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


  • Schaede, Ulrike

    (U CA, San Diego)


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.

Suggested Citation

  • Schaede, Ulrike, 2005. "The "Middle-Risk Gap" and Financial System Reform: Small-Firm Financing in Japan," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 23(1), pages 149-176, February.
  • Handle: RePEc:ime:imemes:v:23:y:2005:i:1:p:149-176

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    References listed on IDEAS

    1. 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.
    2. Ricardo J. Caballero & Takeo Hoshi & Anil K. Kashyap, 2008. "Zombie Lending and Depressed Restructuring in Japan," American Economic Review, American Economic Association, vol. 98(5), pages 1943-1977, December.
    3. Mitchell A. Petersen & Raghuram G. Rajan, 1995. "The Effect of Credit Market Competition on Lending Relationships," The Quarterly Journal of Economics, Oxford University Press, vol. 110(2), pages 407-443.
    4. Smith, David C., 2003. "Loans to Japanese borrowers," Journal of the Japanese and International Economies, Elsevier, vol. 17(3), pages 283-304, September.
    5. David C. Smith, 2003. "Loans to Japanese borrowers," International Finance Discussion Papers 769, Board of Governors of the Federal Reserve System (U.S.).
    6. Hideaki Hirata & Tokiko Shimizu, "undated". "Purchase of SME-related ABS by the Bank of Japan: Monetary Policy and SME Financing in Japan," Working Paper 164521, Harvard University OpenScholar.
    7. Takeo Hoshi & Anil Kashyap, 2004. "Corporate Financing and Governance in Japan: The Road to the Future," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262582481, January.
    8. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
    9. Boot, Arnoud W. A., 2000. "Relationship Banking: What Do We Know?," Journal of Financial Intermediation, Elsevier, vol. 9(1), pages 7-25, January.
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    Cited by:

    1. International Monetary Fund, 2012. "Japan; Selected Issues," IMF Staff Country Reports 12/209, International Monetary Fund.

    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects


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