DP2018-03

Japanʼs Credit Guarantee System
Reform of 2017 and New Functions ofCredit Guarantee Associations
Nobuyoshi YAMORI

February 13, 2018

February 13, 2018

Japan’s Credit Guarantee System Reform of 2017 and
New Functions of Credit Guarantee Associations
Nobuyoshi Yamori #Professor
Research Institute for Economics and Business Administration
Kobe University

Abstract
In June 2017, the Japanese Diet passed “the Act on the Partial Revision of the Small andMedium-sized Enterprise Credit Insurance Act to Promote Improvements and Developments of
SME's Business Management” (Credit Guarantee System Reform Act in short) in order to enhance
the roles that credit-guarantee system plays in terms of supporting SMEs. In this paper, the author,
who was a member of the Small and Medium Enterprise Policy-Making Council's Financial Working
Group (the Financial WG), tries to explain what this reform aims.

Key Words
Credit Guarantee, SMEs, Bank, Government Support, Japan# Needless to say, this paper consists of the author's personal opinions and interpretations, and is notintended to represent the positions of the Small and Medium Enterprise Policy-Making Council's
Financial Working Group (the Financial WG) or the Small and Medium Enterprise Agency of theJapanese Government.
11. Introduction
In June 2017, the Japanese Diet passed “the Act on the Partial Revision of the Small andMedium-sized Enterprise Credit Insurance Act to Promote Improvements and Developments of
SME's Business Management” in order to reform the credit-guarantee system. The author was amember of the Small and Medium Enterprise Policy-Making Council's Financial Working Group (theFinancial WG). The Financial WG prepared “the Report to Establish a Sustainable Credit
Enhancement System to Support the Development of Business of SMEs and Small Enterprises,"
which served as the foundation of the reform act. As I participated in deliberations, I have high hopes
for various developments in line with the reform act and the enrichment of support for small andmedium-sized enterprises (SMEs).
For these hopes to be met, it is essential to have an accurate understanding of what the reform act
requires the credit guarantee associations. This paper, based on the Financial WG report, discusses the
new functions that credit guarantee associations are expected to provide and the issues faced inaddressing those challenges.

2. What Issues Did the Financial WG of the Small and Medium Enterprise
Policy-Making Council Try to Solve?
In the Japan Revitalization Strategy 2015 (June 2015), the Small and Medium Enterprise Agency
was asked to "deliberate regarding credit-guarantee system’s developments to promote further active
support by financial institutions to SMEs that undertake management reforms and productivity
improvements." Following the directions of the Japan Revitalization Strategy, the Financial WG wasestablished within the Small and Medium Enterprise Policy Making Council, and began deliberationsin November 2015.
As pointed out by the Japan Revitalization Strategy, the main reason why this deliberation started
was a concern that the credit guarantees were so generous that they were presenting an impediment tothe support incentives of financial institutions. As the launch point of these deliberations was theJapan Revitalization Strategy, it is clear that the focus of the discussions was how to transform thecredit-guarantee system to enrich the support offered to SMEs by financial institutions. In other words,
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the main purpose was not how to contract the role of the credit-guarantee system, nor how to reduce its
fiscal burden.
For example, following the collapse of Lehman Brothers, the increase in the number of companies
with relaxation of terms for loan repayment was unavoidable, but normally companies would be
expected to implement management improvements with support from financial institutions andextricate themselves from these tough circumstances within a few years. However, according to datafrom the Small and Medium Enterprise Agency, although the number of companies with relaxation ofterms for loan repayment has decreased slightly, the rate of decrease has been unexpectedly slow.
Some argued that this was because financial institutions were no longer providing sufficient support
as the result of the robust protections provided under the Emergency Guarantees 1.

