The Japanese Banking Sector – Part II: the Cause of Crisis

In this paper I will show the main factors which contributed to the banking crisis in Japan in the 1990s. There were many factors but I consider these the most significant because in my view they made the Japanese banking crisis very serious and one of the longest in the post-war history of the world’s economy.

During the 1990s Japan faced a very serious banking crisis. This crisis was developing gradually and many experts were surprised that from the beginning of the 1990s Japan witnessed a steady decline in the health of its banking system. The surprise was even bigger as Japan’s banking system was considered the largest and strongest in the world (Patrick, 1999: 3). Nine of the world’s top ten banks in asset size were Japanese. Banks had ample, low-cost deposit funds, the highest credit ratings and the largest were expanding their international operations vigorously. The banking crisis had a significant impact not only on the Japanese economy but also influenced the Asian crisis in the late of the 1990s.

Banknot: 10000 yenów

The origin of the banking crisis in Japan in the 1990s

The banking crisis in Japan did not emerge suddenly. It was a long, gradual process which was rooted in the 1970s. As was described in Chapter Two of this study, the Japanese banking system was heavily regulated by the Ministry of Finance and the Bank of Japan. The financial sector was segmented and the financial institutions were allowed to operate only in their own sectors. Thus, for example banks could not operate in the sector where insurance companies conducted their activity. Moreover, in the convoy system which was established by the MOF, all banks should have grown at the same pace. In that system weaker banks were protected against the competition of stronger banks. This system was secure because no one bank could fail but this system was also ineffective. The competition was underdeveloped and banks could not expand their activities. The policy conducted by the regulators meant that from the end of the Pacific War to the 1970s the core of activity of Japanese banks was collecting deposits and granting loans. According to Lincoln and Friedman (1998: 353) this system worked well when the economy was growing quickly, averaging almost 10 percent annually from 1950 to 1973. This system connected savers to investors successfully. Households put their savings into bank deposits and insurance policies, and the banks and insurance companies, in turn, extended loans to industry. This was important for the government which wanted to channel funds for rebuilding Japan after the Pacific War.

After the two decades of very fast development in the Japanese economy in the 1970s the surplus of saving exceeded the domestic investment. Moreover, the Bank of Japan established the low interest policy. Some banks found themselves holding surplus funds, earning only very low, regulated interest rates. Hence, the pressure by major financial institutions and large corporations to deregulate financial markets increased dramatically over time (Patrick, 2001: 15). On the other hand, in the 1970s the government began to run sizable deficits. The deficits were growing because of slower tax revenue growth, which was caused by the slow increase of the Japanese economy after the Oil Shock in 1973. The government also increased the deficits trying to spur the economy and began spending more on the Social Security system. In order to finance the deficits, the government significantly increased its bond issuance (Hoshi and Kashyap, 1999: 134). According to Lincoln and Friedman (1998: 353) the issuance of large amounts of government bonds to finance this deficit led directly to the gradual breakdown of tight control over interest rates, as banks were not interested in purchasing at the low rates at which the government tried to float an increasing amount of debt. Rosenbluth (1999: 113) noted that banks even boycotted and refused to purchase the government’s bonds and forced the MOF to relent. Thus, the Ministry of Finance found that it could no longer prevent the development of a secondary bond market. Therefore, the MOF was forced to open the market for government bonds in 1977, and to start issuing some bonds through public auctions in 1978 (Hoshi and Kashyap, 1999: 153). Moreover, in the Banking Act of 1982, the MOF allowed banks to: sell government bonds to the public, trade government bonds for customers, and deal for their own account in government bonds to profit on price fluctuations. All of these activities had previously been permitted only for securities companies (Rosenbluth, 1999: 117). Additionally, financial institutions had been permitted to issue combination-type deposits, resident foreign-currency deposits and money market certificates with interest rates tied to the certificate of deposit (CD) rate, along with other new instruments. Financial futures, options, swaps, and other derivative markets had also been introduced (Royama, 1999: 77).

The Banking Act of 1982 was a very important step to deregulate the financial sector because of two reasons. Firstly, the segmentation of the financial sector between banks and securities companies was abolished. Banks were allowed to conduct their activity in the sector which previously belonged only to securities companies. Therefore, banks could develop their activity and increase their profitability. It also meant that competition on the financial market increased.  Secondly, the Act encouraged the development of the secondary market for government bonds. The government bonds were now traded at market prices which attracted more investors. It led to the situation that many investors lost interest in placing their funds into deposits.

Patrick (1998: 7) stressed that in that way Japan has been moving to a competitive, market-based system of banking and capital markets. Financial institutions began to be under great pressure to cut costs, increase efficiency and develop new financial products in order to compete.

