27,2014)
6 W. Raphael Lam and Jongshoon Lim “What Role can Financial Policies Play in Revitalizing SMEs in Japan,” IMF Working Paper
7 Yet, as will be further explained, not all SME missions are the target of VC/public partnerships (and not all have plans to become anIPO), and thus alternative mechanisms such as Hometown Investment Trust Funds through socially-minded investment financial
intermediaries like Music Securities will become crucial for broader SME investment support.
8 Currently financial institutions do not share credit information through a single common credit registry

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Interview with selected SME support agencies/financial and public institutions

profitability “zombie” SMEs weakens the credit risk assessment of banks, reducing credit availability to startups and higher profit model firms. 9
Overall, venture capital and the use of risk capital remains limited in Japan. According to 2012 OECD data,
despite being the third largest economy in the world, Japan ranked 17th in OECD countries for amount ofventure capital investment as a percentage of GDP. 10 As many experts note, besides revision of specificpolicies to attract and promote the use of risk capital, greater work needs to be done to deepen capital
markets as a whole.

METHODOLOGY AND SCOPE OF ANALYSISThe following report collates takeaways from interviews with respective public/private agencies and firms
regarding the future of SME finance. The scope of analysis for discussion about SME finance was limited tobusiness activities in Japan rather than overseas business growth/activities of Japanese SMEs. For the
purposes of this paper, analysis of risk capital in Japan will be divided into two types: “crowdfunding/microfunding” (project-based funds from individual investors directed through a non-traditional financial
intermediary towards SME target businesses) and venture capital (investment partnerships through theacquisition of shares and capital gain at the time of stock sale). However, venture capitalists were notinterviewed directly and this sector is only explored in this paper through public initiatives to garner VC intargeted industries/regional revitalization strategies.

RESEARCH QUESTIONSWhat type of businesses depend on CGS supported and non-CGS supported bank loans and why? What type ofbusinesses depend on risk capital and why? Is it feasible to focus on risk capital as a stable means of financing
for the future expansion of SMEs?

PUBLIC SUPPORT TO SMES–MORAL HAZARD VS. SAFETY NET
ROLE OF PUBLIC INSTITUTIONS IN FINANCIAL SUPPORT TO SMES
Loans to Japan SMEs

Government-affiliated financial institutions

Small and Medium
Enterprise Unit, JFC

47,000Micro Business andIndividual Unit, JFC

930,000

Shoko Chukin Bank

73,000Credit Guarantee Corporations

1,460,000

National government affiliated financial institutions directly provide about 10% of total volume of loans to
SMEs, most notably being The Japan Finance Corporation (JFC) for Small

9 W. Raphael Lam and Jongshoon Lim “What Role can Financial Policies Play in Revitalizing SMEs in Japan,” IMF Working Paper
10 OECD (2013), “Access to finance: Venture capital”, in Entrepreneurship at a Glance 2013, OECD Publishing.

http://dx.doi.org/10.1787/entrepreneur_aag-2013-27-enPage 3

Interview with selected SME support agencies/financial and public institutions

Tasked with supporting SMEs as a source of “economic revitalization and job creation,” METI’s SME Agency
is in charge of deciding 1) characteristics and budget of the financial safety net (included amountcompensated in the credit supplementation system) and 2) providing revitalization support (such as in theform of subsidies or funds as well as longer term, low interest direct loans) to SMEs. For example, in response
to natural disaster, METI’s SME agency increased the amount of public guarantees under the credit
supplementation system to 100%12 of loan value for firms affected by the Great East Japan Earthquake.13
Current efforts by the government, now that the economy is improving, are to monitor and limit overuse of
the credit supplementation system and other publicly supported measures, in interests of fiscal austerity as
well as in reducing the incidence of moral hazard for banks through risk sharing14. Although some worry
about the expansion of public guarantees to support SMEs, after speaking with an officer of METI’s SME
agency, overall the financial situation appears to be stabilizing, with a decreasing trend in the total percentage
of SME loan amounts backed by credit guarantees. In addition, entering credit guarantee systems is still avoluntary decision for firms which may have difficulty accessing finance otherwise, since the fee rate theymust pay would be greater than the rate they would pay if they could access private bank loans directly.
Nevertheless, being attached to national interests, the agency is tasked with supporting broader SME sector
financial health and doesn’t have the channels to support very small or niche area SMEs which have notpreviously established themselves in communities. Additionally, although initiatives may be made in the
future to further shift risk sharing towards private institutions, according to the official consulted, there are
no plans to eliminate the credit supplementation system in the near future, particularly in ensuring that
regional economies stay afloat despite lower returns for some SME businesses.

