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Lessons from the Japanese Main Bank
System for Financial System Reform
in Poland
Takeo Hoshi, Anil Kashyap, and Gary Loveman
3
Working Papers Series
Macroeconomic Issues
Research Department
Federal Reserve Bank of Chicago
June 1993 (W P-93-6)
FEDERAL RESERVE BANK
OF CHICAGO
Lessons from the Japanese Main Bank System for Financial
System Reform in Poland
Takeo Hoshi
Graduate School of International Relations and Pacific Studies
University of California, San Diego
La Jolla, CA 92093-0519
(619) 534-5018
Anil Kashyap
NBER and Graduate School of Business
University of Chicago
1101 East 58th Street
Chicago, IL 60637
(312) 702-7260
Gary Loveman
Graduate School of Business Administration
Harvard University
Soldiers Field Road
Boston, MA 02163
(617) 495-6652
First draft: May 1992
Revised June 1993
The authors thank Michael Gerlach, Rob Gertner, Peter Gourevitch, Simon
Johnson, Toru Konishi, Morio Kuninori, Millard Long, Leonard Lynn, John
McMillan, Hideaki Miyajima, Takafusa Nakamura, Barry Naughton, Tetsuji
Okazaki, Hugh Patrick, Yingyi Qian, Tom Roehl, Gerard Roland, Paul Sheard,
Satoshi Sunamura, Juro Teranishi and Kazuo Ueda as well as seminar
participants at the Japan Export and Import Bank, the Japan Development
Bank, Kyoto University, Osaka University, University of Tokyo and the World
Bank Main Bank project for helpful comments. We also thank Yoshito
Sakakibara and David Kotchen for research assistance. We received research
support from the Federal Reserve Bank of Chicago, The University of Chicago
IBM Faculty Research Fund, the National Science Foundation, and the
Division of Research, Harvard Business School. This paper was prepared for
the World Bank, Columbia, Stanford, project on “The Japanese Main Bank
System and Its Relevance for Developing and Transforming Socialist
Economies.The views in the paper, however, are strictly those of the
authors.
Lessons from the Japanese Main Bank System for Financial
System Reform in Poland
Abstract
This paper compares the problems facing the Japanese financial system
following World War II with those currently facing Poland.
In particular,
we consider whether the Japanese experience offers important lessons for
Polish decision-makers responsible for structuring a new financial system
to support the transition to a market economy.
We argue that there are
several reasons to suspect that Poland would benefit from arranging its
banking system along the lines of the Japanese system.
The paper begins by pointing out the principal similarities between
the two situations: 1) that both economies were emerging from a period of
considerable centralization, 2) that in each case banks had been instructed
by the government to lend to certain designated firms (often without regard
to the profitability of loans), 3) that both economies experienced very
high inflation along with acute capital shortages at the beginning of the
transition to capitalism, and 4) that in both cases as the transition began
the balance sheets of firms and banks throughout the economy were filled
with massive amount of bad debts.
We then review the Japanese experience
and outline the theoretical and practical advantages of their approach.
We
argue that the institutional arrangements that permitted banks to play an
active role in corporate governance were especially beneficial.
We close
with an assessment of the current Polish situation and a discussion of the
potential for application of the Japanese Main Bank System in Poland.
June 3, 1993
Hoshi, Kashyap, Loveman
Page 1
0.
Introduction
Poland has, for more than three years, been engaged in a process of
economic reform from a planned to a market economy, and as the first of the
formerly communist eastern and central European countries to engage in the
reform process, it has had to grapple with enormously complex problems
without many meaningful precedents.
The reform process in Poland can be
characterized as having four central components:
macroeconomic reform and
stabilization; institutional reform to establish the basic legislative and
structural mechanisms to support a market economy; financial system reform
to separate the central bank from commercial banking, and to introduce
intermediation into the economy; and, privatization of state assets.
When
comparing the command planning system of Poland and its Warsaw Pact allies
with the capitalist systems of the industrialized western countries, the
differences are obvious and substantial.
But when presented with the task
of actually establishing some kind of market economy where there has been
none for decades, it quickly becomes clear that there exists a multitude of
alternative arrangements within the general rubric of a “market economy,“
each of which have compelling attributes that vary as a function of
political and economic circumstances, transitional properties, and the need
for complementarity amongst the four components of reform.
In this paper we focus on the choice facing Polish policymakers
regarding how to structure the financial system, and its relation to the
privatization and restructuring of Polish industry.
Financial sector
reform has progressed painfully slowly in Poland despite its crucial role
in enabling the revitalization of Polish industry.
Indeed, more than three
years after the introduction of the “shock therapy* macroeconomic reforms
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Hoshi, Kashyap, Loveman
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on January 1, 1990 the banking system remains almost entirely state-owned
and operated, and, more importantly, remains largely dysfunctional in
collecting funds from depositors and allocating them to the most worthy
borrowers.
As the Polish economy begins to emerge from a severe downturn, the
failure of the financial system is widely viewed as a crippling impediment
to recovery.1 Taking a longer term perspective, privatization and
restructuring of Polish state enterprises will require careful valuations
of companies and planned investment projects, large infusions of capital
where warranted, and substantial financial expertise in the management of
the privatized enterprises.
In addition, the rapidly growing small private
business sector in Poland also badly needs efficient and accessible
intermediation to support further development.
New legislation allows for
the creation of private banks, and some have been established, but their
share of banking activity remains quite low.
Only a few foreign-owned
banks have been established, and there has also been little foreign
investment in Polish banks.
Bankruptcy procedures exist, but they are
cumbersome and often disadvantageous for creditors and, hence, are rarely
used.
Meanwhile, the nine regional commercial banks that were spun-off from
the National Bank of Poland continue to have the vast majority of the
deposit and loan business.
First steps toward the privatization of these
nine banks have taken place, including the commercialization of the banks,
the creation of a Supervisory Board overseeing the management of each bank,
the classification of all outstanding loans into five categories on the
lSee Berg and Blanchard (1992) .
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Hoshi, Kashyap, Loveman
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basis of likelihood and timeliness of repayment, and the imposition of
Ministry of Finance restrictions on further lending to state enterprises
with existing non-performing loans.2 As an incentive for improved
management, the Ministry of Finance plans to privatize the banks in an
order determined by their relative financial performance.
Although there is no precedent among eastern and central European
countries for the problems of financial system reform, there are important
lessons to be learned from the post-World War II experience of Japan.
The
post-war Japanese economy was faced with transitioning from extensive
centralization and government intervention in the economy to support the
war effort, including measures that directed funds and tangible resources
to enterprises supplying the military, to a de-militarized, market economy.
Post-war Japan, too, had severely limited productive capacity, a very high
rate of inflation, and extremely close ties between large banks, large
firms and government administrators.
Japanese banks were left after the
war with balance sheets full of munitions company loans that were initially
guaranteed by the government, but following pressure from the Allies the
guarantees were dropped and the loans were uncollectible.
The large
Japanese banks thus faced a balance sheet clean-up problem similar to that
currently faced by the Polish banks, whose assets are almost entirely loans
to state enterprises, the majority of which are likely to be uncollectible.
Rather than adopting a financial system based largely on financing
through equity, bond markets and arms-length bank lending, like the US
system and the system currently contemplated for Poland, Japan developed a
Commercialization involves the conversion of a state-owned enterprise into
a joint-stock company, in which the state.initially owns all of the shares.
Commercialization is a pre-condition for privatization.
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system dominated by financial intermediation through banks, in which banks
also own some equity of the companies to whom they lend money.
In the
former system corporate control is exercised through the stock market by
shareholders and their elected representatives, and in the latter banks
are more important, particularly in periods of financial distress when they
often exercise control.
In many cases, large Japanese firms pair off with
a single bank that becomes the dominant lender to the firm.
These “main
banks- play a particularly active role in the governance and long-term
financial needs of their large corporate customers.
Recent theoretical and empirical analysis suggests that the “main
bank" system has several advantages over the arms-length banking
relationships and reliance on securities market financing common in AngloSaxon countries; and, these advantages are especially important for firms
in financial distress.
Concisely stated, the principle advantages are
reductions in monitoring costs associated with long-term, closely
integrated relationships, reductions in agency costs from significant bank
ownership of debt and equity, coordination efficiencies from having one
bank with a large stake as lead lender and reductions in rescue or
liquidation costs for firms in financial distress.
There are clearly a number of important differences between post-war
Japan and Poland in the early 1990s, but the parallels are sufficient to
support further analysis of the virtues of the Japanese system for Poland.
In particular, the circumstances facing Polish industry and the current
condition of the Polish banking system raise additional challenges that
seem well suited to the main bank structure:
a complete lack of "modern"
organizational and technological banking competence; the need for a long
June 3, 1993
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Page 5
term financial commitment to support restructuring of Polish enterprises;
and the enormous information and credibility problems posed by an unstable
economy with inexperienced and poorly trained managers.
Furthermore, Poland has embarked on a novel and highly complicated
Mass Privatization Program that is aimed at rapidly privatizing hundreds of
companies.
Under the terms of this program, the shares of the privatized
companies would be held by roughly 20 management funds, and each fund would
hold a substantial ownership share in a few companies (as much as 50-60%).
The management funds will have foreign investment banks and venture
capitalists as advisors and are expected to behave as active investors,
choosing and monitoring management, selling assets and facilitating
restructuring through advice to management and the provision of capital.
The management funds, in turn, are to be owned by the Polish citizenry,
each of whom will receive one share in each fund.
The management funds are
intended to concentrate ownership and introduce scarce management
expertise, thereby facilitating restructuring.
The source of financing for
these funds has been assumed to follow from the foreign advisors' access to
capital markets.
Since foreign direct investment in Poland has, to date,
been far less than what is necessary to finance restructuring and
investment on a large scale, substantial domestic funds will be required to
support the privatization effort.
The main bank system presents a model for financial system reform that
offers many benefits for the cluster of problems facing Poland's economy.
The privatization and restructuring of Polish enterprises seems especially
well-suited to take advantage of the distinctive attributes of a main bank
system.
However, it is crucial to distinguish between the benefits of a
June 3, 1993
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main bank system for private Polish banks and the adoption of a main bank
system under the current largely state-owned banking structure.
The main
bank system will work effectively if, and only if, the large commercial
banks are privatized and well capitalized, and bank managers operate under
profit-based incentives that prevent the lending of funds to unworthy
borrowers.
"Soft budget constraints," a fundamental characteristic of
banking under the communists, will not arise with a main bank system in
which managers of banks are rewarded for the profitable use of private
capital.
In the remainder of this paper we examine the relative merits of the
main bank system for Poland.
The next section describes the problems
facing Japan during the period when the main bank system emerged.
Section
2 discusses how the system resolved these problems and the more general
features of the modern main bank system.
Section 3 describes the Polish
situation in greater detail, and draws on the preceding sections to analyze
the virtues of the main bank system for Poland.
Our conclusions are in the
final section.
1.
The Background Leading to the Development of the Main Bank System in
Japan
The purpose of this section is to review the pre-conditions that led
to the development of the main bank system in Japan.
Although the version
of the Japanese Main Bank System that was operative during the high growth
era (1955-1973) has been widely studied and is nicely summarized in Chapter
1, it did not emerge instantly following World War II.
Rather the system
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evolved from the financial system that was in place at the conclusion of
the war through the process of dealing with the challenges associated with
rebuilding the economy.
