Outline the main problems facing the Japanese banking industry during the 1990s. How did the Japanese authorities help address these problems? The 1990s is a period in Japanese finance history known as the ‘lost decade’. Having experienced a period of unprecedented growth during the 1980s, where GDP rose on average over 4% on the previous period, Japan’s banking sector and economy as a whole was faced with fall out when in 1989 the asset ‘bubble’ burst.
This essay will go on to identify the issues faced by the banks during the ‘lost decade’, pre-existing factors that may have contributed to the severity of the crisis and what steps were taken by the various authorities to tackle these issues. Before identifying the problems Japanese banks faced in the 1990s it is necessary to build up a brief background of the banking sector in Japan. It is also necessary to highlight economic and regulatory factors that may have influenced the sector’s performance during this period.
Since WWII Japan had not experienced the failure of a major bank. When institutions had been in trouble the Bank of Japan (BoJ) stepped in, either to make more capital available or to ensure that the faltering business was absorbed by a more robust bank. In return for this protection it was expected that the banks would function as financial intermediaries transferring money from household savings to the industrial sector.
This role saw banks operating as providers of public financial services rather than competitive intermediaries where a case of ‘the survival of the fittest’ would entail (Nakaso 2001). Another important background factor was that during the later half of the 1980s, in an attempt to continue this growth, the Japanese authorities undertook a regime of accelerated liberalisation and deregulation. This process included the relaxation of interest controls, capital market deregulation and the relaxation of restrictions on permissible activities (Kanaya and Woo 2000).
Hall (1999) identified seven serious issues faced by the Japanese banking sector during the financial crisis of the 1990s: a weak domestic economy, continuing weakness in the domestic property market, continuing weakness in domestic stock prices, excess capacity in the banking and financial sectors, threats posed by deregulation, costs borne in the name of preservation of the financial system and finally a bad debt mountain. The weak state of the Japanese economy in the 1990s was to have a serious impact on the banking sector.
GDP fell off dramatically averaging 1. 4% and even experiencing negative GDP in 1998 and 1999, see Figure 1. Unemployment rose significantly to reach a post war high of 4. 8% and the number of businesses filing for bankruptcy rose from under 1000 in 1990 to over 5000 in 1998. The effect of a retracting economy meant not only were the sources of funds for banks becoming limited but demand for their services and products was also waning.
The large number of businesses failing and in difficulty meant that the banks were also faced with a rise in the number of nonperforming loans (NPLs) as well as having to write off and restructure a lot of their lending. The weakness in the property market is perhaps best highlighted by the crash in property value from 1990-1997 which saw the market lose 20% of its value. Residential land was hit the hardest losing nearly 40% of its value. Like most banking sectors world wide the Japanese banks were heavily invested in the property markets both residential and commercial.
The collapse was felt more prominently in Japan because it was common practise to take property as collateral for loans. This feature of Japanese lending meant that banks were faced with a much greater exposure to the volatility of the property market and that the previously ‘covered’ loans were now ‘uncovered’ by as much as 40% of their value. The property crash and perhaps the actions of the founder banks lead to the jusen problem which cost the Japanese financial sector i?? 5730 billion and the tax payer a further i?? 680 billion.
The jusen companies were founded by the banks in the 1970s to operate in the mortgage lending sector. However by the 1980s the banks themselves had moved into mortgage sector forcing the jusen companies to move their operations to commercial lending, where they had little experience. Their lack of experience in the commercial lending, the collapse of the property market and loss of core business, ultimately lead to the seven jusen companies losing i?? 6410 billion (MoF 1995). In 1989 the Nikkei 225 reached an all time high, 38915.
90. By 1998 the market value had fallen by over half to a low, 12879. 97, see Figure 2. Banks and the businesses with which they traded had considerable holdings in each other. This situation, while potentially opening the door to negotiating favourable lending and investment arrangements, also meant that during a period of downturn the banks were exposed to the declining performance, share performance, of not only their customers but all the other banks in the economy and their customers.
BIS rules at the time also allowed the shares held by banks to count as Tier 2 capital which meant that not only were banks suffering from depressed earnings but also from a weakened balance sheet (Hall 1998). Excess capacity in Japan’s banking and financial sectors was a problem inherent of the regulatory system in place at the time. Because of the ‘convey’ system, which did not allow the weakest banks to fail, the number of banks in operation was far greater than demand required.
Regulatory and operating decisions by the authorities were made ensuring that the viability of the weakest banks would not be undermined. If an institution was facing failure the MoF would step in to ensure either further capital was made available or that the firm in difficulty was taken over by one of the more stable institutions. The excess capacity in the system meant that banks were operating on very fine margins, resulting in low profitability, and were heavily reliant on the continuing growth in domestic property and stock markets.