15

As detailed above, Japan’s credit supplementation system (with loans from private banks backed by CGC
credit guarantees in 51 regions nationwide, which in the case of subrogation16, are in turn insured 70% or
11 Roughly 90% of total private loan amounts to SMEs are non-guarantee backed although in terms of number of companies, nearly 30%

of SMEs use some form of guarantee backed loan
12 Application formally for this special provision ended March 31, 2014
13 “Financial Policy for SMEs in Japan,” Masayuki Sakata SME Agency METI June 12, 2014

14 This approach to be detailed in the next section, but basically instead of guaranteeing 100%, guaranteeing 80% of loans instead
15 From JFC website- https://www.jfc.go.jp/n/english/sme/demonstrating.html
16 Subrogation here referring to the compensation by CGCs to banks when guaranteed loans are defaulted

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Interview with selected SME support agencies/financial and public institutions

80% by JFC) is an important component of Japan’s SME finance policy. The economic rationale is that with“minimal public cost,” smooth financing by private institutions can be provided to “SMEs that are in fact
healthy but unable to secure enough loans because of the informational gap between lenders and borrowers.”
However, according to some studies, this does not wholly resolve asymmetric information gaps since most ofthese loans with guarantees may be issued by banks that transact with risky small businesses (adverse
selection) and with such guaranteed loan contracts, risky small businesses may be more likely to default(moral hazard). Additionally, the JFC accepts all credit insurance for CGCs, implying that CGCs may have lessincentive to monitor banks and small businesses.17
However, upon interviewing officials from JFG, the central organization of CGCs in Japan, it became
apparent that efforts are being made to limit moral hazard/adverse selection through a responsibility-sharing
system where only 80% of credit is guaranteed, the remainder of loan risk borne by banks.18 In addition toceilings on guarantees for firms with or without collateral19, other controls and incentives include reduced
fees for firms with stronger credit ratings20, especially those which enter under the responsibility-sharing
system. While JFG officials noted that there were not specific repercussions for firms or banks engaging inrisky loan behavior (such as cut contracts or penalty fees), they did note that credit evaluation and bankmonitoring may “become stricter.” More significantly, JFG officials explained that when considering issues of
information asymmetry and potential for moral hazard, it is also important to understand the financial
culture of Japan and to notice the total percentage of loan amounts compensated by credit guarantees—inJapan, due to issues of saving face and close community ties (part of relationship lending), actual default risk
remains low (amount of loans subrogated by CGCs nationally remains about 2%, climbing only to 3% after thefinancial crisis). In addition, while the total amount of outstanding guaranteed liabilities was highest in 2009,
the current outstanding liabilities amounts have largely returned to pre-crisis levels (see appendix Fig. 1).
Thus, the use of CGC guarantee backed loans have not been as widely abused as one may assume, and theactual amounts compensated by CGCs are much less than may be expected.
Nevertheless, the JFG officials warned that uncertainties remain about the future sustainability of the credit
supplementation system, in addition to limitations in government funds to keep this system afloat. Although
JFG officials noted that efforts are being made to expand the nature and form of their services toaccommodate the expansion of bank offerings at the local level, they were quick to admit that they cannot
support every type of financial business, and that as an intentionally limited safety net mechanism, the utilityof guarantee backed loans may be outgrown as SMEs successfully expand and grow. Thus, CGCs have begun toexpand their services beyond traditional financial guarantee support, such as business management training
for SMEs to improve performance and credit standings. 21

