RIETI Policy Symposium

Japan's Financial System: Revisiting the Relationship between Corporations and Financial Institutions

Information

  • Time and Date:
    Thursday, February 16, 2006, 13:30-17:10
    Friday, February 17, 2006, 9:00-17:00
  • Venue:
    Hall, Shinsei Bank (1st Floor, Head Office, 2-1-8 Uchisaiwaicho, Chiyoda-ku, Tokyo)
  • Language:
    Japanese / English (with simultaneous interpretation)

Summary of Proceedings

Session 3: Is relational banking relevant for corporate revitalization? Cooperation among and respective roles of financial institutions, revitalization funds and public institutions

Session Chair: HIROSE Sumio (Assistant Professor, Faculty of Economics, Shinshu University)

Presentation 1: XU Peng (Faculty Fellow, RIETI / Professor, Faculty of Economics, Hosei University)
"Bank-firm relationship and choices in legal bankruptcy proceedings of SMEs"

Presentation 2: MATSUO Junsuke (Professor, Faculty of Business Administration, St. Andrew's University)
"Relationship between regional revitalization funds and regional financial institutions"

Presentation 3: TAGASHIRA Shoichi (Professor, Law School, Sophia University)
"Policy deployment and the role of regional financial institutions in SME revitalization"

Comments: YASUDA Takehiko (Faculty Fellow, RIETI / Professor, Faculty of Economics, Toyo University)

Session Summary

In this session, three presentations were made to examine the impact on corporate revitalization of relationships with financial institutions, employing corroborative evidence, examples, and system research.

As commentator on the session as a whole, Professor YASUDA Takehiko made comments that encompassed all three reports, pointing out that the concept of relationship banking in its pure form would be somewhat difficult to apply at the stage of the initial financing of a firm and in its revitalization phase. He posed the comprehensive question, "If relationship banking is employed at the revitalization phase and it is ultimately unsuccessful, in what way should the relationship banking differ from normal cases?"

Outline: Professor XU Peng presentation

Prof. Xu's presentation was on the subject of "Bank-firm relationship and choices in legal bankruptcy proceedings of SMEs," setting out the following points.

The role of a bank is said to be the production of information, playing the dual role of advance screening and subsequent monitoring.

The role of collateral is to manage risk and to control moral hazard on the part of the firms being financed. Unless the collateral value is less than the amount of the loan, banks do not conduct advance screening.

A key point about relationship banking is the absence of collateral and of guarantees. It creates the incentive to place maximum effort on advance screening, but it does not give any incentive to conduct subsequent monitoring.

In the case of collateralized short-term loans there is no incentive for banks to produce information. Therefore, even if firms' business performance undergoes some degree of deterioration, the situation tends to go unattended, and that leads to a very high probability of their going bankrupt if they are subject to legal liquidation.

Among large firms there is a high probability of opting for revitalization, whereas we find that in most cases small firms end in bankruptcy. Looking at business performance just before the bankruptcy, it is not necessarily the case that good firms were revitalized.

We found indications that when firms are under legal restrictions, whether they are revived or liquidated depends to a large extent on their relationships with their banks, the collateral pledged, and the volume of deposits rather than on fundamentals.

The options for restructuring a bank's business model are (1) to scale down, (2) to increase uncollateralized and unguaranteed financing, and (3) covenants.

In the case of uncollateralized and unguaranteed financing, unless very serious advance screening and risk management are conducted, the course of relationship banking would likely end in misery.

Prof. Yasuda posed the following questions concerning Prof. Xu's presentation.

Do earnings factors prior to a firm's bankruptcy have an effect on the choice of rehabilitation or liquidation?

How do you deal with type of business as a factor in your analysis?

The following response was made to these questions.

Business performance just before bankruptcy has had little impact on the form that revival takes. Relationship banking, which encompasses a wide range including the establishment of collateral, has until now had a great deal of influence on the form that revival takes.

The following questions were posed from the floor.

What is your opinion on the existence of trade credit?

What kind of impact will there be from the move from real estate collateral to the pledging of movable property as collateral?

As for the comment that banks are prone to liquidate firms with high liquidity relatively quickly, the causal relationship is the reverse, isn't it?

Do you not think that the issue of uncollateralized and unguaranteed financing should be considered separately from the field of relationship banking?

The following responses were made to these questions.

Trade credit is highly important, as the entities that are provided with trade credit can be monitored closely, and therefore the cost is low. However, whether or not this could take the place of bank financing is a different question.

In the case of real estate collateral, as a system of fixed collateral exists, once it is registered it does not incur costs. There is some degree of doubt as to the feasibility of conducting the monitoring of movable property collateral.

