Nonbank Financing and the Moral Hazard of SMEs

One of the major lenders to small and medium-size enterprises (SMEs) is nonbank financial institutions. Unlike deposit-taking banks, nonbank financial institutions - those that do not take deposits - tend to charge high interest rates, instead of asking for collateral, in extending credit to SMEs. Thus, there is a high possibility that information asymmetry between such nonbank lenders and SME borrowers may be creating adverse selection and moral hazard problems. Using the data taken from the "Survey of Financial Environment" conducted by the Small and Medium Enterprise Agency, this paper empirically examines whether or not moral hazard exists on the part of SMEs borrowing from nonbank financial institutions. The paper asserts the following two points:

1) Despite a decrease in both the amount of outstanding loans and the number of establishments, nonbank financial institutions are maintaining a high level of return on assets (ROA), measured as a percentage of recurring profits to total assets, and the total number of branches is not decreasing. Thus, judging from the data available on the part of nonbank financial institutions, it is hard to say that the market for nonbank financial institutions is shrinking.

2) Findings from an analysis of microdata on SMEs with a Bivariate Probit Model point to a high probability that borrowers from a nonbank financial institution will fall into a state of net capital deficiency within one year after resorting to such nonbank financing. Based on this, it is conceivable that companies using nonbank financing are opting for high-risk businesses thus resulting in higher loan loss risks. Such quantitative analysis results suggest that the problem of moral hazard is arising.