Quantitative Assessment of the Roles Played by Governmental Financial Institutions for SMEs

During the serious recession in the aftermath of the collapse of Lehman Brothers, governmental financial institutions served as a major source of finance for businesses. What impact does such government-backed lending have on the financing and business performance of companies? The government sector has an important role to play in the process in which financial institutions act as an intermediary to channel funds between various economic entities such as households and corporations. In particular, financing through financial institutions owned and operated by governments has a significant influence on the flow of funds in the economy.

A unique feature observed in Japan is that there was a big swing in the public's perception of the role of governmental financial institutions. In the mid-2000s, when the government under then Prime Minister Junichiro Koizumi pushed forward the reform of governmental financial institutions in parallel with the privatization of post offices, governmental financial institutions were criticized for impeding the efficient allocation of capital by squeezing out private-sector participation in financing. This perception resulted in the reorganization and consolidation of governmental financial institutions and a decrease in the volume of their work. However, the shrinking trend in the volume of work came to an end in the wake of a huge negative shock. As Japan was hit by a succession of negative events, namely, the collapse of Lehman Brothers in fall 2008 and the subsequent sharp economic downturn and the Great East Japan Earthquake of March 2011, the importance of governmental financial institution as a provider of funds was re-emphasized and the share of governmental financial institutions in the total outstanding loans increased.

One reason why the public's perception of governmental financial institutions has swung back and forth is the limited availability of empirically-supported knowledge on the role of governmental financial institutions. While they are perceived to have played a significant role during the severe recession that started in fall 2008, very few quantitative findings are available to substantiate the perception. What kinds of companies were given loans by governmental financial institutions in times of crisis? How have such companies performed after receiving government-backed loans? Have the lending activities of private-sector banks been unaffected by government-backed lending? Those questions remain largely unanswered with very few convincing answers offered.

Against the backdrop of these observations, I would like to introduce some of the findings from our research (Uesugi, Uchida, and Mizusugi (2014)) conducted by using a large volume of firm- and contract-level data that have been made newly available. The target of our analysis is lending by the SME Unit of the Japan Finance Corporation (known as the Japan Finance Corporation for Small and Medium Enterprise (JFCSME) before October 2008; hereinafter referred to as "JFC"). JFC had approximately 6.5 trillion yen in outstanding loans as of the end of March 2013, serving as a major source of funds for SMEs, which typically have limited means of financing other than borrowing from banks. In this study, we examined JFC loans made in the period from the late 1990s to date. For this article, however, I will focus on the role played by JFC during the period of severe recession following the collapse of Lehman Brothers. Specifically, I will examine: 1) what kinds of companies were provided with JFC loans during the crisis and 2) how such companies' performance changed after receiving JFC loans, i.e., whether or not JFC provided loans to those that would eventually go bankrupt.

During the recession following Lehman Brothers' collapse in fall 2008, not only did JFC increase the number of loans made, but also changed its lending behavior significantly to accommodate loans even to those companies whose performance in the latest period has been rather poor. Fig. 1 shows the number of new borrowers of JFC loans for each year from 2005 through 2012. We can see that the number of new loan contracts, which had been on a gradual decline, doubled in 2010 (between April 1, 2009 and March 31, 2010) and was fairly high in 2011.

In addition to the increase in the number of borrowers, the attributes of borrowers changed significantly. Shown in Fig. 2 are the marginal effects of determinant factors on JFC's new loan decisions made each year. From this, we can see that typical new borrowers of JFC loans used to be companies that are highly profitable, those having good credit standing and thus subject to low interest rates, and those with growing sales. However, such tendency became less pronounced in the post-Lehman period. For instance, a one percentage point increase in return on assets (ROA) pushed up the probability of obtaining a JFC loan by 0.6 to 1.0 percentage point in the years through 2009, but by only 0.2 percentage point from 2010 onward. Likewise, our estimates found that two other factors--i.e., the rate of sales growth and the rate of interest paid as an indicator of creditworthiness--did not have a statistically significant impact on the probability of obtaining a JFC loan in 2010. It is presumed that in the face of the deepening recession, JFC broadened the scope of borrowers to include companies with low creditworthiness.

The next question is whether or not JFC's lending in the post-Lehman period caused more companies to go bankrupt afterwards than would have been the case otherwise. In order to verify this, we need to examine how the performance of companies that borrowed differed from that of those companies that had similar financial attributes but did not take out JFC loans. Fig. 3 presents the results of one such comparison, for which default probability in a given year (t) in which a JFC loan was made to a borrower and the following year (t+1) is used as a performance measure.

It shows that the default probability of companies that obtained a JFC loan in the post-Lehman period is generally lower than that of their non-borrower counterparts. For instance, as shown in the right-end column of the table, the probability of defaulting in 2011 for companies that took out a JFC loan in 2010 was 1.5 percentage points lower than that for their non-borrower counterparts. As far as judging from these findings, JFC lending in the post-Lehman period was effective in reducing the default probability of loan recipients for the period examined.

Based on the above findings, we can say that JFC broadened the scope of borrowers in the wake of the serious recession following Lehman Brothers' collapse, making loans even to those with relatively low credit standing, and that the default probability of JFC loan borrowers in the subsequent period was generally lower than that of non-borrowers.

However, further verification is needed before translating these analytical findings into precise policy proposals. The cost of emergency measures must be considered. JFC's granting of loans to an extensive scope of borrowers would alleviate their liquidity constraints. However, this would entail serious moral hazard on the part of companies if they come to expect that they can get support from the public sector in the event of crisis. Further analysis is required to determine how such cost will be reflected in the bad debt ratio and other performance indicators on the side of lenders.

Apart from our analysis presented in this article, a series of attempts are being made to quantitatively evaluate the effects of government-backed lending by focusing on JFC loans. Research themes being pursued include: the economic welfare effects of government-backed lending in times of crisis; the effects of the JFCSME's special lending programs in 1997-1998 designed to help SMEs suffering from credit crunch; characteristics of governmental financial institutions as found in a survey of borrower companies; a comparison of governmental and private-sector banks in credit appraisal techniques; and the effects of JFCSME's unsecured loan program implemented on a large scale in 2008 onward. It is hoped that the accumulation of those research findings will prepare the ground for more precise discussions on the role of public-sector financial institutions.