Deposit Guarantees and the Burst of the Japanese Bubble Economy

By Cargill, Thomas F.; Hutchison, Michael M. et al. | Contemporary Economic Policy, July 1996 | Go to article overview

Deposit Guarantees and the Burst of the Japanese Bubble Economy


Cargill, Thomas F., Hutchison, Michael M., Ito, Takatoshi, Contemporary Economic Policy


I. INTRODUCTION

This paper describes the current status of deposit insurance systems in Japan and reviews the history of deposit guarantees in the past several years. During this period, some of the Japanese financial institutions have faced near or outright insolvency for the first time in the postwar history. This paper gathers publicly available data and facts on deposit guarantees in Japan in order to gain perspective on the problems.

II. BUBBLE, BURST Of THE BUBBLE, AND FINANCIAL DETERIORATION

The Japanese economy of the second half of the 1980s is commonly known as a "bubble economy" while the first half of the 1990s is known as the burst of the bubble economy. Starting in 1986, asset prices including stock and land, fine art paintings, and country club memberships doubled and then tripled within a few years. Following the peak in 1989, asset prices rapidly came down in the first half of the 1990s. Stock prices declined by 60 percent from 1990 to August 1992. Even as late as Spring 1995, stock prices remained at about half of the peak level. Representative land prices in metropolitan areas also declined by half from 1991 to 1995.

In retrospect, the rise and fall of asset prices from 1985 to 1995 is a typical financial bubble, but one that rivals many other spectacular examples in history. The burst of the bubble in the first half of the 1990s left many corporations, especially in the real estate business, holding large debts without sufficient earnings from properties to service outstanding loans. The financial deterioration, manifested by a nonperforming loan problem of major proportions, is Japan's most serious financial challenge in the postwar period.

The total size of the nonperforming loan problem is open to debate. In July 1995, the Ministry of Finance reported that Japanese banks and other creditors held about [yen]40 trillion worth of nonperforming loans of which 30 percent were regarded as uncollectible. The Ministry further indicated that another [yen]8 trillion in loans were "questionable" if one applies a more rigorous definition of "nonperforming loans." This qualification made the total estimate of nonperforming loans [yen]48 trillion.(1) Of this amount, the 21 major banks - consisting of the 11 city banks, three long-term credit banks, and seven trust banks - held approximately [yen]23 trillion. As a result, credit rating agencies have continually downgraded Japanese banks, once regarded as among the most financially secure in the world. In August 1995, Moody's released a new rating system for the major Japanese banks. The new rating system is designed to rate banks on a "stand alone" basis without government support and gives the top 50 Japanese banks an average rating of D because of weak fundamentals and earning powers.

The financial press and regulatory authorities have focused on the bank nonperforming loans held by banks and housing loan companies or jusen. However, the nonperforming loans held by credit cooperatives represent a serious though less publicized problem because of their relatively small capital base. Their similarity to S&Ls in the United States is intriguing. Many observers (e.g., Ostrom, 1992; Cargill, 1993; Kane, 1993) have drawn several parallels between the credit cooperatives in Japan and the S&Ls in the United States. These parallels include the following: (i) Agricultural credit cooperatives have diversified significantly away from their traditional specialization on loans to farmers related to agricultural operations. (ii) Some credit cooperatives have strong ties to the local community and politicians. (iii) Credit cooperatives hold significant amounts of real estate related loans. (iv) Credit cooperatives are not directly supervised by the Ministry of Finance or Bank of Japan but by local prefectural governments such that the extent and sophistication of local supervision is likely uneven. Some credit cooperatives have diversified without adequate supervision. …

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