The liberalisation of the market for government bonds and slower growth of the Japanese economy at the end of 1970s meant that banks lost many customers. Many companies had surplus funds and did not need to loan money. Moreover, large companies obtained alternative financing options. They began to replace their bank loans with new bond financing and so reduced the dependence on banks (Hoshi, 2001: 10). Hence, Japanese banks were forced to seek new customers. Searching for new growing markets for loans, the banks moved in two important directions: into overseas markets and real estate.

The activity of Japanese banks abroad was growing especially after the revision of the Foreign Exchange and Foreign Trade Control Law in 1980. From that moment banks and insurance companies could lend abroad and establish branches abroad. Additionally, by the mid-1980s, foreign direct investment into and out of Japan was completely liberalized (Lincoln and Friedman, 1998: 354). Banks also expanded loans to small and medium sized companies. Due to the fact that banks had entered a new unknown loan market they extended loans on a secured basis backed by some kind of collateral. The most popular type of collateral was land. Land was widely believed to be the most profitable and safest assets to hold for a long period of time. Additionally, land prices in Japan consistently rose after the Pacific War. Shimizu (1999: 169) pointed out that the increased value of land raised the creditworthiness of many borrowers such as small and medium sized companies, individuals, the real estate industry and non-financial institutions. It was the “myth of land” – a belief that land prices never fall. In the first half of the 1980s it was common practice for banks to lend 60 to 70% of the market price of the land serving as collateral. In the late 1980s it became standard practice for lenders to make loans equal to 100% of the market price of the land. It was very risky to make a loan believing only that land prices will never fall. The value of lending to real estate grew rapidly from 7 percent annually in the second half of the 1970s, it was up in the first half of the 1980s at an annual rate of 18%, and at a 20% annual rate in the second half of that decade. On the other hand international lending of the Japanese banks  accelerated  in  the  first  half  of the 1980s but substantially more slowly in the second half (Lincoln and Friedman , 1998: 355).

The burst of the “bubble economy”

During the 1980s the land prices and real estate prices started to increase very quickly. Tokyo real estate prices more than doubled in the four-year period during 1986-1990; land prices in other metropolitan areas followed – albeit to a smaller degree (Amyx, 2004: 145). Banks began to invest in land and in real estate with speculative purpose. Bank loans to real estate related firms, non-bank financial institutions, and building contractors were especially high in the second half of the 1980s. The flow of funds to the property sector led to the further sharp increases of property prices. Amyx (2004: 145) pointed out that banks established subsidiaries and affiliates, and invested in land through these firms. Especially involved in the real estate lending were the jusen. The jusen were established in the 1970s by banks, securities companies, and insurance companies initially to engage in home-mortgage lending. In the 1980s their primary investment sector was real estate sector (Kanaya and Woo, 2001: 28). The jusen borrowed heavily from banks and then they invested in the real estate sector. The majority of investment cases in the real estate sector had speculative purpose. The competition among banks was furious as well as the belief that land prices would never fall. Because of that banks wanted to increase their loan portfolio very quickly. The enthusiasm connected with growing land prices was so great that banks very often granted loans avoiding prudential regulations and financial analysis. There was only one purpose – to expand loan portfolio.  Werner (2003: 95) stressed that usually banks were liberal in their lending attitude. But from 1987 it changed. Many bankers were aggressively pursuing potential customers. Banks even were looking for small and very small firms in an attempt to grant them a loan. The BBC’s Bubble Trouble series from 1999 presents the example of Kenichi Shigeta, the owner of the middle-size company Shinshin Denka Co. In his opinion many banks encouraged potential customers to take a loan even they did not need money. When he wanted to take a loan of 77.000 pounds a bank persuaded him to take the loan of 115.000 pounds.

