Chapter 2.ppt of macroeconomics by mankiw 9th edition
Kawai.ppt
1. JAPAN’S BANKING SYSTEM:
FROM THE BUBBLE AND CRISIS TO
RECONSTRUCTION
Masahiro Kawai
Institute of Social Science
University of Tokyo
Japan
Center for Global Partnership Conference
“Macro/Financial Issues and International Economic Relations:
Policy Options for Japan and the United States”
Tokyo, May 13, 2004
2. PRESENTATION
I. INTRODUCTION
II. MACROECONOMIC DEVELOPMENTS
AND THE BANKING SECTOR
III. CAUSES OF THE BANKING SECTOR
CRISIS AND DIFFICULTIES
IV. IMPACT OF BANKING SECTOR
DISTRESS
V. POLICY FRAMEWORKS FOR BANK
RESTRUCTURING AND ITS PROGRESS
VI. CONCLUDING REMARKS
3. I. INTRODUCTION
• What are the factors behind the recent banking sector
difficulty, particularly the 1997-98 systemic crisis, in
Japan?
• Why did the government fail to address the problem
early, quickly and decisively?
• Since the crisis, has the FSA formulated and
implemented a comprehensive policy to resolve banking
sector problems?
• Has there been sufficient progress on financial sector
and corporate sector restructuring?
• Is the worst over in the Japanese banking system? Is the
banking sector solvent? What are risks?
• What should be done to transform the Japanese banking
system into a competitive market-based system?
4. II. MACROECONOMIC DEVELOPMENTS
AND THE BANKIG SECTOR
1. Macroeconomic Performance and Policy
• Output stagnation (Figure 1) : The average annual growth rate
of real GDP was 1.1 percent during the last decade, 1992-2002.
Near-zero growth (0.1%) in 1998-2002. In addition, nominal
GDP has been more stagnant (-1.2% in 1998-02).
• Price deflation (Figure 2) : The average annual inflation rates
during 1992-2002 were low or negative at 0.2% for CPI and -
0.1% for GDP price deflators. The GDP deflator fell in 1995-
2002 (except 1997) at 1.0% per year and CPI fell in 1999-2002
at 0.7% per year.
• High unemployment rate, reaching a peak of 5.5%.
• Keynesian fiscal spending in 1992-2002, rising from the
average size of 32% of GDP in 1991 to 39% in the early 2000s,
with a declining fiscal revenue (from 34% of GDP in 1991 to
31% recently).
5. Figure 1. Japan's Nominal GDP and Real GDP, 1980-2003
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
1980 1985 1990 1995 2000
Annual
Rates
of
Change
in
GDP
（％）
Nominal GDP Real GDP
6. Figure 2. Japan's Price Developments―GDP Deflator, Consumer Price Index (CPI),
a n d D o m estic C o r p o r a te G o o d s P r ice I n d ex (D C G P I ), 1 9 8 0 -2 0 0 3
-5.0
0.0
5.0
10.0
15.0
1980 1985 1990 1995 2000
Annual
Rates
of
Change
in
Price
Indices
(%)
GDP Deflator Consumer Price Index Domestic Corporate Goods Price Index
7. II. MACROECONOMIC DEVELOPMENTS
AND THE BANKIG SECTOR (cont’d)
2. Asset Prices
• There was an asset price bubble in the late 1980s.
The increases in asset prices were much faster than
nominal GDP (Figure 3).
• The equity price reached its peak in December 1989
and has since then declined as a trend.
• The urban land price for six major city areas reached
its peak in September 1991 and since then has been
declining persistently.
• Relative to nominal GDP (1980=100), the land price
became lower in 1996 and the equity price in 2002.
8. Figure 3. Japan's Asset Prices―Stock and Land Prices―and Nominal GDP, 1980-2003
100
150
200
250
300
350
400
450
500
550
600
1980 1985 1990 1995 2000
Asset
Prices
and
Nominal
GDP
(1980=100)
Urban Land Price Index of Six Large City Areas TOPIX Nominal GDP
9. II. MACROECONOMIC DEVELOPMENTS
AND THE BANKIG SECTOR (cont’d)
3. Banking Sector Conditions
• Expansion of bank loans in the late 1980s, together with the
expansion of bank deposits (Figure 4). Loans were extended to
firms with assets such as land as a collateral.
• Loans were concentrated in wholesale and retail trade, real estate,
finance and insurance, and construction (Table 1).
