The reform of Japan’s
policy-based lending institutions
The deliberations on the reform
of Japan’s policy finance institutions have reached the final stages.
As a private member of the Council on Economic and Fiscal Policy pointed
out during the debate, it is widely accepted that “the days of traditional
policy finance are basically over,” and if policy finance institutions
are to play a role at all, it is essential that this be limited to functions
that the private sector cannot fulfil.
So far, the focus of the deliberations
has been on how many government-affiliated policy finance institutions
there should be after the reorganization. But if the debate stops here,
there will be insufficient consideration of what useful role they can
still play, leading to the danger of half-measures in the curtailment
of their scope. For example, there are strong concerns that even once
the institutions are merged, unnecessary functions may in fact be retained.
The following are two examples
of the problems associated with the current policy finance system. First,
not only are the policy finance institutions supported with large sums
of taxpayers’ money; on top of that, they are also financially unstable.
In fiscal 2004, the total amount of additional capital and subsidies
for the eight government-affiliated policy finance institutions (excluding
the Housing Loan Corporation) climbed to ¥373.7 billion. Second, because
the government-affiliated policy finance institutions can lend funds
at lower interest rates than private financial institutions thanks to
the government support they receive, they undermine the business of private financial
institutions. The interest rate charged by the policy finance institutions
does not adequately reflect risk, leading to a distortion of interest
rates in credit markets. Appropriate monitoring does not take place
and among the firms which receive loans from the policy finance institutions
are many that otherwise essentially would have to close down. In turn,
as a result of such ailing companies’ staying in the market, the earnings
of financially healthy companies are undermined.
For this reason, the policy
finance institutions should withdraw from fields in which they compete
with the private sector and instead, once their transparency has been
increased, devote themselves to areas in which they compliment the private
sector and where the use of large amounts of taxpayers’ money can
be justified.
Areas where policy lenders
can complement private lenders are limited to lending in those fields
where private returns are low but the social return is extremely high.
Loans with such a “social return” include, for example, loans to
developing countries in the context of international co-operation where
the benefit is spread thin and wide across the entire population; the
nurture of new industries in which it is difficult for private enterprises
to prosper but which offer a benefit for wider society; or investments
in public projects in which there are few precedents on which to base
an assessment of risk. In these instances, loans from private financial
institutions will not be forthcoming even if an investment is desirable
from a societal point of view. Consequently, there is justification
for government institutions (and, in the final analysis, the taxpayer)
to take on the risk, and this solution is preferable to the provision
of subsidies to private-sector financial institutions to take on the
risk where this is difficult to evaluate. However, in order for government-affiliated
financial institutions to fulfil this function, they need intelligence
gathering and monitoring abilities as well as financial expertise matching
those of private-sector institutions.
Among the issues that policy-based
lending is supposed to address according to the private member’s bill
put forward by the Council on Economic and Fiscal Policy, those that
can be justified from the viewpoint of policy-based lending as complementing
the private sector are infrastructure policy and international economic
co-operation. However, strong doubts remain with regard to policy-lending
objectives focusing on small and medium enterprises (SMEs), agriculture,
forestry, and fisheries, and Okinawa put forward in the same proposal.
Let’s have a closer look
at policy-based lending to small and medium enterprises. The background
to this debate is that in light of the role government-affiliated institutions
played in providing lending to SMEs during the financial crisis a few
years ago, it is thought that a safety net for a period of financial
crisis should be maintained. However, when dealing with a financial
crisis, the natural policy response for restoring the financial sector
to health is to consolidate insolvent banks and provide support for
those that are facing a temporary liquidity shortage. In the event that
it take times to restore private-sector banks to financial health, it
would be sufficient for the government to provide support or moderate
government guarantees (taking the danger of moral hazard into account,
a 100% guarantee would be undesirable) for private sector banks that
lend to troubled small and medium enterprises. The point is that even
if the support of SMEs in times of financial crisis is an important
policy goal, there are ways to achieve this objective other than to
rely on government-affiliated financial institutions.
