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Federal Reserve Bank of Cleveland between government and private financial institutions is escalating in such fields as shipbuilding and construction of hotels and cement factories. The government's choice to rely on administrative control in the allocation of resources proved to be extremely effective during the reconstruction of the Japaneseeconomy because of the underdeveloped condition of the capital market. Now, as the capital market matures, and as economic growth slows and corporate financial demand declines, the appropriateness of extensive governmental influence over the flow of funds is being questioned. decades, sliding to 39 percent of total loans outstanding in 1982from 55 percent in 1960.On the other hand, the lending share of government-related financial organizations has increased steadily. The sustained expansion of loans made by the Trust Fund Bureaufrom 10 percent of the total in 1960to the current 22.7 percent-has been instrumental in lowering the banking industry's share of the lending pie. Since funds garnered in the PSSare channeled, via the Trust Fund Bureau, to governmental lending institutions and hence to private industry, the more money post offices absorb and make available for lending, the steeper the competition isamong commercial banks. The private financial sector, in effect, must compete directly with an institution whose activities are outside the market economy. Thus, the flow of funds is being directed, to a significant extent, by governmental bodies rather than by the free market; i.e., the tremendous growth of postal savings deposits has created a substantial flow of credit from the private to the public sector, bypassing the market mechanism. A question of efficiency and equity then arisesconcerning the appropriate allocation of funds in the nation's economy as a whole. Major portions of the funds channeled through government financial institutions via the Treasury Investments and Loans program went into housing (26.2 percent in FY 1981), small enterprise promotion (19.6percent), living environment (13.9 percent), and transportation and communication (10.1 percentj.? These sectors often find it difficult to attract capital without paying a premium. Moreover, the social and economic benefits derived from public intervention may justify the intervention itself. Intertwined with criticism over the handling of postal savings is the issue of the government's "crowding out" the private sector by encroaching on areas of private financing. Competition Implications for Monetary Policy The PSSsets interest rates paid on its own deposits independently of the monetary authorities. The usual resistance of the MPT to cut interest rates on postal savings accounts when the BOJ decides to lower the discount rate influences the timing of money market effects desired by the BOJ. When declines of interest rates on postal deposits lag behind those of private financial institutions, a shift of funds to the PSSoften results, reducing the share of funds made available through private sources, particularly smaller banks and thrift institutions. In July 1972 and in May 1977,for example, when interest-rate declines in PSSaccounts lagged behind the reductions in private-sector deposits by 15 days, the total value of postal savings, as a proportion of all fixed deposits, increased substantially. For the same reason, during July-September 1980,the accounts of the Treasury moved into a sizable surplus, the counterpart of which was a record shortage of funds in the money markets." The MOF and the BOJ are advocating unification of the present two-tier decision making process on interest rates, claiming that the effective operation of monetary policy is hin- 5. See "Highlight of FY1981 Budget Treasury Investments and loans Program," japan Economic journal, January 13, 1981, p. 15. 6. "Trends in Personal Savings and Personal Financial Assets Selection," Bank of Japan, Special Paper #93 (April 1981), pp. 15-16. dered because such a large source of funds is outside the scope of their direct control. The extent to which the PSShas reduced monetary control in Japan is not clear, however. Although the PSS maintains a large share of personal deposits and the percentage of loans generated by commercial banks has steadily declined, the PSSchannels the vast majority of its funds through government agencies. Because the MOF monitors these agencies (loan rates have to be approved by the MOF), the overall range of monetary and credit control has not been diminished by the shift to postal savings-the composition has merely changed. If, however, the PSSfollows through with plans to expand its own lending capacity (currently a personal loan of up to about $2,800per borrower is allowed) to include housing finance and educational loans, the credit it extends will be outside the control of the monetary authorities and could weaken the effectiveness of monetary policy. Conclusion The Japanesegovernment has played Federal Reserve Bank of Cleveland Research Department P.O. Box 6387 Cleveland, OH 44101 an active and important role in financial intermediation and credit allocation. By collecting personal savings through the PSSand then allocating them to public institutions, the Japanesegovernment has structured an effective system that functions in concert with its industrial and social policies. Although unsophisticated in terms of free-market fluctuations, this system provided the needed capital for postwar economic reconstruction. Now, however, the financial community isconcerned about the power that the PSShas amassed and the encroachment of government institutions in areas of private-sector finance. The debate centers around the issue of whether a bureaucracy is better qualified to direct the flow of credit than a private market. Also debated is how increased governmental intervention will affect the efficiency of a freemarket system. Determining the appropriateness of government vs. private financing is a problem not peculiar to the Japanesesituation. Indeed, American policymakers are now raising similar issuesabout the development of a national industrial policy. BULK RATE U.S. Postage Paid Cleveland, OH Permit No, 385 ~£QnomicCommentary The Japanese Postal Savings System: A State-Run Financial Monster? by Laura A. Kuhn apan maintains the highest personal savings rate of all the major industrialized countries. In 1982the Japanese personal savings rate was about 19.3 percent of disposable income-almost three times that of the United States.' Many analysts consider the thrift of the Japanese people to be the primary reason for that country's tremendous industrial growth and technological advancement after World War II. Through the postal savings system (PSS),the Japanesegovernment has converted personal savings deposits into long-term capital for industrial, trade, infrastructural, and social development. The state-run PSS has played a vital role in channeling assetsto the private sector and in helping to finance the huge government deficits. Post office savings have mushroomed 1. For additional information on the savings rate, see Organization for Economic Cooperation and Development, OECD Economic Outlook, July 1983. Although the observed frugality in household savings results from many factors, much can be explained by the rapid growth in income and by institutional factors, such as the wage payment system, the underdeveloped condition of the