As was mentioned above, the aggressive competition among banks resulted that many banks began to avoid prudential regulation and also conducted a high risk loan policy. There is a very interesting example of the largest single default by a women, Nui Onoue. Shimizu (1999: 172) described that she was a restaurant owner and active trader in the stock market in the late 1980s. She went bankrupt with a debt of 430 billion yen. The important lender to her was Industrial Bank of Japan, which traditionally made loans only to large firms. The fact that this bank lent money to an individual person demonstrates the policy shift of long-term credit banks to enter into the new area of individual loans seeking higher returns. Because of the good financial standing and opinion of that bank, many other financial institutions also extended huge amounts to her. Her close relationships with the bank and the fact they granted her a significant loan was regarded by other lenders as a sign of good creditworthiness. Moreover, other lenders were interested in granting her loans in the late 1980s when stock prices were rising. The case of Nui Onoue and Kenichi Shigeta confirmed that during the “bubble economy” banks conducted very risky loan policies with very weak financial analysis. Shimizu (1999: 179) described that situation as: “it was difficult for a bank to stay out of the circle alone when all other banks were enjoying the fruits of high profits”. The expectation of future high profits and confidence that land prices were still growing is an example of the weakness of the management of Japanese banks. It seems that the managements of banks were extremely influenced by the euphoria on the financial market.  From the mid-1980s onward, land and stock prices were rising tremendously. Between January 1985 and December 1989, stocks rose 240% and land prices 245%. Werner (2003: 89) stressed that real estate prices had reached unprecedented levels. As an example it is interesting to look at the value of the garden surrounding the Imperial Palace in Tokyo. Its value was worth as much as all the land of the entire state of California. Stock prices also rose vigorously. The Nikkei Stock Average Index, started at 7,042 yen in August 1982 and continued to rise to 38,150 yen in December 1989, more than a fivefold increase (Sato, 1995: 1).

Werner (2003: 97) pointed out in the late 1980s banks granted too many loans and hence created too much money. The money was not mainly used for consumption. It was used for financial transactions, thus creating asset price rises – asset inflation, what is now called the “bubble”. In many cases the main purpose of investing in land was to make a quick buck by selling the land soon after.

The growing land prices and real estate prices meant that at the end of 1980s many Japanese could not afford to buy their own flat or house. In 1989 the Bank of Japan began to conduct a restrictive monetary policy, forced partly by social criticism over the rapid rise in land prices that destroyed people’s hope to purchase their own houses. The Bank of Japan raised the discount rate five times from 2.5% to 6% within about one year. Moreover, it imposed a restraint on loans related to real estate transaction. It also created a new tax for large-scale land holding, intended to discourage land holdings held for speculative purposes. As a result, stock prices started to plunge at the beginning of 1990. The Nikkei Stock Average Index fell 57% from its highest value of 38,915 yen on 28 December 1989 to 16,572 on 22 April 1992, and further fell to a low of 14,822 yen on 11 August 1992 (Shimizu, 1999: 171). Land prices also started to decline, losing close to 20% of their value and 60% by 1997 (Kawai, 2003: 2).  Figure 1 demonstrates both the Nikkei Stock Average Index and the Japanese Land Price Index Average of Six Largest Cities during the “bubble economy”.

The Nikkei Stock Average and Japanese Land Price Index during the “bubble economy”


Source: Peek and Rosengren (1999: 27)

The sharp decline of stock and land prices had a serious impact on the whole financial sector. First of all, the decline in land prices in the 1990s was an unexpected shock. It was a shock not only for speculators but also for the banks which granted huge loans secured by the land. Corporations and individuals that had borrowed large sums based on inflated property prices were left with high total debt and declining asset prices. On the other hand, banks were left with high unrecoverable debt (Maswood, 2002: 21). Many loans became non-performing and the collateral lost its value. The long-term credit banks, trust banks, and some city banks were most aggressive in expending to new loans markets and thus experienced large amounts of non-performing loans. In general, non-performing loans are those from which banks no longer receive repayments and interest payments as scheduled (BOJ, 2002). Ito (1999: 87) stressed that the problem was serious because real estate and construction companies could not pay interest on their loans or sell assets to pay off the loans. Many of them became bankrupt. Thus, it also led to the situation that loans were non-performing. On April, 1993 the MOF disclosed that the total amount of non-performing loans of long-term credit banks, trust banks, and city banks totaled 7 to 8 trillion yen, including bad loans of 2 to 3 trillion yen that eventually would have to be written-off. These figures represent 2% and 0.8% of the total loans of these banks (Shimizu, 1999: 174). However, the problem of non-performing loans was much more serious. In 1998, the new Financial Supervisory Agency, an independent agency from the MOF, assessed the value of non-performing loans as 87.5 trillion yen ($630 billion), which should be added to 35.2 trillion yen ($253 billion) already declared, making a total of 123 trillion yen ($880 billion) of non-performing loans (Lincoln and Friedman, 1998: 357).

Dekle and Kletzer (2003: 327) stressed that reliable non-performing loans data were available after 2002 when the MOF first recognized the NPL problem. The figure 2 demonstrates the trend in the ratio of non-performing loans to total loans. Non-performing loans rose sharply from 2% of GDP in 1992-1994 to about 5% of GDP in 1996, and then to 7% of GDP in 2000. We can also see that after the land prices began to decrease the ratio of non-performing loans to total loans started to increase.

