Academic journal article Academy of Strategic Management Journal

Credit Risk Diversification as an Incentive for Japanese Bank Mergers

Academic journal article Academy of Strategic Management Journal

Credit Risk Diversification as an Incentive for Japanese Bank Mergers

Article excerpt

(ProQuest: ... denotes formulae omitted.)

BANKING CRISIS AND FINANCIAL DEREGULATION IN JAPAN

After World War II, banks in Japan had been heavily regulated by the Ministry of Finance. Interest rates, scope of business and foreign exchange were strictly regulated. As a result, competition was very limited and customers viewed banks indifferent from each other. Under the strict regulated system, banks are fully guaranteed by the Ministry of Finance. That is, banks can never fail under this system. The system proved itself to be quite efficient in building Japan after World War II as evidence reveals that the there were no major bank failures after the World War II up until around mid-1994.

Japan started deregulated its financial system in 1970s. The deregulation and liberalization were built around the motivation to make Japan a major world financial center. However, transforming Japanese financial system in to the US-style system is not an easy process given existing cultures and tradition of Japanese financial system. One unique characteristic of Japanese financial system before deregulation in 1970s is the low level of consumer credit. Young workers had to save to build the house given such scarce consumer financing. Overall saving rate of Japanese population was thus higher than that of most developed countries. On the other hand, firms in the real sector were deeply in debt because the system encourages real sector corporations to heavily borrow with the main objective of injecting the economy with high level of investment.

The ratio of the financial liabilities of the real sectors to total Gross National Product (GNP) has been rapidly increasing after World War II through the financial deregulation period. Japanese banks were treated as an intermediary that channels surplus household saving to industrial sectors. Therefore, Japanese banks acted more like providers of public financial services than competitive private sector intermediaries. Given such uniqueness of Japanese financial system, the authority decided to move with the financial reform policy by using a stepwise basis. Since the enforcement of the Financial System Reform Law of 1992 in April 1993, banks and other depository institutions are allowed to compete with securities firms via subsidiaries.

The deposit insurance system was established in 1971 to act as a safety net for banking system in Japan. The deposit insurance law was later revised in 1986 and enacted in March 1987. It specified that the Deposit Insurance Corporation (DIC) can deal with failed banks under two options: liquidation and financial assistance. The insurance amount under the liquidation option is up to ten million yen for each depositor. The loss amount above this upper limit might be recovered depending on the remaining value of the failed bank. Under the financial assistance option, the business of a failed bank would be transferred to an assuming bank. The DIC also transfers fund to an assuming bank as a financial assistance provision. Before the financial crisis, the insurance fund hold by the DIC was only 300 million yen, which was far too small compared to the actual deposit amount of banking system in Japan.

Japan began to experience major bank failures after mid-1994. In December 1994, two urban credit cooperatives; Tokyo Kyowa and Anzen, went bankrupt with a combined deposit of 210 billion yen. To avoid bank runs, the Ministry of Finance and the Bank of Japan decided to resolve the problem of these two failed banks by choosing financial assistance option, but there was no financial institution willing to be an assuming bank. As a consequence, the new bank named Tokyo Kyoudou Bank (TKB) was established to assume the assets and deposits of the two failed credit cooperatives.

In 1995, Daiwa Bank, an internationally active city bank was ordered by the US regulators to close all its operations in the US market. In that same year, seven Junsen companies or housing loan corporations, non-bank institutions providing heavy lending to real estate developers, also went bankrupt, with the estimated total loss of 6,410 billion yen. …

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