social security system, the limited availability of consumer and housing credit, and the tax system. See Henry C. and Mable I. Wallich, "Banking and Finance," in Hugh Patrick and Henry Rosovsky, Eds., Asia's New Giant, Brookings Institution (Washington: 1976), pp. 249-315. Address Correction Requested: Pleasesend corrected mailing label to the Federal ReserveBank of Cleveland, ResearchDepartment, P.O. Box 6387,Cleveland, OH 44101. September 26, 1983 Laura A. Kuhn, a research assistant with the Federal Reserve Bank of Cleveland, studied in japan in 1982. The views stated herein are those of the author and not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. in the past two decades. With a network of over 22,400branches, the PSShad deposits of more than $330 billion in 1983:IIQ, making it the largest recipient of deposits in the world.' The PSScompetes directly with commercial banks for personal deposits, which make up about 99 percent of its deposit base, compared with lessthan 40 percent for commercial banks. An attractive savings source for Japanese households, the PSS can provide more favorable rates, terms, and tax treatment than commercial banks. Consequently, the financial community is concerned about the unrestricted expansion of post office savings, which are viewed as a serious threat to the commercial banking industry. This Economic Commentary discussesJapan's postal savings system, its characteristics and problems, and its effect on the Japaneseeconomy. The Japanese Financial System In contrast to the U.S. financial system, the Japanesefinancial market structure is highly specialized. The system shows extensive separation of financial activities, a comparatively high degree of regulation and control of private financial institutions by the monetary authorities, and a much more active governmental role in financial 2. The deposits of the PSS are about three times those of the outstanding accounts of Banque Nationale de Paris (the world's largest bank in terms of deposits) and about five times those of Japan's largest bank. See Gordon F. Boreharn, "The Financial System: One Reason for Japan's Success," Canadian Banker and fCB Review, vol. 88, no. 6 (December 1981), pp. 12-17. intermediation and credit allocation.' The main overseer of almost all aspects of the Japanese financial system is the Ministry of Finance (MOF). The MOF is the powerful budget-making agency with many responsibilities, including financial management policy of the central government. The only exception to the MOF's domain is the PSS,which is under the authority of the Ministry of Posts and Telecommunications (MPT). The central bank, the Bank of Japan (BOj), works in concert with but under guidelines set by the MOF in determining and implementing national monetary policies. The major instruments of monetary policy available to the BOJ are similar to tools used by the Federal Reserve System. Bank credit replaces a large portion of equity capital in Japan, i.e., many Japanese firms are very highly leveraged, depending heavily on bank credit rather than on forms of internal finance. Thus, the monetary authorities rely heavily on credit controls (particularly ceilings on central bank credit to private banks) and "window guidance" (the nature and levels of bank lending being directed by the BOJ according to national economic and industrial policies). Rather than change reserve ratios or perform open-market operations, the BOJ influences financial markets primarily by changing its credit and discount policies. To meet the high credit demands of Japanese firms, commercial banks borrow heavily from the BOJ through its discount window. The BOJ discount rate is the foundation of the interest-rate structure of the entire financial system. Short-term interest rates, along with the lending rates of private financial institutions, generally move by the same margin as the change in the discount rate. Interest rates on postal savings deposits are again the exception, being deter3. For an overview of Japan's financial system and a description of the current liberalization process, see Charles Pigott, "Financial Reform in Japan," in Financial Development and Reform in the Pacific Basin, Federal Reserve Bank of San Francisco, Economic Review, no. 1 (Winter 1983), pp.25-46. mined independently by a committee of the MPT. The government plays a direct and active role in financial intermediation and credit allocation. These functions are central to the implementation of Japan's industrial and social policies. Funds are channeled through a group of government-owned banks and finance corporations to promote and develop key industries, foreign trade, small- and medium-sized enterprises, agriculture, housing, and social infrastructure. The Japanese public is a major supplier of funds (savings) to these institutions, the primary intermediary being the PSS. Post office savings, which now account for about 30 percent of the entire personal savings of Japan, are turned over to the Trust Fund Bureau (TFB) of the Ministry of Finance. The TFB channels the money, along with pension-fund payments, into areas specified for development (see figure). The TFB receives slightly more than one-half of its financial resources from post office savings and is the main supplier of funds for the Treasury Investrnents and Loans program. Under this program, which is determined each year along with the national budget, funds are allocated to various governmentaffiliated agencies. In the 1950s and 1960s, funds from Treasury Investments and Loans were used primarily for large-scale industrial projects, foreigntrade finance, and promotion of smalland medium-sized enterprises. The focus of the program shifted in the 1970s to mortgage financing and social development, reflecting the maturation of the industrial structure and the real need for social infrastructure investment. The current phase emphasizes energy resources and technology as well. Last year Treasury Investments and Loans channeled more than $72 billion into government-lending institutions, and appropriation requests for FY 1983 rose to a high of $86 billion. Postal savings funds also are used, via the TFB, to finance part of the government's budget deficit. Absorbing almost Flow of Personal Savings through I I Treasury Investments and Loans budget appropriation for FY 1982aj billions of dollars @ 249.5 yen per dollar the Postal Savings System Personal savings Postal savings system I I I Trust Fund Bureau Postal life Insurance and Annuity Fund (I Public enterprise I I I Japan National Railways ......................... ~ Treasury Investments and loans 2J~ I Public corporations 4.25 Nippon Telegraph & Telephone Public Corp ....... 0.60 II I Pension funds I •• h J Government bonds local governments I Finance corporations I I local governments ............. 13.231 Special accounts .................. 1.64 I I Japan Development Bank ....... 3.20 Hokkaido & Tohoku Development Corporation ............. Housing & Urban Development Corporation .................... 2.91 , , Pension Welfare Service Corporation .................... 3.04 Japan Highway Corp ............. 3.48 Japan Railway Construction Corporation .................... 0.46 Overseas Economic Cooperation Fund ............ 0.83 Others .............................. 2.63 0.24 Export-Import Bank of Japan ... 3.58 Small Business Finance Corporation .................... 6.17 People's Finance Corporation ............................. 