The analysis here will focus on four key economic conditions that
contributed to the emergence of the main bank system.
First, the
manufacturing and financial sectors of the economy underwent an extreme
concentration during the militarization of the economy.
Second, the
government arranged centralized financing by pairing banks and firms, and
the bank was charged with taking care of the firm's financial needs.
end of war brought with it two significant challenges.
The
One problem was a
near-hyperinflation that destroyed much of the country's wealth just as the
economy needed to be rebuilt.
A second difficulty was that Japanese banks
and industrial firms were left with balance sheets full of wartime
commitments that were ultimately repudiated.
It will be argued that these
four factors had a lasting effect on the banking system.3
Of course, there were other important factors that shaped the system,
and it is important to recognize both the continuity and the shifts that
occurred in the transition between the wartime and postwar financial
system.
For example, monitoring patterns in the wartime banking system
differed significantly from those in the post war system.
Nevertheless,
there are some similarities between the two systems and the purpose of this
section and the next one is to explain how the transition occurred and why
the process of working the problems the economy faced after the war
3 In Chapter 2, Teranishi emphasizes another factor: the loan syndication
arrangements that became prevalent during the war. He argues that these
arrangements were instrumental in the development of the lending consortia
that are an important characteristic of the main bank system.
June 3, 1993
Ho sh i, Kas hyap, Loveman
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ultimately led to a system that was so successful during the high growth
era.
One of the main effects of war was an increase in the concentration of
the Japanese banking sector.
From the onset of hostilities with China in
1937 through the end of WWII, the number of banks in Japan shrunk from 377
to 61.
It appears that several laws passed by the government to assist in
the war effort were largely responsible for this shift and for an increase
in the concentration of the banking and industrial sectors of the
economy.4
The first of these acts occurred in 1937 when a set of financial
controls were designed to allocate funds preferentially to war-related
industries.
These industries tended to be located in the regional centers,
(Teranishi 1982, pp 341-342), so that by discriminating against firms in
non-war-related industries, the policies generally hurt firms that were
located outside of the metropolitan areas.
As these companies declined, so
did the regional banks with whom they did business.
Thus many regional
banks eventually found that their best option was to merge with larger
banks.
The war-time controls also were particularly advantageous to the
largest banks because they had the most funds available to direct to the
war effort.
this period.
By acquiring small banks the larger banks grew further during
Table 1-1 confirms this observation by showing time series
information on the share of the five largest banks in various activities.
Notice that even between 1940 and 1945, there was a considerable increase
4 As Hoshi (1993a) describes, the government had previously passed other laws
that led to considerable concentration in the bank sector - overall between
1901 and 1945, 98% of the banks in Japan disappeared.
June 3, 1993
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in concentration.
By all conventional measures the militarization of the
economy left Japan with an incredibly concentrated banking sector.
Another way to measure the importance of the war effort is to note the
compositional shift in output towards heavy capital-intensive industries at
the expense of light industries.
For instance, Hoshi (1993a) reports that
between 1934 and 1942 the share of output coming from steel and metal and
machinery industries increased from 27% to 49%, while the fraction of
output produced in the food and textile industries declined from 42% to
19%.
Along with this general shift towards heavy industry, the government
also sought to shift production to certain favored firms.
The result was that the zaibatsu firms significantly increased their
importance in the economy over this period.
48-55)
reports that
and Yasuda)
For instance, Hadley (1970, pp
the “Big Four- zaibatsu (Mitsui, Mitsubishi, Sumitomo
accounted for roughly 15% of production in heavy industries
(defined as mining, metal manufacturing, machine tools, shipbuilding and
chemicals) in 1937 and 32% of production by the end of the war.
Apparently, many of the gains came because the Japanese army and navy
routinely “turned industrial and mining areas coming under Japanese
jurisdiction over to Mitsui, Mitsubishi or Sumitomo to operate." (Hadley
1970, p 41)
In fact, Hadley's data indicate that in the non-Japanese
territory controlled by Japan, the Big Four zaibatsu accounted for over 60%
of production in heavy industries at the end of the war.
Overall, the
drive to convert the economy to prepare for war left both the manufacturing
sector and financial sectors highly concentrated.
This reorientation of the manufacturing sector led to further changes
in the credit flows.
An examination of the sources of industrial funding
June 3, 1993
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during this period shows that with the increasing importance of capital
intensive sectors in the economy, firms were no longer able to rely on
internally generated funds to finance their investment.
These changes led
to a pronounced aggregate increase in the demand for bank financing.
For
instance, the share of firm financing coming from banks more than tripled
between 1936 and 1944 - increasing from 18% to 58% - while the share
financing coming from internal funds fell by nearly half - from 47% to 24%.
(See Ministry of Finance 1978, pp 462-463.)
To assist with this adjustment, another set of legal changes regarding
the way that individual companies arranged their financing was implemented.
Initially these changes were made at the industry level.
For instance,
soon after Japan initiated the war with China, the Temporary Funds
Adjustment Law was promulgated in order to guide the overall allocation of
long term funds and provide preferential allocations for war-related
industries.5
Over the next six years the government passed a series of
laws that gave increasing authority over the way funds would be allocated
throughout the economy - see Hoshi (1993a) for more details.6
The financial controls reached the final phase when the government
passed the Munitions Companies Act (October 1943) and the Munitions
Companies Designated Financial Institutions System (January 1944) .
The
Munitions Companies Act put major companies that were considered
5 Operationally this meant that each industry was classified into one of three
categories: those which were to get approval for most long-term funding
requests, those which would sometimes get approval, and those which could
generally not expect to get approval.
6 During this period the demand for loans by war-related industries increased
dramatically. The commercial banks responded to demand by forming lending
consortia.
See Chapter 2 for more details on this process and an argument
for why these lending consortia may have had a lasting effect on lending
arrangements in the post-war main bank system.
June 3, 1993
Koshi, Kashyap, Loveman
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strategically important under the direct control of the government, while
the Munitions Companies Designated Financial Institutions System assigned a
major bank to each munitions company to take care of the firm's financial
needs.
Large firms sometimes had more than one bank assigned to help
them.7
In many cases, a lending consortium was formed around the
designated bank to serve the munitions company.
Judging from the “Selection Policy for Munitions Companies Designated
Financial Institutions-
many of the designations are likely to have been
based on the past relations through loans, shareholdings, and directorship
(Bank of Japan Research Bureau 1973, p 397 and Mitsubishi Bank 1954, pp
348-350.)
Thus some assignments under the Munitions Companies Designated
Financial Institutions System served only to reinforce pre-existing ties
between banks and firms - especially in cases evolving zaibatsu firms and
banks.
But historical accounts of the matching process also suggest that
there was competition among banks to receive designations for munitions
companies.
For example, in the corporate history of Mitsubishi bank, it is
reported that the bank lobbied to obtain as many designations as possible
because loans made to munitions companies were perceived to be riskless
(see Mitsubishi Bank 1954, pp 349-350.
Also Miyazaki and Itoh 1989, p 202,
in their review of the history of Fuji Bank, reach the same conclusion.)
As a result of this process some non-zaibatsu firms started to have
close ties to zaibatsu banks. An interesting example is Ajinomoto, which
The Munitions Company Act also allowed managers to increase their power
relative to shareholders by giving the managers much more autonomy provided
that they were acting in the interests of the nation by trying to ■increase
productivity". (See Okazaki 1991, pp 392-393.) Hoshi (1993a) explains how
this shift in power further contributed to the rise of a bank-led financing
system.
7
June 3, 1993
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changed its name to Dai Nippon Kagaku Kogyo during the latter stages of the
war and then was designated as a munitions company and assigned to
Mitsubishi Bank.
Judging from the low levels of debt prior to the war,
Ajinomoto does not appear to previously have had extensive relations with
Mitsubishi (or any other bank) before the war.
(Ajinomoto 1971, Vol. 1,
Appendix, pp 10-11).8 After the war, Ajinomoto gradually moved closer to
the Mitsubishi group.
For example, during the reconstruction period,
Mitsuo Ogasawara of Mitsubishi Bank served as one of its five special
managers charged with supervising the rebuilding of the firm.
By 1962,
Mitsubishi Bank was the largest lender to Ajinomoto and by 1972 had become
both the largest lender and largest shareholder of Ajinomoto (Keizai Chosa
Kyokai 1963, 1973).
In addition to the financial ties, Ajinomoto and the
Mitsubishi group developed close relations in intermediate product markets.
For example, Ajinomoto's Tokai factory purchases raw materials from
Mitsubishi Chemical, Mitsubishi Petro-Chemical, and Mitsubishi Monsanto
(Ajinomoto 1989, p 281).
Thus, even for the former zaibatsu banks there
appear to have been new long-lasting relationships that formed because of
the designation system.
For the non-zaibatsu banks that were far less likely to have had many
long-standing ties to draw upon, the designation system may have been the
key to establishing a number of new relationships.
Hoshi (1993a) attempts
8 A further hint that suggests the lack of any prior ties between Ajinomoto
and Mitsubishi is that another munitions company, Showa Nosan Kako, which was
established by Ajinomoto to deal with alcoholic liquor business in 1934, was
assigned Teikoku and Yasuda Banks as
its designated institutions.
Interestingly, Showa Nosan Kako, which changed its name to Sanraku Ocean
after the war had Mitsubishi Trust as its largest lender and the third
largest shareholder in 1962.
This suggests the ties established through
government assignments were not as strong as the ties between a company and
its former subsidiaries.
June 3, 1993
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to calibrate the importance of these designated arrangements by comparing
the identity of a firm's main bank in 1962 with its designated lender
during the war.
Among 158 munitions companies that were assigned
designated financial institutions during the first round of designation in
1944, he is able to track 112 of these companies and their successors.
Of
these 112 cases, the designated financial institution was both the largest
lender and one of the ten largest shareholders in 1962 in 71 cases (63%).
In another 13 cases the trust bank or the life insurance company in the
same enterprise group as the designated financial institution is the main
bank, so that the proportion rises to 75%.
Finally there were 16 other
cases where the designated financial institutions were the largest lenders
but not one of the top ten shareholders, so, by this "looser" standard, the
designations had a persistent effect on the financing patterns for 89% of
the former munitions companies.
To the extent these figures merely confirm the fact that many formerzaibatsu firms and banks stayed together after the war, they are not
particularly noteworthy; among the 112 companies Hoshi studied, 42 are
considered to have had close links to one of the zaibatsu even before the
designation of financial institutions and therefore may be of less
interest.
A more important finding, however, is that the ties through the
designated financial institutions system were long lasting even for the
other 70 firms which did not have close ties to zaibatsu.
Out of 70, 61
companies (or 87%) had their designated institution or a financial
institution in the same group as their largest lender in 1962.
The same war-time controls that laid the groundwork for a strong bankled financing system also caused some problems.
The most important problem
June 3, 1993
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for the financial system was the paralysis of its monitoring function.
Financial institutions were turned into organizations which merely followed
the government's lending orders.
The evaluation and monitoring of
borrowers, which are central to a healthy banking system, were no longer
the banks' business in the war-time economy.
The following quote taken
from a banker's memoirs shows what the banking business was like during the
war:
I was in charge of the loan business for the companies connected
with production of top secret bombs: balloon bombs. My name was
registered with the Army Headquarters for Weapon Administration, and
my activities were a closely guarded secret.
I dealt with all the
loan documents related to balloon bombs, which was flagged by a letter
"fu."