• The bursting of the bubble in the early 1990s made highly
indebted firms in these sectors unable to repay due to the decline
in collateral values, thus creating non-performing loans (NPLs).
• But bank exposure to certain sectors, such as real estate and
construction, continued to expand until the second half or the
middle of the 1990s.
• As a result, NPLs rapidly increased in the banking sector, and the
banking system fell into a systemic crisis in 1997-98.
12. III. CAUSES OF THE BANKING CRISIS
1. Overextension of Loans during the Bubble Period
Several factors led to loan overextension in the second half of
the 1980s.
• Financial liberalization and greater opportunities for risk-
taking: Financial liberalization in the mid-1980s allowed
small financial institutions to venture into new areas,
particularly funding housing finance companies (Jusen) and
other real estate investments.
• Shifts in bank clients to non-manufacturing firms: With large
firms increasingly having access to capital markets, major
banks began to direct their loans towards non-manufacturing
firms, like in real estate, construction and SMEs,
• Unwarranted expectations of high economic growth.
• Low interest rate policy.
• Weak corporate governance on the part of banks.
13. III. CAUSES OF THE BANKING CRISIS
(cont’d)
2. Severe Negative Impact of Asset Price Deflation
• Rapid credit growth had been accompanied by a doubling
of stock prices and a massive rise in commercial estate
prices, particularly in major cities.
• A sharp increase in interest rates and the introduction of
credit ceiling on bank loans to real estate-related activity
led to the bursting of the asset price bubble.
• The bursting of the bubble created substantial losses for
firms that held equities and had borrowed from banks with
real estate as a collateral.
• This transformed overextended loans into non-performing
loans, and the large build-up of capital investment and
labor employment during the bubble period into excesses.
• Asset price deflation has continued for more than ten years.
14. III. CUASES OF THE BANKING CRISIS
(Cont’d)
3. Policy Failure to Contain the Problem Quickly
• Policymakers initially had a strong bias against the
bubble and continued to suppress asset prices even after
the price collapse.
• Hesitation in taking decisive measures for fear that it
might touch off a banking sector panic.
• The initial approach was based on the expectation that a
resumption of economic growth would restore financial
health of banks and their clients.
• Keynesian fiscal policy sustained minimum growth.
• There was no domestic or external pressure to accelerate
the resolution of banking problems.
15. IV. IMPACT OF BANKIG DISTRESS
1. Collapse of the Traditional “Convoy System”
• Until the 1990s, the process for managing bank failure was largely
ad hoc, based on the informal “convoy system.”
• Using its branch licensing authority, MOF encouraged stronger,
healthier banks to absorb insolvent institutions through informal,
administratively orchestrated, bank P&A transactions.
• In addition, BOJ often provided liquidity assistance to prevent
systemic crises.
• But it became increasingly difficult to persuade banks to provide
assistance to other troubled banks because even relatively strong
banks faced serious NPL problems.
• Major shareholders and firms associated with Hokkaido
Takushoku Bank, Yamaichi Securities and Sanyo Securities
refused to help them. Relatively strong banks also refused to
provide assistance.
• Temporary nationalization of the Long-Term Credit Bank of Japan
in October 1998 signified the end of the “convoy system.”
16. IV. IMPACT OF BANKIG DISTRESS
(cont’d)
2. Downsizing of Bank Business
• One response to the banking crisis has been further
deregulation, rather than stopping it, along with the
principle of “Financial Big Bang,” and the encouragement
of mergers and consolidation.
• The temporarily nationalized LTCB was sold to foreign
stakes.
• Commercial banks have been forced to rethink their
business strategies by downsizing their operations
-End of quantitative targets (maximization of deposit
collection and loan extension)
-Focus on core competency
-Retreat from foreign operations
17. IV. IMPACT OF BANKIG DISTRESS
(cont’d)
3. Impacts on Monetary and Fiscal Policy
• Commercial banks with large NPLs have not been expanding
loans, and indebted firms have had no appetite to borrow, and
instead have been repaying their bank loans to reduce debt.
• Weaker monetary transmission mechanisms:
-Under the zero interest rate policy, BOJ switched to
“quantitative easing” (March 2001) providing liquidity to the
banking sector. Monetary base has been growing relatively
fast, but M2&CD has not been growing as fast (Figure 5).
-Absence of banks’ normal financial intermediary function
weakens monetary policy transmission mechanisms.
