Japan Financial Crisis By: Sander Chau Winslow Han

Postwar Financial System Bank-based system with underdeveloped stock and bond market. Stable system – no threat of new entry Safe but inefficient system Postwar system could not last forever Banks grew too large but restricted by many restrictions

4 Basic Causes of Bank Difficulties Failure to create prudential regulatory system Macroeconomic mismanagement Effects of Globalization High rate of financial innovation

Prudential Regulatory System Deregulation of the system took place without creating a effective system Generates competition Profit no longer guaranteed

5 Macroeconomic Policy Mistakes Interest Rates were at postwar lows Not easing monetary and fiscal policies in the early 90’s Relying excessively on easy monetary policies in the mid 90’s Fiscal Stimulus through supplementary budgets in the mid 90’s, too little too late. Wrong optimistic forecast for ‘97

Effects of Globalization Economic and financial policies subject to foreign pressures World’s largest creditor nation: Japanese financial institutions engaged in foreign lending and portfolio investment Flourishing of a free global capital market Big Bang deregulation creates competition in Japan home market from foreign financial institutions

Financial Technology Innovation Wide range of new financial derivatives Mostly American and some European players Japanese banks unable to learn The most capable Japanese are hired away by foreign firms

Banking Sector Problems Mergers and failures have left Japan with 7 major banks Low profitability for more than 10 yrs Banks depend too heavily on revenue from lending Government sponsored financial institutions Evergreening

Comparison to US Banks Interest Margin of Japanese banks 1.2% compared to 3.3 to 3.5% of assets “Other Revenue” 38% revenue from lending operations compared to US 73% of lending revenue

Government Sponsored Institutions Japan Post: post office and largest deposit- taking institution in the world Heavily subsidized 9 times the branches of all city banks Same rate on deposits, explicit government guarantee, no maintenance fee, lower rate on lending, no prepayment penalties Strong government resistance to address this problem and no public recognition of the losses that these government institutions have made with explicit subsidies

Table 1: An Overview of the Japanese Financial System Number Of Total Assets Deposits Outstandin g Loans and Discount Outstandin g InstitutionsBranchesEmployessTrillion% of GDPTrillion Banks City Banks (Consolidated) Others Cooperative Financial Institutions Non-depository financial institutions Life Insurance Other Insurance Remaining Public Financial Institutions Postal Savings Government Financial Institution Total Financial System

Bank Problem Example 1.1 trillion yen of public funds injected into Asahi and Daiwa Banks March 2003: Asahi and Daiwa Banks merge into Resona Bank (5 th largest) Resona granted another 1.96 trillion yen September 2003: Resona records loss of 1.76 trillion yen for period between Mar-Sept 03 (90% capital provided, disappears) Regulators principal aim to avoid large bank failures Little attention to future viability of recapitalized banks Regulators did not systematically force other banks to reassess their risk ratings Gives little incentive for Banks to restructure

Book Value and Adjusted Capital in the Japanese Banking Sector Mar-89Mar-91Mar-93Mar-95Mar-97Mar-99Mar-01Mar-03 Market Value of Shares A Book Value of Shares B Reported Book Value of Bank Capital C Defered Tax Assets D Estminated Underreserv ing E N/A Adjusted Capital C+ ((A- B)*.05)-D-E Equity Capital Held by the Govt Nikkei225 Stock Price Average

Conclusion Cumulative loan losses by banks since 1990 is 91.5 trillion yen (18% of current Japanese GDP) Tax payer burden very likely at least 100 trillion yen (20% of GDP) Solutions: –Banks must shrink in size –Find alternative means of income other than lending –Recapitalization and restructuring –Reining in of Government sponsored financial institutions