("fu" for "fusen*" the Japanese word for balloon)
Incidentally, the documents with a letter "ro" was for rocket bombs
for Navy, and another person was in charge of these loans.
My job was to make the loan immediately whenever a slip with a
letter "fu" came to my desk. Lots of companies, such as paper
manufacturers, producers of percussion caps, and konnvaku paste-makers
(paste made from arum root), took part in the production of balloon
bombs.
(Matsuzawa 1985, p 14)
This absence of any monitoring was also reported in the corporate
history of the Mitsubishi bank.
For instance, Mitsubishi Bank (1954, pp
351-353) notes the managers of the munitions companies "never had to worry
about financing" and the banks "could rarely use their own judgements
regarding loan requests."
Ironically, the result of the massive
intervention by the Japanese government to support the war effort seems to
have left the financial system operating with a set of "soft budget
constraints."9
With the conclusion of World War II Japan found itself facing two
additional problems (that more recently Poland has also had to confront).
9"Soft budget constraints" is a term coined by Janos Kornai to describe the
communist systems' willingness to subsidize poor performing companies and
reluctance to press insolvent firms into bankruptcy and liquidation.
June 3, 1993
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One problem arose because the war destroyed much of the capital stock.
As
Table 1-2 shows, during the war, Japan lost about 25% of the total
productive assets and 30% of transportation related durables and
infrastructure.
Until 1949, a major portion of the funds used to support
the rebuilding effort came from the Reconstruction Bank, which raised the
money by issuing Reconstruction Bonds.
Unfortunately, in many instances,
more than 60% (and sometimes more than 90%) of the bonds were bought by
Bank of Japan (Kosai 1981), and the Reconstruction Bank financing fueled
inflation.
This inflation, in turn, destroyed much of the financial wealth in the
economy.
Table 1-3 shows the level of gross financial assets for the
personal sector and corporations.
Although the nominal value of financial
assets increased during the period of 1946-1954, relative to GNP the stock
of financial assets fell substantially during the 1946-47 hyperinflation
and still had not recovered by 1954.10 Thus, like Poland 40 years later,
Japan found itself trying to rebuild its economy with an acute shortage of
domestic funds.
A second dilemma brought about by the end of the war was the
extraordinary amount of wartime compensation that the government owed the
munitions companies.
The Japanese government initially planned to pay the
compensation by collecting property taxes, but following pressure from
Allies, the government eventually decided to completely suspend
10 Even afterwards, relative to the US, where comparable ratios at that time
were around 1.5 for household financial assets and around 2 for private
nonfinancial sector assets, the Japanese ratios seemed low. In fact, Hamada
and Horiuchi (1987 p 229) report that it took Japan another 30 years to catch
up with the US in this respect.
June 3, 1993
Hoshi, Kashyap, Loveman
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compensation payments.11
Since financial institutions obviously had high
exposure to munitions companies, the suspension of wartime compensation
also seriously deunaged their balance sheets.
To make the matter worse, the
government also decided to drop its commitment to honor government
guaranteed corporate bonds, most of which were held by financial
institutions, and to suspend compensation for the losses due to
uncollectible government-ordered loans to munitions companies.
The total losses stemming from the default were enormous.
government estimated the amount to be 66.9 billion yen.12
The
If one adds the
losses due to the repudiation of government guaranteed bonds (19.8 billion
yen) and the losses due to the suspension of compensation for losses
arising from government-ordered loans (5.0 billion yen), the total losses
rise to an estimated 91.8 billion yen.
This is almost one fifth of Gross
National Expenditure in the fiscal year 1946 (474.0 billion yen).13
To sum up, Japan was forced to rebuild its economy starting with a
highly concentrated manufacturing sector that was receiving unmonitored
credit from a highly concentrated but nearly insolvent banking sector.
Moreover,
losing the war had wiped out much of the capital stock and the
inflation after the war had wiped out much of the nation's wealth.
Thus,
credit during the early phase of the reconstruction was likely to be
scarce.
Against this backdrop the main bank system emerged.
The next
11 For a detailed description of negotiations between the Japanese government
and Allies, see Ministry of Finance (1983a), pp 183-347.
12 This estimate was published on October 2, 1946.
(1983b), p 699.
13 Ministry of Finance (1978), pp 26-27.
See Ministry of Finance
June 3, 1993
Hoshi, Kashyap, Loveman
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section investigates both the institutional and theoretical considerations
that suggest that the main bank system was well-suited to the challenge.
2.
The Rationale for the Main Bank System in Japan
In this section it will be argued that each of the major problems
discussed in the last section - particularly, the pairing of specific banks
and firms and the associated soft-budget constraint problem, the massive
amount of required rebuilding starting from a position of low wealth, and
the significant balance sheet problems - played an important role in the
selection of a bank-led financing system that eventually became the main
bank system.
Of course, the Japanese banking system was going through a
major transition following the war and these considerations were only some
of the factors that ultimately led to the main bank system.
Some of the
other factors will be discussed at the end this section.
In examining the Japanese system, two points deserve particular
emphasis.
On the one hand, it will be argued that a bank-led financing
system was well-suited to addressing the critical problems facing the
economy.
However, a second point is equally important: no other
alternative to a bank-led financing system would have been likely to
succeed.
As discussed by Aoki, Patrick and Sheard in Chapter 1, the main
alternative to a main bank style financing system would be a securities
market based system.
In the latter, significant funding is obtained
through equity and bond markets and the equity market plays a central role
in the corporate governance structure.
Throughout this discussion, it is
important to recognize that while the main bank system may be imperfect it
must be contrasted to a realistic alternative.
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Perhaps the contrast between the relative strengths of a bank-led
system and a securities market based system is sharpest in terms of the
difficulties posed by the balance sheet problems that existed in Japan at
the end of the war.
The Japanese tackled these problems by initially
freezing the balance sheets of both banks and industrial firms in August
1946.14 The rules were finalized in October of that year.15 The
authorities hoped by taking these measures they could stop the accumulated
war related debts from choking the ongoing operations of the firms.
Thus
the policymakers explicitly recognized that for any progress towards
reconstruction to occur, the adverse incentive effects of the insolvency of
lenders and borrowers had to be addressed.
Because the Polish banks now face a similar solvency problem it seems
appropriate to review how the Japanese addressed the problems.16
For the
financial institutions their balance sheets were separated into a new
account and an old account.
Those assets that were expected to be
uncollectible because of suspension of wartime compensation were assigned
14 The restructuring of financial institutions and industrial companies was
only one of many changes that the Japanese financial system went through.
The Japanese government, under the supervision of the Allies, implemented
several other important financial reforms.
Financial institutions in the
former Japanese colonies (such as Taiwan Bank and Chosen Bank) and those for
wartime controls (such as Wartime Finance Corporation) were completely shut
down. The Munitions Companies Designated Financial Institutions System was
formerly abolished. New financial institutions which exclusively handled the
distribution of long-term funds were created to replace the pre-war special
banks.
Financial institutions specializing in the financing of small and
medium-sized firms and those for farmers were also established and the Bank
of Japan Act was partially reformed to increase independence of the central
bank from the government (see Kato 1974).
15 The initial laws were the Financial Institutions Accounting Temporary
Measures Act (FIATMA henceforth) and Corporations Accounting Temporary
Measures Act (COATMA) and the permanent laws were called the Financial
Institutions Reconstruction and Reorganization Act (FIRRA) and Corporations
Reconstruction and Reorganization Act (CORRA) - see Teranishi (1991b, pp 2324) for a brief description of FIATMA and FIRRA.
16 The discussion below relies on Ministry of Finance (1983b), pp 213-327 and
pp 699-913.
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to the old account and this account was expected to go through a
reorganization.
In the meantime, the banks were encouraged to continue
operations using the new account.
This new account included cash,
government and municipal bonds, credits against the government other than
bonds, credits against other financial institutions, and other assets
specified by the Finance Minister.
This meant that because most of the
munitions company loans and government guaranteed bonds were expected to be
uncollectible, they were placed in the old accounts.
The liabilities of
the new account included a limited amount of deposits,17 tax obligations to
central and local governments, loans from other financial institutions, and
other liabilities specified by the Finance Minister.
Depositors were left
with access to only a fraction of the money that they had put into the
bank.
In aggregate about half of the deposits were transferred to the old
accounts where they were frozen and were at risk of being canceled to cover
the bad munitions company loans and government guaranteed bonds.18 The
banks' capital and retained earnings were also put in the old account and
were, therefore, at risk.
Differences between assets and liabilities in
one account were recorded as an unsettled account against the other.
For
instance, if the liabilities of the new account happened to exceed its
assets, the difference was entered as a credit against the old account.
17 In February 1946, in order to combat run-away inflation, the government
prohibited withdrawals of deposits that exceed the minimum amount assumed to
be necessary for living.
Financial Institutions Accounting Temporary Act
classified a limited amount of frozen deposits (per household) into the new
account (these were termed first line frozen deposits), and classified the
rest into the old account (second line frozen deposits) • Much of the second
line frozen deposits were later repudiated during the process of
reorganization. See Teranishi (1991a) for more on frozen deposits.
18 Ministry of Finance (1983b), p 228.
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If, in the course of doing business, a bank used assets (such as
offices) in the old account, then compensation had to be paid from the new
account to the old account.
These sorts of payments generated some
transfers to the old accounts.
Finally, in March 1948, the assets were
marked up to current prices and the losses due to suspension of wartime
compensation were canceled out.19 This process was finished in May 1948
when new and old accounts were merged.
Most banks were forced to
significantly reduce capital and to cut into the frozen deposits to cover
the losses.
For example, 55 out of 61 ordinary banks reduced their capital
by more than 90% and had to default on some of the deposits.
The capital
was subsequently replenished by issuing new shares.
The restructuring of the non-financial corporations was done in a
parallel fashion but proved more difficult.
The process began with the
government letting the companies which were expected to be damaged by
suspension of wartime compensation declare themselves "special account
companies"
(tokubetsu keiri gaisha).
These companies then had their
balance sheets separated into new and old accounts on August 11, 1946, and
were allowed to operate using the new account.
In this case, the assets of
the new account included only those assets that were deemed necessary to
•continue the current business and promote the post-war development."20
Meanwhile the firm's liabilities and other assets were moved into the old
19 The following prioritization was used in the process:
first, capital
gains on assets; second, retained earnings; third, then up to 90% of the
bank's capital; fourth, 70% of the deposits that were at risk would be
written down, followed by the remaining 10% of the capital; and, finally, the
remaining 30% of the deposits would be written down.
20 Ministry of Finance (1983b), p 734.
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account and the total value of assets classified into the new account was
recorded as the liabilities of the new account against the old account.21
More importantly, this process included an important role for banks.
Specifically, in the process of restructuring non-financial firms, each
firm had to select a set of "special managers" (tokubetsu kanrinin).
As a
rule, the special managers consisted of two of a company's own executives
and two representatives of the firm's creditors.
So, in almost all the
cases, former munitions companies had representatives from their designated
financial institutions as their special managers.
For example, as pointed
out earlier, Mitsuo Ogasawara of Mitsubishi Bank became a special manager
of Ajinomoto.
Special managers played a central role in the restructuring process.
For instance, it was their responsibility to determine which assets should
be included in the new account.
They were also required to draw up a
restructuring plan and submit it to the Finance Minister for approval.
