Towards True Revival of Small and Medium Enterprises: Moratorium is not the Answer

Japanese Shadow Financial Regulatory Committee
November 13, 2009
Masaya Sakuragawa (Keio University, Chair)
Mitsuhiro Fukao (Keio University)
Kimie Harada (Chuo University)
Takeo Hoshi (University of California, San Diego)
Takatoshi Ito (The University of Tokyo)
Satoshi Koibuchi (Chiba University of Commerce)
Nobuyoshi Yamori (Nagoya University)
Shizuka Kamei, the Minister of Financial Affairs of the new government, surprised the world byannouncing a plan to force banks to provide a three-year moratorium for small and medium enterprisecustomers who are in financial trouble. The final bill that was submitted to the Diet and approved on Nov.
30 does not require banks to suspend debt collection but just encourage them to reschedule the loans
when small and medium enterprise borrowers ask for it. Whether the decision to grant concession is
given to banks or the FSA (Financial Services Agency) de facto requires such concession by strong
guidance remains to be seen.
Problems in the Small and Medium Enterprise Finance Smoothing Act
Even when banks are not forced to reschedule loans against their wish, the new law will generate
several problems. First, the law substantially expands the coverage of the government guarantee on SMEloans. If SMEs default on their loans after those have been rescheduled, the government-run Credit
Guarantee Association will pay for the loans. This extension of government credit guarantee reduces thecost of default on banks and exacerbates the moral hazard problem. Such moral hazard was one of thefactors behind the failure of New Bank Tokyo, which was rescued by ¥40 billion recapitalization from its
founder Tokyo Government.
Second, government credit guarantee can make loan rates insensitive to credit risk. Indeed theBank of Japan’s Financial System Report (September 2009) points out that the expanding government1

guarantee has made it difficult for banks to charge high enough interest rates to compensate for the credit
risk. Inability to charge appropriate interest rates can jeopardize the profitability and financial health of
the banking sector.
Third, many SMEs may be hesitant to apply for the loan restructuring, fearing the stigma attachedto it. As a result, only the firms in the deepest trouble would apply for restructuring, increasing thelikelihood of defaults of restructured loans. Thus, the new scheme can just end up subsidizing the firmsthat eventually fail.
Fourth, under the new scheme, the FSA is reported to change the inspection manual so that thebanks do not have to count the restructured loans as non-performing. Such opportunistic revision of thefinancial supervision will reduce its transparency and hurt its credibility.
Finally, if the FSA ends up de facto forcing the banks to restructure SME loans, banks will
become reluctant to extend new SME loans, fearing that those loans may be forced to be rescheduled inthe future. Thus, the scheme to protect the current SME borrowers can increase the risk of new SME
loans and end up hurting new SME borrowers. Since the law encourages banks to restructure mortgage
loans as well, it can have a serious impact on the market for securitized loans, too.
Problems for the Small and Medium Enterprises in Japan
What motivated the law is the recognition that credit crunch and credit squeeze are hurting SME
borrowers. Statistical and survey data, however, do not support such a concern.
Figure 1 shows the number of SME bankruptcies by year. In 2008, the year of the Lehman Shock,
15,323 SMEs went bankrupt, but this was much less than around 19,000 a year in the early 2000s.
Moreover, the SME bankruptcies have been declining since April 2009. The total amount of bank loans
for SMEs does not show any sign of sudden decline in recent years. Japanese banks did not have much
exposure to sub-prime related products compared with the US and European counterparts and has not lostmuch capital. Thus, credit crunch caused by the capital shortage like the one in the late 1990s is not likely
happening this time.

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Figure 1: Bankruptcies of SMEs in 1980-2009（Jan.-Sept.）

Number of Firms
25,00020,00018,69919,09019,022

16,19015,52315,00014,015

13,62912,941

13,201
11,885

10,000

5,000

0
2000

2001

2002

2003

2004

2005

Year

2006

2007

2008

2009.1～9

Source: Tokyo Shoko Research (TSR)

Indeed, banks have already been rescheduling SME loans. For example, a survey by TheResearch Institute of Economy, Trade and Industry (RIETI) in February found that about 9% of small andmedium enterprises (sales less than ¥1 billion) received moratorium for their loan repayments after theLehman Shock of September 2008. The survey also shows that smaller firms are more likely to receivemoratorium.
In the Survey on Small and Medium Enterprises conducted by the FSA in August, more than 70%of SMEs listed "deteriorated business conditions" as the primary cause of their financial difficulty. Few
firms outside the construction and real estate industries chose "tighter lending attitude of banks" as theprimary cause. The trouble of many SMEs does not come from credit crunch but from low profitability of
their business. Figure 2 shows the average profit rates for small manufacturers (capital less than ¥10million) and large manufacturers (capital more than ¥1 billion). Profit rates for both types of firms fell in
the 1990s, but the drop was more dramatic for small firms. Thus, the SMEs have to restructure not only
their liability side but also their business to restore profitability.

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Figure 2: Operating Profit / Total Asset (Manufacturing Firms)
10.0%Sma ll firms with capital less than 10 million yen
Large firms with capital more than 1 billion yen
8.0%

6.0%

4.0%

2.0%

0.0%

‐2.0%
Source: Policy Research Institute, Ministry of Finance, Japan,"Financial Statements Statistics of Corporations by Industry"‐4.0%

Fiscal Year

New entry of profitable firms would also help restoring the profitability of the SME sector, but
the entry rate remains much lower than that of other developed economies.
Reviving the SME Sector
As we discussed, the new law is likely to generate many problems. If the FSA forces banks toreschedule the SME loans by strong guidance, the problems would become even more serious.
What is necessary for revival of SMEs is not the expansion of government guarantee and moregovernment intervention, but economic restructuring at both firm level and industry level. There areseveral government policies that may help the process. The first and foremost is a policy to keep thebanks well capitalized. Well capitalized financial institutions will actively seek for new customers withprofitable prospects. Although the capital shortage is not yet a serious issue for many Japanese banks now,the continued global financial turmoil can still make some of them short of capital in the near future.
Second, institutions like the Industrial Revitalization Corporation in Japan (IRCJ) may be helpful
in resolving the collective action problem among multiple creditors of distressed firms. Unlike the early42000s when the IRCJ was established, however, Japan now has many private equity funds for corporate
restructuring and improved court-supervised bankruptcy procedures. A government sponsored entity like
IRCJ is probably not necessary at this point.
Third, there are policies that can encourage new entry more directly. The government may
consider expanding the preferential tax treatment for individual investors for startup companies to otherfinanciers of such companies. Financial institutions can be encouraged more to explore SMEs with newtechnologies. It is important to note that a policy to protect incumbent firms often ends up discouraging
new entries and is counterproductive.
Finally, it is very difficult for the SMEs to improve their profitability under deflationary
environment. Bolder macroeconomic policy to fight deflation is a necessary condition for the revival of
the SMEs and the Japanese economy.

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