17 Kuniyoshi Saito, Daisuke Tsuruta “Adverse selection and moral hazard in the Japanese public credit guarantee schemes for SMEs”

http://www.voxeu.org/article/adverse-selection-and-moral-hazard-japanese-credit-guarantees
18 This system was introduced in 2007 although lost traction after the setbacks of the global financial crisis and East Japan Earthquake
where emergency credit was issued to firms at 100% guarantee rate. Nevertheless, efforts are being made to reduce guaranteedamounts to 80% as the economy improves
19 The ceiling for firms without collateral (80,000,000 yen) appears to more than enough for most firms, considering that 80% of users

are microenterprises with 5-10 employees and borrowing of 10,000,000-30,000,000 yen
20 Evaluated based on a firm’s three year business performance record
21 Nevertheless, fees are not charged for business improvement trainings run by CGCs, and it is unclear how they may continue togenerate revenue without the publicly supported guarantee system

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Interview with selected SME support agencies/financial and public institutions

EFFORTS TO NURTURE VC-LIMITS OF HIGH-RISK/HIGH RETURN FOCUS
Recognizing the need to grow equity finance in Japan and expand the provision of risk capital to stimulate
entrepreneurship and increase the return on innovation investment, Japan’s Economic Revitalisation Strategy
aims to raise the business start-up and closure rates from a roughly 4.5% average to the 10%22 rate in the
United States. As part of these efforts, SMRJ’s SME Growth Support Fund Unit seeks to grow the market for
venture capital (VC) and investment by co-funding (50%) investment of high-growth potential ventures with
VC companies. As of the end of March 2014, SMRJ contributed 289.5 billion yen to a total fund amount of
651.5 billion yen to 203 venture funds, during which 139 supported companies went public. In addition to
sharing risk with VCs by co-investing, SMRJ also provides business management support for venture SME
enterprises, helps with business incubation and matching of VC to SME start-ups, and monitors SME
growth/development with VCs. Funds are monitored for a five year period and expected to deliver a return
after another five years.
In some ways this can be seen as a parallel mechanism to the credit supplementation system, supporting
higher risk enterprises which, being at the start-up level, may be unable to secure traditional bank/loan
relationships. In terms of the moral hazard dilemma, equity financing may be more effective since according
to some studies, in comparison to banking institutions, venture capitalists have a more pronounced role incorporate governance and monitoring the companies they finance.23 However, as officials from SMRJ
admitted, the VC market in Japan remains nascent at best and before risk capital becomes more widely
utilized and understood, it will be difficult to generate returns in the short term (thus, SMRJ’s activities
remain highly dependent on government support). Additionally the scope of start-up SMEs supported by suchfunds remains limited (such as high-tech firms seeking IPO). Nevertheless, SMRJ’s efforts to build
relationships with VC and expand the market for risk capital are notable steps towards improving SME
innovation and ensuring sustainable future growth.

PRIVATE SUPPORT FOR THE “MIDDLE RISK” FINANCING GAPWhile much public focus has been placed on supporting higher risk or high-growth potential enterprises,
both through guarantee backed lending and/or co-investment programs with VC, still this support fails to
capture the needs of a larger segment of SMEs which may exhibit slower growth but are ‘middle-risk’ and rely
heavily on relationship lending. Accordingly, a few notable crowd-funding and multi-investor platforms fromprivate sector have emerged to service this gap. One example of this is Kaz Ohmae’s Crowd Securities Japan,
an online-only securities company which provides funds to support small domestic companies (as well as
micro-financing across emerging markets in Asia), listing a 5% annual yield on average. According to Mr.
Ohmae, the strength in crowdfunding is that although funds are smaller, each individual lender generally
contributes out of personal interest in a company and is more patient about returns 24. Currently, Crowd
Securities Japan’s main offering is crowdfunding supported loan programs, popular among target SMEs. As
Mr. Ohmae explained, even early stage SMEs want to show confidence in their business models, that they can
pay back loans, and thus are eager to borrow. In addition to loan platforms, Mr. Ohmae hopes to expand thebusiness by issuing crowd equity in accordance with recent changes to financial regulation. Under an FSA
22 Based on data measuring the period 2004-2009
23 Financial Intermediaries, Ownership Structure, and the Provision of Capital to SMEs: Evidence from Japan

http://dare.uva.nl/document/2/63531
24 Mr. Ohmae noted that although investors may be patient, as a financial intermediary, Crowd Securities Japan cannot take excessive

risk and in some aspects can be as stringent as traditional banks in checking the credit of the firms it services