Miyajima (1992, pp 229-30) reports that drafting a restructuring plan
required the special managers to assess the value of remaining assets, make
plans for future production and finance, and create forecasts of balance
sheets and income statements.
Accordingly, the restructuring of special
account companies gave the special managers (and, therefore, the banks) an
excellent opportunity to acquire information about the companies.
Indeed
Miyajima (1992) argues that the "banks accumulated information about
borrowers during this period rather more intensively than during the period
of Designated Financial Institutions System, when the government legally
21 The special account companies were prohibited from settling liabilities
incurred before August 11, 1946, and were protected from seizure of their
assets (in the old account). The companies were also forbidden to declare
bankruptcy.
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forced loan contracts and basically guaranteed against the risk."
Ultimately, the accumulation of information and the responsibility
associated with the restructuring process must have significantly enhanced
the capabilities of banks.
In effect, this process served to reverse the
deterioration of bank monitoring skills that had been brought on by the
wartime forced lending arrangements.
The restructuring of non-financial companies took much longer than the
restructuring of financial institutions, and not until four years after the
process began (in late 1950) had all the special account companies
submitted their restructuring plans.
The process was delayed because
coordination with anti-trust measures was required.
The implementation of
the plans took even longer, and more than 20% of the special account
companies were still undergoing restructuring as of the end of 1952.
About
12% of the companies seem to have disappeared without completing the
restructuring.22
The losses incurred by shareholders and creditors were
not as large as expected.
The profits of the old account, which included
the proceeds from sales of assets, reached 45.9% of the total losses, and
the capital gains of assets covered another 21.3%.
Thus the losses of
shareholders and creditors were "limited" to 32.8% of the total losses (or
30 billion yen) .23
In evaluating the entire restructuring process it is essential to
recognize that the pivotal role played by banks was almost unavoidable.
For instance, suppose authorities had opted for a securities market
approach to restructuring where companies were instructed to issue equity
22 See Ministry of Finance (1983b), pp 899-900.
23 See Ministry of Finance (1983b), p 902.
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to reliquify themselves.
Given the complex web of debts between banks, the
government, and firms and the considerable uncertainty over how the various
obligations would be resolved, it would have been hard to establish the
value of a typical firm.
But without accurate valuations, equity financing
would have been very difficult to attract, since equity financiers have
only a junior claim against the firm.
Attempts to rely in any significant way on equity financing would have
been further complicated because most Japanese investors had only limited
experience with the stock market.
The pre-war market had been small.
One
of the goals of the Occupational Forces in Japan was to breakup the
zaibatsu companies that were thought to have been responsible for
encouraging military aggression (see Hadley 1970) .
In the course of
engineering this dissolution, the government decided to sell shares in the
companies.
However, the government and securities industries found that
they had to educate potential investors about the opportunities associated
with stock ownership.
Responding to this ■securities democratization" movement, many
households put their savings into stocks.
Other measures such as low
interest loans for employees purchasing their own company's shares and
permission to use frozen deposits to buy shares also helped to create the
demand for shares.
Although the stock exchange was closed, people actively
traded shares at Shudan Torihiki (collective trading), where many
securities companies gathered to offer over-the-counter trades.
When the
stock exchange was reopened in 1949, it started with a boom but soon began
to sag, as the Dodge stabilization plan took hold and the economy slid into
a recession.
The Tokyo Stock Exchange composite stock index lost more than
50% from the reopening of the exchange (May 1949) to the end of the year -
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Ministry of Finance (1979), p. 399 .
Thus, many investors were left with
initial skepticism regarding the virtues of equity ownership.
In our view,
these sorts of difficulties with establishing an active securities market
are probably unavoidable when an economy is beginning such a transition.24
The disinflation program also had other important effects.
For
instance, by cutting off credit extensions from the Reconstruction Bank,
the Dodge Stabilization Plan also led to a serious credit contraction.
While documenting a credit crunch is always difficult, there is abundant
anecdotal evidence suggesting that credit became quite tight.
For example,
Toshio Nakamura of Mitsubishi Bank recalled "shortage of funds made it
difficult to lend to even keiretsu firms" during this period (Ohtsuki 1987,
p 77).
Research reports from the Bank of Japan also frequently discussed
the shortage of funds.25
In response to these financing problems many companies turned to
banks, and the banks seem to have increased their power over industrial
firms.
Banks rescued many companies from the ensuing liquidity crisis, and
sometimes directly intervened in their management.
In his memoirs, Eiji
Toyoda, who was president of Toyota Auto from 1967 to 1982, looks back on
this time as the period when Toyota Auto reluctantly started to depend on
banks, especially Mitsui Bank, and was forced to accept bank intervention
in management.24 Mitsui Bank and other banks helped Toyota through its
liquidity crisis in 1950, but required substantial layoffs and that Toyota
24 Of course, this does not mean that a stock market cannot be useful in
helping to redistribute ownership. Rather, given the fragile nature of the
economy, it seems very unlikely that much new money can be raised to finance
businesses.
25 These reports can be found in Bank of Japan Research Bureau (1980), pp.
451-592, and occur between December 1947 to December 1951.
24 Nihon.Keizai Shimbun-sha (1987).
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split up the sales department as conditions for the rescue.
Mitsui Bank
also sent in a director, Fukio Nakagawa, who later served as president of
Toyota.
This type of rescue operation seems to have been quite common during
this period.
Indeed, Miyajima (1992, pp 233-235) argues that between 1949
and 1952 many banks regularly began sending their employees in as directors
to the companies to which they were lending.
He also finds that main bank
dependence was negatively correlated with profitability during this period,
but not during other periods.
He interprets this correlation as evidence
that the main banks were systematically taking on a higher fraction of
distressed clients in the aftermath of the stabilization.
Thus, the taming
of inflation not only left the banks in a better position to monitor their
clients, but also seems to have accelerated the practice of the banks
intervening in cases of financial distress.
With the disinflation program, however, the banks also suffered from a
shortage of funds.
For instance, Makoto Usami of Mitsubishi Bank recalled
that "the demand for funds came in continuously, but not the deposits."27
The recent memory of high inflation and the deposit freeze undermined the
public's trust and reduced their willingness to let the banks manage their
money.
The situation was especially serious for large zaibatsu banks,
which depended heavily on deposits by large zaibatsu companies.
Because
those companies were in the process of restructuring, they did not have
much money available to deposit.21
27
Thus, the large banks had to compete*
9
2
Nihon Keizai Shimbun-sha (1980).
29 Sumitomo Ginko (1979), pp 400-401.
(p 229) .
Also see Miyajima (1992), Tables 5-6
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for inter-bank loans and Bank of Japan lending to make up for the shortage
of deposits.
This competition among large banks also seems to have further helped
the soft-budget constraint problem that had characterized the wartime
lending arrangements.
Since the banks had their balance sheets cleaned up
and were now solvent, they did not seem inclined to waste money on loans to
friendly, but unworthy companies.
The case of Mitsui Seiki described by
Goro Koyama of Mitsui Bank is suggestive (see Edo 1986, p 129).
Although
Mitsui Seiki was chokkei (of direct lineage) of Mitsui, and, therefore,
considered to be a central Mitsui company, it got into trouble after the
war because of loose management.
Koyama argued that Mitsui Bank should
help other firms that were trying hard rather than instinctively helping
Mitsui Seiki because it had the "Mitsui" name.
This argument persuaded
President Sato of Mitsui Bank to let Mitsui Seiki go through restructuring
under Kaisha Kosei Ho (Restructuring Law). Consequently, Mitsui Seiki
became the first company to be restructured under that Restructuring Law.
As the economy emerged from the restructuring in the early 1950s,
funding continued to be difficult to obtain and the possibility of facing
financial distress was a concern for most companies.
banking relations continued to evolve.
By the middle of the decade many of
the features of the main bank system were in place.
important patterns had emerged.
Against this backdrop
In particular, three
First, banks were firmly established as
the primary providers of external financing for firms.
Second, banks had
been permitted to hold equity (as well as debt) claims of their clients and
were regularly taking an active role in corporate governance (for instance
by serving on boards of directors).
Finally, firms and banks were
June 3, 1993
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continuing to pair off, so that everyone could clearly identify the main
bank of a particular firm.
As discussed in Chapter 1, these attributes are only a subset of the
sorts of ties that characterize the main bank system.
But in suggesting
that Poland borrow from the Japanese experience, we think these attributes
are essential and would have to be adopted for the system to be
successfully implemented in Poland.
We close this section with a
discussion of how these three characteristics of banking relationships
assist in the delivery of financing to firms in an economy with scarce
capital and assist in minimizing the costs of financial distress.
Starting with firms experiencing cash flow problems, the main bank
system provides four distinct theoretical advantages over a US style system
where banks' actions are more tightly controlled.
First, concentrating the
firm's financial obligations eases the type of coordination problems that
typically accompany any reorganization effort and thus helps improve the
delivery of financing.
In most cases, different creditors will have very
different incentives for providing relief or additional funding.
In a
system where there are few debtholders with large stakes, the number of
parties that must come to an agreement about the fate of the company can be
(and often seems to be greatly) reduced.
Indeed, in many unsuccessful
workouts one of the major hurdles is securing agreements from small or
marginal investors.
A second and related benefit is that by allowing debtholders to take
equity positions, one helps align the interests of the two parties.
Thus
if some bargaining is required in the course of negotiating an agreement,
the disparate interests of debt and equity holders are less likely to be a
stumbling block.
This effect can be relatively small unless the debt
June 3, 1993
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holders have significant equity positions, so as an empirical matter it is
unclear whether this feature is particularly important.
On the other hand, in the US there are a number of legal impediments
that limit a bank's incentive to intervene and try to bailout one of its
clients prior to the start of formal bankruptcy proceedings.
For instance,
the laws regarding the treatment of concessions offered by creditors differ
depending on whether a firm has been declared bankrupt.
Similarly, the
nature of public debt contracts (where unanimity is effectively required to
defer the payment of principal or interest) also makes it difficult for
bargaining to take place outside of bankruptcy proceedings.
Overall, the
considerable consolidation of claims and alignment of the interest of the
creditors in Japan may lead to important differences in the efficiency with
which these type of cases are resolved in the two countries.
A third benefit of the main bank system in cases of financial distress
is that the main bank is well positioned to make informed judgements about
whether additional assistance is prudent.
In many cases, the inability to
reach an agreement on the likely impact of an assistance package comes into
play.
Even if creditors can agree on what steps to take, assuming the
benefits of these steps were certain, no single creditor is well enough
informed to help the group come to a decision.
The main bank by virtue of
its close ties to the firm should be able to make such a decision and is
likely to be looked to for leadership.
A fourth consideration that is closely related to the last point, and
is emphasized by Hoshi (1993b) is the repeated participation of the same
principal lenders across a number of deals helps facilitate workouts.
If
the largest creditors have previously been through other workouts and know
that they will likely gain by cooperating in subsequent situations, these
June 3, 1993
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parties may be better able to reach a compromise than would be true in a
one-shot bargaining session.
In essence, the environment permits
reputational factors to be deployed to help smooth over disagreements and
may help to reduce the costs of financial distress.
In analyzing the actual Japanese experience, one might debate whether
this assistance is always efficient since from an economy-wide perspective
the bailouts may lead to too few failures.
feature that does help on this front.
The main bank system has one
Specifically, these bank-led
assistance programs often include significant managerial
reorganizations.29 The well-known Sumitomo group bailout of Mazda provides
an excellent example of this practice.
