View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

FRBSF Ul)€€KLV U ttcr
May 10,1985

Japan's Financial Reform
The financial reform process referred to as "de­
regulation" in the United States is also occurring
in Japan, where it is called "financial liberaliza­
tion." Both processes share certain catalysts and
objectives, but the cultural, institutional, and
economic environments of the two countries
ensure significant differences in their respective
approaches to financial reform. This Letter outlines
the liberalization process in Japan and discusses
the importance of liberalization from the U.S.
Japanese financial liberalization
Financial liberalization in Japan is focused on re­
structuring the domestic and international flow of
funds between lenders and borrowers to satisfy
better the new requirements of economic growth
in the 1980s. Specific reforms, which officially
started in 1976, have been designed to increase
the role of market forces by relaxing interest rate
constraints and broadening portfolio opportunities
for market participants; expanding existing secur­
ities markets and developing new securities
markets for both private and public debt; increas­
ing capital flows in and out of Japan; widening
access by foreign financial institutions to Japan's
financial system; and "internationalizing" the yen
with the objective of increasing Japan's role in the
international financial system.
Japan's financial system prior to liberalization was
highly constrained by regulation and administra­
tive guidance from the Ministry of Finance (MOF)
and the Bank of Japan (BOJ). Banks and other
financial institutions were subject to portfolio
restrictions, interest rate constraints on deposit
and lending activity, and restrictions on inter­
national transactions. Securities markets were
undeveloped since government deficits were small
and corporate borrowers relied almost exclusively
on large banks for short- and long-term funding.
The domestic financial system was internationally
isolated via a complex set of capital controls,
restrictions on Euro-yen activity, and limited
access by foreign financial institutions.
The objectives of this highly structured, seg­
mented, and regulated system were to support
export-led economic growth, industrialization,

and high personal savings, and to provide a simple
conduit for transferring the large surplus of funds
in the personal sector to the large deficit in the
corporate sector.
The objectives were well-served by the regulatory
system until the first oil-price shock of 1973-74,
which marked the end of rapid economic growth
in Japan. Real GNP growth declined from a 10
percent level to the present range of 3 to 5 percent.
The impact of reduced economic growth on the
flow of funds must be judged the most important
catalyst for financial liberalization for three reasons.
First, the slowdown increased the size of the public
sector deficit significantly. Public sector deficits
had averaged about 2 percent of GNP prior to
1973, but had quickly increased to over 7 percent
of GNP by 1975. Rather than sell the increasing
volume of government debt on the open market,
the MOF placed the debtdirectly with a "captive"
syndicate of banks and other institutions that were
required to purchase the debt at below-market
rates and to hold it for as long as one year. Syndi­
cate members did not resist the procedure prior to
1975 largely because the amount of debt was
small. Also, the BOJ was willing to repurchase the
debt from banks at prices that guaranteed no cap­
ital loss, and the MOF allowed securities com­
panies to use the debt to support a repurchase, or
"gensaki," market as it is called in Japan. After
1975, when the size of the debt rose, the MOF met
with increasing market resistance and was forced
to make a number of concessions to market forces,
which officially started the liberalization process.
Second, slower economic growth with concom­
itant reductions in profit opportunities and in the
need to expand plant and equipment meant that
the corporate sector deficit declined significantly.
Corporate sector deficits have averaged about 6
percent of GNP prior to 1973; they declined to less
than 4 percent of GNP after 1975. The banking
system's market share dropped as a result of re­
duced corporate demand for credit. And corpora­
tions became more aware of alternative sources of
funding, particularly the management of financial
assets as a new source of profit. Banks thus became
advocates of increased flexibility as a means of

