Are lending relationships beneficial or harmful for public credit guarantees? : evidence from Japan's Emergency Credit Guarantee Program

This paper examines the effectiveness of Japans Emergency Credit Guarantee (ECG) program set up during the financial turmoil following the failure of Lehman Brothers, in increasing credit availability and improving the ex-post performance of small businesses. In particular, using a unique firm-bank matched dataset, the paper examines whether lending relationships enhanced or dampened the effects of the ECG program. It is found that the ECG program significantly improved credit availability for firms using the program. However, when it is a relationship lender (main bank) that extends an ECG loan, the increased availability is partially, if not completely, offset by a decrease in non-ECG loans by the same bank. Further, propensity score matching estimations show that the ex-post performance of firms that received ECG loans from the main bank deteriorates more than that of firms that received non-ECG loans. We do not find such loan substitutionʺ or performance deteriorationʺ effects when a non-main bank extends ECG loans. Our findings suggest that close firm-bank relationships may have perverse effects on the efficacy of public credit guarantees.