Approaches for Improving and Maintaining Soundness of

Credit Supplementation System

November 17 , 2015

Motohide HashimotoExecutive Director

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Problem Awareness

Over the past ten years the Japanese economy was hit by two major crises, namely the Global Financial Crisis and the Great East Japan Earthquake.

Credit Supplementation System played significant roles in overcoming these two major crises.

However, as Credit Supplementation System played major roles, the system held huge risks.

How can we maintain the soundness of Credit Supplementation System while dealing with these two major crises ?

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1. The Global Financial Crisis, the Great East Japan Earthquake, and Credit Supplementation System

(1) Damage to Japanese Economy from the Global Financial Crisis and the Great East Japan Earthquake

(Source) Mi ni st ry of Economy, Trade and I ndust ry. "I ndi ces of I ndust r i al Product i on".

117.3(Aug.2007)

76.6(Feb.2009)85.8(Mar.2011)

124.0(Jun.2001)

94.5(Mar.2008)

70.0

80.0

90.0

100.0

110.0

120.0

01 02 03 04 05 06 07 08 09 10 11 12 13 14

(FY10= 100)1) Trends in Industrial Production

Ressionary phase Production index Inventory index

Great EastJapan Earthquake

GlobalFinancial Crisis

2001

4

(Source) Mi ni st ry of I nternal Aff ai rs and Communi cat i ons. "Labor Force Survey".(Source) Mi ni st ry of Heal th, Labour and Wel f are. "Empl oyment Ref erral s f or General Workers".

3.6(Jul.2007)

5.5(Jul.2009)

1.08(Jul.2006)

0.42(Aug.2008)0.2

0.4

0.6

0.8

1.0

1.2

1.4

3.0

3.5

4.0

4.5

5.0

5.5

6.0

01 02 03 04 05 06 07 08 09 10 11 12 13 14

(Times)(%) Trends in Unemployment rate and Job-openings to appicants ratio

Unemployment rate

Job-openings to applicants ratio

GlobalFinancial Crisis

2001

5

(2) Massive Damage from the Great East Japan Earthquake (March 11, 2011)

1) The impact on Japan’s society and economy were enormous with 18,465 people killed or missing and with the industrial production index falling sharply.

(Source) White Paper on Small and Medium Enterprises in Japan 2011

Boat swept into the center of Miyako City, Iwate Prefecture

Shopping district buried under rubble in Ishinomaki City, Miyagi Prefecture

6

(Source) Mi ni st ry of Economy, Trade and I ndust ry. "I ndi ces of I ndust r i al Product i on".

40.0

50.0

60.0

70.0

80.0

90.0

100.0

110.0

120.0

130.0

140.0

08 09 10 11 12 13 14

(FY10= 100)Trends in Industrial Production

(All Japan/Affected regions : Iwate pref., Miyagi pref., Fukushima pref.)

All Japan Iwate pref. Miyagi pref. Fukushima pref.

Great East Japan Earthquake

2008

48.6(Mar.2011)

[ Credit Guarantee Corporations (CGCs) ]I. Establishment of “Emergency Guarantee Program” and “Great East Japan Earthquake Recovery Emergency Guarantee Program” II. Supporting demand for capital due to weakened fund raising capabilities, business reconstruction, and business stabilization

1) Establishment of Credit Guarantee Programs, Expansion of Special Treatment of Insurance

[ Japan Finance Corporation (JFC) ]　 - Expansion of Special Treatment of Insurance for the above credit guarantee programs

(3) Credit Supplementation System to Overcome the Global Financial Crisis and the Great East Japan Earthquake

Type of Insurable Funds

Max Amount ofInsurance

Insurance Coverage

Ratio

Insurance Premium Rate

(p.a.)

Guarantee Coverage

Ratio

Special Treatment of Insurance Related to

Business StabilityBusiness stabilization funds

Additional ceiling of 280 million JPY is set 80%

Ordinary/No-collateral

0.41%100%

Great East Japan Earthquake Recovery

Emergency Guarantees

Fund for reconstruction, other business stabilization

Additional ceiling is set:400 million JPY for Ordinary Insurance160 million JPY for No-collateral Insurance

90%Ordinary/

No-collateral0.41%

100%

General InsuranceOrdinary Insurance Business funds 200 million JPY 70% 0.25% - 1.69% 80%

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2) Actions Taken by CGCs (Credit Guarantee Corporations)

I. Extended operating hours on weekdays, established weekend consultation desk to better respond to customer needs for financial advice.

