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The "Middle-Risk Gap" and Financial System Reform: Small-Firm Financing in Japan

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Author Info
Schaede, Ulrike (U CA, San Diego)
Abstract

This paper addresses the puzzling existence and persistence of a pronounced "middle-risk gap" in Japan's interest rate structure, which reflects an underdeveloped and distorted market for small-firm finance. The paper shows that a confluence of systemic reasons (including a shift away from the former reliance on real estate collateral, social constraints on bank strategies, bank capital adequacy constraints, and an underdeveloped market for securitized debt) and political pressure on banks have inhibited private bank activity in the middle market and necessitated specialized banks for small-firm financing. A second concern is the overall low level of the loan interest rate structure. The paper argues that the Japanese governments small-firm loan programs at greatly subsidized rates have depressed loan rates and exacerbated the middle- risk gap, creating great impediments to banking reforms. However, these subsidized small-firm loans are best understood as welfare, and while they are market-distorting they cannot simply be abolished without a substitute. The middle-risk gap is both a strong indicator of, and an important reason for, the slow course of financial system reform in Japan . Successful reforms toward a greater market orientation in Japanese banking must begin with the interest rate structure.

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Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

Volume (Year): 23 (2005)
Issue (Month): 1 (February)
Pages: 149-76
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Handle: RePEc:ime:imemes:v:23:y:2005:i:1:p:149-76

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Find related papers by JEL classification:
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates

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  1. Smith, David C., 2003. "Loans to Japanese borrowers," Journal of the Japanese and International Economies, Elsevier, vol. 17(3), pages 283-304, September. [Downloadable!] (restricted)
  2. Strahan, Philip E. & Weston, James P., 1998. "Small business lending and the changing structure of the banking industry1," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 821-845, August. [Downloadable!] (restricted)
  3. David C. Smith, 2003. "Loans to Japanese borrowers," International Finance Discussion Papers 769, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  4. Petersen, Mitchell A & Rajan, Raghuram G, 1995. "The Effect of Credit Market Competition on Lending Relationships," The Quarterly Journal of Economics, MIT Press, vol. 110(2), pages 407-43, May. [Downloadable!] (restricted)
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  5. Boot, Arnoud W. A., 2000. "Relationship Banking: What Do We Know?," Journal of Financial Intermediation, Elsevier, vol. 9(1), pages 7-25, January. [Downloadable!] (restricted)
  6. Takatoshi Ito & Yuri Nagatake Sasaki, 1998. "Impacts of the Basle Capital Standard on Japanese Banks' Behavior," NBER Working Papers 6730, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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