• Fiscal worsening: Rise in government spending, decline in
tax revenue, large budget deficits and mounting public debt.
18. Figure 5. Japan's Money Supply and Bank Loans, 1980－2003
-5
0
5
10
15
20
25
30
1980 1985 1990 1995 2000
Annual
Rates
of
Change
in
Average
Outstanding
(%)
Monetary Base M2+CD Domestic Bank Loans
19. V. POLICY FRAMEWORKS FOR BANK
RESTRUCTURING AND ITS PROGRESS
1. Stabilization of the Banking System
• The banking sector was in systemic crisis in late 1997 to
1998. The banking sector has been stabilized since then
due to more decisive policy actions.
• Means of stabilizing the banking sector:
-Blanket deposit guarantee
-Extension of emergency liquidity assistance to troubled
banks
-Financial assistance to promote mergers among troubled
financial institutions
-Decision to inject capital to weak but viable banks
-Temporary nationalization of non-viable banks
20. V. POLICY FRAMEWORKS FOR BANK
RESTRUCTURING AND PROGRESS (cont’d)
2. Bank Restructuring
• Public recapitalization (March 1998, March 1999, May
2003). See Table 2.
• Recognition of NPLs—with tighter loan classification and
loan loss provisioning—helps not only identify the size of
NPLs but also prompts faster NPL disposals
• Disposal of bank NPLs, close to 90 trillion yen in the last
ten years. Despite disposals, bank NPLs have not declined
fast due to the emergence of new NPLs (Table 3).
• Exit of a number of inefficient deposit-taking institutions.
• Establishments of public AMCs (RCC, IRC) has
encouraged the carving out of NPLs.
21. Table 2. Public Capital Injection into the Banking System, March 1998 and
1999
(Billions of yen)
March 1998 March 1999
Banks
Total Preferred
Shares
Subord.
Debt.(a)
Subord.
Loans
Total Preferred
Stocks
Subord.
Debt
City Banks
Tokyo Mitsubishi 100 0 100 0 -- -- --
Daiichi Kangyo 99 99 0 0 900 700 200
Sakura 100 0 100 0 800 800 0
Sumitomo 100 0 100 0 501 501 0
Fuji 100 0 100 0 1,000 800 200
Sanwa 100 0 100 0 700 600 100
Tokai 100 0 0 100 600 600 0
Daiwa 100 0 0 100 408 408 0
Asahi 100 0 0 100 500 400 100
Long-Term Credit Banks
Industrial Bank of Japan 100 0 100 0 600 350 250
Long-Term Credit Bank(b)
176.6 130 0 46.6 -- -- --
Nippon Credit Bank(b)
60 60 0 0 -- -- --
Trust Banks
Mitsubishi Trust Bank 50 0 50 0 300 200 100
Sumitomo Trust Bank 100 0 100 0 200 100 100
Mitsui Trust Bank 100 0 100 0 400.2 250.2 150
Yasuda Trust Bank 150 0 150 0 -- -- --
Toyo Trust Bank 50 0 50 0 200 200 0
Chuo Trust Bank 60 32 0 28 150 150 0
Regional Banks
Yokohama Bank 20 0 0 20 200 100 100
Hokuriku Bank 20 0 0 20 -- -- --
Ashikaga Bank 30 0 30 -- -- --
Total 1,815.6 321 1,080 414.6 7,459.2 6,159.2 1,300
Note: (a) These debentures are generally of a consol nature and are therefore considered upper tier-2
capital. The only exceptions are those issued by Sanwa Bank and the Industrial Bank of Japan
whose debentures are of fixed (10-year) duration and are therefore lower tier-2 capital, which is
limited to no more than half of tier-1 capital.
(b) These banks were granted only part of the injection for which they applied.
Source: Deposit Insurance Corporation and the Financial Reconstruction Commission.
