The Political Economy of SME Financing and Japan's Regional Bank Problems

Abstract

The regional bank problems in Japan can be summarized as accumulating non-performing loans, the lack of diversification and attendant portfolio risk, and the absence of effective competition. This paper argues that the regional bank problems should be addressed in conjunction with the financing of small and medium enterprises (SMEs) and the political interests of the central and regional governments. The political interests may necessitate funding suboptimal investment projects of regional SMEs or keeping non-performing SMEs alive. Through close ties with regional banks, the governments can influence the banks' financing decisions either explicitly or implicitly. In particular, loan repayment guarantees are shown to reduce the banks' incentives to screen loan applications and harm competition by deterring entry of other banks. This paper offers some policy implications in solving Japan's regional bank problems.

Keywords: Japanese regional banks, small and medium enterprises, political economy, loan

JEL Classification: G21, G28, R51