Non-performing loans and land prices


Source: Dekle and Kletzer (2003: 327)

The most serious problem was connected with the bad loans which were granted by the jusen. As was mentioned earlier, jusen borrowed heavily from banks and other financial institutions and were involved in the real estate lending. In 1995 the MOF conducted a special examination to evaluate the extent of the problem. Of 13 trillion yen in jusen assets, non-performing loans were estimated at 9.6 trillion yen (74%), of which 6.4 trillion yen was considered unrecoverable and 1.2 trillion yen was considered a possible loss. The problems of the jusen became the focus of an intense political debate in 1995. The Ministry of Finance and institutions, which provided funds for jusen (21 major banks, agricultural credit cooperatives, regional banks and life insurance companies) agreed to dissolve them and in 1996 the Jusen Resolution Corporation assumed 6.4 trillion yen of unrecoverable loans (Ito, 1999: 90).

The government’s response to the banking crisis

The government’s policy towards the emerging financial crisis in the early 1990s was inadequate. Japan continued to rely on a policy of delay, forgiveness, and forbearance. The government had a hope that asset prices and economic growth would recover and mitigate the financial distress (Cargill, 1998: 48). Such a policy was conducted by the government until 1995 when measures were taken to resolve the earlier mentioned problem of jusen.

The government policy of underestimating the bad loans problem had a significant impact on the behaviour of the Japanese banks in the early 1990s. Banks had incentives to conduct business in the same way as during the time before the crisis. Banks continued to pay dividends, continued to support financially weak companies and continued to operate with high staff levels. Ito (1999: 91) pointed out that banks could have pursued more aggressive remedies to resolve the problem of bad loans. He suggested that banks could have sold assets and subsidiaries and cut personnel costs in order to reduce operating costs. These things were not done because there were no incentives from the government. The government was not interested in disclosing the problem of the bad loans because it was believed that this problem was temporary. There was also a fear of triggering a public panic, especially in the absence of an adequate deposit-insurance scheme. Moreover, the regulators did not want to create a bad image of Japanese banks on the international financial market.  On the other hand, the banks also were not inclined to perform any restructuring. Their policy response was still rooted in the old financial system, especially in the convoy system. It was still a strong belief that no one bank would be allowed to fail. The Ministry of Finance and other regulatory authorities minimized the problem and permitted accounting and reporting changes that allowed banks to cover up non-performing loans (Cargill, 1999: 49). The government had also conducted the policy of non-transparency of the real problem of non-performing loans. Ueda (2000: 79) described that non-performing loans had an impact on the erosion of the capital base. Bad loans and their write-offs were directly related to a bank’s capital. Moreover, the difficulty of obtaining public funds to clean up the system, led regulators to adopt a non-transparent approach to the problem of non-performing loans. On the other hand, during the 1990s the regulators had problems estimating the real amount of non-performing loans in the banking sector. The unstable situation of the Japanese banks also had negative international impact. Hiwatari (2000: 113) pointed out that international investors reacted to rumours of troubled Japanese banks by selling stocks and yen and by increasing the Japan premium. This meant that the borrowing of money at the international inter-bank money markets was more expensive for Japanese banks because they had to pay a premium to LIBOR. Thus, the Japan premium indicated a lack of confidence in the credibility of Japanese banks.

The reluctance to resolve the problem of non-performing loans in the early  1990s meant that problem came to be very serious in the second half of the 1990s. The first wave of failures emerged in December 1994. Within a year, five credit unions and one regional bank (Hyōgo Bank) collapsed. In 1996 Taiheiyō Bank announced its bankruptcy and Hanwa Bank was ordered by the MOF to close down operations because of excess bad loans. In 1997 there were three further bankruptcies: – Kyōtō Kyōei Bank, Hokkaido Takushoku Bank (one of Japan’s top 20 banks) and Tokuyō Bank announced their bankruptcy (Malcolm, 2001: 99). In 1997 the crisis was very serious because two big Japanese banks – Nippon Credit Bank and the Long Term Credit Bank of Japan (LTCB) announced the suspension of their international operations. Moreover, it was evident that LTCB was about to become the largest Japanese bank ever to fail. Its assets of 26 trillion yen were three times as great as those of Hokkaido Takushoku Bank at the time of its failure (Flath, 2003: 277). In that situation the government decided to take measures to stop the banking crisis and reform the financial system as a whole. The reforms which began in 1997 will be widely described and analyzed in the Chapter Four of this study.

