Business Feasibility Evaluation and Risk of Natural Disaster: Establishment of the Small and Medium Enterprise Strengthening Act and Expectations for Regional Financial Institutions

In 2019, severe natural disasters occurred across Japan, and many small and medium enterprises (SME) that suffered as a result are frantically working to recover from the damage. As is well known, advance preparations (such as business continuity plans [BCP] (Note 1)) accelerate the restoration and recovery of the business. However, because many small and medium enterprises cannot receive sufficient support for creating a BCP, they have been unable to make advance preparations, and the percentage of SME with a BCP remains at around 20%.

In light of these circumstances, a "law to revise parts of the small and medium enterprise management improvement law in order to contribute to sustaining the business activities of small and medium enterprises" (Small and Medium Enterprise Strengthening Act) was submitted to the Diet, passed in May 2019, and implemented in July. The fact that both the House of Representatives and House of Councilors unanimously approved the bill is evidence of society's strong desire for this law. One of the central pillars of this SME Strengthening Act is to provide support, such as additional credit guarantee limits, low-interest financing, preferential tax treatment for disaster-prevention and damage-reduction equipment, and priority approval of subsidies, made possible via the Minister of Economy, Trade and Industry's approval of business continuity and improvement plans formulated by such SMEs, from the perspective of strengthening the ability of SME operators to sustain their businesses.

The "basic guidelines for business continuity and improvement plans" formulated by the Small and Medium Enterprise Agency 1) espouse the view that in terms of "strategies and efforts for contributing to the strengthening of business continuity capacities," "since there are certain limits to small and medium enterprise operators' ability to set up all advance preparations on their own, encouragement and support by those surrounding SME operators is important," and 2) prescribe "cooperation with efforts to strengthen the business continuity capabilities by parent operators, government-associated financial institutions, and others." As efforts by involved actors, the guidelines then list "the promotion of risk awareness among SME operators by government-associated financial institutions, local banks, credit unions, credit association and the like, support for efforts to strengthen business continuity capabilities, the provision of capital to support such efforts, and support via cooperation with local governments and the like."

The positioning of not only non-life insurance companies but also of regional financial institutions as central actors in efforts to strengthen the business continuity capabilities of SMEs is a significant point of these guidelines, and regional financial institutions must act accordingly.

Due to the fact that a survey regarding efforts by regional financial institutions to support strengthening small and medium enterprises against natural disasters had not been undertaken, as a RIETI research project, we carried out a "survey on SME preparations for natural disasters and support by regional financial institutions" in May 2019, surveying 7,000 branch managers of regional financial institutions. We received responses from 2,623 subjects. The results suggest the following points.

1) Few financial institutions have a firm grasp of whether their business clients have formulated a BCP, and there are similarly few that have encouraged their clients to create such a plan. When asked about "the percentage of businesses among your corporate clients that have established a BCP," 55% of branch managers responded with "I don't know."

2) Regional financial institutions cannot do everything on their own, and they must collaborate with other actors. However, there are few financial institutions that know about recovery support funds, credit guarantee systems and the like, which are related to BCPs, and there is likewise a lack of understanding regarding the BCP support policies of local governments. When asked, "Does your local government (prefecture or metropolitan region) have effective support policies regarding BCP creation by small and medium enterprises?" 71% of respondents answered, "I don't know what kind of support there is," although their local government has BCP support policies for SMEs.

3) On the other hand, efforts towards business feasibility evaluations are making substantial progress, and the ability of personnel to evaluate business feasibility has improved as well. Significant reforms are likewise being implemented in terms of HR evaluation structures and the like in order to substantiate this. When asked, "How has the business feasibility evaluation ability of your corporate business directors changed in the past three years?" 60.1% of respondents said, "It has improved." This marks a large increase compared to responses (43.5%) to the same question asked as part of the "survey on the current states and issues of regional revitalization and regional finance from the viewpoints of branch managers of regional financial institutions" in January 2017 that targeted 7,000 regional financial institution branch managers (Note 2).

4) There is also discernible progress in collaboration with third-party institutions such as credit guarantee associations, the Japan Finance Corporation, and tax accountants (although this is outside of the BCP field).

5) Consideration related to BCPs, however, has not been incorporated into business feasibility evaluations. For example, when asked, "In the event of a large disaster, what kind of responses are you implementing or considering on the financial side in order to support the business continuity of your branch's primary corporate clients?" 70% of respondents said, "We plan to provide working capital," and it is evident that they intend to fully support their primary clients in the event of a disaster. However, only 20% said, "We have estimated the financing to be provided after a disaster." This result shows that there is insufficient communication with businesses regarding risk and that financial institutions are poorly positioned to make advance preparations in conjunction with businesses.

Our survey shows that currently, regional financial institutions are not providing BCP support to the extent expected with the passing of the SME Strengthening Act. On the other hand, there is steady progress in business feasibility evaluation efforts. The reason for this is that improving business feasibility evaluation capabilities is the only path to survival for regional financial institutions.

Whether or not financial institutions will be able to play the role envisioned by the SME Strengthening Act will likely depend on their ability to incorporate plans for strengthening businesses against natural disasters, such as through formulating BCPs, into business feasibility evaluation frameworks. I am optimistic in this matter. After all, understanding natural disaster risk is essential in understanding the strengths and weaknesses of business operators and is consistent with business feasibility evaluation efforts. I hope that regional financial institutions will work on improving the business continuity capabilities of small and medium enterprises as they are essential parts of business feasibility evaluations.