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Japan’s continuing credit squeeze is turning the spotlight onto small-business loans from commercial moneylenders — so-called “shoko” (commerce and industry) loans that carry extremely high interest rates because they require no collateral, only a third-party guarantee. To collect loans, the lenders reportedly use strong-arm methods that often come close to extortion.

The Metropolitan Police Department has arrested a former employee of Nichiei Co., the largest shoko lender headquartered in Kyoto, on suspicion of pressuring a guarantor by suggesting that he repay his debts by selling off his body parts.

Reports about such cases prompted the Financial Supervisory Agency to start investigating shoko lending practices. What must first be clarified is whether such cases of extortionate debt collection were isolated acts by desperate employees or part of an organized drive to recover unpaid loans.

Besides an investigation, there is also a need to update the legislation that regulates these collateral-free, high-interest loans. At the same time, administrative authorities in charge should bolster their supervisory activities. Even that is not enough. There must be a better financing system for helping small firms strapped for cash.

Shoko loans usually amount to anything from several million yen to over 10 million yen. Since no collateral is required, borrowers can take out expensive loans beyond their ability to repay them, while lenders try to make maximum loans under dubious guarantee agreements that set unrealistically high lending limits.

These contracts are usually signed between lenders and borrowers without the full consent of guarantors. So additional loans can be made without notifying the guarantor, provided they do not exceed the specified limit. In the event of default, the guarantor must repay the debt, even if he (or she) had not been informed about the details of the contract.

Nichiei and other lenders now face hundreds of lawsuits over their lending and collecting practices. A lawyers group dealing with shoko loan problems says these commercial loan sharks make it a rule to collect interest from borrowers and principal from guarantors.

Shoko lenders borrow money from banks at interest rates of 2 to 3 percent and lend the money at over 20 percent. The wide differential generates big profits. That is why they are keen to expand loans to small businesses, using various pressure tactics, and why they roll over debts that are coming due, instead of demanding repayment on schedule.

In response to mounting public criticism, the national group of moneylenders associations has established new ground rules aimed at improving lending and other practices. For example, the terms of the guarantee contract must be fully explained to the guarantor; loan amounts must be limited according to the borrower’s ability to repay; and the borrower must inform the guarantor about additional loans.

It is doubtful, however, whether these guidelines will really improve the situation, because they are voluntary rules that have no binding force. Lenders who break the rules will not be punished. The practice of concluding loose guarantee contracts will likely continue. The lawyers group is seeking a ban on these contracts.

The usury law sets the maximum interest rate at anywhere between 15 percent and 20 percent, depending on the loan amount. The law has no punitive provisions, however. By contrast, the investment law, which has such provisions, fixes the maximum rate at 40.004 percent. Some lenders are reportedly making loans at close to 40 percent by taking advantage of this legal loophole. It is absurd that such a recklessly high interest rate should be allowed by law.

Small businesses with low credit ratings are hardest hit by the continuing credit crunch. They are not welcomed by regular financial institutions still struggling to clean up their bad debts — not only city and regional banks, but also community banks such as credit unions and associations. It is unconscionable that major banks — which have received trillions of yen in public funds to bolster their capital — are supplying large amounts to shoko lenders.

The shoko loan problem points up the need to create a flexible financial system so that lending rates can be set freely, but within reasonable bounds, on the basis of borrowers’ creditworthiness, or lack of it. In addition, public assistance to small businesses needs to be bolstered. This is a timely and appropriate question that must be addressed by the current extraordinary Diet, which has been dubbed the “small-business session.”

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