Banking Failures in the 1990s

  • August 1995 Hyōgo Bank, a regional bank, announces bankruptcy, becoming the first bank to fail since the 1920s. Its operations are taken over by Midori Bank, a specially created private institution.
  • March 1996 Taiheiyō Bank, a second-tier regional bank, announces its bankruptcy. Its operations are taken over by Wakashio Bank, a specially created private institution.

  • November 1996 Hanwa Bank, a regional bank, is ordered by the MOF to close down operations because of excess bad loans. Its operations are taken over by a Kii Yokin Kanri Bank, a specially created private institution.
  • October 1997 Kyōtō Kyōei Bank, a regional bank, announces its bankruptcy. Its operations are taken over by Kōfuku Bank, another regional bank.
  • November 1997 Hokkaido Takushoku Bank, a city bank, announces its bankruptcy. Its operations are to be taken over by the North Pacific Bank, a regional bank.
  • November 1997 Tokuyō Bank, a regional bank, announces its bankruptcy. Its operations are taken over by Seventy-seven Bank, another regional bank.

Source: Malcolm (2001: 99)

In my view, there was no one main factor which caused the Japanese banking crisis in the 1990s. There were several factors which contributed to the crisis. The most important were:

  • Gradual deregulation of the Japanese financial system,
  • The weak banking supervision,
  • The moral hazard and weak management of Japanese banks,
  • The burst of the stock market and real estate bubbles in the early 1990s,
  • The delay of resolving the problem of non-performing loans by the government.

The deregulation of the Japanese financial system which began in the 1970s was necessary to create the competitive, market-based system of banking and capital markets. However, banks were forced to compete against each other fiercely and also compete with other financial institutions. It resulted in banks entering a new and unknown market. Especially banks searching for new customers through the real estate and international markets. It was very risky. Deregulation created new risks for banks like: credit risk, interest-rate risk and foreign exchange-risk. During several decades Japanese banks existed in the main bank system where lenders, usually big companies, were well-known. In many cases loans were granted on the basis of the long-term strong personal relationships between a bank and a company. The financial analysis was inadequate and weak. Moreover, banks had a belief in the guarantee system of the Ministry of Finance and in the fact that no one bank would be allowed to fail. All of this meant that conducting business was more difficult and risky for banks. In addition, the deregulation process took place without the creation of a strong and independent supervisory agency. In many cases, banking supervision was based on informal personal relationships between banks and the MOF. Especially the amakudari system; where retired regulators working in the banks resulted in the weaknesses of banking supervision. On the one hand, regulators were assigned to monitor bank management, but on the other hand, they expected to be employed later by the banks they had monitored. The lack of strong banking supervision also created a situation of moral hazard, in which banks took on greater risks in the expectation that if they suffered losses the MOF would bail them out. It was especially common during the bubble economy where banks heavily invested in land and real estates avoiding any prudential regulations. This is also a good example of the weak management of the majority of Japanese banks. The managements were influenced by the great euphoria which was common during the bubble economy. It was a euphoria based on the meteoric rise of both land and real estate prices. There was also confidence that the price of land would never decline (Shimizu, 1999: 169). They were interested in increasing their loan portfolio as soon as possible. In many cases it led to the situation that loans were granted without any financial analysis of borrowers.

Finally, the big impact on the emergence of the banking crisis in Japan was the burst of the stock market and real estate bubbles in the early 1990s and the delay of resolving the problem of non-performing loans by the government.

The basic cause of the bubbles was, the belief that land prices would never decline; therefore real estate was excellent collateral. Thus, banks started to heavily invest in land and real estate. It resulted that prices of land and real estate began to rise very rapidly. Finally, this process created a high degree of speculative excess in both real estate and stock markets. The bursting of the bubble in the early 1990s transformed the overextended loans into non-performing loans. It was the beginning of very serious banking crisis which lasted about 10 years. In the early 1990s the government did not take appropriate measures to resolve the problem of non-performing loans. The Japanese government was confident that asset prices and economic growth would recover the financial distress. It was mistake and the regulators started to resolve the crisis from 1995. As a result, 5 years of delay meant that the Japanese government needed the next 5-6 years to introduce complex reforms of the financial system and to resolve the banking crisis. Therefore, the Japanese banking crisis was one of the longest-lasting crises in the post-war history of the world’s economy.

The Japanese Banking Sector – Part II: the Cause of Crisis Reviewed by on 31 stycznia 2010 .

In this paper I will show the main factors which contributed to the banking crisis in Japan in the 1990s. There were many factors but I consider these the most significant because in my view they made the Japanese banking crisis very serious and one of the longest in the post-war history of the world’s





  • Hello! I found your site quite by mistake and it worked out great. This is very interesting an dI will be back for more. Thanks.

Pozostaw odpowiedź