7.73 Shoko Chukin Bank .............. 0.29 Housing loan Corporation ............................. 13.61 Agriculture, Forestry, & Fishery Finance Corp ....... 2.28 Medical Care Facilities Finance Corporation .......... 0.40 a. Figures exclude government guaranteed bonds and borrowing. Environmental Sanitation Business Finance Corportion ...... 1.07 SOURCE: Bank of Japan, Economic Statistics Annual 1982, March 1983. Okinawa Development Finance Corporation .......... one-fourth of the total government bonds outstanding, the TFB serves as an outlet for bonds that the central bank purchases in the secondary market. The underwriting of government bonds is, however, one of the more controversial uses of postal savings proceeds. Making it easier for the government to maintain expenditures in excess of revenues may 0.46 lead to an expansion in the fiscal deficit. Reasons for Growth The PSShas become highly controversial, primarily because the size of its financial base has grown at such an astonishing rate over the past 20 years. In the mid-1960s, PSSdeposits topped the 2 trillion yen level, swelling to over 24 trillion yen by 1975-a growth of 9 times in 10 years. The growth of postal savings deposits has been particularly steep in recent years, soaring to over 80 trillion yen in August 1983. The PSShas captured an increasingly larger share of personal savings, while the share of commercial banks and savings institutions has declined steadily since the mid-1960s. PSS deposits now total more than five times the deposits of Japan's largest commercial bank. There are several reasons for the rapid growth of postal savings and individuals' increasing preference for this system over other financial institutions. With more than twice as many branches as all commercial banking institutions combined, the PSSis very accessible to depositors, even in remote parts of the country. In addition to installing cash dispensers at the major post offices, the PSSrecently implemented an on-line computerized network that enables depositors to withdraw or deposit at anyone of a myriad of nationwide branches. The PSShas mustered a strong political backing within local governments and in the Diet (parliament). This political strength has aided in the passage of favorable legislation, the most important elements of which are preferential rates, terms, and tax treatment. The private banking industry views these advantages as grossly unfair, considering the PSSto be a "state-run financial monster." Preferential tax treatment. In contrast to the United States, where tax preference primarily is given to consumption (or borrowing), the Japanese government promotes saving and grants special tax exemptions to encourage personal savings. Under the current Japanese tax system, an individual is exempt from taxes on interest income from bank deposits and bonds with a principal balance of up to 3 million yen (about $13,000) and on the interest inco~e from an additional 3 million yen in post-office accounts. Interest on postal savings is always tax free, but an individual can hold no more than 3 mil- lion yen in this type of account. The absence of required formal reporting of PSSaccounts has led to widespread abuse of tax-exemption privileges. With little difficulty, individuals can open multiple accounts in excess of the legal limit. In 1980 the PSSmaintained a phenomenal 310 million accounts-more than two and onehalf times the total Japanese population.! Unfortunately, tax evasion is relatively easy and fairly common, much to the dismay of the government whose budget deficit amounted to $44 billion last year. In contrast, savers at private financial institutions must file a return to receive tax exemptions, making it fairly easy to monitor these accounts. Bank deposits are cross-checked to ensure that the 35 percent withholding tax on interest is deducted from any proceeds over the tax-exempt limit. Interest-rate advantages. Another issue in the postal savings controversy is the dual system by which interest rates are set. Postal savings rates are decided by a special committee of the MPT, while a committee of the finance ministry and the central bank set market and bank account rates. Because the PSSis not under the jurisdiction of the monetary authorities, PSSdeposits generally earn higher rates of interest than bank deposits. lending and the Allocation of Capital The disparity of interest rates in favor of the PSSand the security and flexibility provided by its accounts have steadily drained funds from private commercial banks. Post office savings are now posing a threat to commercial banks, not only in the accumulation of deposits but also in lending to both private industry and individuals. The lending share of commercial banks has declined consistently in the past two 4. Of the total postal savings accounts, 240 million were time deposits (about 80 percent of the total) and 70 million were ordinary deposits. See Masahiko ishizuka, "Juggernaut in Domestic Financial Scene?," Japan Economic Journa/, October 7, 1980. intermediation and credit allocation.' The main overseer of almost all aspects of the Japanese financial system is the Ministry of Finance (MOF). The MOF is the powerful budget-making agency with many responsibilities, including financial management policy of the central government. The only exception to the MOF's domain is the PSS,which is under the authority of the Ministry of Posts and Telecommunications (MPT). The central bank, the Bank of Japan (BOj), works in concert with but under guidelines set by the MOF in determining and implementing national monetary policies. The major instruments of monetary policy available to the BOJ are similar to tools used by the Federal Reserve System. Bank credit replaces a large portion of equity capital in Japan, i.e., many Japanese firms are very highly leveraged, depending heavily on bank credit rather than on forms of internal finance. Thus, the monetary authorities rely heavily on credit controls (particularly ceilings on central bank credit to private banks) and "window guidance" (the nature and levels of bank lending being directed by the BOJ according to national economic and industrial policies). Rather than change reserve ratios or perform open-market operations, the BOJ influences financial markets primarily by changing its credit and discount policies. To meet the high credit demands of Japanese firms, commercial banks borrow heavily from the BOJ through its discount window. The BOJ discount rate is the foundation of the interest-rate structure of the entire financial system. Short-term interest rates, along with the lending rates of private financial institutions, generally move by the same margin as the change in the discount rate. Interest rates on postal savings deposits are again the exception, being deter3. For an overview of Japan's financial system and a description of the current liberalization process, see Charles Pigott, "Financial Reform in Japan," in Financial Development and Reform in the Pacific Basin, Federal Reserve Bank of San Francisco, Economic Review, no. 1 (Winter 1983), pp.25-46. mined independently by a committee of the MPT. The government plays a direct and active role in financial intermediation and credit allocation. These functions are central to the implementation of Japan's industrial and social policies. Funds are channeled through a group of government-owned banks and finance corporations to promote and develop key industries, foreign trade, small- and