The purpose of this paper was to examine the Big Bang reform which was introduced in the late 1990s by the Japanese government. At the beginning I presented the structure and the main features of the Japanese banking system prior to the crisis. I focused on the most significant elements of the banking system in Japan such as: the main bank system, the system heavy regulated by the Ministry of Finance, the lack of competition in the financial market, the convoy system, and the amakudari system. In my view, these elements of the Japanese banking systems were very unique compared to Western systems. Additionally, this structure contributed to the fragility of the system in the 1990s and resulted in a banking crisis in Japan that lasted about ten years. The banking crisis in Japan had an influence on the whole of the Japanese economy because the Japanese financial system was a bank-based system. It meant that banks in Japan were key players in the financial market. The bank-based system was very important for the Japanese government. In the policy of the Ministry of Finance the banks had to play the leading role in collecting funds for allowing the Japanese economy to recover from the war damages. Banks were responsible for collecting deposits and then extending loans to industry. The funds were particularly channelled into the fast industrialisation of Japan in the 1950s and 1960s. In this system the capital market was underdeveloped and played a very limited role. The leading role of banks in the Japanese economy meant that many companies were dependent on banking loans. This led to the creation of the main banking system where companies and banks formed a relationship which is described by some authors as “a nexus of relationships”. This relationship was complex because the main banks did not only grant loans to partner companies but very often was also the largest shareholder of the company and provided management assistance. The bank-based system was heavily regulated by the MOF and competition between banks did not exist. The financial market was strictly divided into three main sectors – banking, securities and insurance. All financial institutions were allowed to operate only in their own sector. In reality this meant that there was not competition between banks and other financial institutions and banks could not offer, for example, insurance services. Additionally, the MOF also did not accept any competition between banks. Thus, it established a policy to control the amount of new bank branches to avoid excessive competition among banks. The essence of a heavy regulated banking system was the “convoy system” which was formed by the MOF. In that system all banks grew at the same pace. The MOF also guaranteed that banks would not fail. In other words, in this system the weak banks were protected by the MOF. This system did not discipline banks’ management and contributed to the moral hazard-type of behaviour during the “bubble economy”. There was not any effective mechanism which could prevent a bank’s management from taking excessive risks. The competition on the financial market was underdeveloped and the banking supervision was very weak, replaced very often by an amakudari system. There was also a common belief that the MOF would not allow any bank to fail. The bank-based financial system, the lack of competition among financial institutions and moral hazard-type behaviour were important factors that resulted in the ineffective and bad management of Japanese banks during the “bubble economy” and the 1990s.
The gradual deregulation of the financial system which was begun in the late 1970s, the development of a secondary bond market, the introduction of derivative products and the abolition of the segmentation of the financial sector, caused many companies to start to seek alternative funds. They began to replace their banking loans with new bond financing. Furthermore, banks were forced to seek new customers and hence entered new markets such as overseas markets and real estate. In particular, Japanese banks were interested in investment in real estate. They also extended loans secured by land to small and medium-sized companies. This behaviour was based on the “myth of land” – a belief that land is the best collateral and land prices never fall. Thus, in many cases, banks did not obey prudential regulations and increased their involvement in the real estate sector. There was euphoria and confidence that land prices would continue to rise. The growing investment in land, very often for speculative purposes, resulted in fast increasing land prices. The growing land prices and fierce competition between banks caused banks to begin to engage in very risky loan policies. Many banks had only one purpose – to increase its loan portfolio faster than those of competitors. In that situation the sharp decline of stock and land prices which began in 1989 was a shock for the whole Japanese economy. Companies and individuals who had borrowed huge sums based on inflated property prices were left with high total debt and declining asset values. Significant amounts of loans secured by land became non-performing and the collateral lost its value. Many companies announced bankruptcy because they could not repay their loans. The problem of enormous amounts of non-performing loans emerged in the early 1990s but the government underestimated this problem. The government had the hope that future economic growth would lead to a recovery from the financial crisis. Hence, in the early 1990s, the government did not take adequate measures to stop the banking crisis in a short time. Moreover, the MOF minimized the problem and permitted accounting and reporting changes in order to allow banks to cover the real amount of NPL.
The unwillingness to resolve the NPL problems resulted in the amount of NPL ballooning in the late 1990s. Additionally, from 1995 to 1997, six big banks filed for bankruptcy. It was mistake on the part of the Japanese government that it did not do enough to stop the crisis as soon as possible. The banking crisis became very serious and in 1996 the government decided to prepare complex reforms in order to allow the banking system to recover. However, 5 years of delay meant that the government needed the next 6 years to stop the crisis. Thus, the Japanese economy was adversely affected by the banking crisis for 10 years.
The long-lasting crisis and the collapse of several big financial institutions forced the Japanese government to implement a comprehensive policy to aid the recovery of the banking system. The Big Bang reform was the first broad reform pack from the moment of the emergence of a banking crisis in Japan. It was the government’s response to the crisis which affected Japan at the beginning of the 1990s. The reform was intended to introduce some legislation in order to resolve the problem of weak banks, to resolve the problem of non-performing loans, to inject public funds into the weak banks, to reform accounting standards, to create new, independent financial supervision, to strengthen prudential banking regulations and to strengthen competition in the financial market.