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Interview with selected SME support agencies/financial and public institutions

2014 amendment to the Financial Instruments and Exchange Act to take effect end of May, equity fundraising
will be de-regulated so that companies such as Crowd Securities Japan can begin crowdfunding equity forunlisted SME ventures, provided that such activities follow certain guidelines.
In regards to the argument that crowd funding may conflict with the venture capital space, Mr. Ohmae notedthat he doesn’t think the two are in competition but can rather complement each other since target SMEs may
be different: as VCs may pursue more high return/high growth businesses, innovative but “more old-school”
SMEs outside the scope of VC target industries can also receive a stable supply of finance through crowdfunding. As for as eliminating the current credit guarantee system, Mr. Ohmae noted that CGCs still may benecessary since credit assessment by banks remains difficult. According to Ohmae, considering the futurecompetitive success/innovation of SMEs, a more pressing dilemma than the credit guarantee system could be
the issuance of direct public subsidies to SMEs, which has kept firms afloat that are inefficiently using publicresources.
However, although a promising alternative to bank lending, the scale of crowd-funding in Japan still remains
small and it may be some time until more SMEs can be supported by such services as those offered by Crowd
Securities Japan. As Mr. Ohmae and others noted, one public initiative to potentially increase uptake would be
to include contributions towards socially minded SMEs as “tax deductibles,” such as in the case of donations
to non-profits in the US. In addition, to crowd-funding, another note-worthy private initiative for middle-risk
SMEs is Music Securities Inc. Started in 2000, before the concept of “crowd-funding” surfaced in Japan, Mr.
Komatsu created Music Securities as a Type II Financial Instruments Firm, a non-bank financial intermediaryto pool micro-investments (ranging from USD 100-10,000) into business products of micro and small
medium enterprises. Investors understand that unlike loans, their investment is not capital-safe, and do notbuy shares or equity in target business projects; however, as part of a limited partnership agreement initiatedby Music Securities with its target companies and individual investors, investors can receive a certain amountof sales returns once businesses become profitable. Regardless of investment risks, investors contribute toMusic Securities administered funds due to the small amount required of individual investments (a way toshare and pool risk), and the social impact of an enterprise’s business mission.
The project funds administered by Music securities are significant in that they reach a niche market notsupported traditionally by public or other private institutions. For example, many funds are for Japanesesake, agriculture, and fisheries, sectors not supported by CGC backed loans. The funds are also notable for
their relationship lending attributes. Micro-investment allows risk to be distributed across multiple
investors; nevertheless, a clear connection between lender and borrower is managed by Music Securities
through tendering of the silent partnership agreement. Music Securities facilitates the creation of funds,
connecting perspective enterprises to lenders after MS public accountants perform due diligence on
supported businesses, looking not only at bank statements, but “from the perspective of empathy andfeasibility,” gauging potential investor interest and continuing to monitor businesses after an investment
agreement is formed. Investors can then track the status of their supported businesses online or attend
monthly seminars to meet directly with representatives from target businesses. As a result of suchinformation sharing/relationship building, in addition to receiving returns on sales, many lenders become
direct customers of the target businesses in which they invest.
Thus, Music Securities enables risk capital-based financial support of an important segment of SMEs which
may not be particularly ‘high return”/”high growth,’ nor have the intention of becoming publicly traded (andthus outside the scope of venture capital supported funds). In addition, as such SMEs are new businesses
lacking long-standing relationships in which to access traditional relationship-based lending, MS builds

