Banking is one of the most heavily regulated industries in post-war Japan; thus, with the exception of a few foreign banks, virtually no entry into banking has been allowed. Within the industry, long-term banking and short-term banking have been separated; trust banking services have been provided only by trust banks. Until the late 1970s, most interest rates were set at non-market clearing levels. More important, moral suasion and informal administrative guidelines have been widely used.
This chapter discusses the nature, degree and implications of such heavy government interventions for the performance of the banking sector, especially that of main banks. The implications emerging from the analysis are straightforward. Japanese banks in the late 1940s were in a shaky situation with very low levels of capital and with high operating costs due to a sharp decline in the average size of deposits. The protection provided by a variety of regulations enabled banks to channel funds into targeted industries. Protection was heavier for the larger banks that played the role of main banks. Thus, the existence of government regulation or protection was one of the reasons for the superb performance of Japanese main banks.
The regulatory authorities protected banks essentially in three ways. First, many forms of subsidies were provided, including those arising from interest rate regulations, entry restrictions, and Bank of Japan (BOJ) lending at the discount rate. Second, significant portions of credit risks were borne by the government. Public financial institutions supplied funds jointly with private banks. The trust fund bureau bought large amounts of debentures issued by long-term credit banks. Most important of all, the Ministry of Finance (MOF) and the BOJ rescued troubled banks by any possible means. Third, the flow of funds through the capital market, especially the bond market, was severely controlled.
The decline in management efficiency expected from such heavy protection was minimized by the MOF's guidelines to limit bank expenses. In