medium-sized enterprises, agriculture, housing, and social infrastructure. The Japanese public is a major supplier of funds (savings) to these institutions, the primary intermediary being the PSS. Post office savings, which now account for about 30 percent of the entire personal savings of Japan, are turned over to the Trust Fund Bureau (TFB) of the Ministry of Finance. The TFB channels the money, along with pension-fund payments, into areas specified for development (see figure). The TFB receives slightly more than one-half of its financial resources from post office savings and is the main supplier of funds for the Treasury Investrnents and Loans program. Under this program, which is determined each year along with the national budget, funds are allocated to various governmentaffiliated agencies. In the 1950s and 1960s, funds from Treasury Investments and Loans were used primarily for large-scale industrial projects, foreigntrade finance, and promotion of smalland medium-sized enterprises. The focus of the program shifted in the 1970s to mortgage financing and social development, reflecting the maturation of the industrial structure and the real need for social infrastructure investment. The current phase emphasizes energy resources and technology as well. Last year Treasury Investments and Loans channeled more than $72 billion into government-lending institutions, and appropriation requests for FY 1983 rose to a high of $86 billion. Postal savings funds also are used, via the TFB, to finance part of the government's budget deficit. Absorbing almost Flow of Personal Savings through I I Treasury Investments and Loans budget appropriation for FY 1982aj billions of dollars @ 249.5 yen per dollar the Postal Savings System Personal savings Postal savings system I I I Trust Fund Bureau Postal life Insurance and Annuity Fund (I Public enterprise I I I Japan National Railways ......................... ~ Treasury Investments and loans 2J~ I Public corporations 4.25 Nippon Telegraph & Telephone Public Corp ....... 0.60 II I Pension funds I •• h J Government bonds local governments I Finance corporations I I local governments ............. 13.231 Special accounts .................. 1.64 I I Japan Development Bank ....... 3.20 Hokkaido & Tohoku Development Corporation ............. Housing & Urban Development Corporation .................... 2.91 , , Pension Welfare Service Corporation .................... 3.04 Japan Highway Corp ............. 3.48 Japan Railway Construction Corporation .................... 0.46 Overseas Economic Cooperation Fund ............ 0.83 Others .............................. 2.63 0.24 Export-Import Bank of Japan ... 3.58 Small Business Finance Corporation .................... 6.17 People's Finance Corporation ............................. 7.73 Shoko Chukin Bank .............. 0.29 Housing loan Corporation ............................. 13.61 Agriculture, Forestry, & Fishery Finance Corp ....... 2.28 Medical Care Facilities Finance Corporation .......... 0.40 a. Figures exclude government guaranteed bonds and borrowing. Environmental Sanitation Business Finance Corportion ...... 1.07 SOURCE: Bank of Japan, Economic Statistics Annual 1982, March 1983. Okinawa Development Finance Corporation .......... one-fourth of the total government bonds outstanding, the TFB serves as an outlet for bonds that the central bank purchases in the secondary market. The underwriting of government bonds is, however, one of the more controversial uses of postal savings proceeds. Making it easier for the government to maintain expenditures in excess of revenues may 0.46 lead to an expansion in the fiscal deficit. Reasons for Growth The PSShas become highly controversial, primarily because the size of its financial base has grown at such an astonishing rate over the past 20 years. In the mid-1960s, PSSdeposits topped the 2 trillion yen level, swelling to over 24 trillion yen by 1975-a growth of 9 times in 10 years. The growth of postal savings deposits has been particularly steep in recent years, soaring to over 80 trillion yen in August 1983. The PSShas captured an increasingly larger share of personal savings, while the share of commercial banks and savings institutions has declined steadily since the mid-1960s. PSS deposits now total more than five times the deposits of Japan's largest commercial bank. There are several reasons for the rapid growth of postal savings and individuals' increasing preference for this system over other financial institutions. With more than twice as many branches as all commercial banking institutions combined, the PSSis very accessible to depositors, even in remote parts of the country. In addition to installing cash dispensers at the major post offices, the PSSrecently implemented an on-line computerized network that enables depositors to withdraw or deposit at anyone of a myriad of nationwide branches. The PSShas mustered a strong political backing within local governments and in the Diet (parliament). This political strength has aided in the passage of favorable legislation, the most important elements of which are preferential rates, terms, and tax treatment. The private banking industry views these advantages as grossly unfair, considering the PSSto be a "state-run financial monster." Preferential tax treatment. In contrast to the United States, where tax preference primarily is given to consumption (or borrowing), the Japanese government promotes saving and grants special tax exemptions to encourage personal savings. Under the current Japanese tax system, an individual is exempt from taxes on interest income from bank deposits and bonds with a principal balance of up to 3 million yen (about $13,000) and on the interest inco~e from an additional 3 million yen in post-office accounts. Interest on postal savings is always tax free, but an individual can hold no more than 3 mil- lion yen in this type of account. The absence of required formal reporting of PSSaccounts has led to widespread abuse of tax-exemption privileges. With little difficulty, individuals can open multiple accounts in excess of the legal limit. In 1980 the PSSmaintained a phenomenal 310 million accounts-more than two and onehalf times the total Japanese population.! Unfortunately, tax evasion is relatively easy and fairly common, much to the dismay of the government whose budget deficit amounted to $44 billion last year. In contrast, savers at private financial institutions must file a return to receive tax exemptions, making it fairly easy to monitor these accounts. Bank deposits are cross-checked to ensure that the 35 percent withholding tax on interest is deducted from any proceeds over the tax-exempt limit. Interest-rate advantages. Another issue in the postal savings controversy is the dual system by which interest rates are set. Postal savings rates are decided by a special committee of the MPT, while a committee of the finance ministry and the central bank set market and bank account rates. Because the PSSis not under the jurisdiction of the monetary authorities, PSSdeposits generally earn higher rates of interest than bank deposits. lending and the Allocation of Capital The disparity of interest rates in favor of the PSSand the security and flexibility provided by its accounts have steadily drained funds from private commercial banks. Post office savings are now posing a threat to commercial banks, not only in the accumulation of deposits but also in lending to both private industry