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The impact of international financial crises on SMEs: The case of Japan

The impact of international financial crises on SMEs: The case of Japan

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The impact of international financial crises on SMEs: The case of Japan

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  1. The impact of international financial crises on SMEs: The case of Japan 5/24/2010 Iichiro Uesugi Institute of Economic Research Hitotsubashi University

  2. Outline 1.Development of SME financing after the late 1990s (Japan’s “lost decade”) 1.1SME financing in Japan 1.2Credit misallocation 1.3Role of the government 2.Impact of the current financial crisis on SMEs and their financing 3.Future directions

  3. 1.Development of SME financing after the late 1990s in Japan

  4. 1.1SME financing in Japan (1) Definition of small and medium enterprises

  5. (%) Number of Number of Value of ship - e nterprises employees ments / sales 62.6 99.6 47.7 Manufacturing ( 87.8 ) ( 18.3 ) ( 6.9 ) Wholesale 99.1 69.8 66.0 t rade ( 68.9 ) ( 10.3 ) ( 5.7 ) Retail 99.7 64.8 71.4 t rade ( 86.1 ) ( 22 .8 ) ( 15.8 ) Total 99.7 69.4 n.a. (Non - p rimary ( 87.0 ) ( 23.2 ) i ndustries) Note: Data as of 2006. Figures in ( ) are those of " small " enterprises . Source: White Paper on Small and Medium Enterprises in Japan 2008 1.1SME financing in Japan (2) Share of SMEs in the Japanese economy

  6. 1.1 SME financing in Japan (3) Financing structure of manufacturing firms

  7. (4) Banks’ lending attitude and firms’ financial position 1.1SME financing in Japan

  8. 1.1SME financing in Japan (5)Long-term and stable transaction relationship between SMEs and banks Average number of years of transactions with the bank Japan 31.9 (Uchida, Udell, and Watanabe, 2008) U.S. 10.8 (Petersen and Rajan, 1995) Germany22.2 (Elsas and Krahnen, 1998) France 14.4 (Ziane, 2003) Italy 16.1 (Herrera and Minetti, 2007) Table 4.1 in Degryse, Kim, Ongena (2009)

  9. 1.1SME financing in Japan (6)Multiple transaction relationships with banks Number of transaction relationships with banks Japan(White Paper on SMEs, 2006)U.S.(SSBF,1998)

  10. 1.1SME financing in Japan (7)Longer relationship duration not necessarily associated with better credit conditions (e.g. lower interest payment, better credit availability) Change of interest rate incurred by additional one year of transaction relationship JapanFirms with Shinkin bank + in less competitive credit market + no audit pay 3.5bp less(Kano, Uchida, Udell, and Watanabe, 2006) U.S.(In many studies) pay 3~9bp less Europe(In many studies) pay 1~10bp more Table 4.10 in Degryse, Kim, Ongena (2009)

  11. 1.1SME financing in Japan (8)Decreasing contact frequency between SMEs and banks in recent years Contact frequency with loan officer of the firm’s main bank in 1996 and 2006(White Paper on SMEs, 2006) Present> 10 yrs ago Present< 10 yrs ago

  12. 1.2Credit misallocation (1)Previous studies Forbearance lending: Financial institutions provide life-support measures including reduced and/or deferred debt repayment to firms with negative NPVs Credit crunch:Financial institutions tighten credit conditions even to firms with positive net present values (NPVs) Previous studies report forbearance lending to “too-big-to-fail” Japanese firms in the late 90s (Peek and Rosengren, 2005; Caballero, Hoshi, and Kashyap, 2008) In contrast, forbearance lending seems less frequent among SMEs

  13. 1.2Credit misallocation (2)Sakai, Uesugi, and Watanabe (2010) Focus on SME financing and examine if there exists unnatural selection in that low quality firms pay lower interest rates and/or survive in the market ①Dataset Use financial statements collected by Credit Risk Database (CRD) and construct a panel dataset of about 100,000 SMEs Definition of default:bankruptcy, de-fact bankruptcy, no repayment in the past three month or more, repayment by the public credit guarantee corporations

