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The Japanese Banking Crisis

Introduction

For more than a decade after 1990 the Japanese Banking Sector was in crisis being plagued by bad loans and a fast deterioration in the value of its assets. One of the most important factors that contributed to the banking troubles during this period was the slow and incomplete deregulation of financial markets.

During the high growth era between 1955 and 1973 the Japanese financial market was highly regulated with bond markets repressed and equity issuance rare. Risk-averse savers had few alternatives to holding saving deposits and rapidly growing corporations had to rely heavily on bank loans to finance their extraordinarily high rates of fixed investments. However as a result of slower economic growth during the mid 70s this structure began to change with the restrictions on bond and equity markets relaxed. As the markets opened up established firms shifted to alternative cheaper financing options in the form of bonds and equity. This greatly reduced their dependence on banks. For example, figure 1 shows the ratio of bank loans to total assets for large manufacturing firms in Japan. The ratio was around 0.35 in the 1970s, but started to decline in the 1980s. By 1990, it fell below 0.15. This exodus from bank borrowing shows that by the 1980s many large firms had started to feel the cost of depending exclusively on banks.

Although the bond and equity markets began to be deregulated the restrictions on household's investment moved much slower. Most Japanese savings until late 1990s continued to flow into banks. The banks therefore remained large but had to search for new lending opportunities. Since deregulation of financial markets considerably reduce the need for bank financing by healthy firms, banks shifted their lending priorities