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October 8, 1982
Financial Reform: JapanStyle
Any financial system is ultimately shaped
by the economy it serves. Thus, economic
changes often lead to adaptations in financial
structure. In the U.S., the growth of money
market funds, the decline of the thrift industry, and other changes stemming in large
part from our inflation have graphically
demonstrated this relation. So it should not
be surprising, given the exceptionally severe
worldwide economic shocks of recent years,
that even more far-reaching transformations
have been occurring in many financial systems abroad.
Virtually every aspect of Japan's financial
system has changed dramatically overthe last
decade. The main forces spurring these
changes-oil, inflation, prolonged recession,
fluctuating exchange rates-are similar to
those causing financial change in the u.s.
and elsewhere. But the direction Japan's system has taken in response has been critically
shaped by its historical characteristics, causing changes there to differ in some ways from
our own.
Origins
Traditionally, formal and informal regulation
of Japan's financial system has been extraordinarily pervasive by U.S. standards. As
late as 1 970, most key interest rates were
constrained by government regulation to
some degree. As in the U.S., deposit interest
rates were fixed at artificially low levels, and
allowed to vary only sporadically. The shortrun flexibility of bank lending and most other
short-term interest rates were severely restricted. Regulation even extended to the
capital markets, where yields on newly
issued bonds generally were kept below
those on the secondary market.
The activities of financial institutions have
been regulated no less severely. Until recently, banks were forbidden to purchase funds
from the public by issuing certificates of
deposit or similar instruments (a common
practice of banks in the U.s.), to act as dealers
in the securities markets, and even, in most
cases, to open new branches. Controls on
financial flows between Japan and other
countries have been especially severe, with
virtually every transaction subject to quotas,
prior approval, and other forms of scrutiny.
Foreign banks and other foreign financial
institutions have been prevented from gaining more than a "toehold" in Japan's markets.
Not surprisingly, this extensive regulation
distorted Japan's financial system. Interest
rate controls led to widespread credit rationing. Money and capital markets remain comparatively underdeveloped (only about ten
percent of funds typically flow through such
markets in Japan, considerably less than
here). Regulati'on also largely accounts for the
historical dearth of consumer credit, and the
restricted availability of mortgages. Capital
controls had virtually "walled-off" Japan's
financial system from those abroad and prevented many Japanese institutions from fully
using international capital markets.
Why then have the authorities regulated the
financial system so heavily? In large part,
financial regulation attempted to alleviate
perceived problems in Japan's economy. For
example, deposit interest rates were held
down partly to encourage corporate investment by lowering the cost of bank loans.
(Whether this policy succeeded is another
matter.) Capital controls were used partly to
conserve scarce foreign exchange reserves.
Japan's authorities have also been more
willing than officials here to "cushion"
private institutions against unusually large
shocks, a policy that often entails some
control over their activities lest such "free
insurance" induce them to assume excessively large risks.
Changingtimes
Still, Japan's authorities have long been
aware of the
of such regulatory
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Finally, the breakdown of fixed exchange
rates among the major currencies has also
spurred reform, particularly in Japan's financial relations with other countries. Generally,
countries have pursued more divergent
macroeconomic policies under floating exchange rate systems, so pressures for capital
flows have tended to be greater than under
the fixed rate system. This has probably made
the task of controlling these flows through
capital controls more difficult. Moreover,
controls on capital flows can addto currency
instability that arises from temporary fluctuations in the balance of payments, and are
therefore less desirable. For example, a currency depreciation resulting from a temporary fall in exports encourages an offsetting
capital inflow-to take advantage of the
appreciation expected when the shortfall
ends-helping to stabilize the balance of
payments and the exchange rate. Controls
would impede such "stabilizing" capital
flows. Freer capital flows are also needed to
facilitate Japan's lending to foreigners when
domestic savings exceed the domestic demand for them, by business and government,
a frequent condition in recent years.
"solutions," as evidenced by their limited
moves to increase interest rate flexibility during the 1960s. The economic upheavals of
the next decade drastically accelerated reform, though, by fundamentally altering the
economic basis of regulatory policy.
In contrast to the U.S., inflation has played a
comparatively modest role in these changes,
not least because Japan's authorities have
been more successfull in containing inflation.
More important have been the effects of
slower real growth and changes in industrial
structure seen since 1 973.
Slower growth has undermined the traditional basis for monetary policy-corporations'
heavy dependence on bank loans-by
lowering business investment demand and,
hence, its need for external funds. Monetary
policy now has to rely more heavily on regulating the cost of credit, making more interest
rate flexibility necessary. Difficulties in funding recent massive government deficits (incurred to spur growth) have underscored
the advantage of well-developed financial
markets which Japan lacked.
By altering traditional financing patterns,
these factors probably made it considerably
more difficult for Japan's regulated system to
allocate savings efficiently. A financial system based on rationing relies heavily on
information available to lenders in allocating
credit. This reliance works adequately only
when economic structures, and therefore
financing needs, have been stable long
enough for lenders to learn of them. With
economic conditions changing rapidly,
though, lenders' information alone will be
inadequate to channel savings to their most
productive uses.