The combination of the first OPEC
oil shock and the low fuel efficiency of their new rotary engine vehicles
left Mazda with serious financial problems.
Worse yet, Mazda's management
was already widely viewed as being ineffective.
For instance, the company
had the highest production costs of all Japanese automakers.
As Pascale
and Rohlen (1983, p 223) put it, "the oil crisis of 1973 did not cause Toyo
Kogyo's (Mazda's Japanese name) problems, it simply exposed them."
Mazda's
main bank, Sumitomo, stepped in and provided new cheap loans, wrote down
some existing loans and convinced other lenders and suppliers to stick with
the firm.
Perhaps even more importantly, Sumitomo bank sent Tsutomu Murai
and four other employees as "delegates" to Mazda, who were responsible for
overhauling Mazda's management structure (see Pascale and Rohlen 1983).
This direct intervention by the bank was instrumental in transforming an
inefficient company into an efficient company.
As Sheard (1989, p 399)
29 Kaplan and Minton (1993) found that in a sample of 121 large Japanese
firms, during the 1980s, the appointments of outside directors with bank
experience tended to rise when the firm's cash flow deteriorated.
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puts it, "The main bank system substitutes for the 'missing' takeover
market in Japan."
A second set of features become relevant when assessing the ability of
the main bank system to deliver funds to firms that are financially
healthy.
Here there are four distinct effects of the main bank system.
The first effect is that the system helps prevent duplication of monitoring
efforts.
In other words, because the main bank has such a large stake at
risk with the firm, it will have definite incentives to keep tabs on the
firm.
Since all other lenders recognize that this is the case, less
monitoring is required and the system will be more efficient than one in
which multiple monitors might be required.
A second reinforcing effect arises due to the different channels of
significant information flowing back and forth from the bank and its
customer.
The example cited earlier where Mitsui sent an employee to
Toyota who later became a senior manager at Toyota appears to be quite
common.
For instance, Hoshi, Kashyap and Scharfstein (1990) report that as
of 1982, roughly 34% of the firms listed on the Tokyo Stock Exchange had
one internally appointed board member whose last employer prior to joining
the current firm was a bank that did business with the current firm.30
They also report that an additional 8% of the firms had a board member that
was currently employed by a bank.
Through these sorts of informal ties the
main bank can conduct its policing activities quite effectively, so that
30 Kaplan (1992) reports, however, that in most cases, by the time a person
is appointed to be a board member at the very largest Japanese firms, that
person has typically been employed by the company for at least 7 years. It
is not clear how to interpret this evidence. The data we reviewed supports
the following arrangement:
a person works for a bank for 25 to 30 years,
then moves to the client company as a senior manager; and after another 7-10
years, this person becomes a board member-
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the monitoring that does take place uses fewer resources than would
otherwise be necessary.31
(See Chapter 1, as well as Schoenholtz and
Takeda (1985) and Sheard (1989) for more discussion on these points.)
Hoshi, Kashyap and Scharfstein (1991) identify another channel by
which a main banking system can be beneficial.
This channel emerges
because of standard asymmetric information problems that lead to a cost
differential between internally generated funds and externally generated
money.
To the extent that investment opportunities are less cyclical than
firms' cash flows this cost differential may lead to underinvestment.
Hoshi, Kashyap and Scharfstein (1991) point out that a firm with an
informed main bank may partially circumvent these difficulties.
Indeed,
they find the investment of firms with tight banking relationships is less
sensitive to fluctuations in internal funds than is the investment of firms
without tight bank relationships.
These findings suggest the presence of a
main bank may help insulate some Japanese firms from business cycles and
other disturbances.
An additional effect comes from the interaction of the main bank
system with the tax code.
In Japan, like many other countries, interest
31 Another chance for informal information sharing occurs at the regular
monthly meetings which are attended by the chief executive officers of the
core companies in the kicrvo shudan. These gatherings, commonly referred to
as shacho-kai (Presidents Club) meetings, are generally described as being
somewhat ceremonial and more oriented towards being an outlet for informal
information sharing rather than for explicit strategic planning. (For details
see Gerlach (1992), chapter 4.)
Nevertheless, the banks seem to play a
central role when a joint decision among the members is made. For example,
Toshio Nakamura, a former president of Mitsubishi Bank, reports that the bank
was instrumental in the joint projects started by the Mitsubishi group,
including Mitsubishi Cement (1954), Mitsubishi Petro-Chemical (1956), and
Mitsubishi Atomic Power (1958). He also notes that the bank coordinated the
group's effort to buy Mitsubishi Oil shares from Texaco after Texaco had
acquired the shares by taking over Getty Oil (Ohtsuki 1987, pp 80-81).
Similarly, Tsuda (1988, pp 100-101) describes how Sumitomo Bank mobilized the
Hakusui-kai (the Sumitomo Presidents Club) in its rescue plan for Sumitomo
Machinery in 1954*when the manufacturer was financially distressed.
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payments on debt are tax deductible.
Because of the previously mentioned
lowered costs of financial distress, Japanese firms are able to load up on
more debt than they otherwise would.
From a purely corporate perspective,
this is another advantage of the main bank system, although from society's
point of view it is not clear whether this is desirable.
Overall there
appear to be a number of reasons why the main bank system has been
advantageous for Japan.
Lastly, it is worth noting that while the banking system was very
important in Japan, until very recently securities markets remained fairly
primitive.
As mentioned earlier, in the immediate aftermath of the war the
stock market was shut down, but even after it reopened in the 1950s it was
not a terribly important source of funding for even the large corporations.
Given the low level of wealth of most investors, it is perhaps not
surprising that concerns about diversification might have led them to shy
away from investing in particular companies.
The alternative of pooling
money with other investors by lending to a bank that can invest in many
firms might have been much more attractive.
Regarding bond markets, one would also suspect that, in the initial
period following the war with turbulence in the economy, unmonitored
lending that was secured by a borrower's reputation would have been
unlikely to succeed.
Rather investors would probably insist that firms
either post collateral (which would mitigate the attractiveness of this
borrowing strategy) or receive some sort of credit rating to guarantee
their credit worthiness.
While this would have been difficult at the
outset of the high growth era, one might have thought that as the economy
matured, a deeper bond market would develop.
have prevented the growth of the bond market.
However, regulation seems to
In fact, until the early
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1980s, bond issuance was tightly controlled, so that firms had little
choice as to where they would get their external funding.32
Since the restrictions have been eased, there has been a flurry of
bond issuance among the largest, most successful Japanese companies - see
Hoshi, Kashyap, and Scharfstein (1993).
In advocating that Poland and
other countries consider mimicking the main bank system, we want to be
clear that we do not favor following the Japanese example with regard to
the regulations pertaining to bond and equity markets.
Rather our view is
that until the economy reached a fairly mature state, the economic
advantages of the main bank system described above would have made bank
financing relatively attractive even if the bond and stock markets were not
so tightly controlled.
3.
Financial Reform in Poland
The preceding sections have described the emergence of the main bank
system in post World War II Japan, and discussed research findings
concerning the distinctive differences between the Japanese main bank
system and the “arms length" separation of lending from ownership and
control that characterize the US and British banking systems.
This section
considers whether the features of the main bank system are attractive for
the ongoing reform process in Poland.
The applicability of the main bank
system depends on the existing institutional structure and economic
conditions in Poland, as well as the specific demands that the
privatization and reform process places on the financial sector.
These
issues are considered in turn.
32 It is often asserted that the costs of raising funds in the equity market
were unnecessarily high because of regulation (see Miller 1992).
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3.1
The Economy and the Financial Sector in Poland
The first Solidarity-led government was installed in September 1989
under Prime Minister Mazowiecki, and it moved quickly and with remarkable
resolve to implement a package of sweeping reforms, most of which began on
January 1, 1990:
essentially all price controls were removed (food prices had been
liberalized in August 1989), and energy prices were increased by
as much as 500%;
the government budget was brought into balance through the
reduction of subsidies to state enterprises and the elimination
of tax credits;
_
current account convertibility was introduced and the zloty was
pegged to the US dollar;
foreign trade was liberalized and government allocation of
materials was eliminated;
the "excess wage" tax was increased and virtually all exemptions
were eliminated in an effort to slow the growth of wages in
response to rising prices;
the National Bank of Poland (NBP) moved to establish positive
real rates of interest after years of negative real rates and
very high inflation.
The discontinuous nature of these reforms contrasted sharply with
calls for a gradual reform process, and earned the name of "shock therapy."
The effect of these reforms on the key macroeconomic variables is evident
in Table 3-1:
the hyperinflation was stopped, the real interest rate
increased substantially, the government achieved a surplus, and output fell
precipitously.
The substantial fall in industrial output was all accounted
for by state enterprises and output in the state enterprise sector fell
further in 1991, in part, because of the loss of the CMEA export market.
Although the "shock therapy" macroeconomic reforms were the most
dramatic and widely discussed of the economic reforms, a distinguishing
feature of the Polish economy is a history of important reforms implemented
by the communists as early as 1982 in an effort to resuscitate the
June 3, 1993
Hoshi, Kashyap, Loveman
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floundering Polish economy.33 The National Bank of Poland (NBP) was
separated from the Ministry of Finance in 1982 and given independent
authority to lend on commercial criteria.
Although this authority was
rarely exercised, the independence of the NBP was an important first step
in the separation of banking from the planning system.
Five years later,
in 1987, the State Savings Bank (PKO BP) was spun-off from the NBP, and
given primary responsibility for personal savings deposits and housing
loans.
The most important financial reform took place in January 1989 with
the passage of the New Banking Law and Act on the National Bank of Poland.
Under the terms of this legislation, the nine regional offices of the NBP
became autonomous commercial banks and the NBP remained as a central bank
with few commercial activities.34 The 1989 Banking Law also authorized
universal banking, although the concept has not yet been clearly defined in
law or in practice.
The new commercial banks inherited the assets and
liabilities associated with the depositors and borrowers in their region
and were expected to serve as generalists; ie, there was no specialization
amongst the commercial banks.
It is important to emphasize that although
the banks were subsequently commercialized (ie, turned into joint stock
companies) in preparation for privatization, commercialization left
ownership in the hands of the government, and the senior executives for
each bank were appointed by NBP officials.
Not surprisingly, there was
little increase in competition amongst the banks for deposit or lending
33 The discussion of banking and macroeconomic reforms draws
Corbett and Mayer (1991) and Berg and Blanchard (1992).
heavily on
34 The NBP continued to issue hard currency accounts and was involved in
channelling credit from the PKO BP (savings bank) to the other commercial
banks.
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opportunities.
The NBP, meanwhile, was left with conventional central
banking responsibilities, and the imposition in 1989 of limits on credits
to the government increased the NBP's capacity to operate as an independent
institution.
A Department of Bank Supervision was created within the NBP
in May 1989 in an effort to begin building the capacity to monitor banks
and ensure stability in the financial sector.
The 1989 legislation also amended the charters of three other special
function banks that the communists had operated, to allow these banks to
engage in commercial banking.
The Bank Handlowv serviced the needs of
Polish state enterprises engaged in foreign trade, and the Bank PKO SA
handled all foreign currency transactions for private persons.
The Bank
Gospodarki Zywnosciowej (Bank of Food Economy), a collection of 1,500 small
cooperative (but state-controlled) banks, served the many small Polish
family farms.35
These specialized banks had been established by the
government with non-overlapping scopes of activity to ensure that there was
no competition; each had a monopoly over a sector of the economy.