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important connections for these SMEs, facilitating the popularization of such firms among potential investors
in local areas to integrate these firms into local revitalization activities. Nevertheless, Mr. Komatsu noted that
their business still has more potential to expand and widen its reach depending on changing regulatory andbank lending practices. For example, an FSA provision in 2011 which allows in some cases for “silent
partnership deposits to be regarded as capital,” could potentially spur bank lending to otherwise capital poor
SMEs on top of investment by micro-investors. As such, Mr. Komatsu explained that they are in ongoing
discussion with various financial institutions to persuade them to complement their lending activities withthe micro-investment platform of music securities, with the future goal of banks one day offering MS’s microinvestment options as part of their products and services at local branch offices.
In this sense, it is important to consider which types of banking counterparts may be the most appropriate
partners for crowd funding or multi-investor platforms. One potential madoguchi or local customer ‘service
window’ are shinkin banks, which emerged as special financial institutions for SMEs and local residents.
While their lending is in principle limited to members 25, their functions are mostly the same as commercial
banks as they deal with non-members as well, accepting deposits and providing exchange services in 7,500
locations across the country. Because of their extensive local reach, Shinkin banks are able to monitor theirloans through relationship lending and the officials interviewed emphasized their focus on characteristics
such as business “added value,” and contribution to regional revitalization over pure capital gains. In thissense, Shinkin cooperatives seek to gain profits from expanding numbers of customers over focusing solely on
gains per customer. The officials also explained that they are able to gather information about the businesses
they work with through business support activities 26 which further improves relationship lending practices
and addresses management/marketing issues “other than financing”—issues they believe will be morepressing for SMEs in the future than access to credit.

CONCLUSIONAs crucial sources of employment and building blocks to Japanese economic growth, SMEs remain a central
part of Japanese financial and economic policy discussion. Both public and private actors search for effective
financing models in order to successfully support existing SMEs in regional economies while simultaneously
encouraging market dynamism and growth through the introduction of innovative new entrant SMEs.
Although at first glance, Japan’s extensive credit guarantee supplementation system may appear to be overly
protectionist, propping up risk-laden low profitability “zombie firms,” after speaking with various officials andlooking at current data, it would appear that present use of the CGS is more demonstrative of its original
intention, as a predominantly safety net mechanism, with extended use and coverage during periods of
economic crisis, only to decrease in percentage of total loan amounts and subrogated ratio once the economy
stabilizes. In reality SMEs seem to be employing other outlets to secure private funding as CGC backed loans
only make up 10% of total private loans. This may be due in part to the efforts of METI’s SME agency, JFG,
and other government affiliated financial institutions to monitor use of the credit supplementation system
and institute controls/incentives to check against moral hazard and abuse. Additionally, despite continuing
struggles by banks to accurately access SME credit records, a point much of the literature surveyed failed tosignificantly address was the pervasive nature of relationship lending in Japan’s banking culture, which became

25 While regional banks may serve medium sized corporations and mega banks larger corporations, Shinkin Banks are targeted towards

smaller businesses.
26 Business and financial support help businesses at all levels of development but primarily support businesses that are growing andonwards rather than seed level start-ups (similar to Music Securities)

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apparent especially in discussion with shinkin bank officials and multi-party funding platforms such as Music
Securities which attempts to build on this culture of relationship lending. As JFG officials admitted, in the
future SMEs naturally may no longer even require CGCs as a safety net to achieve stable flows of finance.
Certainly improvements can be made to public and private lending programs to introduce more competitive
schemes and build more efficiency into current mechanisms (such as further reductions in the percentage ofcredit guaranteed by CGCs or elimination of non-performance based grants). However, after completing theinterviews for this report, it became clear that publicly backed credit guaranteed loans did not necessarily
crowd out the space for risk capital and innovative investment/funding platforms. In actuality, depending on
the organization interviewed, the target SMEs (by risk level, sector, and/or level of establishment) differed
greatly among financial intermediaries. For example, while the current credit supplementation system
supports more established SMEs in specific sectors, small or niche area SMEs which are less established may
not have credit supplementation available to them as a recourse of action and thus may rely on more
“empathy”/social value based platforms such as Music Securities’ micro-investment. Similarly, withoutpromises of returns as high as the tech industry, such niche but high in local value SMEs (such as sake brewing
projects) may be outside the current scope of SMRJ supported VC/public partnerships funds. The financing
gap for such “middle-risk” enterprises may in the future be filled by the expansion of multi-investor, crowdfunding platforms such as Music Securities and Crowd Securities Japan.
Additionally, as risk appetite in Japan remains low and there is a difficulty to secure early stage “angel”
investors to supply initial capital, even venture-oriented SMEs may still be dependent on bank lending credit;
thus forming strong relationships with local banks willing to support start-ups should be crucial for thesesmall enterprises to establish credit reliability. Thus, in order to facilitate SME financing, not only policy
responses but also cooperation between non-traditional and traditional private financial institutions may benecessary. As Mr. Komatsu of Music Securities indicated, he hopes to one day complement their microinvestment platform with the lending activities of local banks, using the reach of their “madoguchi” or bankservice windows to further build on the advantages of relationship lending. In this sense, traditional lending
offered by institutions such as shinkin banks, rather than being in competition, may one day form the naturalcomplement to multi-investor/multi-funder platforms.

