Public sector holds about 40 percent of the assets that the banking sector around the globe owns, and policies to provide funds through financial institutions that governments owns have huge influence on flow of funds to and from firms and households. In Japan, government-affiliated financial institutions have been criticized as putting pressure on private banks because their borrowers overlap. Focusing on loans to small- and medium-sized enterprises (SMEs), this paper examines differences in the loan interest rates between the SME unit of the Japan Financial Corporation (JFC-SME, formerly Japan Finance Corporation for Small and Medium Enterprise), one of the government-affiliated financial institutions in Japan, and other banks. It also examines the existence of substitution between JFC-SME loans and those extended by other banks. Our findings are threefold: (1) The mean and the median of loan interest rates of JFC-SME are lower than those of other banks; (2) An institutional change to lower interest rates for higher-rated borrowers of JFC-SME is not followed by a subsequent decrease in loan interest rates of other banks; and (3) Although an increase in the amount of loans from JFC-SME to higher-rated firms is larger than that to lower-rated firms because of the decrease in the interest rate for the former, this is the case also for loans from other banks, and thus the dependence of higher-rated firms on loans from JFC-SME does not increase due to the institutional change.
