Magazine article American Banker

Japanese Banks Are Poised on a Precipice

Magazine article American Banker

Japanese Banks Are Poised on a Precipice

Article excerpt

Japanese banks are discovering that their dizzying ascent in the last decade brought them not to the promised land but to the brink of disaster.

Everywhere they turn, Japan's banks find more problems. Morale been sapped by a series of financial industry scandals, and balance sheets have been drained by mounting losses from bad real estate loans.

Five years of interest rate deregulation have eroded operating margins, and tumbling stock prices continue to eat away at the unrealized securities gains that make up almost half of Tier 2 capital at many banks.

Meanwhile, the nonbank financial companies that were funded by the nation's banks are in trouble, too. The industry has tens of billions of dollar exposed - and perhaps hundreds of billions of dollars.

|Meltdown Is Possible'

"In theory, a financial meltdown is possible," said John Choy, an analyst for the government-funded Japan Economic Institute. "There's a lot of speculation that one failure could start a chain reaction" that would topple one institution after another.

Still, most analysts, including Mr. Choy, say that kind of doomsday scenario is unlikely to be realized in a country of protective regulators.

"My guess is that the Ministry of Finance would step in and help in any way necessary," Mr. Choy said.

Yet it is undeniable that Japan's banks, after a decade-long rise to global preeminence, are under considerable pressure. Worldwide, they are pulling in their horns, scaling back loan growth, and raising concerns in some quarters that they will no longer play the vital role they once fulfilled as banker to the huge U.S. budget deficit.

Unstable 'Bubble Economy'

What happened? The "bubble economy" of the 1980s may well have carried the seeds of its own destruction. "It was a true bubble economy," said Arthur Alexander, president of the Japan Economic Institute. "It just fed on itself."

Japanese banks, benefiting from their nation's prodigious ability to save, had plenty of money to lend. Interest-rate deregulation was cutting into margins, and banks, as a result, were looking for investment opportunities that offered better rates of return.

The real estate market looked as though it would spiral upward forever, and Japanese banks -- despite their traditional conservatism -- jumped in readily. Banks not only funded all manner of real estate loans but also increasingly began to lend against properties that were already mortgaged.

With land values seemingly poised to continue rising as far into the future as one could see, bankers began lending against expected future values rather than cash flows.

By the beginning of the 1990s, it was not unusual to find that four or five banks had extended credit against the same property, often without the knowledge of the more senior creditors.

"It is very difficult to explain," said Shuichi Sugara, senior vice president at Sakura Bank Ltd.'s New York office. "But if you were a Japanese banker and your competition was making those loans, you would do the same thing as your competitor."

Moody's Investors Service said loans to real estate companies rose from 6.6% of domestic loans in 1984, to 10.3% in 1990.

At the same time, banks began backing finance companies that also invested heavily in real estate. At Sept. 30, 1991, according to Moody's, 40% of the loans made by nonbank financial companies were real-estate-related.

Not surprisingly, Japan's bank regulators began to worry that the system was spinning out of control.

Pricking the Bubble

In mid-1990, the Ministry of Finance began pushing up interest rates in an attempt to put the brakes on what appeared to be reckless investment practices. It doubled rates within a year.

Also in 1990, the Ministry of Finance restricted loans to real estate companies and nonbanks, The resulting credit crunch wounded the real estate sector, touching off a spree of bankruptcies that crippled the banks. …

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