  14. 1.2Credit misallocation ②Examining unnatural selection Either one of the formulas is satisfied if unnatural selection: where R is the borrowing cost and Q is firm’s quality However, we have opposite inequalities in most of the cases. Natural rather than unnatural selection even in the tumultuous years of 1997-2002 in Japan Low quality firms are separated from high quality firms, charged higher interest rates, and eventually forced out of the market or

  15. 1.2Credit misallocation ③Results

  16. 1.3Role of the government (1) Loans by government affiliated financial institutions and credit guarantees Have sizeable shares among the total loans to SMEs Alleviate credit crunch Positive effect on the firm performance? Detrimental to the private bank-firm relationships? Credit guaranteed loans/SME loans outstanding (%) SME loans outstanding: by bank types (September, 2008)

  17. 1.3Role of the government (2)Uesugi, Sakai, and Yamashiro (2008) Examine the effect of one of the largest single credit guarantee programs (Special credit guarantee program) Policy response to the severe credit crunch during the period ①Special credit guarantee (SCG) program Period: From October 1998 to March 2001 Objective: Alleviate credit crunch among SMEs, stabilize Japan’s (fragile) financial system after 1997 Amount: 30 trillion yen(Planned), 28.9 trillion yen(Used) Coverage: 100% Conditions for rejection: Significantly negative net worth, tax delinquency, default, window dressing

  18. Public credit guarantee system in Japan 1.3Role of the government 18

  19. 1.3Role of the government ②Dataset and empirical approach Construct a firm-level panel dataset by 2001-2004 Surveys of financial environment (SFE, SME Agency) and 1998-2005 Financial information database (FID, Tokyo Shoko Research Inc.) Identify borrowers who use the SCG program for the first time in year t and those who do not Measure the ex-post performance with the variables in year t+i, where i=1,2,3,4, by propensity score matching estimation Sample size of 2,087 for the SCG users and 8,090 for non-users

  20. 1.3Role of the government ③Hypotheses Firms’ credit availability Alleviate firms’ credit crunch(Availability hypothesis) Banks, especially undercapitalized ones, tend to substitute non-guaranteed loans for guaranteed loans which have lower risk weight. This limits the extent of availability improvement (Substitution hypothesis) Firm performance Many profitable projects previously unfunded will be implemented with the guaranteed loans(Investment hypothesis) Reduces banks’ incentive to monitor borrowers due to the 100% guarantee and thus induces borrowers’ moral hazard (Moral hazard hypothesis)

  21. 1.3Role of the government ④Results Loans to total asset ratio(LOANRATIO), Long-term loans to total asset ratio(LONGRATIO) significantly increase among SCG users. However, the increase shortly disappears among users transacting with undercapitalized major banks. Both in terms of profitability(ROA) and probability of financial distress (p(ICOVER_SM=1)), firm performance deteriorates more among SCG users than among non-users. Availability hypothesis (except for firms transacting with undercapitalized major banks) and moral hazard hypothesis are consistent with the results

  22. Baseline

  23. Effect of the bank capital on loan availability

  24. 2. Impact of the current financial crisis on SMEs and their financing

  25. This section covers Changes of business environment and firms’ response Changes of firm-bank relationships Role of the government Refers the two firm-level surveys by RIETI (Research Institute of Economy, Trade and Industry) February 2008, “Survey on transactions between enterprises and financial institutions” (6,124 respondent firms out of 17,018) February 2009, “Survey on transactions between enterprises and financial institutions under the financial crisis” (4,103 respondent firms out of previous respondent firms in the 2008 survey excluding exited ones) Details are provided in Uesugi et al. (2009, in Japanese) Translated questionnaires are provided upon request

  26. 2.1Changes of environment and response (1)Deteriorating business environment after the fall of year 2008 Diffusion indices (Percentage of firms that report conditions as “better” – percentage of firms that report as “worse”) are the smallest in business sentiment, cash flow, and relations with customers in February 2009. DIs are relatively better in lending attitude of largest lender, lending attitude of second largest lender. Relationships with financial institutions are not severed so much as those with customers.