and individuals. The lending share of commercial banks has declined consistently in the past two 4. Of the total postal savings accounts, 240 million were time deposits (about 80 percent of the total) and 70 million were ordinary deposits. See Masahiko ishizuka, "Juggernaut in Domestic Financial Scene?," Japan Economic Journa/, October 7, 1980. intermediation and credit allocation.' The main overseer of almost all aspects of the Japanese financial system is the Ministry of Finance (MOF). The MOF is the powerful budget-making agency with many responsibilities, including financial management policy of the central government. The only exception to the MOF's domain is the PSS,which is under the authority of the Ministry of Posts and Telecommunications (MPT). The central bank, the Bank of Japan (BOj), works in concert with but under guidelines set by the MOF in determining and implementing national monetary policies. The major instruments of monetary policy available to the BOJ are similar to tools used by the Federal Reserve System. Bank credit replaces a large portion of equity capital in Japan, i.e., many Japanese firms are very highly leveraged, depending heavily on bank credit rather than on forms of internal finance. Thus, the monetary authorities rely heavily on credit controls (particularly ceilings on central bank credit to private banks) and "window guidance" (the nature and levels of bank lending being directed by the BOJ according to national economic and industrial policies). Rather than change reserve ratios or perform open-market operations, the BOJ influences financial markets primarily by changing its credit and discount policies. To meet the high credit demands of Japanese firms, commercial banks borrow heavily from the BOJ through its discount window. The BOJ discount rate is the foundation of the interest-rate structure of the entire financial system. Short-term interest rates, along with the lending rates of private financial institutions, generally move by the same margin as the change in the discount rate. Interest rates on postal savings deposits are again the exception, being deter3. For an overview of Japan's financial system and a description of the current liberalization process, see Charles Pigott, "Financial Reform in Japan," in Financial Development and Reform in the Pacific Basin, Federal Reserve Bank of San Francisco, Economic Review, no. 1 (Winter 1983), pp.25-46. mined independently by a committee of the MPT. The government plays a direct and active role in financial intermediation and credit allocation. These functions are central to the implementation of Japan's industrial and social policies. Funds are channeled through a group of government-owned banks and finance corporations to promote and develop key industries, foreign trade, small- and medium-sized enterprises, agriculture, housing, and social infrastructure. The Japanese public is a major supplier of funds (savings) to these institutions, the primary intermediary being the PSS. Post office savings, which now account for about 30 percent of the entire personal savings of Japan, are turned over to the Trust Fund Bureau (TFB) of the Ministry of Finance. The TFB channels the money, along with pension-fund payments, into areas specified for development (see figure). The TFB receives slightly more than one-half of its financial resources from post office savings and is the main supplier of funds for the Treasury Investrnents and Loans program. Under this program, which is determined each year along with the national budget, funds are allocated to various governmentaffiliated agencies. In the 1950s and 1960s, funds from Treasury Investments and Loans were used primarily for large-scale industrial projects, foreigntrade finance, and promotion of smalland medium-sized enterprises. The focus of the program shifted in the 1970s to mortgage financing and social development, reflecting the maturation of the industrial structure and the real need for social infrastructure investment. The current phase emphasizes energy resources and technology as well. Last year Treasury Investments and Loans channeled more than $72 billion into government-lending institutions, and appropriation requests for FY 1983 rose to a high of $86 billion. Postal savings funds also are used, via the TFB, to finance part of the government's budget deficit. Absorbing almost Flow of Personal Savings through I I Treasury Investments and Loans budget appropriation for FY 1982aj billions of dollars @ 249.5 yen per dollar the Postal Savings System Personal savings Postal savings system I I I Trust Fund Bureau Postal life Insurance and Annuity Fund (I Public enterprise I I I Japan National Railways ......................... ~ Treasury Investments and loans 2J~ I Public corporations 4.25 Nippon Telegraph & Telephone Public Corp ....... 0.60 II I Pension funds I •• h J Government bonds local governments I Finance corporations I I local governments ............. 13.231 Special accounts .................. 1.64 I I Japan Development Bank ....... 3.20 Hokkaido & Tohoku Development Corporation ............. Housing & Urban Development Corporation .................... 2.91 , , Pension Welfare Service Corporation .................... 3.04 Japan Highway Corp ............. 3.48 Japan Railway Construction Corporation .................... 0.46 Overseas Economic Cooperation Fund ............ 0.83 Others .............................. 2.63 0.24 Export-Import Bank of Japan ... 3.58 Small Business Finance Corporation .................... 6.17 People's Finance Corporation ............................. 7.73 Shoko Chukin Bank .............. 0.29 Housing loan Corporation ............................. 13.61 Agriculture, Forestry, & Fishery Finance Corp ....... 2.28 Medical Care Facilities Finance Corporation .......... 0.40 a. Figures exclude government guaranteed bonds and borrowing. Environmental Sanitation Business Finance Corportion ...... 1.07 SOURCE: Bank of Japan, Economic Statistics Annual 1982, March 1983. Okinawa Development Finance Corporation .......... one-fourth of the total government bonds outstanding, the TFB serves as an outlet for bonds that the central bank purchases in the secondary market. The underwriting of government bonds is, however, one of the more controversial uses of postal savings proceeds. Making it easier for the government to maintain expenditures in excess of revenues may 0.46 lead to an expansion in the fiscal deficit. Reasons for Growth The PSShas become highly controversial, primarily because the size of its financial base has grown at such an astonishing rate over the past 20 years. In the mid-1960s, PSSdeposits topped the 2 trillion yen level, swelling to over 24 trillion yen by 1975-a growth of 9 times in 10 years. The growth of postal savings deposits has been particularly steep in recent years, soaring to over 80 trillion yen in August 1983. The PSShas captured an increasingly larger share of personal savings, while the share of commercial banks and savings institutions has declined steadily since the mid-1960s. PSS deposits now total more than five times the deposits of Japan's largest commercial bank. There are several reasons for the rapid growth of postal savings and individuals' increasing preference for this system over other financial institutions. With more than twice as many branches as all commercial banking institutions combined, the PSSis very accessible to depositors, even in remote parts of the country. In