re-establishing and increasing their market share,
and corporations became advocates of more fund­
ing sources and more market-sensitive financial
Third, the household sector also brought pressure
to liberalize the financial system. Prior to 1974,
households' alternatives for investing their savings
were restricted to a narrow set of regulated finan­
cial assets. For a variety of reasons, they did not
use the financial system as a major source of bor­
rowing. Slower economic growth, however, in­
creased household awareness of the burdens of
being limited to investing wealth in regulated,
relatively low-yielding investments. In addition,
the changing age distribution of the population
toward older individuals increased the need to
manage financial assets for retirement.
Other forces also were important in bringing
pressure for liberalizing Japan's financial struc­
ture. The shift from a fixed to a floating exchange
rate system after 1973 brought pressure to end
restrictions on short- and long-term capital
movements in and out of Japan. In addition,
deposit rate ceilings became seriously binding on
the occasions when secondary market rates ex­
ceeded regulated rates. As well, advances in com­
puter technology increased the ability of financial
institutions to innovate and introduce new services
(such as cash dispensers and credit cards) and new
financial assets (such as combined demand/time
deposit accounts and government bond mutual
fund accounts).
Pressure from outside Japan recently has become
an important impetus to further liberalization.
Japan has been encouraged to open its markets to
international competition, including its financial
system to access by foreign financial institutions,
and to take steps that will make the yen an inter­
national currency like the dollar—one widely
used to make international payments and which is
attractive as an investment vehicle for foreigners.
What has been accomplished

The financial reforms in Japan have been directed
toward four areas: intermediation finance, the
government bond market, the short-term money
market, and international finance.
In intermediation finance, banks have been
authorized to issue large CDs paying interest rates

that are responsive to market rates, to offer new
deposit accounts that earn higher regulated rates
of return, and to increase consumer lending.
Securities companies have been authorized to
issue bond fund accounts with limited transaction
features. Deposits, with the exception of large CDs,
are still subject to interest rate ceilings. However,
the regulators have been willing to adjust ceilings
more frequently to minimize the spread between
market and regulated interest rates. Most of the
controls over lending rates previously enforced by
the regulators have been removed.
In the government bond market, the MOF has
permitted syndicate members to sell government
debt 100 days after purchase, offered medium-term
government bonds publicly (at market rates), al­
lowed banks to make over-the-counter sales of
new government issues, and narrowed the spread
between the market and issue rate on securities
sold to syndicate members. Overall, the new issue
market for government bonds has become sensi­
tive to market forces.
In short-term securities markets, transactions in
the government bond repurchase market, or gensaki trade, have expanded greatly since the market
was officially recognized in 1976. The volume of
CDs has grown quickly since their authorization
in 1979. Despite the lack of a new-issue Treasury
bill market, the shortened maturity of existing
long-term debt has de facto established a short­
term government securities market. Finally, reg­
ulators have expanded participation in the inter­
bank money market and largely freed it of interest
rate restrictions.
In international finance, liberalization has in­
creased access by foreign financial institutions
and relaxed or eliminated most of the restrictions
over capital flows. The 1980 amendments to the
Foreign Exchange and Foreign Trade Control Law
officially established the principle that capital
flows in and out of Japan are not to be regulated,
and that controls will only be used in an
emergency to prevent disruptive exchange rate
fluctuations. In addition, the environment for an
expanded Euro-yen market has been improved by
allowing nonresidents to issue Euro­
yen bonds, by removing the withholding tax on
non-residents holding Euro-yen bonds issued by
Japanese residents, and by allowing Japanese
banks and foreign banks to issue Euro-yen CDs.

