Japan Plans to Back Corporate Lending With Public Funds: A Regional Bank Rescue Behind the Strategic Industry Push

Support to extend to major commercial and regional banks through two-step lending using government funds
Coverage to include 17 sectors, including AI and semiconductors, with the treasury covering some bad-loan losses
Funds tied up in loans that keep struggling companies afloat could prolong weak investment and increase the fiscal burden

The Japanese government is pursuing a plan to channel public funds into private bank lending to expand investment in strategic industries. With corporate bankruptcies and rising interest rates weakening the private sector’s capacity to invest, the government intends to provide loan funding while also sharing the risk of losses. The plan also has a strong element of support for the banking sector, as it would provide funding and revenue sources to regional banks facing higher deposit acquisition costs and shrinking local lending markets. However, if the support is used to keep struggling companies afloat, investment could recover more slowly while the fiscal burden of covering unpaid corporate debts continues to grow.

Publicly Funded Lending Through Private Banks

According to the Yomiuri Shimbun on the 27th, the Japanese government is considering a plan under which public policy lenders would supply loan funding and the treasury would cover some lending losses to support corporate investment in strategic industries. Funding would be provided through “two-step lending,” in which the wholly government-owned Japan Finance Corporation lends money to financial institutions, which then lend it to companies. The aim is to broaden the channels supplying funds to businesses by bringing major commercial banks and regional banks into a lending framework previously operated primarily through the Development Bank of Japan and Shoko Chukin Bank. Participating banks would use funds raised from public policy lenders to lend to companies pursuing capital investment or mergers and acquisitions (M&A) in 17 strategic sectors, including artificial intelligence (AI) and semiconductors.

The government plans to fund the loans through “fiscal loans,” under which it provides long-term, low-interest financing. The aim is to support lending for corporate capital investment and M&A by lowering financial institutions’ funding costs and providing funds that can be deployed over the long term. While supplying funds on the condition that the principal is eventually repaid, the government will also introduce safeguards against corporate defaults. Central to these is “loss indemnification,” under which public funds cover a specified proportion of losses when loan recovery runs into trouble. The Japanese government is considering extending this mechanism, previously used to respond to crises such as major disasters, to investment in strategic industries. During COVID-19, the scheme covered up to 80% of financial institutions’ losses.

The government will also pursue public-private consultations and legislative changes to introduce the scheme. The Ministry of Economy, Trade and Industry is reportedly expected to disclose its proposal as early as this month at a public-private meeting on investment and lending in the 17 strategic sectors. It plans to launch the scheme during fiscal 2027 after making the necessary legal amendments. The detailed scope of eligible loans has not yet been finalized, and the ministry will specify it after further review. With the government having set a target of more than JPY 370 trillion (approximately USD 2.39e+3 billion) in combined public and private investment in strategic sectors by fiscal 2040, the latest financial support plan forms part of efforts to develop frameworks that facilitate financing for those sectors.

Japanese Corporate Bankruptcies Hit a 13-Year High

Corporate funding difficulties underpin the Japanese government’s move to expand financial support. According to corporate credit research firm Tokyo Shoko Research, 5,373 companies with liabilities of at least JPY 10 million (approximately USD 64,615) went bankrupt between April and September this year, the highest figure for that period in 13 years. More than 60% of the bankrupt companies had capital of less than JPY 10 million, indicating that small and micro businesses have borne the brunt of the damage. The Bank of Japan’s increase in its policy rate to 1.25% last month has added to the burden on companies that have relied on borrowing to stay in business. An analysis of 168,000 companies by Japanese credit research firm Teikoku Databank estimated that a further 0.25-percentage-point rise in borrowing rates would push about 2,700 companies into recurring losses because of higher interest expenses. Banks are also tightening their scrutiny of loan profitability and borrowers’ repayment capacity as interest rates rise, putting companies whose earnings are slow to recover under additional funding pressure.

To make matters worse, the government is also discussing measures that would increase companies’ tax burdens. The Japanese government plans to determine defense spending for fiscal 2027–2031 when it revises its three key security documents by the end of the year. Within the administration, a corporate tax increase has emerged as a way to secure stable funding for the additional spending. If taxes rise, companies will pay a larger share of their profits in tax, leaving less internal funding for capacity expansion and research and development. Even if they seek loans to cover investment shortfalls, higher interest expenses make taking on more debt a difficult decision. Companies with low profitability and a heavy reliance on borrowing, in particular, are likely to face increasing pressure to adjust the scale and timing of new investments as they are left with insufficient funds after paying taxes and interest.

Table 1. Corporate Bankruptcies and Financing Pressures in Japan

Unpaid Corporate Loans Ultimately Covered by Taxpayers

However, expanding lending when corporate finances have deteriorated means the government must also accept fiscal losses from bad debt. If supported companies fail to earn profits and cannot repay their debts, taxpayer money will be used under the loss-compensation agreements. Japan has previously seen large losses accumulate at a public policy lender after publicly guaranteeing loans to small and medium-sized businesses. According to an analysis by the Centre for Economic Policy Research (CEPR), Japan Finance Corporation’s credit insurance account posted losses of JPY 568 billion (approximately USD 3.67 billion) in fiscal 2009 and JPY 436 billion (approximately USD 2.82 billion) in fiscal 2010. These deficits arose from a structure in which credit guarantee associations repay debts that companies cannot pay, and the corporation then covers 70–80% of the associations’ losses through insurance. Support initially provided as a guarantee at the time of lending thus became an actual public-sector loss after corporate defaults.