addition to installing cash dispensers at the major post offices, the PSSrecently implemented an on-line computerized network that enables depositors to withdraw or deposit at anyone of a myriad of nationwide branches. The PSShas mustered a strong political backing within local governments and in the Diet (parliament). This political strength has aided in the passage of favorable legislation, the most important elements of which are preferential rates, terms, and tax treatment. The private banking industry views these advantages as grossly unfair, considering the PSSto be a "state-run financial monster." Preferential tax treatment. In contrast to the United States, where tax preference primarily is given to consumption (or borrowing), the Japanese government promotes saving and grants special tax exemptions to encourage personal savings. Under the current Japanese tax system, an individual is exempt from taxes on interest income from bank deposits and bonds with a principal balance of up to 3 million yen (about $13,000) and on the interest inco~e from an additional 3 million yen in post-office accounts. Interest on postal savings is always tax free, but an individual can hold no more than 3 mil- lion yen in this type of account. The absence of required formal reporting of PSSaccounts has led to widespread abuse of tax-exemption privileges. With little difficulty, individuals can open multiple accounts in excess of the legal limit. In 1980 the PSSmaintained a phenomenal 310 million accounts-more than two and onehalf times the total Japanese population.! Unfortunately, tax evasion is relatively easy and fairly common, much to the dismay of the government whose budget deficit amounted to $44 billion last year. In contrast, savers at private financial institutions must file a return to receive tax exemptions, making it fairly easy to monitor these accounts. Bank deposits are cross-checked to ensure that the 35 percent withholding tax on interest is deducted from any proceeds over the tax-exempt limit. Interest-rate advantages. Another issue in the postal savings controversy is the dual system by which interest rates are set. Postal savings rates are decided by a special committee of the MPT, while a committee of the finance ministry and the central bank set market and bank account rates. Because the PSSis not under the jurisdiction of the monetary authorities, PSSdeposits generally earn higher rates of interest than bank deposits. lending and the Allocation of Capital The disparity of interest rates in favor of the PSSand the security and flexibility provided by its accounts have steadily drained funds from private commercial banks. Post office savings are now posing a threat to commercial banks, not only in the accumulation of deposits but also in lending to both private industry and individuals. The lending share of commercial banks has declined consistently in the past two 4. Of the total postal savings accounts, 240 million were time deposits (about 80 percent of the total) and 70 million were ordinary deposits. See Masahiko ishizuka, "Juggernaut in Domestic Financial Scene?," Japan Economic Journa/, October 7, 1980. Federal Reserve Bank of Cleveland between government and private financial institutions is escalating in such fields as shipbuilding and construction of hotels and cement factories. The government's choice to rely on administrative control in the allocation of resources proved to be extremely effective during the reconstruction of the Japaneseeconomy because of the underdeveloped condition of the capital market. Now, as the capital market matures, and as economic growth slows and corporate financial demand declines, the appropriateness of extensive governmental influence over the flow of funds is being questioned. decades, sliding to 39 percent of total loans outstanding in 1982from 55 percent in 1960.On the other hand, the lending share of government-related financial organizations has increased steadily. The sustained expansion of loans made by the Trust Fund Bureaufrom 10 percent of the total in 1960to the current 22.7 percent-has been instrumental in lowering the banking industry's share of the lending pie. Since funds garnered in the PSSare channeled, via the Trust Fund Bureau, to governmental lending institutions and hence to private industry, the more money post offices absorb and make available for lending, the steeper the competition isamong commercial banks. The private financial sector, in effect, must compete directly with an institution whose activities are outside the market economy. Thus, the flow of funds is being directed, to a significant extent, by governmental bodies rather than by the free market; i.e., the tremendous growth of postal savings deposits has created a substantial flow of credit from the private to the public sector, bypassing the market mechanism. A question of efficiency and equity then arisesconcerning the appropriate allocation of funds in the nation's economy as a whole. Major portions of the funds channeled through government financial institutions via the Treasury Investments and Loans program went into housing (26.2 percent in FY 1981), small enterprise promotion (19.6percent), living environment (13.9 percent), and transportation and communication (10.1 percentj.? These sectors often find it difficult to attract capital without paying a premium. Moreover, the social and economic benefits derived from public intervention may justify the intervention itself. Intertwined with criticism over the handling of postal savings is the issue of the government's "crowding out" the private sector by encroaching on areas of private financing. Competition Implications for Monetary Policy The PSSsets interest rates paid on its own deposits independently of the monetary authorities. The usual resistance of the MPT to cut interest rates on postal savings accounts when the BOJ decides to lower the discount rate influences the timing of money market effects desired by the BOJ. When declines of interest rates on postal deposits lag behind those of private financial institutions, a shift of funds to the PSSoften results, reducing the share of funds made available through private sources, particularly smaller banks and thrift institutions. In July 1972 and in May 1977,for example, when interest-rate declines in PSSaccounts lagged behind the reductions in private-sector deposits by 15 days, the total value of postal savings, as a proportion of all fixed deposits, increased substantially. For the same reason, during July-September 1980,the accounts of the Treasury moved into a sizable surplus, the counterpart of which was a record shortage of funds in the money markets." The MOF and the BOJ are advocating unification of the present two-tier decision making process on interest rates, claiming that the effective operation of monetary policy is hin- 5. See "Highlight of FY1981 Budget Treasury Investments and loans Program," japan Economic journal, January 13, 1981, p. 15. 