  27. 2.1Changes of environment and response (1) Deteriorating business environment after the fall of year 2008 Specific changes experienced in relation to customers, suppliers, and financial institutions (FIs) since September 2008 (Customers) Decrease in sales/orders(71.6%), No particular change(17.2%) (Suppliers) Hike in purchase costs(28.5%), No particular change(64.4%) (FIs) In relation to the largest lender: Decline in loans outstanding from the largest lender(8.4%), followed by decline in loan offers, increase in interest rates, rejection of new loan applications; No particular change(77.7%)

  28. 2.1Changes of environment and response (2)Changes in relations to FIs 13.0% of respondents report the existence of FIs that frequently offered loans but suddenly changed their lending attitude in September 2008 These FIs are often large sized “megabanks” The category of FIs matters It is yet to be examined which category of FIs has made the right decision in allocating credit

  29. 2.1Changes of environment and response (3)SMEs’ responses to the changes Responses to FIs Borrowing from largest lender(29.9%), borrowing with credit guarantees(19.2%), borrowing from 2nd largest lender(16.4%), enhanced explanations to FIs, borrowing from other FIs, overdraft, borrowing from government FIs 46.0% of respondents take “no particular response” Smaller SMEs often use payment deferral in addition to borrowing from largest lender

  30. 2.2Changes of firm-bank relationship (1)Increase of the number of borrowing relationships Number of FIs from which firms has borrowings Average number increasing from the year 2008 Tendency of mean-reversion Firms that receive loan offers from FIs tend to reduce the number of borrowing relationships, while those that do not receive offers increase the number of the relationships

  31. 2.2Changes of firm-bank relationship (2)Increase of borrowings amount Total borrowings amount from FIs outstanding Average amount of borrowings increasing from the year 2008 Smaller firms with sales no larger than 100 million yen decrease their borrowings Main bank Share of firms that position largest lender FIs as their main banks increasing from the year 2008 Two possible interpretations: - Firm’s main bank increased loans and became the largest lender - Firms’ perception that FIs that extend larger amount of loans are their main banks

  32. 2.3Role of the government (1) Emergency credit guarantee (ECG) program ECG program Period: From October 2008 to March 2011 Objective: Assist financing of SMEs that face adverse business conditions including sales decrease Amount: 36 trillion yen(Planned), 19.1 trillion yen(Used by the end of March 2010) Coverage: 100% Conditions for rejection: Not publicly announced (screening process seems to be more stringent than previous SCG program Use of the program Current ECG program user(24.3%), firms that are willing to use in the future(15.2%) FIs that provide loans with ECG More than 70% of them are the largest lender FI, probably a firm’s main bank

  33. 2.3Role of the government (1) Emergency credit guarantee (ECG) program Reasons to use Majority of firms to secure liquidity in the form of cash/deposit and use the fund for operating expenses Smaller number of firms use the program since their applications for non-guaranteed loans are rejected by FIs Terms of loans with ECG Larger amount of ECG loans than loans with general credit guarantees Most of the loans are long-term: about 90% of them with the duration between 3 to 10 years

  34. 3.Future directions

  35. 3.Future directions Firm-bank relationships seem to alleviate the firms’ financial difficulties during the crises in Japan Exceptions include firms transacting with megabanks or smaller SMEs Yet to be examined whether the current credit allocation is efficient ECG program functions to provide liquidity Fortunately, business conditions among SMEs bottom out after the 2009Q1 and the number of bankruptcies decrease after the latter half of 2009

  36. 3.Future directions Further issues on SME financing (1)Cost and benefit of the government involvement Previous empirical study suggests that the SCG program improved firms’ performance only marginally We have yet to examine the effectiveness of the current ECG program The current ECG program applies stricter rules for approval but provides longer duration and larger amount of credit than the previous SCG program

  37. 3.Future directions (2)Relationship between firms and regional FIs Rather than large sized “megabanks” that were more likely to sever their relationships with borrowers, regional financial institutions (regional banks, shinkin banks, and credit unions) proved to be relationship lenders However, still uncertain if they are really relationship lenders without government credit guarantees