II. Significantly increased guarantee screening officers

Credit Guarantees related to the Great East Japan Earthquake

11 12 13 140

100

200

300

400

500

0%

10%

20%

30%

40%

50%

60%

70%

423

114 101 124

65.8%

40.9%

32.0%38.4%

(Billion JPY)

(FY)

The ratio of the amount of insurance acceptance(affected 3 pref. ) related to “Great East Japan Earthquake Re-covery Emergency Guarantees” to the total amount of insurance acceptance(affected 3 pref.)

The amount of Insurance Acceptance (as of 2014)Affected regions : Iwate pref., Miyagi pref., Fukushima pref.

2011

9

(4) Credit Guarantee Results (guarantees accepted)

1) Amount of Guarantees Accepted

　　 Amount of guarantee acceptance increases during times of economic crisis. 　　　　　 Thus, Credit Supplementation System plays a significant role. 　

04 05 06 07 08 09 10 11 12 13 140

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000 Safety-net guaranteesGeneral guarantees

(FY)

(Trillion JPY)

Global Financial Crisis

Great East Japan Earthquake

Emergency Guarantee Program

Great East Japan Earthquake Recovery Emergency Guarantee Program

2004

10

2) Effects of Guarantee Program

Bankruptcies avoided through emergency guarantee program (estimate)

FY

Expected Bankruptcie

sA

ActualBankruptcie

sB

AvoidedBankruptcie

sC=A-B

2008 10,178 8,283 1,895

2009 23,706 14,732 8,974

2010 18,317 13,065 5,252

Total 52,201 36,080 16,121

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Outstanding Guaranteed Liabilities (stock)

(5) Credit Guarantee Results

　　　　 The amount of Outstanding Guaranteed Liabilities increases during times of economic crisis.

　 Outstanding Guaranteed Liabilities underscore the important role filled by Credit Supplementation System. This means that risks increase as the amount of Outstanding Guaranteed Liabilities increases.

05 06 07 08 09 10 11 12 13 140

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

Outstanding Guaranteed Liabilities

Global Financial Crisis

Great East Japan Earthquake

Great East Japan Earthquake Recovery Emergency Guarantee Program

Emergency Guarantee Program

(FY)

(Trillion JPY)

2005

1) Schematic of Credit Supplementation System

(1) Risk Sharing through Two-tiered System

2. Approaches for Maintaining / Improving Soundness of Credit Supplementation System

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JFC(Japan FinanceCorporation)

CGCs(Credit

GuaranteeCorporations)

SMEs

National Government

LocalGovernments

　 Loans

Contributions

Guarantee Contract

Insurance Contract

Credit Insurance System Credit Guarantee System

Financial Institutions

Guarantee Fee

Recovery

Subrogated Payment

Contributions

Insurance Premium

Payment of Recovered Money

Insurance Money

Loss CompensationSupervision

ContributionSupervision

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2) Historic Context behind Establishment of Credit Insurance System

From the 1930s into the 1950s, many Credit Guarantee Corporations were established in regions across Japan (51 CGCs as of 1952). 　

A “Guarantee Insurance” system was established in 1952 to cover the risks held by CGCs.

　　 - With functions similar to the current “Credit Insurance,” the objectives of this system were to reduce losses for CGCs and improve the soundness of their assets.

　　 - This “Guarantee Insurance” was directly managed by the national government.

In 1958, Small Business Credit Insurance Corporation (now Japan Finance Corporation) was established. Since that time, credit insurance has been managed by JFC.

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I. Subrogated payments

II. Insurance payments

3) Risk Sharing in Credit Supplementation System

JFC, CGCs and financial institutions share risks.

Subrogation and Insurance Money Payment

The percentage of risk sharing (In the case of guarantee coverage ratio 80% and insurance coverage ratio 80%)

FinancialInstitutions CGCs JFC

20% 16% 64%

SMEs

CGCs(Credit Guarantee

Corporations)

FinancialInstitutions

1. Default

2. Request for subrogation

3. Subrogated payment (Coverage ratio: 80% in principle)

4. Insurance claim

5. Insurance money(Coverage ratio: 70 - 90%)

(Average coverage ratio in FY14 : 78%)

JFC(Japan FinanceCorporation)

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The balance of insurance account remained deeply in the red and there are a large number guaranteed SMEs in need of rescheduling. System improvements, including continued enhancements of the financial base, are needed.

4) Enhancing Financial Base for Insurance (Obtaining Contributions)

Large contributions from the national government were received after the Global Financial Crisis in anticipation of deterioration in the balance of insurance accounts.

JFC estimates future anticipated losses and requests contributions from the national government based on these estimates.