22. Table 3. Outstanding Stock and Disposals of Non-Performing Loans, All Domestically Licensed Banks
(End of Fiscal Year)
(Unit: Billion yen)
FY1992 FY1993 FY1994 FY1995 FY1996 FY1997 FY1998 FY1999 FY2000 FY2001 FY2002
Non-performing Loans:
Outstanding Stock
--
(12,774)
--
(13,576)
--
(12,546)
28,504
(21,868)
21,789
(16,491)
29,758
(21,978)
29,627
(20,250)
30,366
(19,772
32,515
(19,281)
42,028
(27,626)
34,849
(20,433)
Loan Loss Provision:
Outstanding Stock
--
(3,698)
--
(4,547)
--
(5,536)
13,293
(10,345)
12,334
(9,388)
17,815
(13,601)
14,797
(9,258)
12,230
(7,678)
11,555
(6,939)
13,353
(8,657)
12,585
(7,897)
NPL Disposals --
(1,640)
--
(3,872)
--
(5,232)
13,369
(11,067)
7,763
(6,210)
13,258
(10,819)
13,631
(10,440)
6,944
(5,398)
6,108
(4,290)
9,722
(7,721)
6,658
(5,104)
New Net LLP --
(945)
--
(1,146)
--
(1,402)
7,087
(5,576)
3,447
(2,534)
8,403
(6,552)
8,118
(15,490)
2,531
(1,339)
2,732
(1,371)
5,196
(3,806)
3,101
(2,042)
Direct Write-offs --
(424)
--
(2,090)
--
(2,809)
5,980
(5,490)
4,316
(3,676)
3,993
(3,501)
4,709
(4,268)
3,864
(3,609)
3,072
(2,650)
3,974
(3,414)
3,520
(3,038)
Other --
(271)
--
(636)
--
(1,022)
302
(1)
0
(0)
863
(766)
804
(683)
548
(449)
304
(269)
552
(501)
37
(25)
Operating Profits 4,685 4,439 4,484 6,753 6,418 5,503 3,129 4,675 4,768 4,693 4,674
Total Loans:
Outstanding Stock
474,783 477,150 477,801 482,701 482,312 477,979 472,610 463,484 456,965 440,610 423,286
NPL/Total Loan (%) -- -- -- 5.91 4.52 6.23 6.27 6.55 7.12 9.54 8.23
Capital Adequacy Ratio (%) -- -- -- -- -- -- 10.06 10.88 10.75 10.12 9.52
Note: (1) Data in the table are figures for the Banking Accounts of All Domestically Licensed Banks (i.e., city banks, long-term credit banks, trust banks, and
regional banks) while data in parentheses are those for city banks, long-term credit banks and trust banks. Data for operating profits and capital adequacy
ratios also include foreign trust banks.
(2) Non-performing loans in this table refer to “risk management loans” (losses＋loans more than 3 months overdue＋loans with term restructured), except
that the definitions prior to FY1997 are slightly different: they are losses + overdue loans for FY1992-94 and losses＋loans more than 6 months overdue＋
loans with interest reduced for FY1995-96.
(3) The capital adequacy ratio is the ratio of capital to risk assets.
Source：Financial Services Agency; Bank of Japan.
23. V. POLICY FRAMEWORKS FOR BANK
RESTRUCTURING AND PROGRESS (cont’d)
3. Bank Business Strategies and Consolidation
• Consolidation of city banks into four major financial groups
and one weak group (Table 4).
-Mizuho Financial Group (January 2003)
-Sumitomo Mitsui Financial Group (December 2002)
-Mitsubishi Tokyo Financial Group (April 2001)
-UFJ Holdings (April 2001)
-Resona Holdings (December 2001).
• Banks’ strategic objectives:
-Gaining maximum market power in a niche market
-Attaining economies of scale
-Investing in IT
-Investment banking, asset management, fee-based business
24. Table 4: Banking Groups and Consolidated Assets
(Billions of yen)
New Groups Major Subsidiary Banks Former Banks Consolidated Assets
March 2003
End
(a)
1. Mizuho Financial Group
(MHFG)
(Established in January 2003)
Mizuho Bank, Mizuho
Corporate Bank, Mizuho
Trust & Bankig
Industrial Bank of Japan,
Daiichi Kangyo, Fuji,
Yasuda Trust Banks
134,033
2. Sumitomo Mitsui Financial
Group (SMFG)
(Established in December 2002)
Sumitomo Mitsui
Banking Corporation
(SMBC)
Sumitomo Bank, Sakura
Bank
102,395
3. Mitsubishi Tokyo Financial
Group (MTFG)
(Established in April 2001)
Bank of
Tokyo-Mitsubishi (BTM),
Mitsubishi Trust &
Banking Corporation
Bank of
Tokyo-Mitsubishi (BTM),
Mitsubishi Trust Bank,
Nippon Trust Bank
96,532
4. UFJ Holdings
(Established in April 2001)
UFJ Bank, UFJ Trust
Bank
Sanwa Bank, Tokai Bank,
Toyo Trust & Banking
80,207
5. Resona Holdings
(Established in December 2001)
Resona, Saitama Resona,
Kinki Osaka, Nara Banks,
Resona Trust & Banking
Asahi Bank, Daiwa Bank 42,892
Source: Individual groups’ website.
