Support to expand to major commercial and regional banks through two-step lending using government funds
17 sectors, including AI and semiconductors, targeted; public funds to cover some losses on bad loans
Support tied up in loans keeping troubled firms afloat could weaken investment and increase fiscal burdens

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 bank-support element, 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 troubled companies afloat, investment could recover more slowly while the fiscal burden of covering debts that companies cannot repay 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 policy lenders would supply loan funding and the national 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 plan would broaden the channels for supplying funds to companies by bringing major commercial banks and regional banks into a lending framework that has primarily operated through the Development Bank of Japan and Shoko Chukin Bank. Participating banks would use funds raised from policy lenders to provide loans 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 its fiscal loan program, which provides long-term financing at low interest rates. The aim is to lower financial institutions’ funding costs and provide long-term funding to support the loans companies need for capital investment and M&A. While supplying funds on the condition that the principal is eventually repaid, the government will also establish safeguards against corporate defaults. Central to this is a loss indemnification mechanism under which public funds cover a specified share of losses when loan recovery runs into difficulty. The Japanese government is considering extending this mechanism, previously used in responses to crises such as major disasters, to investment in strategic industries. During the COVID-19 pandemic, the mechanism 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 unveil 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 flesh it out following 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-sector investment in strategic sectors by fiscal 2040, the financing plan forms part of efforts to establish frameworks supporting funding in those sectors.

Japanese Corporate Bankruptcies Hit 13-Year High

Corporate funding difficulties are driving the Japanese government’s move to expand financial support. According to corporate credit research firm Tokyo Shoko Research, 5,373 companies with debts 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 the damage was concentrated among small and microbusinesses. 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 approximately 2,700 companies into losses on an ordinary income basis because of higher interest expenses. Banks are also placing greater emphasis on loan profitability and companies’ repayment capacity as interest rates rise, putting funding pressure on businesses whose earnings have been slow to recover.

Adding to these difficulties, measures to increase companies’ tax burden are also being discussed within the government. The Japanese government plans to determine defense spending for fiscal 2027–2031 when it revises its three key national security documents by the end of the year. Within the administration, a corporate tax increase has emerged as a potential stable source of funding for the higher expenditure. If the tax increase materializes, companies will pay a larger share of their profits in taxes, leaving less internal funding for capacity expansion and research and development. Even if they seek loans to cover investment funding shortfalls, rising interest expenses make it difficult to commit to additional borrowing. Companies with low profitability and heavy reliance on debt, in particular, are likely to face greater pressure to adjust the size and timing of new investments as less cash remains after taxes and interest payments.

Table 1. Corporate Bankruptcies and Funding Pressures in Japan

Unpaid Corporate Loans Ultimately Covered by Taxes

However, expanding lending when companies’ finances have deteriorated also exposes the government to fiscal losses from bad debts. If supported companies fail to generate profits and cannot repay their debts, tax revenues must be used under the loss compensation agreements. Japan has previously seen large losses accumulate at a policy lender after publicly guaranteeing loans to small and medium-sized businesses. According to an analysis by the Centre for Economic Policy Research (CEPR), the Japan Finance Corporation’s credit insurance account recorded 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 under a structure in which credit guarantee associations repaid debts on behalf of companies unable to pay, and the corporation covered 70–80% of the associations’ losses through insurance. Support initially provided as loan guarantees thus became actual public-sector losses after corporate defaults.

There is also a risk that banks will relax their lending standards. The larger the share of losses borne by the government, the less pressure banks face to curb bad lending. Japan has previously experienced the unintended consequence of continued lending to troubled companies after banks received public funds. During Japan’s financial crisis, the government injected JPY 1.8 trillion (approximately USD 11.6 billion) into bank recapitalization in March 1998, followed by 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 so they could repay existing debts, or by extending loan maturities. Fearing that disposing of bad loans would erode their replenished capital, banks resorted to “evergreening”—lending to keep troubled companies afloat.

For individual banks, this was a survival strategy to avoid immediate capital impairment and suspension of operations. But as banks cut lending simultaneously, credit supply across the system contracted, delaying economic recovery. A joint study by Hiroyuki Kasahara, Yasuyuki Sawada and Michio Suzuki, based on financial data from Japanese banks and manufacturers, found that lending to low-productivity zombie firms also increased after the capital injections. The study found no evidence that these companies expanded investment, and the researchers suggested that the borrowed funds may have been used to repay existing debts 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 growing numbers of zombie firms. The researchers explained that zombie companies sustained by bank support supplied products at low prices, undercutting the profits of healthy businesses as well.

A Lifeline for Regional Banks

Funding conditions in the banking sector appear to have influenced the Japanese government’s decision to include private banks in the support scheme, despite the risk of repeating past failures in support for troubled businesses. Because the government would supply loan funding and share the risk of bad debts, banks struggling to raise funds would also benefit directly. Japan’s regional banks face a shrinking local customer base because of 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. Banks need to offer higher interest rates to retain deposits, but the weak financial condition of their corporate customers makes it difficult to pass those higher costs on through lending rates. The government’s proposed long-term, low-interest funding would thus ease the costs regional banks bear in competing for deposits and help them maintain their lending operations.

Even if funding pressures ease, regional banks still face the challenge of securing profits in a shrinking lending market. The Mitsubishi Research Institute estimates that lending volumes in 18 Japanese prefectures will fall by at least 5% between 2022 and 2030 because of population decline and slowing growth. Banks that have relied on local businesses urgently need to find new borrowers. Aomori Michinoku Bank, Iwate Bank and Akita Bank, whose integration talks became public this month, are all based in the Tohoku region, where population decline is severe. Bloomberg Intelligence assessed that these banks are seeking greater scale in response to intensifying competition and funding pressures. Under these conditions, government efforts to encourage regional banks to participate in strategic industry lending would give them opportunities to finance new business ventures. They would earn interest income on funds borrowed from the government and receive public compensation for an agreed share of losses if the loans turn bad.

Securing Profits Remains Difficult Even With More Lending

However, regional banks are likely to remain under financial strain if they cannot earn sufficient returns on existing loans even as they expand new lending using policy funds. According to the financial system report released by the Bank of Japan on the 23rd, only a small share of regional banks’ fixed-rate corporate loans had undergone interest rate adjustments, leaving the rates actually applied largely unchanged. This means that even if banks pay more interest to attract deposits, interest income from their existing fixed-rate loans is unlikely to rise immediately. Maturities on fixed-rate loans, excluding short-term rollover loans, were found to be concentrated in 2030–2031. Since banks must absorb higher deposit interest costs until those loan rates are adjusted, some of the income from new loans may also be used to offset deteriorating profitability on existing business.

After 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 the COVID-19 pandemic, and that companies with weaker finances tended to have longer remaining maturities. Low fixed rates have contained these companies’ interest burdens and postponed the impact of rising rates, but refinancing at higher rates after maturity could bring the cost increases they have so far avoided. Companies whose operating profits have not recovered may struggle to meet higher interest payments, inevitably increasing the risk of delinquency. Banks, too, may have to set aside some of the additional profits from higher interest rates as provisions against bad loans. They face a dilemma: while hoping for improved earnings from higher lending rates, they must weigh how far to raise them against companies’ ability to repay.