▲ 5,678

▲ 1,602

▲ 6,000

▲ 4,000

▲ 2,000

0

Balance of Insurance Account

20,516 10,409

0

2,000

4,000

6,000

8,000

10,000

12,00021,000 (100 million JPY)

Contributionsfrom goverment

04 05 06 07 08 09 10 11 12 13 14(FY)

(100 million JPY)

2004

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6) Analyzing Information, Providing Information to CGCs

- JFC endeavors to understand and analyze the insurance underwriting risks of various CGCs, balances of insurance accounts, and lending by private sector financial institutions to SMEs. It then provides the results of such analyses to CGCs.

Contributes to sustainability and sound management of overall system.

Guaranteeagreements

Provision of information, etc.

Provision of information, etc.CGCs

(Credit Guarantee Corporations)

Bureaus of Economy,Trade and Industry,

Financial Bureau

Supervision, inspection,guidance

Local Governments

Contribution,supervision

FinancialInstitutions

PartnershipsSMEsand

micro businesses

Guarantees /management support

Insurance contracts

Guarantees /management support

Supervision, inspection, guidance

JFC(Japan FinanceCorporation)

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1) Enhancing Financial Base

Enriching basic assets is important so that CGCs can conduct sound management and maintain external credit.

Contributions (A) Contributions from local governments etc.

Subsidies (B) Subsidies from national government to CGCs

Reserves (C) Accumulated amount of accepted basic assets from CGCs account surpluses each year

In addition to the basic assets(A+B+C), CGCs hold reserves for changes in balance differences (D).

Assets (A+B)

Reserves (C)

Basic Assets (A+B+C)

Reserves for changes in balance

differences (D)

506 1,244 1,750 618

(Unit: billion yen; FY14)

(2) Approaches for Improving and Maintaining Soundness of CGCs (Credit Guarantee Corporations)

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2) Indicator-based CGCs (Credit Guarantee Corporations) Management

Basic asset ratio : Guaranteed Liabilities / Basic Assets

- Each CGC sets allowable limits from the perspective of sound management.

- 60X is the maximum ratio in national guidelines.

- In managing its assets, CGCs utilize the liquid asset ownership ratio (Liquid Assets / Outstanding Guaranteed Liabilities) and other indicators from the perspective of maintaining reserve requirement assets.

Maximum amount of guarantees provided to one SME

- Indicator for maintaining soundness of CGCs’ financial conditions

- Analysis of subrogated payment ratio by financial institution groups and 　 SME business types as “Emergency Guarantee Program” results.

Subrogated payment ratio : Subrogated Payments for particular year / Outstanding Guaranteed Liabilities for same year

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3) Management Support by CGC (Credit Guarantee Corporation)

Example 1 Business consulting for firms with deteriorating earnings

- Discuss conditions of a firm with a main bank

- Visit the firm, provide management advice

- Propose problem resolution measures after several visits

Example 2 Subsidy for dispatching experts

- Send SME consultants and other experts to companies- Related expenses subsidized by CGCs

Example 3 Promote utilization of SME support networks

- Networks of local governments, chambers of commerce, CGCs, and SME support organizations working together for smoother SME support- Provide business expertise guidance and financial support utilizing the functions of each member in the network

Management support

Improved SME management

Reduced risk of bankruptcy

Improved CGC soundness

Risk Curtailment through Management Support

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I. The credit supplementation system played major roles in helping overcome the economic crises resulting from the Global Financial Crisis and the Great East Japan Earthquake. Meanwhile, the following approaches have been adopted to maintain the soundness of our systems.

　　 (1) Risk Sharing through two-tiered System　　　　 1) Covering risk by utilizing credit insurance system　　　　 2) Enhancement of financial bases (obtain government contributions in

proportion to risk)　　　　 3) Insurance risk management (sharing risk analysis and risk information)

　　 (2) CGC Approaches　　　　 1) Enhancement of financial bases (obtain local government contributions,

book reserves)　　　　 2) Risk management (utilization of basic asset ratio, subrogated payment

ratio)　　　　 3) Management support (consulting for SMEs)

II. JFC will make an effort to improve the soundness of Credit Supplementation System to continue promoting smooth financing for SMEs.

3 Summary

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References

Small Business Credit Insurance Corporation. (1989). Small business

credit insurance corporation thirty years’ history.

Japan Federation of Credit Guarantee Corporations. (2005). Credit guarantee

the 3rd edition. Eguchi, K. (Ed.).

Japan Federation of Credit Guarantee Corporations. (2011, 2014, 2013). Credit

guarantee, No.120, No.121, No.122, No.125.

Small and Medium Enterprise Agency. (2012). White Paper on Small and

Medium Enterprises in Japan.