6. "Trends in Personal Savings and Personal Financial Assets Selection," Bank of Japan, Special Paper #93 (April 1981), pp. 15-16. dered because such a large source of funds is outside the scope of their direct control. The extent to which the PSShas reduced monetary control in Japan is not clear, however. Although the PSS maintains a large share of personal deposits and the percentage of loans generated by commercial banks has steadily declined, the PSSchannels the vast majority of its funds through government agencies. Because the MOF monitors these agencies (loan rates have to be approved by the MOF), the overall range of monetary and credit control has not been diminished by the shift to postal savings-the composition has merely changed. If, however, the PSSfollows through with plans to expand its own lending capacity (currently a personal loan of up to about $2,800per borrower is allowed) to include housing finance and educational loans, the credit it extends will be outside the control of the monetary authorities and could weaken the effectiveness of monetary policy. Conclusion The Japanesegovernment has played Federal Reserve Bank of Cleveland Research Department P.O. Box 6387 Cleveland, OH 44101 an active and important role in financial intermediation and credit allocation. By collecting personal savings through the PSSand then allocating them to public institutions, the Japanesegovernment has structured an effective system that functions in concert with its industrial and social policies. Although unsophisticated in terms of free-market fluctuations, this system provided the needed capital for postwar economic reconstruction. Now, however, the financial community isconcerned about the power that the PSShas amassed and the encroachment of government institutions in areas of private-sector finance. The debate centers around the issue of whether a bureaucracy is better qualified to direct the flow of credit than a private market. Also debated is how increased governmental intervention will affect the efficiency of a freemarket system. Determining the appropriateness of government vs. private financing is a problem not peculiar to the Japanesesituation. Indeed, American policymakers are now raising similar issuesabout the development of a national industrial policy. BULK RATE U.S. Postage Paid Cleveland, OH Permit No, 385 ~£QnomicCommentary The Japanese Postal Savings System: A State-Run Financial Monster? by Laura A. Kuhn apan maintains the highest personal savings rate of all the major industrialized countries. In 1982the Japanese personal savings rate was about 19.3 percent of disposable income-almost three times that of the United States.' Many analysts consider the thrift of the Japanese people to be the primary reason for that country's tremendous industrial growth and technological advancement after World War II. Through the postal savings system (PSS),the Japanesegovernment has converted personal savings deposits into long-term capital for industrial, trade, infrastructural, and social development. The state-run PSS has played a vital role in channeling assetsto the private sector and in helping to finance the huge government deficits. Post office savings have mushroomed 1. For additional information on the savings rate, see Organization for Economic Cooperation and Development, OECD Economic Outlook, July 1983. Although the observed frugality in household savings results from many factors, much can be explained by the rapid growth in income and by institutional factors, such as the wage payment system, the underdeveloped condition of the social security system, the limited availability of consumer and housing credit, and the tax system. See Henry C. and Mable I. Wallich, "Banking and Finance," in Hugh Patrick and Henry Rosovsky, Eds., Asia's New Giant, Brookings Institution (Washington: 1976), pp. 249-315. Address Correction Requested: Pleasesend corrected mailing label to the Federal ReserveBank of Cleveland, ResearchDepartment, P.O. Box 6387,Cleveland, OH 44101. September 26, 1983 Laura A. Kuhn, a research assistant with the Federal Reserve Bank of Cleveland, studied in japan in 1982. The views stated herein are those of the author and not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. in the past two decades. With a network of over 22,400branches, the PSShad deposits of more than $330 billion in 1983:IIQ, making it the largest recipient of deposits in the world.' The PSScompetes directly with commercial banks for personal deposits, which make up about 99 percent of its deposit base, compared with lessthan 40 percent for commercial banks. An attractive savings source for Japanese households, the PSS can provide more favorable rates, terms, and tax treatment than commercial banks. Consequently, the financial community is concerned about the unrestricted expansion of post office savings, which are viewed as a serious threat to the commercial banking industry. This Economic Commentary discussesJapan's postal savings system, its characteristics and problems, and its effect on the Japaneseeconomy. The Japanese Financial System In contrast to the U.S. financial system, the Japanesefinancial market structure is highly specialized. The system shows extensive separation of financial activities, a comparatively high degree of regulation and control of private financial institutions by the monetary authorities, and a much more active governmental role in financial 2. The deposits of the PSS are about three times those of the outstanding accounts of Banque Nationale de Paris (the world's largest bank in terms of deposits) and about five times those of Japan's largest bank. See Gordon F. Boreharn, "The Financial System: One Reason for Japan's Success," Canadian Banker and fCB Review, vol. 88, no. 6 (December 1981), pp. 12-17. Federal Reserve Bank of Cleveland between government and private financial institutions is escalating in such fields as shipbuilding and construction of hotels and cement factories. The government's choice to rely on administrative control in the allocation of resources proved to be extremely effective during the reconstruction of the Japaneseeconomy because of the underdeveloped condition of the capital market. Now, as the capital market matures, and as economic growth slows and corporate financial demand declines, the appropriateness of extensive governmental influence over the flow of funds is being questioned. decades, sliding to 39 percent of total loans outstanding in 1982from 55 percent in 1960.On the other hand, the lending share of government-related financial organizations has increased steadily. The sustained expansion of loans made by the Trust Fund Bureaufrom 10 percent of the total in 1960to the current 22.7 percent-has been instrumental in lowering the banking industry's share of the lending pie. Since funds garnered in the PSSare channeled, via the Trust Fund Bureau, to governmental lending institutions and hence to private industry, the more money post offices absorb and make available for lending, the steeper the competition isamong commercial banks. The private financial sector, in effect, must compete directly with an institution whose activities are outside the market economy. Thus, the flow of funds is being directed, to a significant extent, by governmental bodies rather than by the free market; i.e., the tremendous growth of postal savings deposits has created a substantial flow of credit from the private to the public sector, bypassing the market mechanism. A question of efficiency and equity then arisesconcerning the appropriate allocation of funds in the nation's economy as a whole. Major portions of the funds channeled through government financial institutions via the Treasury Investments and Loans program went into housing (26.2 percent in FY 1981), small enterprise promotion (19.6percent), living environment (13.9 percent), and transportation and communication (10.1 percentj.? These sectors often find it difficult to