Consequently, the specialized banks, together with the NBP, held the vast
majority of deposits in the banking sector.
The reform process begun in 1989 did little to change the level of
concentration.
New rules were implemented in July 1989 allowing
enterprises to have deposit accounts at more than one bank, which were
intended to increase competition amongst the banks.
Nonetheless, nearly
two years after the separation of the nine commercial banks from the NBP,
the four specialized banks and the NBP still held more than 75% of total
35 Polish agriculture remained in private hands under the communists, and its
small scale made centralized banking very difficult for the agricultural
sector.
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Polish banking deposits (see Table 3-2), despite the fact that the nine
commercial banks inherited the assets in their region.36
The Banking Law of 1982 permitted, in theory, the establishment of new
banks with non-state capital.
However, any new bank had to be approved by
the Council of Ministers, who were free to decide on the scope of
operations, location, and name of the bank.
During the period 1982 to 1989
no new banks were established as a result of this "reform."
The restrictions on the establishment of new banks were liberalized
substantially in 1989, and have been amended subsequently.
Permission from
the president of the NBP to open a new bank requires that three conditions
be met:
i)
own capital (in 1990) of 20 billion zloty or $2 million for
Polish owned banks; and, $6 million for foreign-owned banks.
ii)
suitable premises for banking operations.
iii) senior bank officials with suitable experience and training.
By early 1991 there were more than 100 new commercial and cooperative
banks, and four foreign-owned banks.
However, these new private banks were
very small and accounted for less than 3% of total banking assets.
Capital
requirements for new private banks had been lower in previous years roughly $100,000 in 1989 - and most private banks were created under those
less stringent conditions.
At this point, with the banks commercialized, the next step in banking
reform in Poland is widely considered to be the privatization of the nine
commercial banks.
Several have already been "twinned" with western banks
to develop greater banking skills and improved infrastructure.
The
36 The low level of deposits in the nine commercial banks spun-off from the
NBP was clearly also a function of the financial circumstances facing state
enterprises - their main customers.
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critical actions that must be taken prior to privatization are
rationalization of their loan portfolios to eliminate bad debts and
recapitalization to assure solvency after cleaning up the balance sheets.
Since under the communist system the banks did not face credit risk, they
had no reserves against loan losses.
Therefore, in the absence of infusion
of new funds the writing-off of bad loans would directly reduce the banks'
capital .37
The severe recession within the state sector in 1990 and 1991 (see
Table 3-1) greatly worsened the quality of the banks' loan portfolios.
The
Ministry of Finance has recently overseen the review and categorization of
all significant loans currently on the books of the nine commercial banks.
Using a five-category hierarchy from very high to very low likelihood of
collection, more than half the zloty value of the total loans were rated in
the lower two categories.
Although precise figures are hard to find, it is
clear that cleaning-up balance sheets prior to privatization will be a
time-consuming and costly process.
As an incentive for improvement in bank
balance sheets, the Ministry of Finance has committed to privatizing the
nine banks in an order determined by the quality of their balance sheets.
The first bank privatization, the Wielkopolski Bank Kredytowy (WBK) in
Poznon, finally took place in April 1993 when shares were issued on the
Warsaw Stock Exchange.
The Ministry of Finance judged WBK to have done the
best job of the nine commercial banks in improving the quality of its
balance sheet, mainly by curtailing lending to state enterprises and
37 A June 30, 1990 study of three banks by international auditing firms
suggested that roughly 15% of their portfolios were non-performing. Applying
the estimates of bad loans from the three banks to all nine banks, their
capital after provision for loan losses in June 1990 would have been about
9%, which compares favorably with international standards.
June 3, 1993
Hoshi, Kashyap, Loveman
Page 39
carefully increasing lending to private entrepreneurial companies.
The WBK
also distinguished itself by attracting a large deposit base of more than
250,000 people served by 44 branches around Poznon.
The European Bank for
Reconstruction and Development invested $10.6 million to purchase 28.5% of
the newly issued shares.
Progress in privatizing state enterprises has also been agonizingly
slow.
There have been at least three mechanisms used to privatize
industrial assets.
First, in the few cases where large Polish enterprises
were considered to have positive net worth and be viable in the near term,
western consultants performed valuations and the firms were sold using
initial public offerings (ie, the "British model").
This process turned
out to be very slow and extremely costly, with consultant fees occasionally
exceeding the proceeds of the sale, and it has been used for fewer than 20
enterprises.
Second, small companies have been sold on an ad hoc basis to
incumbent managers or local business people.
The vast majority of retail
shops, restaurants, etc., have been sold by local governments to private
owners.
Indeed, more than 60% of wholesale and retail trade is now in
private hands.38 Third, a Mass Privatization Program (MPP) was developed
and approved by the Parliament to quickly privatize hundreds of industrial
enterprises.
The MPP was formulated as a means to simultaneously achieve four
goals:
speed, low administrative cost, concentration of control to
facilitate restructuring, and, broad-based ownership amongst the Polish
citizenry.
Clearly the latter two goals require a novel solution, since
concentration of control and broad-based ownership are difficult to
38 Note that Polish agriculture remained largely in private hands under the
communists.
June 3, 1993
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Page 40
reconcile using traditional mechanisms.
The MPP was originally conceived
as a means to privatize a substantial percentage of Poland's 8,000
industrial state enterprises.
The scope of the MPP's initial activity,
however, was restricted to the healthiest enterprises in an effort to learn
from the most promising cases before tackling the more difficult cases.
Thus far, only those firms with both positive net cash flow and positive
operating profits have been allowed into the MPP.
As of early 1993, only
roughly 600 enterprises met these criteria and were slated for inclusion in
the MPP.
Under the complicated terms of the MPP, the 600 enterprises are first
commercialized into joint-stock companies.39 The shares are then
allocated 30% to the state, 10% to the current work force, and 60% to
twenty "management funds" established under the MPP.
Initially, roughly
30% of each enterprise will go to one "lead" fund and the remaining 30%
will be evenly distributed amongst the remaining 19 funds.
Funds will then
be allowed to trade shares amongst themselves which, of course, will likely
lead to further concentration of ownership of the individual companies by a
"lead" fund whose controlling interest can be used to facilitate the
restructuring or the sale of assets.
The management funds will engage
western firms as advisors, or managers, under contract with the Ministry of
Privatisation.40
The fund managers will be empowered to borrow money and
issue new shares in the funds.
Every Polish citizen 18 years of age and older will receive a share in
each of the 20 management funds.
In an effort to forestall speculation and
39
For details see Polish Ministry of Privatisation (1992) .
40
The fund managers will have performance-based incentives.
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Hoshi, Kashyap, Loveman
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quick concentration of ownership among a few people, the shares will not be
tradable for a period of at least several months.
Since the shares in the
enterprises themselves are not initially traded in a well-defined market,
it will be difficult to value the citizens' ownership shares in the
management funds.
The plan foresees the management funds moving to public
offerings for the enterprises in their portfolios when restructuring has
proceeded to an appropriate extent, and gradually the enterprises would
leave the management funds, the management funds would hold cash or
tradable securities, and the citizens would have ownership shares with
clearly defined market values.
The MPP was to be implemented in the fall
of 1992, but after several setbacks in the Polish Parliament, it was
finally approved in the spring of 1993 and is expected to be implemented in
the very near future.
There has been little recognition of the connection between the
privatization of the state industrial enterprises and financial sector
reform.
One important manifestation of this lack of connection is that
responsibility for privatizing the banks rests with the Ministry of
Finance, and the process has been kept almost entirely independent of the
enterprise privatization process managed by the Ministry of Privatisation
and the Ministry of Industry.
In addition, a number of schemes have been
proposed for cleaning-up bank balance sheets that involve debt-for-equity
swaps in which the old debts of state enterprises are forgiven in exchange
for equity in the new privatized company.
Clearly such an arrangement
would have to be integrated into the other privatization processes especially the MPP - but there has been little discussion of integrated
solutions to these problems.
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The much more rapid and dynamic road to private ownership in Poland
has been the establishment and growth of private small businesses.
Under
the communists legitimate private business was virtually non-existent
outside the agricultural sector.
Liberalization of the rules governing the
formation of private cooperatives in 1982 marked the beginning of the
explosion of private employment in Poland.
Legal changes in 1985 for the
first time in the communist era permitted the registration of private
limited liability companies under the terms of the 1934 Code of Commerce.
Finally, the 1989 New Law on Economic Activity removed most licensing and
registration restrictions on self-employment and the establishment of
unincorporated firms.
The process for setting-up joint ventures was also
liberalized significantly in 1989.
The response to these reforms has been swift and dramatic.
The first
joint-venture company was registered in July 1986, and 52 more were
registered in the next two years.
Table 3-3 shows that since 1989,
however, the number of private limited liability companies, including
joint-ventures has grown several fold.
Likewise, Table 3-4 shows that the
number of persons self-employed or with unincorporated businesses had grown
to nearly 2.5 million by September 30, 1991.
Total non-agricultural
private employment was in excess of 3 million persons by the end of 1991.
The near absence of private businesses until recently in Poland meant
that the state banking system had no experience with the needs of growing
small businesses.
Indeed, the banking system was structured to allocate
funds amongst large state enterprises according to the terms of the plan,
and there were no incentives for bankers to consider even opening deposit
accounts for small or private businesses.
Data from small businesses that
have been successful during the economic reform show that their growth has
June 3, 1993
Hoshi, Kashyap, Loveman
Page 43
been in spite of the banks' unwillingness to provide loans or, in most
cases, even to provide simple transactions processing on a timely basis.41
Irrespective of the details of future economic reforms in Poland, it
is abundantly clear that the sustained growth of the private small business
sector is vital for economic revitalization and job generation.
Given the
crucial role of external financing in small firm development, it is equally
clear that the Polish financial sector must reform itself in a fashion that
supports the needs of the small business sector as well as the
restructuring of the large state enterprises.
4.2
Financial Restructuring and the Future of Reform in Poland
The preceding discussion has described the context in which competing
financial reform proposals must be the considered.
The objectives for any
financial system in Poland can now be stated concisely:
1)
the provision of a credible and stable depository system that
attracts domestic savings for investment;
2)
given the dysfunctional state of Polish accounting systems and
budgeting procedures, and the lack of valuation mechanisms that
follow from these systems and procedures, lenders must have the
capacity to distinguish amongst prospective borrowers under
conditions of poor information, scarce experience or credit
history and unreliable projections of future earnings;
3)
a long time horizon to support lending to enterprises in need of
massive restructuring and small businesses whose profitability
and growth may occur only several years after the first provision
of financing;
4)
the capacity to play an active role in helping borrowers to
acquire badly needed general management expertise, especially
with respect to management under conditions of financial distress
and an inadequate supply of capital;
5)
an absence of “soft budget constraints": the lenders must be
willing to curtail lending to firms with inadequate prospects for
future earnings and lend only to those that can deliver at least
the market rate of return on borrowed funds;
n See Johnson (1992) and Johnson and Loveman
small business sector.
(1992)
for evidence from the
June 3, 1993
Hoshi, Kashyap, Loveman
Page 44
6)
an avoidance of inefficient liquidations; that is, the capacity
to prevent the liquidation of any enterprises with positive net
present values.