3. What Did the Financial WG Propose to Enhance Functions of Credit Guarantee
Associations?
Through over a year of deliberations, in December 2016, the Financial WG issued a report titled,"Establishing a Sustainable Credit Enhancement System to Support the Development of Business of
SMEs and Small Enterprises." The "Support the Development of Business" portion of the title
reflected the Financial WG's members’ hopes for reforms.
The introduction of the Financial WG report stated, "It is important to provide sufficient credit
through the credit enhancement system." The report pointed out the importance of the credit-guarantee
system for SME financing, and stated that the objective of the report was to deliberate regarding
policies for "promoting the business development of SMEs and contributing to greater productivity
and regional revitalization while minimizing side effects." This indicates that the key to theseguarantee system reforms was the enhancement of functions for providing support to SMEs, and that itwas expected that credit guarantee associations would play major roles in providing this support.
Based on the "efforts based on life stages" and "guarantee association operation" in the report, this1

When the loans guaranteed under the Emergency Guarantees become uncollectible, banks

extending the loans can receive 100% compensation from credit guarantee associations and therefore
suffer no losses.
3section explains specifically what the report expects with regard to enhancements of credit guarantee
associations’ function.

(1) Securing of conventional loans
As discussed above, the major objective of this reform was to promote the provision of support byfinancial institutions, led by main banks, for SMEs that had been left unchanged, without
implementing management improvements. In the words of the report, its goal was for financial
institution activity which would "provide financing based on evaluations of business, without excess
reliance on credit guarantees, appropriately provide follow-up management and business support
during the financing period, resolve problems while communicating with enterprise operators, andpromote the development of business."
Initially, the Financial WG considered uniform reductions to guarantee ratios depending on
individual firms’ life stages. However, through interviews with financial institutions, the Financial
WG found that bank branch managers didn’t focus on the difference between 100% guarantees and
80% guarantees. Therefore, we concluded that the current sharing of responsibility did not produce
significant differences in terms of fostering support incentives at bank branches. This suggests that tochange the behaviors of branch managers of financial institutions, significant reduction of guarantee
ratios would be necessary, but this would greatly increase the likelihood that they would not serve as
safety nets when the SMEs really need governmental supports (e.g., the Lehman Crisis). Also, there
were concerns that mechanically deciding guarantee ratios based on life stage, etc., would frequently
result in incompatibility with the actual management conditions of SMEs, which are highly unique,and therefore deteriorate the quality of credit guarantee-based SME support.
The report therefore recommended prioritizing the securing of conventional loans (i.e., bank loans
without public credit guarantees), stating, "Noting the conditions and trends of credit transactions,
including past loans by financial institutions, operation condition assessment and understanding ofbusiness viability, such as the effects of recent loans of funds, and support efforts such as policies forproviding loans in the future, it would be effective to flexibly allocate risk burdens between credit
guarantee associations and financial institutions based on the actual conditions of individual SMEs."
It also called for the ratio of conventional loans to be "flexibly adjusted based on the actual conditionsof individual SMEs." For example, even companies that have seen steady growth in sales and are still4

in their growth and development phase may experience a sudden downturn in sales due to some factor,
and be unable to secure a conventional loan from a financial institution. Mechanically setting credit
guarantee ratios might result in financial institutions cutting off funding, but using a system in whichratios are flexibly set would make it possible to handle such situations by, for example, increasing theamount of loans with guarantees when necessary.
In order to achieve an appropriate balance of risk bearings, credit guarantee associations are
expected to play new roles when receiving requests for guarantees from private financial institutions.
That is, until now it was enough for the associations to assess the repayment capabilities of the loan
recipient. In the future, however, they must also take the support stance of private financial institutions
into consideration, and they are expected to include the financial institutions' support attitude in theirguarantee approval conditions. In particular, credit guarantee associations are hoped to review andrevise their application processes and evaluate whether applications for usage of guarantees only
increase the amount loaned, without helping to improve the productivity of companies taking out
loans.
Going a step further, appropriate risk allocation is not just a function exercised during the guarantee
use application process. In the future, there is a need for continuous monitoring of whether private
financial institutions are continuing to provide conventional loans and appropriate support forcompanies receiving guarantees. For example, it is essential to avoid situations in which conventionalloans that existed when guarantees were applied for are paid off at some point, and main bank support
stances crumble.
The flexible system proposed by the report, if implemented properly, would be extremely effective,
but great problems could occur if it is not implemented properly. The deciding factor behind thesuccess or failure of this new system is the competence of individual credit guarantee associations. If acredit guarantee association were a bad doctor, it would continue to prescribe medicine for patientsthat weren't sick, and fail to prescribe medicine in a timely fashion to patients who truly needed it. It
would be a great failure indeed if mechanical rules turned out to be the better alternative.