I have expressed my opinion that the Big Bang reforms were completed successfully in terms of the liberalisation of the financial market and increasing competition in the markets. The reforms completely abolished the segmentation of the financial market. It increased competition between banks and other financial institutions like securities companies and insurance companies. However, Japanese banks faced the growing competition of foreign banks. It meant that banks in Japan were forced to restructure radically or merge with each other in order to compete successfully with foreign institutions. The liberalisation of the financial markets and growing competition, meant that only strong banks have remained in the market and weak institutions have had to exit it. It has led to the recovery of the banking system in Japan.
The Big Bang reforms were also successful in terms of the creation of new and independent financial supervision. The financial supervision which was conducted through several decades by the Ministry of Finance was weak and ineffective. The supervision process was mainly based on informal contacts between the regulators and the banks. This kind of supervision totally failed during the “bubble economy” and the 1990s. Furthermore, it was decided to create new financial supervision agencies – the Financial Reconstruction Commission and the Financial Supervisory Agency. Thus, the creation of new financial supervision was a switch from “relations-based” supervision to “rule-based” supervision. The future activity of FRC and FSA, particularly closing several insolvent banks and disclosing the real amount of non-performing loans, shows that it was very important decision on the part of the government which contributed to the recovery of the banking system in subsequent years.
However, the Big Bang reforms failed to resolve the problem of non-performing loans until 2001. It was one of the most important assumptions of the reforms. According to the regulators, the problem of NPL was resolved in 2005 when the non-performing loan rate dropped to 2.9% (FSA). It seems that the value of NPL was so significant that it was really difficult to cope with this problem in such a short period of time. Besides, although the government injected huge amounts of public money, the problem of non-performing loans existed in the portfolios of Japanese banks till 2005. The government had to spend more public money and the banks carried out the long restructuring process to successfully resolve this problem.
To sum up, the Japanese banking system has undergone a long process to resolve the banking crisis. The “Big Bang” reforms have changed the face of the Japanese banking industry. Liberalisation and the formation of new supervision agencies has forced banks to implement restructuring reforms which have led to the recovery of the banking industry. Mergers, failures among the big banks, the entrance of foreign institution meant that the Japanese banking system is more competitive than it was 15 years ago. The reforms have also changed the management culture of the Japanese banks. The moral hazard-type of behaviour has been reduced and banks have developed credit-scoring systems in order to improve credit risk management. Hirofumi Gomi, the commissioner at the Financial Services Agency stressed that since 2002, Japanese banks have been using the discounted cash flow model to estimate loan losses, instead of basing calculations on past losses. He added that many banks now did regular stress testing of their portfolio and this would not have happened under the traditional Japanese banking model (Lambe, 2007). It indicates that the Japanese banking industry has introduced modern measures of risk estimation and has undergone a shift from the traditional Japanese banking model to the Western model. Thus it seems that the banking sector in Japan is taking serious steps to conduct business safely and, in future, will be able to prevent a crisis similar to that of the 1990s.
Timeline of events affecting the Japanese financial system.
Late 1970s Formation of Japanese bond market.
1980s Japanese corporations allowed to issue bonds abroad.
Early 1990s Collapse of both real estate and stock market in Japan.
4/1990 Mitsui Bank and Taiyo Kobe Bank merge, later named Sakura Bank.
4/1991 Kyowa Bank and Saitama Bank merge, later named Asahi Bank.
11/1996 Prime Minister Ryutaro Hashimoto announces a plan to reform
Japanese financial institutions and markets. The plan is termed “Big Bang” for its similarities to similar efforts in Britain.
1997 Hokkaido Takushoku Bank fails.
1998 Long-Term Credit Bank (LTCB) and Nippon Credit Bank are nationalized.
7/1998 Keizo Obuchi is named Prime Minister of Japan replacing Ryutaro Hashimoto.
The Financial Supervisory Agency (FSA) is spun off from the Ministry of Finance to force financial institutions to correct problems.
The FSA reports directly to the Financial Reconstruction Committee (FRC), another newly formed regulatory body reporting directly to the prime minister.
11/1998 Standard&Poor’s places nine large Japanese banks under credit watch.
12/1998 Prime Minister Keizo Obuchi names Hakuo Yanagisawa head of the FRC. Yanagisawa was a former prosecutor.
Securities firms allowed to enter the insurance industry as part of the “Big Bang” reform.
1999 The consolidated accounting method replaces parent-only reporting to enhance transparency.
8/1999 Merger announcement for Industrial Bank of Japan (IBJ), Dai-Ichi Kangyo Bank (DKB) and Fuji Bank.
9/1999 Asahi Bank and Tokai Bank announce they will form joint holding company.
Announcement of sale of LTCB to Ripplewood Holdings.
10/1999 Merger announcement for Sumitomo Bank and Sakura Bank.
4/2000 Insurance firms can enter banking, trust and securities businesses
through subsidiaries as part of “Big Bang”
4/2001 Banks can enter the insurance industry.
Source: Anderson and Campbell (2000: 217)