APPENDIX

Summary of Organizations and Service Offerings
METI Small Medium and Enterprise Agency
Product Offering and/or
Services

Type of
Institution

Target SME
customer(s)Legal Basis

Constraints*management support SMEs
*decide characteristic andbudget for public financial
institutions

National
government

Traditional SME‘middle’ risk tohigh/middle risk andreturnSmall and Mediumsized Enterprise
Basic Act (Act. No
154 1963)

Must support broader
national/regional
economy and overall
health of SME sector

Page 9Interview with selected SME support agencies/financial and public institutions

Japan Federation of Credit Guarantee Corporations (CGCS)
Product Offering
and/or Services

Type of
Institution

Target SME
customer

Legal Basis

Constraints*Credit guarantees*Management support

Public financial‘middle’ high risk
eligible*27 SME

SME Credit Insurance
Act 1950*publicly
insured/funded*non-profit, intended assafety net

Org. for Small & Medium Enterprise and Regional Innovation, Japan(SMRJ)-SME Growth Fund Unit
Product Offering and/or
Services

Type of
Institution

Target SME
customer

Legal Basis

Constraints*50% co-fund with VC to SMEs
*promotion, monitoring, andmanagement of VC equity
investment in SMEs

Independentadministrative
agency (under
METI andpartially
MOFA)

All levels of growth
but at start-up stage
tech/high growth
venture (middle
high risk)28

Act on the
Organization for
Small & Medium
Enterprises andRegional Innovation

Still growing VC risk capitalenvironment so take time tosee returns; fund amounts
not yet widely dispersed

Crowd Securities Japan, Inc.
Product Offering and/or
Services

Type of
Institution

Target SME
customer

Legal Basis

Constraints*loan crowd-funding*equity crowd (begin at futuredate)

Crowd-funding
platform

Middle risk/middle
returnType I andType IIfinancial
instrument

Currently focused on loans(debt must be repaid) tosomewhat more stablebusinesses; social impact
important but revenue oriented

Music Securities, Inc.
Product Offering and/or
Services

Type of
Institution

Target SME customer

Legal Basis

Constraints“Equity” like investment(shares are not bought but
investors get return on sales)

Microfunding
platform

Medium risk/medium
return with high potential
for local support/social
valueType II financial
instrument; limited
partnership

Not as wide reach in termsof number of businesses
compared to traditional
institutions

27 *certain eligibility requirements for SMEs to apply for credit guarantee-in addition to size specifications, qualifying SMEs must be oneof industries designated by SME credit insurance act, notably excluding agriculture, forestry, fisheries, and financial industry
28 SMRJ activities are broad-ranging and support SMEs at all growth stages; however for analyzing risk capital activities and growing VC

space, this analysis will primarily discuss the situation regarding support to start-up businesses by SMRJ’s fund unit

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Interview with selected SME support agencies/financial and public institutions

Shinkin Central Bank (SCB)
Product Offering
and/or Services

Type of
Institution

Target SME customer

Legal Basis

Constraints

Loans, business start-up
support, succession
support/M&A, cofinancing

Privatefinancial

Small to medium size
(middle risk/middle return)1951 Shinkin
Bank Law

Capital adequacy (although
increasing) individual shinkins still
small and widely dispersed

Shoko Chukin Bank Ltd.
Product Offering
and/or Services

Type of
Institution

Target SME
customer

Legal Basis

Constraints

Loans (ex. safety net
and business
innovation)