(2) Enhancement of credit guarantee association functions
In the section on credit guarantee association operation efforts, the report states, "guarantee
association operations have traditionally been focused on guarantees and reclamation, but with the5changing environments the roles required of them are also changing." The report confirms that roles ofcredit guarantee associations have changed to meet the changing demands of the times, and further
states, "their support efforts have been strengthened in terms of management improvements in
response to the sudden increase of companies with relaxation of terms of loan repayments as the resultof the financial crisis prompted by the 2008 collapse of Lehman Brothers, and credit guarantee
associations have prepared objective and fair operation systems." It is evident that the report
positively evaluates the recent efforts of and handling by credit guarantee associations.
The report goes on to provide recommendations for further function enhancements, so I will explain
in line with the report's recommendations.

(i) Appropriate risk allocation between credit guarantee associations and financial institutions
As mentioned in the preceding section, the goals of the current reforms are "to promote support byfinancial institutions by implementing risk allocation through the appropriate combining of credit
guarantee-backed loans and conventional loans based on the business conditions of SMEs."
It is important to note that "when handling with SMEs whose business conditions are deteriorating,credit guarantee associations must take into sufficient consideration the support stances of financial
institutions." Credit guarantee associations must "handle" cases based on "sufficient consideration of
the support stances of financial institutions." In order for this to be effective, it is essential that credit
guarantee associations and private financial institutions deepen their mutual understanding throughday-to-day communication. Credit guarantee associations may also vary their handling methods basedon the stances of financial institutions, such as streamlining association’s screening processes or
prioritizing the handling of preferred credit products for outstanding financial institutions.
The report also states, "When a main bank cannot provide sufficient funding, it is also important toenhance the consultation scheme between credit guarantee associations and SME support institutions,such as having credit guarantee associations provide introductions to other financial institutions, or
having SME support institutions promptly connect with credit guarantee associations when they are
asked from SMEs a help regarding financing." Performing these functions is expected to ensure thatcredit guarantee associations work as safety nets in terms of support. What credit guarantee
associations can do on their own is limited, so it is important that they build close relationships torealize effective coordination with outside support institutions. Fortunately, all credit guarantee
6associations have past experience as the secretariat of the SME support network, so there are highhopes that they will further develop their functions based on this experience.

