Influence of Intellectual Capital Information on Credit Risk Rating Process/Criterion and Credit Conditions - Survey Analysis to Japanese Financial Institutions

In Japan, Guidelines for Disclosure of Intellectual Assets Based Management were issued in December 2005. These guidelines focused on the role of not only intellectual property (in Japan, ``Guideline for Intellectual Property Information Disclosure" was issued in January 2002, but only 22 firms complied with this guideline in 2006), but also intellectual assets management in the same points of view with MERITUM and Danish Guidelines. However Intellectual Assets Based Management Report (IABMR) was disclosed by only 11 firms in 2006. Therefore Ministry of Economic and Trade Industry in Japan has set to encourage the widespread use of the guidelines for better communication with financial institutions, especially for small- and medium-sized firm financing. Their efforts were effective, and these guidelines succeeded in being introduced as a communication tool of ``Action Program concerning the enhancement of Relationship Banking Functions" (2003) by Financial Service Agency in Japan. This paper reports the result of our questionnaire analysis to Japanese financial institutions. Our questionnaire is on how financial institutions use financial and non-financial information, and in which stage, of their credit rating and analysis. Our questionnaire includes 13 financial items as well as 54 non-financial items to compare these differences. It also includes 11 traditional non-financial items as well as 43 intellectual assets items to get a better understanding of which items are prospective to the prevalence IABMR. Our questionnaires were sent to all 575 financial institutions in Japan in May 2008. We received answers from 439 (76.3%). It has not been surveyed systematically at which stage of due diligence, nor to which degree, non-financial information is used so far, in Japan. Our paper is the first one to illustrate which non-financial information is prospective to credit rating and analysis in the view points not only of financial decisions, but also business support (business matching and business planning support, etc), which leads to future financing to the financial institutions. Firstly, it can be said that financial institutions are starting to recognize the increasing importance of non-financial information in general, though the level of importance varies between institutions. Almost half of financial institutions keep a record of non-financial information by using ``Customer management check-sheets" in their due diligence, and input it to ``Customer management support system" systematically. Non-financial information including business planning, business activities and conditions of the counter party, and intellectual assets, is accumulated and these data may be shared. Moreover shared information is being used at internal or external seminars or lectures to improve employee skills of credit rating and analysis. Secondly, the usage ratio of non-financial information vs. financial information is about 26% (within secondary regional banks, 23.8%; Mega banks, 27.5%; regional banks, 28.15%; credit banks, 28.0%; and credit unions, 28.9%). One credit union said that it has started to use more non-financial information for financing judgments, as competition in the region intensifies. On the other hand, one credit bank said that it is not easy to prove the accuracy of non-financial information when in the self-assessment stage. These trade-off effects might lead to the compromise point of 26% usage of non-financial information. This result is almost the same as the ratio of non-financial information when financial analysts make decisions on investments (Koga, 2006). Thirdly, financial institutions usually put great importance on financial information in the first ranking stage of the financing decision, because they calculate the default rate referring to ranking scoring models. However we find that they use non-financial information, including intellectual assets such as management skills and core technologies, to adjust ranking scoring models even in the ranking stage. They think that non-financial information, including intellectual assets, has a great role in preventing the discounting of future prospective firms in judgments based only on financial information in the ranking self-assessment. Fourthly, we report the real effect of non-financial information to financing decisions, that is, influence to (1) the interest rate, (2) the amount of financing, (3) the financing period, and (4) the amount of mortgage. Over half of financial institutions regard non-financial information as an influence in the amount of financing (55.1%) and interest rate (52.2%). It is a lesser influence in financing period (29.6%) and the amount of mortgage (27.4%). We also find that intellectual assets information items have a great importance when they make a financing decision. For example, brand, leadership, and skilled employees influence decisions on interest rates, and employee evaluation system, intellectual property, and succession of top management influence decisions regarding the amount of financing. Lastly, we find that financial institutions use non-financial information as a positive check as well as a negative check. It used to be that non-financial information was used as a tool of negative check, which reflect risk aversion and stability intention attitudes of financial institutions. However we find that, in the past 5 years, typically intellectual assets information has become more important as a tool of positive check.