The first of these six criteria has relatively little to do with Poland's
choices for banking reform, although in a country with low levels of
financial assets, because of consumers' desire for diversification, bankled financing systems may be superior to a securities-market led systems.
The other five criteria, however, can be used to distinguish powerfully
between two distinct alternatives:
the Japanese main bank system and the
combination of equity, bond and "arms-length" banking found in the US and
the UK.42
In assessing the merits of the main bank system for Poland, it is
important to consider both the transition issues and the long-term, or
steady-state, characteristics of the main bank system.
There are two
necessary transition conditions for the main bank system to succeed in
Poland.
First, the main banks must not offer "soft budget constraints" to
enterprises.
This concern is often voiced in Poland, where decades of
lending without reference to ability to repay has led to a gross
misallocation of funds.
The best insurance against a soft budget
constraint is competition amongst adequately capitalized private banks.
Solvent private banks will not find it in their interest, as equity holders
or otherwise, to lend to firms that lack the capacity to repay.43
42 The German system provides an intermediate case.
(1991) and Chapter 1.
See Corbett and Mayer
43 Of course, as has been demonstrated by the US Savings and Loan crises,
private ownership per se does not necessarily stop excessive risk-taking. In
the Polish case, once the bank recapitalization is completed, it will be
important for the regulators to promptly close any institutions that
subsequently become insolvent. Similarly, the central bank should not supply
so much credit as to encourage expansive lending by banks.
June 3, 1993
Hoshi, Kashyap, Loveman
Page 45
therefore,
the reform process must include privatization of the banks that
will serve as main banks.
Moreover, some large banks may need to be
divided into multiple entities to enhance competitiveness.
Second, existing Polish banks lack many of the most fundamental
banking and managerial skills.
Consequently, there is understandable
reluctance on the part of many people to give the banks any more power than
is absolutely necessary in the reform process.
One manifestation of this
unwillingness to rely on the banks has been the separation of the banks
from the MPP.
Although the current lack of confidence in the banks is
completely warranted, any reform process must include a massive effort to
quickly build basic banking competence.
If nothing else, one can
confidently predict that it will be easier to regulate a concentrated main
bank system.
The post-war Japanese financial sector, too, faced the problem of
eliminating soft-budget constraints between enterprises and their
designated banks.
the banking system.
The Dodge plan helped to stop the flow of easy credit to
The curtailment of inefficient lending in Japan was
further reinforced by two key actions:
the cleaning-up of bank balance
sheets to remove uncollectible loans, thereby removing any perverse
incentives for further lending to uncreditworthy borrowers; and, the use of
"special managers" from the banks to work-out existing loans to
enterprises.
Recall that in Japan the munitions companies were paired
during the war with "designated financial institutions."
The restructuring
of the former munitions companies was accomplished by "special managers"
drawn from the debtor companies and the banks.
The bankers involved in the
restructuring gained invaluable familiarity with the debtor companies, and
June 3, 1993
Hoshi, Kashyap, Loveman
Page 46
undoubtedly developed important monitoring skills that served them well as
lenders in subsequent years.
Current Polish circumstances are, likewise, suited to having
commercial bank managers involved in the resolution of enterprise debts,
both to banks and to other enterprises.
The use of "special managers"
could develop badly needed monitoring expertise amongst Polish bankers
while also generating enterprise-specific knowledge useful for future
lending decisions.
As was the case in Japan, the restructuring,process
that featured "special managers" was premised on existing close
relationships between an enterprise and a bank, and the process clearly
facilitated the emergence of a main bank system in Japan.
Given similar
conditions, the same debt restructuring process could be used as a
mechanism for establishing a main bank system in Poland.
An examination of the substantive parallels between the post-war
Japanese experience and the current Polish circumstances suggests that many
of the conditions that led to the success of the main bank system are
extant in Poland.
First, both economies had histories of centralized
control of financial and non-financial assets.
In Japan the wartime
controls on the allocation of credit meant that the market mechanism for
allocating funds to the most worthy borrowers failed to function.
In
Poland the problem is more severe because the precedent and expertise
necessary for market allocation of credit must be traced back more than
forty years.
Second, the Polish banks are themselves concentrated and have very
close financial relationships the highly concentrated industrial sector of
the economy.
If the soft-budget constraint problem can be solved, then the
evidence regarding the Japanese main bank system suggests that these
June 3, 1993
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Page 47
relationships may actually be valuable.
Given the existing web of
financial ties between the banks and the state enterprises, a banking
system that builds on these connections, i.e., the Japanese main bank
system, would seem desirable.
Third, hyperinflations in Japan and Poland, along with other factors,
left both economies with low levels of financial assets, while a largely
destroyed (Japan) or woefully inefficient (Poland) industrial sector
required large amounts of financing for reconstruction.
Together, this
combination of factors on the supply and demand sides of the credit markets
suggests that careful allocation of credit will be crucial.
Finally, the problems associated with accurate valuation of companies
and severe information and reputational inadequacies make the extensive use
of equity financing quite difficult.44
The Japanese stock market did not
reopen until 1949, and in Poland as of early 1993, the fledgling Warsaw
Stock Exchange has 17 listed securities and the total value of the
outstanding shares is about $400 million.45 With privatization and equity
markets in Poland in their infancy, there is likewise little capacity for
shareholders to exercise meaningful control over the management of
industrial companies.
Lacking widespread access to equity markets, the issue for financial
reform becomes focused on the best structure for banking, wherein banks
will be the primary source of financing.
Furthermore, since corporate
control will not be exercised by shareholders there is a vital need for
another form of effective control.
The main bank system, unlike "arms-
44See Lipton and Sachs (1990) .
45 Similarly, bond markets offer little hope for raising substantial sums of
money for restructuring.
June 3, 1993
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Page 48
length" systems, provides a mechanism that can both deliver financing and
exert substantial control over the managerial actions of its borrowers.
a substantial shareholder in the company, the main bank can act dir
As
tly to
influence the composition of the board of directors and, hence, ^
activities of senior management.46 Through its position as a la^ ,.e holder
of debt and equity, the bank has an incentive to work diligently to
increase the borrower's long-term performance.
In Poland, where managerial
expertise is currently very scarce, the provision of such skills from a
bank would be an important resource, and such a conveyance of skills is
much more likely under a main bank system.
Moreover, so long as bankers
are lending private money under profit-driven incentives, there is no
reason to fear that "soft-budget constraints" will lead to the illconceived lending practices of the communist system.
In sum, the main bank system has several virtues with respect to its
control properties that recommend it for the current Polish circumstances.
But it is the economic efficiency properties, documented from Japan in
Section 2, that make the strongest case for adoption of the main bank
system in Poland.
The results from research on Japan suggest that the main
bank system is particularly well suited to meet the challenges associated
with financial sector reform in Poland.
First, the main bank system has been shown to have a number of
advantages in achieving the most efficient monitoring of borrowers.
The
close ties between the bank and the debtor firm, sustained over a long
period of time, reduce information asymmetries and permit the bank to make
more informed lending decisions.
Thus the system saves on two margins, by
46Evidence on bank personnel serving on the boards of directors of Japanese
companies is given in Section 2.
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Page 49
both reducing duplication in monitoring and by increasing the efficiency of
the monitoring that takes place.
These savings are especially important in
the Polish context, where information is poor, credit histories are non
existent, projections are inaccurate and few managers have significant
reputations.
Evidence was presented in Section 2 which showed that main banks are
especially preferable to "arms-length" banking when the borrower is
experiencing periods of financial distress.
The main bank is better
positioned, as a consequence of its monitoring efficiencies, to make
decisions on additional lending.
Inefficient liquidations are, therefore,
less likely, and companies in financial distress are better able to
undertake investment projects with positive net present values.
Furthermore, the evidence from Japan suggests that even healthy firms were
less reliant on internal funds for capital investments when they had a main
bank relationship.
Since main banks accumulate substantial experience with their
customers over time, they are better able to manage the working-out of bad
loans.
In systems with Harms-lengthH banking relationships, work-outs for
large debtors typically involve many lenders who may have widely varying
incentives with respect to the disposition of the debts.
A main bank
relationship, conversely, reduces coordination costs by reducing the number
of lenders and by providing very high quality information about the debtor
and other creditors.
In Japan main banks have, on occasion, gone to the
debtor's suppliers to effectively guarantee outstanding trade credits so
that actions by suppliers will not bring the debtor into bankruptcy.
Polish enterprises currently have a tremendous amount of trade credit that
accumulated during the recession.
Management of the outstanding trade
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Page 50
credit by main banks would facilitate efficient decisions as to the choice
of enterprises that should be liquidated.
It is difficult to overemphasize how important the monitoring
efficiencies may be in Poland where state enterprises face such massive
restructuring problems and where such a large portion of the existing
capital stock will require modernization and rationalization.
It is
difficult to imagine how a system based on diffused financing can succeed
given the problems that will arise in trying to finance massive
restructuring in Poland.
Of course, it is also hard to imagine how a
solvent and efficient decentralized banking system could be feasibly
developed from the existing Polish banking system.47
A final important consideration favoring the selection of the main
bank system for Poland stems from the long time horizons associated with
equity ownership.
There is no doubt that privatization and restructuring
will require a period of several years before enterprises can reasonably
expect to generate consistent profits.
A key factor underlying the
patience demonstrated by the main banks is that as their clients mature,
the banks long-term commitments are rewarded with significant equity
returns.
The alignment of interests between debt and equity holders would
greatly facilitate the flexibility needed by Polish managers to undertake
comprehensive change and restructuring.
While the advantages of the main bank system for large Polish
enterprises follow clearly from the Japanese precedent, there is little
47 In general, bank-led financing system seems better suited to handling
coordination problems in investment decisions than a securities-market based
financial system. Because of coordination problems some analysts argue that
it is important to develop specialized institutions to provide long-term
financing. See Chapter 4 for a discussion of the impact of funding by long
term financial institutions on growth in Japan.
June 3, 1993
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evidence regarding main bank involvement with small businesses.48
Given
the central role currently played by small businesses in Poland it is
important to consider how the banking system can best serve their credit
needs.
Small businesses in Poland currently receive virtually no external
financing from any source,49 and finance themselves largely from personal
savings and retained earnings.
Interestingly, many Polish small businesses
began by providing services or other non-capital intensive activities to
generate sufficient cash flow to finance capital acquisitions, and then
they gradually moved into manufacturing and construction.50
The
unavailability of credit to small businesses is a very large impediment to
the growth and job generation process in Poland.
Financing for small businesses is often considered to be inadequate
and poorly allocated even in western industrialized countries.
Governmental entities, such as the US Small Business Administration, and
venture capitalists play an important role in funding new businesses, while
banks typically find new businesses to be too small or too risky to service
profitably.
There is little evidence upon which to base an argument about the
efficacy of a main bank system for Polish small businesses.
On the one
hand, small businesses share the need for careful monitoring, effective
control and long-term financing experienced by large state enterprises.
The proven ability of main banks to reduce the reliance of Japanese firms
48There has been little research on the Japanese main banks' relationships
with medium and small firms. An exception is Horiuchi (1988).
49See Johnson (1992)
Warsaw region.
for evidence from a sample of 300 small firms in the
50See Johnson and Loveman (1992) for evidence on this point.
June 3, 1993
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on internally generated funds bodes well for their application to small
business, who often experience periods of severe cash shortages despite
having many positive net present value projects.
bank system seems sensible.