(ii) Promotion of management support and business turnaround
Credit guarantee associations have implemented various management improvement measures in thepast. They will be required to implement yet more measures in the future. For example, one of the
problems frequently encountered with corporate turnaround is that multiple financial institutions are
involved, so coordination between creditors stalls, time passes without progress being made, andsupport is therefore delayed. When these difficulties with coordination between creditors occur, credit
guarantee associations can be effective in resolving them by acting as secretariats in bank meetings(management support meetings), and by further enhancing and enriching the support they offer.
Furthermore, with regard to situations in which main banks do not sufficiently respond to issues, thereport recommends that "credit guarantee associations actively handle situations, for example bydispatching experts at their own discretion."
Regarding business turnaround, the report also recommends that they "flexibly abandon the right toreimbursement in order to implement turnaround plans in a timely fashion while taking individual
conditions into consideration," and that, with regard to the reclamation operations of credit guarantee
associations, they "should make the perspective of renewed efforts by enterprise operators into
consideration and take appropriate actions."(iii) Contributions to regional revitalization
With regard to "contributions to regional revitalization, etc.," the report recommends "thedevelopment of new guarantee products (including the nationwide roll-out of products currently only
available to agricultural business implemented in National Strategic Special Zones) in coordination
with local governments, etc., that are addressing regional issues, and support for the promotion ofbusiness creation efforts." In addition, it recommends "capital subscription of regional revitalization
funds (and consideration of expansion of the subscription scope to funds other than revitalization
funds)."
I would like to share my own views on the potential for capital subscription of various funds. First,
the capital subscription of revitalization funds became possible with the legal revisions of 2008, and7credit guarantee associations have already developed an extensive track record of this investment.
However, the actual amount of capital subscription is extremely small, and at present this investment
is more important symbolically than financially. Nevertheless, these efforts have been worthwhile,
because it has become possible for guarantee association personnel to become involved inrevitalization fund operations as revitalization fund financers and build up experiences, and thiscontributes to the creation of personal networks about revitalization business. This experience willcontribute to the expansion of functions of credit guarantee associations. There is great potential forrelaxation of prohibitions to lead to similar extension into new fields other than revitalization.
There have also been criticisms that credit guarantee associations, which have in the past only
guaranteed loans, are unable to serve their functions as fund investors, and they should leave equity
investment to other investors. Credit guarantee associations are, recognizing these concerns, actually
becoming involved through the capital subscription of private funds. Therefore, I do not believe thatthe current state of capital investment, or minor expansion of this investment, will present any major
problems.
I do, on the other hand, believe that credit guarantee associations need to think seriously about how
they will position capital subscription in their business model from a medium- and long-term
perspective. In other words, the question credit guarantee associations must consider is whether they
will position fund operations as financially important operations. From the perspective of achieving
the ultimate goal of improving SME productivity, there are times when providing capital funds is more
appropriate than providing liability funds (i.e., loans backed by guarantees). For credit guarantee
associations to strengthen their support for SMEs, it makes sense to allow them to use a broad range offinancing methods.
In startup support and revitalization support operations, it is difficult to have the companies
receiving the support bear the support costs at the point at which the support is offered. Instead, it isnatural to reclaim the costs later, when business results are on track. The current guarantee system,
though, has little in the way of performance fee elements, and in actuality, financing support is seldom
recouped. Currently, credit guarantee associations still have the financial base strong enough to handle
this task, but, in the future, support is expected to be positioned as their main duty, and the scale ofsupport is expected to grow commensurately. Therefore, it is impossible to allow their support
business to continue to be in a deficit in the future. When considering how the medium- and8long-term sustainability of credit guarantee association operation can be achieved and how
performance fee elements can be included within these operations, the expansion of capitalsubscription will be an effective option.

(3) Promoting information disclosure and improving operation efficiency
The report also expresses hopes for the active efforts of credit guarantee associations with respect topromoting information disclosure and improving operation efficiency in various areas.
With regard to information disclosure, credit guarantee associations do publicly releasemanagement policies, key issues, and business plans on a regular basis. They also perform internal
evaluations and undergo external evaluations, so we can say that they have some degree oftransparency. I have worked as an external evaluation committee member for Aichi Credit Guarantee
Association since 2013, and, based on my experience, I have concluded that outside evaluations
function sufficiently. Of course, they do not have monthly meetings, like the outside directors ofcorporations, and outside evaluation committees only meet once a year, but I have asked questions ofand received explanations from the association on an as-need basis, and have made outside evaluations
based on large amounts of information. However, operation practices appear to vary widely among
credit guarantee associations, so outside evaluations likely need to be further enriched.
At the same time, outside evaluation committees need to evaluate credit guarantee associations
based not only on conventional perspectives such as amounts of approved debt guarantee, amounts of
payment in subrogation, and reclaimed amounts, but also from the perspective of achieving theultimate objectives of improving the management of guarantee recipient companies and contributing
to the vitalization of local economies. As a member of an external evaluation committee, I would liketo emphasize (while also cautioning myself) the need for qualitative improvements to external
evaluations.
Also important is the promotion of operation efficiency improvements. The report points out that
"implementing operation efficiency improvements, such as simplifying systems and administrative
procedures, is important for credit guarantee associations." As readers are surely aware, the fusion offinance and technology (fintech) is advancing at a rapid pace. Unfortunately, inspection tours to somecredit guarantee associations by the Financial WG have left WG members with the feeling that credit
guarantee associations still have a great deal of room for labor-savings through the use of IT.
9Of course, there are also legal and regulatory demands that make it difficult to immediately
eliminate printed paperwork. However, using IT to improve efficiency has the potential to reduce thedocument creation and submission workload placed on SMEs, accelerate screening and otherprocedures, and thereby improve the speed of guarantee procurement. For credit guarantee
associations and financial institutions, reducing administrative processing workloads would make itpossible to assign people to operations in which they are more essential. This is an issue I strongly
believe should be addressed.