There may also be arguments
that government-affiliated financial institutions should provide loans
to small businesses that have just been established because private
sector banks may be reluctant to provide loans as a result of information
asymmetries regarding the trustworthiness of such newly-established
businesses. But the information production capacity of government-related
banks does not exceed that of private-sector ones and it is difficult
to imagine that a government-related financial institution that has
to spread its resources over the entire country is superior to private-sector
banks with expertise in their particular region.
Not only are most government-affiliated
banks unnecessary; it should also be remembered that, as mentioned above,
they have an adverse effect on the financial system. This is because
their loan interest rates are determined by policy factors, so that
it becomes difficult for private sector banks to charge interest rates
that adequately take risk and the length of the loan period into account
as they would in a fully competitive environment; as a result, government-affiliated
bank lending, rather than providing any benefit, in fact obstructs lending
by the private sector. What is more, once a government-affiliated bank
has expanded its sphere, even if private sector banks develop the necessary
financial and risk management techniques and could fill the gap, the
government institution will find it difficult to contract again.
At the time of the reform,
it would be ideal if the government-affiliated banks disposed of the
credit portfolios they currently hold by selling them on the market.
This way, the reform of the government-related financial institutions
would contribute to an enlargement of the credit market and subsequent
loans to small and medium enterprises would be expedited. Moreover,
following the example of the Housing Loan Corporation, which is one
step ahead in the reform process, the government-affiliated banks, while
acting as loan guarantors, could enter the market as buyers of private-sector
bank loans, although this should only be a transitional measure until
the market is fully established.
In sum, institutions that compete
with the private financial sector should be privatized if there is a
prospect that they will be profitable; if they are unlikely to be profitable,
they should be wound up. If the aim is to fund projects that yield a
low private but a high social return, policy-based lending does have
a value and institutions should be reformed by merging overlapping functions
and simplifying structures.
From the points raised above,
the direction that the reform of each of the eight institutions should
take can be easily derived:
The Japan Bank for International
Co-operation (JBIC) complements private financial sector institutions
by providing finance related to high-risk energy projects, by co-operating
with international organizations in the response to currency crises,
and by providing loans to developing countries; in addition, the JBIC
provides concessionary aid and shoulders functions that the private
sector cannot fulfil and it should therefore continue to play these
roles. However, it should reduce its financing directed at developed
countries (such as trade finance).
The Development Bank of Japan
(DBJ) has shown achievements in the development of new financial techniques
and could be privatized as an investment bank. However, should it continue
as a policy-based lending institution, its role should be limited to
fields such as high social-return loans or the development of markets,
an activity which carries high externalities, and it should withdraw
from fields in which it competes with the private sector. These two,
the JBIC and the DBJ, are the only government-affiliated financial institutions
that fulfil functions that compliment the private sector. The remaining
six institutions are active in fields where they basically compete with
the private sector. Even if it is appropriate for the government to
pursue specific policies with regard to, say, SMEs, agriculture, forestry,
and fishery, or the development of Okinawa, the role and organization
of policy-based lending is highly problematic.
Many of the activities of the
National Life Finance Corporation and the Japan Finance Corporation
for Small and Medium Enterprise overlap and the two institutions should
be merged and then withdraw from the loans business and instead, for
the time being, concentrate on credit guarantees and credit securitization.
Once a functioning market has been established and the function of these
two institutions has become obsolete, they should be closed down.
As for the Shoko Chukin Bank,
this can probably be privatized quite easily, because unlike other government-affiliated
financial institutions it has not relied on any government subsidies,
The Japan Finance Corporation
for Municipal Enterprises should be wound up after an appropriate transitional
period to allow for the development of a municipal bond market that
can take its place.
The Agriculture, Forestry and
Fisheries Finance Corporation should be closed down as agricultural
co-operatives and regional banks can easily fill its place.
Similarly, the job of The Okinawa
Development Finance Corporation can also be easily carried out by other
financial institutions and it should be abolished.
Takatoshi ITO (Tokyo University)
Masaya SAKURAGAWA (Keio University)
Kimie HARADA (Chuo University)
Takeo HOSHI (University of California, San Diego)
Kaoru HOSONO (Gakushuin University)
Nobuyoshi YAMORI (Nagoya University)