  38. 3.Future directions (3)Interest rates Relationship lending is costly to FIs They need to be compensated by some “reward” including higher interest margins, which has been difficult in the Japanese loan market One related interesting finding is Uchino and Uesugi (2010), in which borrowers transacting with Bank of Tokyo-Mitsubishi and/or UFJ bank are charged higher interest rates after the merger of these banks in 2005

  39. 3.Future directions (4)Role of collateral Provision of collateral is one of the important conditions for loan contracts and alleviates borrowers’ moral hazard problem (Ono and Uesugi (2009), Ono, Sakai, and Uesugi (2008)) However, the use rate of collateral has declined in recent years Positive role of collateral needs to be pronounced

  40. References Ricardo J. Caballero, Takeo Hoshi, and Anil K. Kashyap, 2008, "Zombie Lending and Depressed Restructuring in Japan," American Economic Review, Vol. 98, No.5, pp.1943-77. Hans Degryse, Moshe Kim, and Steven Ongena, 2009, Microeconometrics of Banking, Oxford University Press. Ralf Elsas and Jan P. Krahnen, 1998, "Is relationship lending special? Evidence from credit-file data in Germany," Journal of Banking & Finance, Vol. 22 No. 10-11, pp. 1283-1316. Ana M. Herrera and Raoul Minetti, 2007, "Informed finance and technological change: Evidence from credit relationships," Journal of Financial Economics, Vol. 83, No.1, pp. 223-269. Masaji Kano, Hirofumi Uchida, Gregory F. Udell, and Wako Watanabe, 2006, "Information Verifiability, Bank Organization, Bank Competition and Bank-Borrower Relationships," RIETI DP series 06-E-003. Arito Ono and Iichiro Uesugi, 2009, "The Role of Collateral and Personal Guarantees in Relationship Lending: Evidence from Japan's SME Loan Market," Journal of Money, Credit, and Banking, Vol. 41, No. 5, pp. 935-960. Arito Ono, Koji Sakai, and Iichiro Uesugi, 2008, "The Effects of Collateral on SME Performance in Japan," PIE/CIS Discussion Paper No. 401. Mitchell A. Petersen and Raghuram Rajan, 1995, “The Effect of Credit Market Competition on Lending Relationships, Quarterly Journal of Economics, Vol. 110, pp.406-443. Koji Sakai, Iichiro Uesugi, and Tsutomu Watanabe, 2010, "Firm Age and the Evolution of Borrowing Costs: Evidence from Japanese Small Firms," Journal of Banking and Finance, forthcoming. Joe Peek and Eric S. Rosengren, 2005, "Unnatural Selection: Perverse Incentives and the Misallocation of Credit in Japan," American Economic Review, Vol. 95, No. 4, pp.1144-1166. Small and Medium Enterprises Agency, 2007, White Paper on SMEs, Gyosei, Tokyo. Hirofumi Uchida, Gregory F. Udell, and Wako Watanabe, 2008, "Bank size and lending relationships in Japan," Journal of the Japanese and International Economies, Vol. 22, No. 2, pp. 242-267. Taisuke Uchino and Iichiro Uesugi, 2010, “How a Mega Bank Merger Affects Bank-firm Relationships,” Mimeo. Iichiro Uesugi, Hirofumi Uchida, Yoshiaki Ogura, Arito Ono, Peng Xu, Daisuke Tsuruta, Tadanobu Nemoto, Hideaki Hirata, Yukihiro Yasuda, Nobuyoshi Yamori, Wako Watanabe, and Masaki Hotei, 2009, “SME Financing under the Financial Crisis: Summary of 2008 and 2009 Surveys of Transactions between Enterprises and Financial Institutions,” (in Japanese), RIETI DP Series 09-J-020. Iichiro Uesugi, Koji Sakai, and Guy M. Yamashiro, 2008, "The Effectiveness of Public Credit Guarantees in the Japanese Loan Market," PIE/CIS Discussion Paper No.400. Ydriss Ziane, 2003, “Number of Banks and Credit Relationships, Empirical Results from Small Business Data,” European Review of Economics and Finance, Vol. 2, No. 3, pp. 33-60.