There is also a risk that banks will relax their lending standards. The larger the share of losses the government assumes, the less pressure banks face to curb bad loans. Japan has previously experienced the unintended consequence of continued lending to distressed companies after public funds were injected into banks. During Japan’s financial crisis, the government injected JPY 1.8 trillion (approximately USD 11.6 billion) into bank recapitalization in March 1998 and JPY 7.5 trillion (approximately USD 48.5 billion) in March the following year. The aim was to help banks clear accumulated bad debts and resume corporate lending. Instead, banks delayed recognizing losses by extending new loans to troubled companies to repay existing debts or by extending loan maturities. Fearing that disposing of bad loans would erode their replenished capital, they resorted to “evergreening”—loans that keep distressed companies afloat.

For individual banks, this was a survival strategy to avoid immediate capital impairment and suspension of operations. But as banks cut lending across the board, credit supply contracted throughout the system and economic recovery was delayed. A joint study by Hiroyuki Kasahara, Yasuyuki Sawada and Michio Suzuki, which analyzed financial data from Japanese banks and manufacturers, found that lending to low-productivity zombie companies also increased after the capital injections. The study found no evidence of increased investment at these companies, and the researchers suggested that the borrowed money may have been used to repay existing debt or cover losses. A separate study by Caballero, Hoshi and Kashyap also found that investment and employment growth at healthy companies were suppressed in industries with more zombie companies. The researchers explained that zombie companies sustained by bank support supplied products at low prices, eroding the profits of healthy companies as well.

A Lifeline for Regional Banks

Banks’ funding conditions appear to have influenced the Japanese government’s decision to include private banks in the support scheme, despite the risk of repeating past support for distressed borrowers. Because the government would supply loan funding and share the risk of bad debt, banks struggling to raise funds would also benefit directly. Japan’s regional banks face a shrinking local customer base due to population decline and aging, while also competing with major banks and online banks for deposits. According to S&P Global, deposit balance growth at 61 Japanese regional banks slowed from 2.2% at the end of March 2024 to 0.9% at the end of March 2025. Retaining deposits requires higher interest rates, but the weak financial condition of corporate customers makes it difficult to pass the increased costs on through lending rates. The government’s proposed long-term, low-interest funding would effectively ease the costs regional banks incur in competing for deposits and help them maintain their lending operations.

Even if their funding burden eases, regional banks still face the challenge of securing profits in a shrinking lending market. Mitsubishi Research Institute estimates that lending volumes in 18 Japanese prefectures will decline by at least 5% between 2022 and 2030 because of population decline and slowing growth. Banks that have depended on local businesses urgently need to find new borrowers. Aomori Michinoku Bank, Bank of Iwate and Akita Bank, whose integration talks became public this month, also operate primarily in the Tohoku region, where population decline is severe. Bloomberg Intelligence assessed that these banks are seeking greater scale to respond to intensifying competition and funding pressure. Under these conditions, government efforts to encourage regional banks to participate in strategic industry lending would give them opportunities to fund new businesses. They would earn interest income on funds borrowed from the government while receiving treasury compensation for an agreed portion of losses if the loans turn sour.

Profitability Remains a Challenge Even With More Lending

However, regional banks are likely to remain under financial pressure if they cannot earn sufficient returns on existing loans, even as they expand new lending with policy funds. According to the Bank of Japan’s Financial System Report released on the 23rd, only a small share of regional banks’ fixed-rate corporate loans had undergone rate adjustments, leaving the rates actually charged largely unchanged. This means that even as banks pay more interest to attract deposits, interest income from existing fixed-rate loans is unlikely to increase immediately. In particular, maturities on fixed-rate loans, excluding short-term refinancing loans, were found to be concentrated in 2030–2031. Because banks must absorb higher deposit interest costs until those loan rates can be adjusted, some income from new loans may also be used to offset deteriorating profitability on existing business.

Once the loans mature, the key question will be whether corporate borrowers can afford higher lending rates. The Bank of Japan noted that many of these fixed-rate loans were small loans extended during COVID-19, and that companies with weaker finances tended to have longer remaining maturities. Low fixed rates have kept these companies’ interest burdens down, postponing the impact of rising rates. But refinancing at higher rates after maturity could bring the cost increases they have so far avoided. Companies that have not restored operating profits may struggle to meet the higher interest payments, inevitably increasing the risk of delinquency. Banks, too, may have to set aside some of the additional income from higher rates as provisions against bad loans. They face a dilemma: while hoping that higher lending rates will improve profitability, they must weigh how far to raise them against companies’ ability to repay.