4. Conclusions
The Financial WG recommends reductions in the use of credit guarantees for growing companies,
and, in reality, approved guarantees are significantly falling within several credit guarantee
associations (Figure 1). This may leave staff members uneasy regarding the futures of theirassociations. I would like to share my opinions on this subject.
As I have stated several times above, the Financial WG does not seek to reduce the roles of credit
guarantee associations. This should be clear from the fact that it recommends expanding maximum
amounts of guarantee coverage for startup firms and establishing new guarantee options forrevitalization.
The Financial WG has advocated that growing firms "graduate" from credit guarantees because theWG recognize that financial institutions often ask corporate customers to use credit guarantee notdue to benefits of customers but due to interests of financial institutions. Namely, financial institutions
can get lazy about monitoring and supporting customers if the loans are protected by the credit
guarantee associations.
Stepping away from the report for a moment, my personal opinion is that I hope that credit
guarantee associations increase their presence so much that companies in their growth phases want to
use the guarantees provided by credit guarantee associations. For example, when purchasing an
automobile insurance policy, premiums are important, but another factor which is no less important is
how the insurance company handles accidents. For a company taking out a loan, a guarantee-backed
loan from a credit guarantee association would provide the company with a sense of security because
the credit guarantee association monitors the bank's actions. The management support and information10

provided by the credit guarantee association would also be valuable contributions to the company's
development. I believe credit guarantee associations should strive to create these conditions, so that
SMEs would spontaneously continue to use guaranteed loans instead of just conventional loans.
Through the Financial WG's deliberations, I have been left with a strong impression that local SMEs
rely significantly on credit guarantee associations. Living up to those expectations is no easy matter. In
a questionnaire survey sending to staff members of regional financial institutions, I found that thesense of accomplishment among staff members working for financial institutions that highly value
efforts to support customers is greater than that of those working for financial institutions that do notvalue providing support to customers (Yamori and Yoneda, 2017). I have not conducted a study ofstaff members of credit guarantee associations, but I suspect that the results would be similar. If so, the
new task expected of credit guarantee associations is all work which would contribute to a greater
sense of accomplishment among staff members. While it may be difficult, I hope that they would findjoy in this rewarding work, and take an enthusiastic approach to it.

Figure 1. Percentage Changes of Amounts of Guaranteed Loans (Comparison of theaverage figure of FY 2014 with that of FY 2016).

120.0%
100.0%
80.0%
60.0%
40.0%
20.0%
0.0%

Kumamoto

Hyogo

Chiba

Aichi

Osaka

SaitamaTokyo

Shizuoka
ToyamaFukui
Ishikawa(note) This figure is based on the author’s calculation, using the disclosed figuresavailable at the website of the Small and Medium Enterprise Agency of the Japanese
Government.
11References
Yamori, Nobuyoshi (2017a), "Fixing the Misunderstanding about the Proposed Reform of theCredit Guarantee Program," http://www.rieti.go.jp/en/papers/contribution/yamori-nobuyoshi/01.html (Japanese version appeared in Kinyu Zaisei Jijyo, May 29, 2017.)
Yamori, Nobuyoshi (2017b), “Challenges Facing the Managers of Japanese Regional Banks: Human
resources capable of helping customers solve problems are the key to success,”
http://www.rieti.go.jp/en/papers/contribution/yamori-nobuyoshi/02.html(Japaneseversionappeared in Nihon Keizai Shimbun, August 29, 2017.)
Yamori, Nobuyoshi (2017c), “Expectations for Enhancement of Functions that Credit Guarantee
Associations Will Provide,” Credit Guarantee No.133 September 2017. (in Japanese).
Yamori, Nobuyoshi, and Yoneda, Koji (2017) “Current Situation and Challenges of Human
Resources Management of Financial Institutions: A Result of the 2017 Survey on Young andMiddle Staff of Financial Institutions,” Kobe University, Research Institute for Economics andBusiness Administration, DP2017-J08. (in Japanese).

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