Japanese Banks' Decision Making Process in SME Lending: An analysis of the SME database and the utilization of investment and trust funds for SME financing

This paper comprises three sections. First, it examines whether or not and how banks use non-quantitative data on borrowers, such as the management skills and personality of owners of small and medium-sized enterprises (SMEs), when making lending decisions. Second, it explores the possibility of utilizing data collected from SMEs to assess the risk of their default. Third, it proposes a way to provide money to start-up companies and riskier businesses in the region.

The first chapter is based on data collected through an interview survey conducted by Professor Tadanori Nemoto (Chuo University), Wako Watanabe (Keio University), and Yoshiaki Ogura (Ritsumeikan University). They found that qualitative data are used more often at the branch office level than at the headquarters level in making lending decisions. This shows that those working at headquarters prefer to use solid data when making their lending decisions whereas intuition and the borrowers' behavior play a large part in the decision process by those working at branches.

In future research, an empirical analysis will be required to determine whether qualitative data are in fact sometimes important for SME lending and whether quantitative data are important even in the case of SMEs.

The second chapter reviews the Credit Risk Database (CRD), a database of financial and non-financial information on Japanese SMEs. The chapter explains the mechanism of how SME data collected by prefectural and municipal credit guarantee corporations are integrated into the database. It also points to the importance of ensuring the independence of the database, which can be achieved by allowing the CRD Association (the administrator of the database) to secure revenue sources by offering consultation services to banks, such as the computation of default probabilities, for example.

The establishment of a similar database of SME information in other parts of Asia would put Japanese SMEs and Japanese banks in a better position in launching and expanding operations in the region. Such a database would also help lower the default risks for SME lending in Asian countries. In this regard, cases related to Thailand and Indonesian are briefly discussed.

The third chapter discusses ways of channeling more funds to start-ups and other relatively high-risk businesses. As the venture capital market in Japan is still not well developed, it is necessary to explore different channels to supply funds to SMEs and start-ups. This paper proposes the creation of regional investment and trust funds, which would be sold to the general public through regional banks and post offices. The funds are not on banks' balance sheets as they are not collected from depositors and any losses incurred by the funds are to be borne by investors. This is to say that banks and post offices are simply serving as sales agents. A few specific examples of such investment and trust funds are presented.