What is the new business of regional financial institutions since COVID-19?

The reason why the number of bankruptcies of SMEs has increased since COVID-19

Although sales decreased for many SMEs during the coronavirus crisis from 2020, there were in fact not so many enterprises that suffered from financing.

One reasons for this is the virtually interest-free and uncollateralized “zero-zero financing” system which was implemented by the government. By using this system, SMEs were able to borrow money smoothly from financial institutions. From the results of my questionnaire survey covering SMEs, I had the impression that during the financial crisis of 2008 there was more financing through emergency measures such as surrendering life insurance.

It can be regarded that the government’s aim to avoid company bankruptcies due to the coronavirus crisis was to some extent realized by the zero-zero financing. Indeed, according to the survey by Tokyo Shoko Research, the number of bankruptcies was 7,773 in 2020, during the coronavirus crisis, and was the lowest level since 1991. In the next year 2021, the number further decreased to 6,030, and in 2022 it was 6,428, maintaining the record low level.

However, in 2023, when the coronavirus crisis calmed down and normal life gradually returned, the number of bankruptcies of SMEs increased.

Again, according to Tokyo Shoko Research, the number of bankruptcies in 2023 was 8,690, showing a significant increase of 35.1% from the previous year. In addition to the fact that the repayment of zero-zero financing with the deadline of three years came into full swing, the impact of the record cheap yen, price surges, etc. are thought to be the cause. Moreover, in April 2024, repayments of zero-zero financing will reach their peak. Thus, some predict that the annual number of bankruptcies cases may surpass 10,000.

While the anesthetic-like effect of zero-zero financing has started to disappear, local financial institutions such as regional banks, Shinkin banks, and credit cooperatives, sharing the same local market, are also facing the need to respond to the post-COVID-19 era.

In the first place, concerning local financial institutions, since several years ago, the Financial Services Agency and the Bank of Japan have published reports pointing out that the main business of more than half of all regional banks in Japan is in deficit and that in the fiscal year 2028, 60% of regional banks will end up at a net loss. Also, the media have repeatedly covered “the crisis of regional banks.”

This is a long-term trend related to the overall Japanese economy rather than the impact of the coronavirus crisis. Some view this as the adverse effect of qualitative and quantitative easing policy by the Bank of Japan (especially, yield curve controls during the time of Governor Kuroda). However, it is merely a short-term impact. Japan’s low birthrate and aging, and particularly the declining productive population, most noticeable in countryside, are thought to be the fundamental problem causing the trend.

Running regional banks just on deposits and loans becomes difficult

While for SMEs the financing issue remains important, many data and questionnaire results show that companies are not so much an “underfunded agent” (nearly equal to no need for financing) as before. Increased internal reserves resulting from the declining investment appetite of the companies due to depression seems to be the cause.

If the funding demand keeps dropping in the declining local economy, the number of borrowers and the amount of borrowing will drop, and lending rates will also decrease. Then the management of local financial institutions will become difficult. The management of regional banks and Shinkin banks may not be sustainable only by revenue from the profit margins of deposits and loans.

Therefore, local financial institutions will be required to build a relationship to increase the corporate value together with local companies by exploring new business models instead of only focusing on the traditional deposit and loan businesses.

In any case, the situation surrounding SMEs and local financial institutions has been forced to change over the past 30 years. Before the financial liberalization of the 1980s, major banks lent money to large companies and were able to gain sufficient profits. However, when financial liberalization advanced abroad, and financing by corporate bonds was deregulated in Japan as well, large companies started to move away from major banks.

Major banks, after losing their conventional borrowers, started to proactively lend money to SMEs as well. Some local financial institutions that originally financed SMEs lost good customers and became involved in high-risk loans such as resort financing and went bankrupt due to nonperforming loans. Especially second-tier regional banks (formerly known as mutual banks) and long-term credit bank that had to compete with corporate bonds disappeared one after another.

In such a trend, after the 2000s, “relationship banking” drew attention as a method to reconstruct small business financing. Relationship banking refers to close ties between borrowers and financial institutions through business such as lending. Simply put, it is a policy aimed at narrowing the gap in the amount of information that a lender and a borrower have, through having a longstanding and close relationship between them.

Especially for SMEs that are inferior in disclosing financial information, etc. to large enterprises, the accumulation of ‘soft’ information (information that is not stated in financial statements, such as the forwardness of the management and atmosphere within the company) will be the foundation to facilitate loans. In research on SMEs, sometimes the length of a transaction period between companies and financial institutions, the number of transacting banks, or physical distance are used as data to be analyzed.

If local financial institutions could have a relative advantage over major banks, that would be the strength of local relations that serves as a foundation of relationship banking, in other words, accumulated soft information. Of course the information production activity of the borrower is important for any financial institution. However, it will be especially important for a local financial institution whose main business is lending.

Highly anticipated new support for SMEs by regional financial institutions

From now on, SMEs need to reform their own business structure, while paying back the debts they incurred during the COVID-19 time. Shouldn’t local financial institutions start to focus on main business support to help such reform?

The management environment surrounding regional financial institutions is becoming more difficult owing to the change in economic structure and low interest rates along with the declining population. Amid this situation, in May 2021, the revised Banking Act was implemented, and the rules of scope of services for depository institutions such as banks were relaxed.

Local trading company businesses and staffing businesses were the typical examples that they were allowed to enter by this legal revision. It is considered that the aim is to activate the economies of scope in economic terms, by allowing them to operate business in the area adjacent to banking business. This is the idea that it will be more advantageous in cost when relevant businesses are diversified and synergy will be generated, rather than separate companies operating the same businesses.

Local trading company business includes, through purchasing and selling local goods, providing help to business partner companies’ sales activities or being involved in the branding of local goods, etc. The results of our questionnaire survey showed that managers of SMEs are struggling with securing and developing customers and distribution routes and securing and developing suppliers and outsourcing contractors, and there seem to be underlying needs for local trading company business.

Moreover, it is known that there are needs for securing employees and cultivating human resources from SMEs of a certain scale, such as 10 or more employees. The 2018 revision of guidelines for supervision by the Financial Services Agency has already enabled financial institutions to engage in recruitment business at a charge. In addition, the 2021 revised Banking Act allowed registered-type dispatching business.

According to our research, the recognition level of local trading company business is very low among managers, and the number of local financial institutions that operate a local trading company is low. Thus, local trading company business faces the challenge of not being familiar enough to SMEs. While the recruitment business started to be recognized among SMEs of a certain scale, it is actually used by very few companies.

However, after we analyzed this in detail, we found out that the managements’ expectations tended to be higher for new business such as the local trading business and recruitment business, if they had already built trustful relationship through loans, etc., or if a person in charge and a branch manager are empathetic and understand “the strength that is not expressed in the figure.”

By deepening the core business of loans, we can say that it is possible to develop a marginal business that works as new support. If we look ahead to 30 or 40 years from now, there is a possibility that these businesses will replace the core businesses of local financial institutions. The post-COVID-19 era can be visualized as a phase to sow seeds for a new revenue source.

Of all companies in Japan, SMEs account for 99.7% of the number of companies and 68.8% of the number of employees. They create 50% or more of the amount of added value in Japan. I think that raising the value of SMEs will lead to the strengthening of the Japanese economy overall, and the role of local financial institutions that support them will be even more important in the post-COVID-19 era.

* The information contained herein is current as of March 2024.
* The contents of articles on Meiji.net are based on the personal ideas and opinions of the author and do not indicate the official opinion of Meiji University.
* I work to achieve SDGs related to the educational and research themes that I am currently engaged in.

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