Joint public andprivate financial
institution

Medium risk
established member
SME

1936 Shoko Chukin Bank
Law

Restricted to member
organizations/firms as
customers

Figure 1 (data from Japan Federation of Credit Guarantee Corporations)Trends of outstanding guaranteed liabilities andsubrogated amount
400,000

350,000

339,192

358,507

350,683

344,464
320,786
297,785

300,000

Outstanding guaranteed
liabilities (in 100 million yen)

250,000
200,000
150,000
100,000

Subrogated amount (~2%)
50,00010,358

11,420

9,366

8,608

7,779

6,510

fy2010fy2011

fy2012fy20130fy2008Page 11fy2009Interview with selected SME support agencies/financial and public institutions

Figure 2-Sample questionnaire sent to perspective interviewees
Q1. Abenomics places emphasis on growing securities and venture capital for the future of SMEs. Considering
the current situation, how much emphasis should be placed on traditional banks/other financial lending
mechanisms and risk capital to foster smooth/sustainable growth of SMEs?
問1

アベノミクスは、中小企業の将来のためになるとして、証券市場とベンチャーキャピタルの拡充を重視しています。中小企業の現状に照らすと、中小企業の円滑で持続可能な成長にとって、従来型の銀行融資の仕組みとリスクキャピタルのいずれがより重要でしょうか。

Q2. Among your services for SMEs, what is your primary focus and performance target? Are loans being
provided as a safety net or as seed money for future growth?
問2

中小企業向け金融サービスのなかで、とくに重視されているものは何でしょうか。また、どのよ
うな業績目標を設定されていますか。貸付は「セーフティネット」でしょうか、あるいは成長資金でしょうか。

Q3. What have been your most successful efforts to date?
問3

これまでに最も大きな成果を上げた取り組みは何でしょうか。

Q4. What challenges do you still face in your programs?
問4

御行（御社）が現在取り組まれている課題は何でしょうか。

Q5. Considering these challenges, how do you plan to improve your services for the future?
問5

その課題への取り組みを通じて、御行（御社）のサービスをどのように改善することを目指しておられるのでしょうか。

REFERENCES
Cumming, D., Schweinbacher, A, Fleming, G. (2005). “Financial Intermediaries, Ownership Structure, and theProvision of Capital to SMEs: Evidence from Japan.” Small Business Economics. Retrieved fromhttp://dare.uva.nl/document/2/63531
Lam, R.W, & Lim, J. (2012). “What Role can Financial Policies Play in Revitalizing SMEs in Japan. IMF Working
Paper. Retrieved from https://www.imf.org/external/pubs/ft/wp/2012/wp12291.pdf
Saito, K., & Tsuruta, D. (2014). “Adverse selection and moral hazard in the Japanese public credit guarantee
schemes for SMEs.” VOX CEPR Policy Portal. Retrieved from http://www.voxeu.org/article/adverseselection-and-moral-hazard-japanese-credit-guarantees
Shin, J. (2014) “Finance to SMEs in Japan and Asia.” JFSA-ADBI-IMF joint conference January 27,2014.
Retrieved from http://www.fsa.go.jp/frtc/kenkyu/event/20140312/s2_2.pdf
OECD (2013), “Access to finance: Venture capital”, in Entrepreneurship at a Glance 2013, OECD Publishing.
Retrieved from http://dx.doi.org/10.1787/entrepreneur_aag-2013-27-enPage 12Interview with selected SME support agencies/financial and public institutions

ACKNOWLEDGEMENTS
Special thanks to individuals from the following organizations and agencies who generously granted theirtime for interview and discussion on SME finance, current and future issues:
1)
2)
3)
4)
5)
6)
7)
8)
9)

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METI Small Medium Enterprise Agency
Japan Federation of Credit Guarantee Corporations
Organization for Small & Medium Enterprise and Regional Innovation
National Federation of Small Business Associations
Crowd Securities Japan, Inc.
Music Securities, Inc.
Shinkin Central Bank (SCB)
Shoko Chukin Bank Ltd.
Bright Link Partners