... and reform
These pressures have led to numerous steps
toward financial liberalization over the last
decade aimed at increasing interest rate flexibility, improving the money and capital
markets, and strengthening links between
Japan's financial system and those abroad.
By 1 980, virtually all controls on interest rates
in the call and commercial bills markets in
Japan had been removed. Money market
yields were left free to respond to forces of
supply and demand. In May 1979, banks
were allowed to issue certificates of deposit
(with some limitations), a step which has
since significantly enhanced their funding
base. Japan's banks were authorized to deal
in government securities (with some limitations) in last April's major overhaul of the
country's banking laws, the first major reform
since World War II.
By contrast, in a free financial system, credit
flows depend upon the knowledge of both
lenders and borrowers. Such a system can
use, or "pool," considerably more information than anyone group of participants possesses,and is therefore essential for efficiency
in a changing economy.
2
will be subject to political and economic
conflicts familiar to observers of financial
reform in the U.S.
Most radical of all in recent years have been
reforms affecting financial flows between
Japan and other countries. In 1979, the shortterm repurchase ("Gensaki") market was
opened to foreigners, linking Japan's money
markets with those abroad. In December
1980, a new foreign exchange law dramatically relaxed many capital controls, reversing
the old principle of "prohibited where not
explicitly authorized" to "permitted except
where explicitly forbidden." These changes
were followed by the removal of overt discrimination against foreign banks in Japan
and by steps making it easier for foreigners
to borrow in Japan's capital markets. In addition, the government has actively encouraged
finance and insurance companies
to open offices in Japan, partly in hopes that
they will spur development of more consumer-oriented financial facilities.
Bank deposit rates remain controlled (although less so than in the past) in part
because complete deregulation could divert
funds from the postal savings system-the
chief source of funds for government lending
institutions. Official desires to minimize interest costs on government debt may help
explain why yields on newly issued bonds are
sti II restri cted.
Progress toward "internationalizing" the
yen -promoting its use by foreigners as well
as Japanese citizens-illustrates the pressures
for and resistances to change. Internationalization is an avowed long-term goal of Japanese authorities, but the authorities have
to date been unwilling to take one widely
desired first step toward this goal-the establishment of an international banking center
(in Tokyo) free of regulations applied to
domestic institutions. They continue to fear,
in part, that it might interfere with domestic
monetary policy. Historical experience,
however, strongly suggeststhat the yen will
not be used internationally unless Japan's
financial system becomes substantially freer
and better developed than at present.
u.s.
In sum, financial reform in Japan has been
much more far-reaching than reform here
largely because past regulation had made
Japan's system less adaptable to changing
economic conditions than our own. Financial change in Japan has most often been the
result of government actions; in the U.S.,
change has more often been the work of the
private sector outside the control of authorities. The reason for this difference is that
Japan's traditionally heavy regulation prevented spontaneous financial innovation by
its private sector. In contrast, the much freer
U.S. system allowed, indeed even encouraged, such innovation.
Japan's progress toward a liberal financial
system is not complete, but the process
of reform itself has generated pressures for
further changes. As U.S. experience demonstrates, the freer a financial system becomes,
the harder it becomes to maintain any remaining controls. So, although it remains unclear where Japan's financial reform will end,
that it will continue seems almost certain.
Where now?
Japan's style of financial reform has pushed
its financial system closer to complete liberalization, but the process is yet unfinished. The
reforms have been limited and future changes
Charles Pigott
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BANKING DATA-TWELFTHFEDERAL
RESERVE
DISTRICT
(Dollar amounts.in millions)
Selected Assetsand Liabilities
Large Commercial Banks
Loans (gross, adjusted) and investments*
Loans (gross, adjusted) - total #
Commercial and industrial
Real estate
Loans to individuals
Securities loans
U.s. Treasury securities*
Other securities*
Demand deposits - total #
Demand deposits - adjusted
Savings deposits - total
Time deposits - total #
Individuals, part. & corp.
(Large negotiable CD's)
Weekly Averages
of Daily Figures
Amount
Outstanding
Change
from
9/22/82
9/15/82
17
4
- 163
123
58
209
13
8
-3,314
452
433
1,271
1,178
919
162,084
142,198
45,600
57,562
23,470
2,751
6,543
13,343
38,842
27,454
30,991
100,313
90,369
37,929
Change from
year ago
Dollar
Percent
-
Weekended
Weekended
9/22/82
9/15/82
81
10
71
100
142
42
10,306
11,372
6,316
3,032
366
1,217
818
1,884
38
545
1,616
14,835
13,013
4,011
6.8
8.7
16.1
5.6
1.6
79.3
14.3
- 12.4
0.1
2.0
5.5
17.4
16.8
11.8
Compi'lrable
year-ago period
Member Bank ReservePosition
Excess Reserves (+ )/Deficiency (- )
Borrowings
Net free reserves (+)/Net borrowed ( - )
58
53
5
* Excludes trading account securities.
# Includes items not shown separately.
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