The process of deregulation has been cited as contributing to the speculative bubble of the 1980s (Cargill, Hutchinson and Ito 1996). The deregulation of late 1980s, highlighted earlier, were followed by Japan’s Big Bang which began in the late 1990s and resulted in the opening up of the financial markets to all participants and the opening of previously banned markets such as the derivative markets. Deregulation in the capital markets greatly improved corporations’ ability to borrow directly from the market (Kanaya and Woo 2000).
Between 1985 and 1997 the corporate bond market grew from i?? 10 trillion to i?? 45 trillion. This was coupled with the creation of the commercial paper market in 1987. The relaxation of permissible activities led to the co-operatives coming into greater competition with the banks as restrictions on their lending limits to non-members were relaxed. The relaxation of interest rates only further increased the competitive nature of banking in Japan, this began with the liberalisation of term deposits in 1985.
With the banks now facing significant competitive pressures, from the newly formed capital markets, the co-operative lenders and from each other, they moved their lending activities to more risky activities to improve their profitability. These activities included customer, real estate and SMB lending. As already mentioned much of this lending was secured by property. Marsh and Paul (1996) argued that the increase in banks profit margins in the late 1980s was due to a short-term positive effect of the increase in high risk loans.
The ‘Big Bang’ in Japan was a planned process of deregulation in the latter half of the 1990s designed at opening up the banking sector. The measures brought in under the Financial System Reform Law of 1993 created opportunities that previously were only available to certain participants or that were previously not permissible activities. Cross-sectional entry meant that banks were now allowed to sell their insurance products and likewise the insurance industry could now engage in banking activities.
This may have seemed like a good opportunity for both industries but whereas the insurance sector began to quickly benefit from such changes; for the banks, benefits were only realised in the medium to long term. The opening of new markets, such as the foreign exchange and derivative markets, and the removal of restrictions on firms operating in the securities markets also provided domestic banks further opportunities to increase their scope and profitability. Again such liberalisation has draw backs, this time attracting overseas interest and competition.
The opening of these markets created opportunities for domestic banks but very few had significant experience in these fields. US firms, from where there had been considerable pressure to introduce the new reforms, already had long term exposure and experience in the new markets would pose a threat to incumbent domestic firms. Because of Japanese authority’s fixation with a zero failure policy, in an attempt not to dent consumer confidence in the system or the authorities themselves, both the banks and the public were forced to endure huge costs.
As already mentioned the Jusen crisis was resolved at a total cost of i?? 6410 billion. Furthermore when the BoJ realised that failures were imminent changes were also made to the DIC. Initially deposit insurance stood at 0. 012% of insured deposits, this was increased by 7 times to 0. 84% in 1996 – this at time when banks were already suffering from weakened margins and balance sheets. Linked with the zero failure policy is the impact of having to act as ‘life boats’ had on those banks that were able to maintain some sort of stable position during the crisis.
Once the MoF had identified ailing firms they would step in to put pressure on certain banks, it considered as being strong enough, to take on the failing business rather than let it go into bankruptcy. The bad debt mountain faced by Japanese banks in 1994 stood at over i?? 38086 billion. However the figures made publicly available are a point of contention for most analysts of Japan’s banking sector. This is because the reporting requirements placed on banks at the beginning of the 1990s the true nature of the problem did not begin to become clear until 1998.
Prior to 1998 the definitions of ‘non-performing’ and ‘restructured’ loans allowed banks to mask the severity of the bad debt they were faced with. A measure, put in place to protect the profitability of the banking system, allowing banks to value capital holdings at the lower of market or acquisition value also created a cloud of confusion as different banks adopted different reporting methods to either protect themselves from misleading their customers (Hall 1998) or to better state their position.
Faced with the situation of declining asset markets, an ailing banking sector with a rising bad debt mountain and a retracting economy the Japanese authorities took a number of steps in an attempt to rectify the situation. This latter half of the essay will briefly discuss the measures put in place. Perhaps the most significant factor when analysing the response of the Japanese authorities is the lack of action until 1997. The strategy of the authorities in the first half of the decade can best be described as one of forbearance.
It has been postulated that such lack of intervention was the authorities’ expectations that the economy would recover and partly not wanting to cause further public panic by taking actions against the banks. Conceivably the most important piece of legislation brought in was the “Law to Ensure the Soundness of Financial Institutions” of 1997. Encompassed in this new law was the framework for Prompt Corrective Action (PCA), as based on the US system of PCA.
The PCA was a step toward removing the culture of forbearance. Initially the PCA only applied to banks with international operations but was expanded to include purely domestic banks in April 1999. It set out clear capital ratio thresholds that if not met the authorities would require management to implement immediate strategy to better capitalise the bank. If the bank fell further below the thresholds then the authorities had the right to take out sanctions against the bank.
These sanctions might include the restriction of dividend payments or restrictions on entering new fields of business (see figure 3 for full detail). Another important aspect of the PCA was the introduction of a self-assessment process for the banks. This required banks to value their assets in a more prudent manner. It also opened up the banks’ own findings to inspection from external authorities, initially by the BoJ but later the FSA also took on a similar on-site inspection role.
1997 also saw the MoF announce that the government would cover the full amount of all deposits both in Yen and foreign currencies. This announcement came even though at the time the Deposit Insurance Scheme (DIS) only guaranteed deposits of up to i?? 10 million. This move by the MoF was in response to depositors more aggressively moving their money from weakened banks; a notable change in the public’s attitude toward the soundness of the financial system (Kanaya and Woo 2000).