Ten years have passed since the initial efforts at
financial reform in Japan, and considerable prog­
ress has been made. Additional reforms, such as
establishing a bankers' acceptance market and a
bond futures market, and removing interest rate
ceilings on large deposits, are planned for the near
Importance from the U.S. perspective
Financial reform in Japan has recently become an
issue in discussions between the U.S. and Japan
over international trade issues. In the May 1984
policy discussions between the U.S. Treasury and
the MOF, the U.S. encouraged Japan to increase
the pace of financial liberalization, especially
with regard to increasing access for foreign finan­
cial institutions to Japan's domestic markets, and
to take steps to increase the use of the yen in
international trade and finance. The U.S. expected
a faster pace of liberalization to increase the world
demand for the yen, and thus contribute to a lower
yen/dollar exchange rate as well as an increase in
U.S. exports of financial services to Japan (by
making Japanese financial markets more access­
ible to U.S. institutions).
Some economists argue it is not certain how the
yen/dollar exchange rate will be influenced by the
liberalization process in Japan. One study, for
example, concluded that some of the proposals
advanced for opening up the Japanese financial
system, if enacted, would increase the exchange
value of the yen while others would decrease it.
Other studies have reached a similar conclusion.
It is by no means clear, therefore, that the dollar's
rise against the yen and other currencies would be
offset significantly by a faster pace of Japanese
liberalization. Instead, the effects of high U.S. inter­
est rates and federal deficits will continue to dom­
inate in determining the yen/dollar exchange rate.
Neither is it clear that giving U.S. financial institu­
tions greater access to Japanese markets will mean
a greater export of U.S. financial services to Japan.
Japan has changed its Banking Law to incorporate
the principle that domestic and foreign banks are
to be treated equally. FJowever, this has meant that
foreign banks now face competition in some areas

for which they previously held a privileged posi­
tion. The case of impact loans is a good example.
An impact loan is a loan to a Japanese resident
denominated in a foreign currency, which, until
recently, only foreign banks could make. As a
result of liberalization, Japanese banks now com­
pete aggressively and may have an advantage in
being more familiar with the needs of Japanese
Despite these reservations, it is still true that there
are significant benefits to the U.S. from Japan's
liberalization process. The increased use of the
yen in international trade and finance will increase
Japan's role to a level commensurate with its
economic size. It also will make it more likely that
the U.S. and Japan will play a joint role in providing
a financial infrastructure for the Pacific Basin
region, a region that shows signs of being the
world's major growth center in coming decades.
There are important benefits to the Japanese from
a more liberalized financial system. The pre-liberalized financial system served Japan's needs for
the three decades after World War II. It was struc­
turally simple and provided an excellent conduit
for the transfer of sizeable household savings to
large corporations in support of export-led eco­
nomic growth and industrialization. Since then,
Japan has become a major industrialized economy
that must face oil-price shocks, slower economic
growth, changing flows of funds, and increased
financial integration with the rest of the industrial­
ized world. Japanese regulators have recognized
the incompatibility of the previously constrained
financial system with the new economic environ­
ment, and have made progress toward creating a
freer, more competitive, and open financial system.
Despite the uncertainty over the beneficial effects
of Japanese liberalization on the yen/dollar ex­
change rate and the U.S. balance on goods and
services, there is no question that the U.S. ulti­
mately stands to gain from a continuation of the
liberalization process.
Thomas F. Cargill

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San
Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Gregory Tong) or to the author____ Free copies of Federal Reserve publications
can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.



nomoH ojujojuo^

uo6 o jo




jo ^uog
0 A J0 S 0 y |DJ0p0-)

qusuuqjodacj ipjoesey
(Dollar amounts in millions)___________________________________________________
Change from 04/25/84
Selected Assets and Liabilities
Large Commercial Banks
Loans, Leases and Investments1 2
Loans and Leases1 6
Commercial and Industrial
Real estate
Loans to Individuals
U.S. Treasury and Agency Securities1
Other Securities2
Total Deposits
Demand Deposits
Demand Deposits Adjusted3
Other Transaction Balances4
Total Non-Transaction Balances6
Money Market Deposit
Time Deposits in Amounts of
$100,000 or more
Other Liabilities for Borrowed Money5
Two Week Averages
of Daily Figures
Reserve Position, All Reporting Banks
Excess Reserves (+)/Deficiency (-)
Net free reserves (+)/Net borrowed(-)

Period ended









- 949
- 230



Period ended


Includes loss reserves, unearned income, excludes interbank loans
Excludes trading account securities
Excludes U.S. government and depository institution deposits and cash items
ATS, NOW, Super NOW and savings accounts with telephone transfers
Includes borrowing via FRB, TT&L notes, Fed Funds, RPs and other sources
Includes items not shown separately

pe'Cent cha" 8e