attract capital without paying a premium. Moreover, the social and economic benefits derived from public intervention may justify the intervention itself. Intertwined with criticism over the handling of postal savings is the issue of the government's "crowding out" the private sector by encroaching on areas of private financing. Competition Implications for Monetary Policy The PSSsets interest rates paid on its own deposits independently of the monetary authorities. The usual resistance of the MPT to cut interest rates on postal savings accounts when the BOJ decides to lower the discount rate influences the timing of money market effects desired by the BOJ. When declines of interest rates on postal deposits lag behind those of private financial institutions, a shift of funds to the PSSoften results, reducing the share of funds made available through private sources, particularly smaller banks and thrift institutions. In July 1972 and in May 1977,for example, when interest-rate declines in PSSaccounts lagged behind the reductions in private-sector deposits by 15 days, the total value of postal savings, as a proportion of all fixed deposits, increased substantially. For the same reason, during July-September 1980,the accounts of the Treasury moved into a sizable surplus, the counterpart of which was a record shortage of funds in the money markets." The MOF and the BOJ are advocating unification of the present two-tier decision making process on interest rates, claiming that the effective operation of monetary policy is hin- 5. See "Highlight of FY1981 Budget Treasury Investments and loans Program," japan Economic journal, January 13, 1981, p. 15. 6. "Trends in Personal Savings and Personal Financial Assets Selection," Bank of Japan, Special Paper #93 (April 1981), pp. 15-16. dered because such a large source of funds is outside the scope of their direct control. The extent to which the PSShas reduced monetary control in Japan is not clear, however. Although the PSS maintains a large share of personal deposits and the percentage of loans generated by commercial banks has steadily declined, the PSSchannels the vast majority of its funds through government agencies. Because the MOF monitors these agencies (loan rates have to be approved by the MOF), the overall range of monetary and credit control has not been diminished by the shift to postal savings-the composition has merely changed. If, however, the PSSfollows through with plans to expand its own lending capacity (currently a personal loan of up to about $2,800per borrower is allowed) to include housing finance and educational loans, the credit it extends will be outside the control of the monetary authorities and could weaken the effectiveness of monetary policy. Conclusion The Japanesegovernment has played Federal Reserve Bank of Cleveland Research Department P.O. Box 6387 Cleveland, OH 44101 an active and important role in financial intermediation and credit allocation. By collecting personal savings through the PSSand then allocating them to public institutions, the Japanesegovernment has structured an effective system that functions in concert with its industrial and social policies. Although unsophisticated in terms of free-market fluctuations, this system provided the needed capital for postwar economic reconstruction. Now, however, the financial community isconcerned about the power that the PSShas amassed and the encroachment of government institutions in areas of private-sector finance. The debate centers around the issue of whether a bureaucracy is better qualified to direct the flow of credit than a private market. Also debated is how increased governmental intervention will affect the efficiency of a freemarket system. Determining the appropriateness of government vs. private financing is a problem not peculiar to the Japanesesituation. Indeed, American policymakers are now raising similar issuesabout the development of a national industrial policy. BULK RATE U.S. Postage Paid Cleveland, OH Permit No, 385 ~£QnomicCommentary The Japanese Postal Savings System: A State-Run Financial Monster? by Laura A. Kuhn apan maintains the highest personal savings rate of all the major industrialized countries. In 1982the Japanese personal savings rate was about 19.3 percent of disposable income-almost three times that of the United States.' Many analysts consider the thrift of the Japanese people to be the primary reason for that country's tremendous industrial growth and technological advancement after World War II. Through the postal savings system (PSS),the Japanesegovernment has converted personal savings deposits into long-term capital for industrial, trade, infrastructural, and social development. The state-run PSS has played a vital role in channeling assetsto the private sector and in helping to finance the huge government deficits. Post office savings have mushroomed 1. For additional information on the savings rate, see Organization for Economic Cooperation and Development, OECD Economic Outlook, July 1983. Although the observed frugality in household savings results from many factors, much can be explained by the rapid growth in income and by institutional factors, such as the wage payment system, the underdeveloped condition of the social security system, the limited availability of consumer and housing credit, and the tax system. See Henry C. and Mable I. Wallich, "Banking and Finance," in Hugh Patrick and Henry Rosovsky, Eds., Asia's New Giant, Brookings Institution (Washington: 1976), pp. 249-315. Address Correction Requested: Pleasesend corrected mailing label to the Federal ReserveBank of Cleveland, ResearchDepartment, P.O. Box 6387,Cleveland, OH 44101. September 26, 1983 Laura A. Kuhn, a research assistant with the Federal Reserve Bank of Cleveland, studied in japan in 1982. The views stated herein are those of the author and not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. in the past two decades. With a network of over 22,400branches, the PSShad deposits of more than $330 billion in 1983:IIQ, making it the largest recipient of deposits in the world.' The PSScompetes directly with commercial banks for personal deposits, which make up about 99 percent of its deposit base, compared with lessthan 40 percent for commercial banks. An attractive savings source for Japanese households, the PSS can provide more favorable rates, terms, and tax treatment than commercial banks. Consequently, the financial community is concerned about the unrestricted expansion of post office savings, which are viewed as a serious threat to the commercial banking industry. This Economic Commentary discussesJapan's postal savings system, its characteristics and problems, and its effect on the Japaneseeconomy. The Japanese Financial System In contrast to the U.S. financial system, the Japanesefinancial market structure is highly specialized. The system shows extensive separation of financial activities, a comparatively high degree of regulation and control of private financial institutions by the monetary authorities, and a much more active governmental role in financial 2. The deposits of the PSS are about three times those of the outstanding accounts of Banque Nationale de Paris (the world's largest bank in terms of deposits) and about five times those of Japan's largest bank. See Gordon F. Boreharn, "The Financial System: One Reason for Japan's Success," Canadian Banker and fCB Review, vol. 88, no. 6 (December 1981), pp. 12-17.
@FedFRASER