Credit allocation and public credit guarantee schemes for small businesses: evidence from Japan

Abstract

ABSTRACT We investigate the relationship between the use of a public credit guarantee scheme for small businesses and the efficiency of credit allocation using region- and industry-level data from Japan for the period from 1968 to 2005. Because credit constraints are more severe for small businesses than for large firms, a public credit guarantee scheme that mitigates this constraint on small firms’ growth could enhance social welfare. If credit-guaranteed loans are allocated to firms with high value added, a public credit guarantee scheme would enhance the efficiency of credit allocation. Conversely, however, public credit guarantee schemes can squeeze credit allocations for small businesses. When financial institutions offer loans through credit guarantee schemes, the incentives of the financial institutions to monitor the activity of small business borrowers may decline. In addition, because Japan’s public credit guarantee scheme is a component of a broader set of social policies aiming to eliminate inequality, credit-guaranteed loans can be offered to economically distressed firms. In this situation, we identify a negative relationship between the amount of credit guaranteed and value added. We show that Japan’s public credit guarantee schemes reduced the efficiency of credit allocations, with negative implications for industry and regional growth.