25. V. POLICY FRAMEWORKS FOR BANK
RESTRUCTURING AND PROGRESS (cont’d)
4. Linkages with Corporate Restructuring
• Corporate sector restructuring is the mirror image of bank
NPL resolution. Resolution of bank NPLs requires real
operational restructuring and revitalization of corporations.
• Market-based restructuring—like direct sales of NPLs to the
market—is key.
• Three frameworks to accelerate corporate restructuring:
-Legal insolvency procedures (Table 5), particularly the
Civil Rehabilitation Law (April 2000)
-A framework of voluntary out-of-court negotiations for
corporate restructuring—based on the London rules of
INSOL—including debt-equity swaps
-Restructuring through the RCC and IRC
26. Table 5. Legal and Instituional Changes to Facilitate Corporate
Restructuring
Year Changed Laws, Procedures and Institutions Contents
1997 Commercial Codes Procedures for corporate mergers rationalized.
December 1997 Anti-Monopoly Law Establishment of pure holding companies allowed.
March 1998 Financial Holding Company Law Establishment of financial holding companies
allowed.
1999 Commecial Codes Share swaps introduced; procedures related to parent
and subsidiary companies rationalized.
April 1999 Resolution and Collection
Corporation (RCC)
A colletion company to purchase and sell collateral-
based NPLs—“in danger of bankruptcy” or blow.
April 2000 Civil Rehabilitation Law (Minji
saisei Ho)
Facilitates filings and decisions for large number of
firms
2000 Commercial Codes Procedures for corporate splits introduced.
September 2001 Voluntary procedures for corporate
debt restructuring based on the
London rules (by INSOL)
Guidelines for debt forgiveness agreed.
April 2003 Corproate Restructuring Law
(Kaisha kosei Ho)
Restructuring provisions eased and some flexibility
allowed in the restructuring measures in line with
those of the Civil Rehabilitation Law.
April 2003 Industrial Revitalization
Corporation of Japan (IRCJ)
Resturucturing of large firms made easier through
purchase of NPLs from all non-main bank creditors.
Source: Financial Services Agency, Ministry of Finance, OECD.
27. V. POLICY FRAMEWORKS FOR BANK
RESTRUCTURING AND PROGRESS (cont’d)
5. Regulatory and Supervisory Reforms
• Overhauling of the regulatory system and the creation of
the FSA (June 1998).
• Prudential norms
-Loan classification and LLP tightened (Program for
Financial Revival, Oct. 2002)
-Quality of capital—treatment of deferred tax credits
-Prompt corrective action fully in place
-After a delay, planned reintroduction of a limited (partial)
deposit insurance in April 2005
• Resolution of 50 percent of NPLs within a year, and 80
percent of NPLs within two years.
28. VI. CONCLUDING REMARKS
• The bubble in the late 1980s and its collapse were largely
responsible for the emergence of NPLs and the banking
sector problem over the last 10 years.
• But the root cause of the problem lied in the lack of prudent
risk management by banks.
• The government failed to tackle the problem because of:
underestimation of the seriousness of the problem;
optimistic expectations of growth; sustained fiscal spending
and lack of domestic hardship; lack of domestic and
external constraints.
• A more comprehensive framework for bank restructuring
put in place since the 1997-98 crisis: temporary
nationalization and subsequent sales of non-viable banks;
recapitalization of weak banks; tighter bank regulation and
supervision; new institutions for bank restructuring.
29. VI. CONCLUDING REMARKS (cont’d)
• Sufficient progress has been made: stabilization of the
banking system, restructuring and consolidation of bank
businesses and new incentives for corporate restructuring
• Restoration of a healthy banking system requires: adequate
capital base and loan loss provisions; reestablishment of
profitable banking business; prudent risk management.
• Recapitalization of banks using public money in itself does
not resolve bank NPL problems. Sustained improvements
of cash-flows and profitability are needed through better
bank management and focus on core competency.
• The banking sector is largely solvent. The risks are
concentrated in regional, vulnerable banks to weak local
conditions and hikes of the long-term interest rate.
