The "Big Bang"?: An Ambivalent Japan Deregulates Its Financial Markets

Article excerpt

Regulatory reform is a hot issue in the United States, as other articles in these pages attest. Successes over the past several decades in deregulating transportation and financial services are being followed by new moves to make government social regulation more effective and to bring the costs and benefits of regulation into better balance. In this article, the authors look across the Pacific to assess a major regulatory reform initiative in Japan.

In November 1996, Prime Minister Ryutaro Hashimoto, borrowing rhetoric from the 1980s deregulation of London's financial markets, called for a "Big Bang" deregulation of his country's financial markets to be completed by 2001. Japanese governments have trotted out various regulatory reform measures over the years, with mixed results at best. Is this time any different?

Certainly the fanfare surrounding the announcement of the Big Bang would lead one to believe the answer is "yes." Indeed, measured against the limited results of past Japanese deregulation initiatives, the new proposals are indeed ambitious and represent a welcome movement by Japan toward freer capital markets. But the ultimate impact of Japan's Big Bang will be limited by its place in a national economy that remains elsewhere highly regulated--and in a society that in many ways remains hostile to deregulation.

BACKGROUND

Until the late 1970s, Japan's financial markets were, like the rest of its economy, highly regulated. The overall financial system intentionally favored banks, the banking sector was finely segmented, banking and securities firms were strictly separated, virtually all interest rates were controlled by the government, foreign exchange was tightly controlled, and the variety of financial instruments of all kinds was limited and subject to approval by the Ministry of Finance. Monetary policy tended to operate through quantitative measures (varying the supply of central bank credit to the commercial banking system) rather than interest rate manipulation. And with interest rates set below market-clearing rates, the government was also in a position to influence commercial banks' allocation of credit to industry.

Changing economic conditions, however, began posing challenges to regulatory controls toward the end of the 1970s. Rapid increases in government deficits and resistance from the financial community to the low fixed interest rates at which government debt was issued led to a gradual freeing of interest rates. Shifts in profitability among different kinds banks led to lower barriers among the various segments of banking. Since the mid-1970s controls over foreign exchange have also been extensively eased.

But the pace of deregulation has been halting, and results have been mixed. Encouraged by the Ministry of Finance, the large commercial banks moved into real estate in the 1980s but quickly engaged in imprudent lending. Their indiscretion helped feed the real estate and stock market speculation in the late 1980s, and the collapse of those speculative bubbles has left the banking sector saddled with enormous amounts of nonperforming loans and badly tarnished reputations. At the end of the third quarter of 1997, nonperforming loans officially totaled 28 trillion yen or some $230 billion. Private estimates run as high as $700 billion (by way of comparison, all commercial and industrial bank loans made in the United States total just over $800 billion).

Japanese financial institutions also used their new freedom to expand rapidly in world markets in the 1980s, only to discover that their highly protected history left them poorly equipped to compete. Able to gain market share through aggressive pricing of loans and other financial services, but unable to evaluate risk, they have been retreating from many of those markets in the 1990s. In the reverse direction, foreign financial institutions rushed into liberalized Japanese markets during the 1980s, only to be hamstrung by remaining regulations that kept transactions costs high and deprived them of many competitive advantages in the market. …