That is possible. Judging from inquiries we have conducted it appears that once banks become aware of the situation, they endeavor to use deposits to offset it.

If one tries to classify the trade between banks and clients as either relationship banking trading or transaction trading, it could take that form, but the reality may be that they are very close to each other in character.

Outline: Professor MATSUO Junsuke presentation

Prof. Matsuo's presentation was on the "Relationship between regional revitalization funds and regional financial institutions," setting out the following points.

The general characteristics of regional revitalization funds are (1) very strong involvement of regional banks, (2) frequent involvement by local governments, (3) rare participation by the major funds, and (4) smallness of scale, with commitment line ceilings no bigger than around ¥10 billion.

The number of established funds is currently 52. There are two types: one type led by regional banks, and the other led by public institutions (prefectural governments, etc.). Regarding targeted firms, they are classified as either open platform type or closed platform type.

The merits of establishing and operating funds are that (1) even if claims are ceded to a fund, they are not treated as bad debts (2) in cases in which coordination among creditors is difficult, funds play an adjustment role, and (3) for tax purposes, recognition as losses is easy.

According to the results of questionnaires, investment performance is not necessarily good. Owing to strong incentives to put off finding solutions to their problems, regional financial institutions may hesitate to make use of funds.

Recent revitalization methods such as debt-equity swaps are being employed. Further study should also be given to approaches such as combinations of the use of funds with debt-equity swaps or debt-debt swaps.

An issue that will need to be addressed in future is about how actively regional financial institutions will be able to guide excessively indebted corporate customers towards revitalization.

Prof. Yasuda posed the following questions concerning Prof. Matsuo's presentation.

What do you think are the factors behind the fact that the use of debt-debt swaps (DDS) is not spreading?

With regard to evaluating the usage of revitalization funds, do you go so far as urging their use?

The following were the responses to these questions.

Certain restrictive conditions are added in order to prevent abuse, and these could make them somewhat difficult for financial institutions to use.

The degree of use of revitalization funds has been poor because of the lack of incentive - for both debtor companies and financial institutions - to take the initiative to implement truly drastic restructuring.

Regarding common questions, these are addressed within a relationship in which it is not possible to unbundle only parts that have been revitalized.

The following question was posed from the floor.

Are there worries that loan portfolios cannot be diversified sufficiently?

The response to this question was as follows.

By implementing thorough restructuring and transparent handling, profitable use of revitalization funds should be possible.

There are some who worry about that. It is said that there is insufficient diversification among industries. (Prof. Xu)

Outline: Professor TAGASHIRA Shoichi presentation

Prof. Tagashira's presentation was on the subject of "Policy deployment and the role of regional financial institutions in SME revitalization," setting out the following points.

The basic role for regional financial institutions is to produce essential information that will form the basis for measures to address SMEs' structural management problems at their early stage, to position this as the foundation of their own business, and whenever necessary to provide it to society at large.

By using information that they produce themselves, regional financial institutions make independent, rational decisions based on their own management judgment with respect to whether to involve themselves in revitalization and other matters, or to entrust other institutions to take concrete steps to address them. In addition, the information produced can provide business opportunities to the private sector, while for public institutions it could be required to be put to effective use for carrying out measures that the private sector is unable to implement.

Support for revitalization until now has been regarded as highly complex and diverse, both with regards to the flow of measures implemented over time and from the perspective of the support institutions.

According to the memo by the chairman, it was pointed out that during the period of the Japanese government's first relationship banking action program it was not possible to deal with structural factors.

The characteristics of the revitalization of a hot springs town used as a case study are that (1) it revitalized distinctive local businesses as an integrated whole, (2) the revitalization sparked the molding of new relationships between regional financial institutions and debtors, and (3) the role of the SME Turnaround Support Committee was to confirm the rationality of plans and to secure coordination among creditors.

Regional financial institutions can play certain roles in the structural reorganization of SMEs. It is essential to put arrangements in place for sustained and efficient monitoring by such means as covenants. The role of public institutions should be slimmed down gradually. For structural business reorganization, in the cases of large-scale revitalization the leading role should be taken by government authorities.

Prof. Yasuda posed the following questions concerning Prof. Tagashira's presentation.

At the revitalization phase, into what form is relationship banking modified? Or does it just become a blank sheet?

What are the specific points in early problem detection and early revitalization?

The following were the responses to these questions.

It is essential to make a change by winding up past relationships and forming new ones. Steps such as debtor-in-possession (DIP) financing, or extending loans to firms that have applied for legal rehabilitation procedures, would of course be possible.

It is necessary to arrange covenants focusing on cash flow.

(This report compiled by YAOITA Shunpei)