Important as they are, SMEs lag behind large enterprises in terms of productivity, technological expertise, financing and other areas. Particularly, their financial disadvantages prevented them from developing their businesses. Most SMEs often lack creditworthiness, so that they have only limited capital resources and have trouble securing funds needed for their business activities such as purchasing materials and products and investing in plants and equipment.
With respect to fund-raising, most SMEs have to rely on borrowing from banks and other financial institutions since they have difficulty in obtaining funds form the capital market. Banks require sufficient collateral or a well-establsihed surety for their debtors to secure a loan. The lack of such assets or appropriate sureties makes it difficult for many SMEs to obtain loans from financial institutions.
The Credit Supplementation System makes up for the financial disadvantages of SMEs by guaranteeing the repayment of their loans, which makes it easier for SMEs to borrow from the financial institutions. This system consists of two interrelated bus-systems: the Credit Guarantee System (CGS) and the Credit Insurance System (CIS). This two-tier structure of credit supplementation is unique to Japan.
The CGS is operated by Credit Guarantee Corp. (CGCs), which had been established in each prefecture (Japan’s largest local government unit) and five cities as public institutions. CGCs provide financial institutions with guarantees for their loans to SMEs. There are 52 independent CGCs throughout the country, and each CGC developed its guarantee activity in response to the actual conditions of SMEs in each area. The CGCs capital had been contgributed by local governments and financial institutions. They also borrow their operating funds from local government and the Japan Small and Medium Enterprises Corp. (Jasmec).
Jasmec operates the CIS, which functions to reinsure the guarantee liabilities of CGCs. Jasmec helps promote CGCs guarantee activities by covering 70 to 80 percent of their risks through the operation of this system. Jasmec holds reserve funds needed for acceptance of insurance from CGCs as part of its capital, which have been supplied by the national government. This reserve fund forms a major part of the financial foundation of the whole credit supplementation system.
Thus, the two-tier structure on the system’s decentralized operation with strong financial support from the national government enables the extensive use of credit guarantees in Japan.
Expanded credit supplementation system Amid financial liberalization, Japanese large enterprises in general are enjoying diversification of fund-raising measures. However, most SMEs have extremely limited access to capital markets, which leads them to be overly dependent on bank loans when they raise funds needed for their business operations. At the same time, Japanese banks restructuring their asset-liability structures tend to be notably risk-averse in extending loans particularly to SMEs having neither sufficient nor a well-established track record.
Under these circumstances, the government revised the Small Business Credit Insurance Law, a relevant Cabinet order, and the Credit Guarantee Corporation Law in order to expand the conventional credit supplementation system in 2000.
With this revision, a new type of insurance–Specific Corporate Bond Insurance–was introduced, and required adjustments were made in order to help promote the development of a secondary market for guaranteed loans.
Once an SME asks a bank for a loan, the bank may ask a CGC to act as a guarantor for the loan. If the CGC investigates the application from the SME and decided to guarantee the loan, the bank will extend a loan to the SME under the guarantee conditions, The SME then pays the guarantee fee to the CGC at a certain rate.
As long as a guarantee provided by a CGC meets the insurance requirements, the guarantee is automatically insured under the insurance system. In general, all guarantees are insured since CGCs refer to the insurance requirements to set eligibility conditions for the guarantee. Then, Jasmec assumes the insurance obligations for the guarantee and the CGC pays an insurance premium to Jasmec. This premium rate is set at a low level in order to reduce the burden of the guarantee fee on SMEs.
Is an SME is unable to fulfill its loan obligations to the bank by the due date, the CGC that has guaranteed the loan must pay the money in place of the SME. This is called a subrogated payment. Once the payment has been made, the CGC can claim the insurance money from Jasmec.
Upon receipt of the claim, Jasmec examines its contents. If they comply with all relevant laws and insurance clauses, Jasmec pay the insurance money to the CGC. The amount of the insurance money is equivalent to 70- to 80-percent of the amioount of the subrogated payment which the CGC made to the financial institution. The remaining 20 to 30 percent is taken as a loss by the CGC.
CGCs are required to make efforts to recover from SMEs the money that CGCs paid to the financial institutions in place of SMEs. If any money is recovered, 70 to 80 percent of the received amount must be refunded to Jasmec. (To be continued)