In this respect the main
On the other hand, the sheer volume of small
businesses could easily overwhelm the capacity of a concentrated banking
sector to provide effective and profitable service.
Whether or not a main
bank system is chosen in Poland, it is clear that government policy must
address the specific needs of small businesses so that their access to
credit markets is given the proper priority.
The growth of small private
banks in Poland seems most promising in this respect, and policies should
be considered to enhance the attractiveness of small bank lending to
entrepreneurs.
Finally, the development of the MPP has proceeded with little direct
involvement or consideration of the Polish banks.
There is an important
role for main banks to play in such a process, however, because the
management funds could draw on the main banks for financing and assistance
in control of the constituent firms.
The main banks need not be part of
the MPP's formal structure, but at a minimum the financial reform process
must proceed at a pace that would permit main banks to be available to
support the management funds in their restructuring efforts.
Without
direct bank support, the management funds will be dependent on raising
funds through the sale of companies or their assets, internally generated
funds from the companies, or solicitation from a number of banks in and
outside of Poland.
None of these alternatives seem very likely to generate
an adequate or consistent source of financing.
Moreover, there has been
little, if any, discussion of the Polish commercial banks being given
access to shares in the management funds.
This is due largely to the
June 3, 1993
Hoshi, Kashyap, Loveman
Page 53
government's aim to distribute shares to individuals and workers as a right
of citizenship, rather than to institutions.
The exclusion of the banks is
also likely a consequence of a desire to separate the planned restructuring
of enterprises under the MPP from the unimpressive management and poor
financial condition of the banks.
5.
Conclusion
This paper has examined the main bank system developed in Japan after
World War II as a model for the financial system reform in Poland.
Pointing out some important similarities between the economic conditions
for Poland today and Japan immediately after the war, we have argued that
the main bank system is a preferred model for Poland due to both (i) the
performance of the system and (ii) the low implementation costs given the
current situation in Poland.
We do not claim that we now have a concrete policy proposal for
financial reform and privatization in Poland, although we believe that the
main bank system should be an important component in such a proposal.
In
order to develop a specific policy toward financial reform, our analysis
must be supplemented by additional considerations.
For example, the main
bank system does not have any clear implications for the deposits
collection mechanism, which as was pointed out in the last section, is an
important aspect of any financial system.
Safety of the deposits is
especially important for an economy like Poland, because each household
holds a small amount of financial wealth.
Analysis of regulatory
mechanisms and deposit insurance that increase the safety (and hence
supply) of the deposits must complement the analysis in this paper.
June 3, 1993
Hoshi, Kashyap, Loveman
Page 54
Another consideration is the participation of international
organizations and foreign banks in the financial reform in Poland.
The
supply of expertise from foreign countries will be important in developing
the human resources necessary to establish a well functioning banking
system.
As the last section has pointed out, the lack of fundamental
banking skills is a serious problem in Poland and may be considered
especially damaging to a main bank approach to reform.
Similarly, we have ignored the political economy aspects of economic
reform.
In immediate aftermath of World War II, the Allies were able to
impose many reforms on the Japanese government.
It is unclear how many of
these changes would have been possible without this guidance or whether
these reforms could have taken place without the help of the Japanese
bureaucracy.
Relative to Poland, there was considerable amount of
stability in the Japanese government during the period when the reform was
taking place.
While the political instability must make reform of any
sort
more difficult in Poland than it was in Japan, it is not obvious to us
that
this necessarily makes it much more difficult to move to a main bank style
system rather than to an arms length banking system.
Nonetheless, we do not claim that the main bank system is an ideal
financial system.
While this paper has focused almost exclusively on the
benefits of the main bank system, in closing we want to emphasize that the
system does have some limitations and is not necessarily appropriate for
all types of economies.
In particular, a major consideration in the design
of the banking system was the list of possible alternative financing
arrangements.
For reasons that we have discussed above, both in Japan in
the early 1950s and in modern-day Poland, the feasibility of a system that
did not rely on bank financing seemed dubious.
Thus the debate over the
June 3, 1993
Hoshi, Kashyap, Loveman
Page 55
of the financial system is effectively limited to a discussion over which
set of banking rules to adopt.
Obviously in many other cases, a system based on security market
financing is a completely viable alternative to a bank led financing
system.
In comparing these two types of systems one would likely be led to
study a different set of contrasts than we have focused on in this paper.
For instance, to the extent that unmonitored lending can succeed, the
associated savings in monitoring costs make it probable that bank lending
will be a dominated form of financing.
Of course, a firm's reputation is
likely to be the central determinant of whether it can rely on public bond
and equity markets to secure funding.
Therefore, if an economy includes a
significant number of firms that can circumvent bank dependence, then the
financial system is likely to evolve to de-emphasize the role of banks.
Indeed, one way to view the US economy is that by relying on public markets
and exploiting firms reputations the US is able to run a financial system
that is much less dependent on bank financing than many other capitalist
economies.
An implication of this setup is that banks no longer seem like
the natural party to be involved with corporate governance.
From this
perspective it is not surprising that the US system of corporate governance
has been different than that of Japan in the 1950s and 1960s.
An interesting recent development in Japanese corporate financing is
that many large Japanese companies have begun to shift away from bank
financing in favor of bond and equity financing.
As Hoshi, Kashyap and
Scharfstein (1993) discuss this shift appears to be driven both by
deregulation that has made the use of these instruments legal and by the
continued success and improved visibility of the companies that have made
the securities attractive to investors.
Ironically, although the major
June 3, 1993
Hoshi, Kashyap, Loveman
Page 56
Japanese corporations may previously have been very well served by the type
of main bank system that we have described, they may have outgrown it.
In
thinking about Poland, we think it also prudent to recognize that this type
of evolution is possible, but it remains a long way down the road of
economic reform.
June 3, 1993
Hoshi, Kashyap, Loveman
Page 57
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Page 61
Table 1-1 Shares of the Five Largest Banks in All Ordinary and Savings Banks
End of Year
Paid-In
Capital %
Deposits (%)
1900
1910
1920
1930
1940
1945
5.
10.
13.
24.
31.
40.4
15
17
20
31
35.4
45.7
Source:
Lending (%)
10.6
15.1
16.5
27.6
44.7
58.6
Teranishi (1982), p 295.
Note:
1.
The five largest banks include Mitsui, Mitsubishi, Sumitomo, Daiichi,
and Yasuda until 1942, and Mitsubishi, Sumitomo, Yasuda, and Teikoku
after 1943. Teikoku was created through a merger of Mitsui Bank and
Daiichi Bank in 1943, it then acquired Juu-Go Gank in 1944.
In 1948,
Teikoku split back into Mitsui and Daiichi (with the former Juu-Go
branches belonging to Mitsui).
Hoshi, Kashvap, Loveman
June 3, 1993
Page 62
Table 1-2
Damage of National Wealth by the War
Total Damage
Producer durables
Consumer durables
Transportation durables
Source:
Wealth at 1945
Damage Ratio
59,689
105,894
23,269
24.9
24.7
29.2
19,838
34,823
9,617
Ministry of Finance 1978, pp 14-15.
Notes to Table 1-2:
1.
The damage ratio is defined to be (Total Damage)/ (Total Damage + Wealth
at 1945).
Hoshi, Kashyap, Loveman
June 3, 1993
Page 63
Table 1-3
Private
Year
1946
1947
1948
1949
1950
1951
1952
1953
1954
Gross Financial Assets Held by Nonfinaneial Private Sectors
Households
All Private
Households
(¥ million)
(¥ million)
(per GNP)
259,511
259,811
827,241
929,101
1,376,204
1,887,053
2,726,759
3,547,437
4,223,028
380,574
655,097
1,216,852
1,384,109
2,017,051
2,796,976
3,994,592
5,195,570
6,104,910
Source: Ministry of Finance 1973, pp 424-441
0.547
0.351
0.310
0.275
0.349
3.443
0.428
0.475
0.540
All
(per GNP
0.803
0.501
0.456
0.410
0.511
5.103
0.627
0.690
0.780
Table 3-1
Basic Macroeconomic Statistics: 1990-91
89:4
Industrial Sales
1.00
Employment
17.6
(State)
11.7
(Private)
1.8
Unemployment Rate
0%
CPI Inflation
31%
Exports
Dollars
2,412
TR
3,910
Imports
Dollars
2, 182
TR
2,725
Markups
40%
Gvt surplus (% of GDP) -3.6
Refinance Rate
12%
Hoshi, Kashyap, Loveman
June 3, 1993
Page 64
90:1
90:2
90:3
90:4
91:1
91:2
91:3
91:4
0.77
0.72
0.74
0.75
16.5
10.0
2.3
6%
5%
0.65
0.57
0.57
0.57
15.9
8.8
3.0
11.4%
3%
2%
32%
3%
5%
5%
3%
7.1%
8%
8.4%
3%
10.4%
2%
2,182
2,688
2,705
3,110
3,133
2,305
4,000
3,011
2,751
561
4,459
560
3,196
84
4, 182
175
1,573
1,706
31%
1.6
22%
1,465
1,505
29%
3.4
5.8%
1,825
1,443
28%
1.7
2.8%
3,391
1,985
24%
-3.9
4.3%
3,050
558
16%
-2.4
5.5%
3,457
163
14%
-3.6
5.3%
3,047
68
19%
-3.8
3.8%
4,692
47
13%
-3.1
3.3%
Source:
Berg and Blanchard (1992)
Notes:
The index of real sales is measured in the last month of each quarter. Employment is measured in thousands
at the end of the year. Private employment does not include agriculture. Umemployment is in the last month
of each quarter, expressed as the share of the labor force. CPI inflation is the average monthly inflation
for the quarter.
Exports and imports are for the quarter, in millions of transferable rubles (TR) and
dollars.
The markup is defined as (Sales - Costs)/Costs for the quarter, for the socialized sector.
Government surplus is for the quarter, as a percent of GDP.
It is computed as the surplus as a share of
expenditures, multiplied by the ration of expenditures of GDP for the year. The refinance rate of the NBP
is the averge for the quarter in monthly rates. Some data is not (yet) available on a comparable basis for
1992. Real sales in industry are seasonally adjusted in 1992.
Hoshi, Xashvap, Loveman
June 3, 1993
Page 65
Table 3-2 Polish Banks by Balance Sum and Own Funds - Capital (at the end of
1990, in billion zloty)
Balance Sum
Total of all banks
Narodowy Bank Polski
Bank Handlowy w Warszawie SA
Bank Polska kasa Opieki SA
Powszechna kasa Oszczednosci BP
Bank Gospodarki Zywnosciowej
Panstwowy Bank Kredytowy (W-wa)
Bank Slaski (Katowice)
Banki Spoldzieicze
Bank Przemyslowo-Handlowy (Krakow)
Powszechny Bank Gospodarczy (Lodz)
Source:
Own Funds
481,732
145,147
103,479
54,456
38,700
29,376
14,522
12,673
11,583
11,390
9,305
The statistical data contained in
materials of Narodowy Bank Polskir.
this
29,379
2,079
6,313
2,855
686
2,927
1,845
2,122
884
1,336
845
paper
are
taken
from
Hoshi, Kashyap, Loveman
June 3, 1993
Page 66
Table 3-3
The Number of Private Spolki1 in Poland:
Venture (j.v.)
31.12.1989
Industry
Domestic
j .v.
Construction
Domestic
j .v.
Agriculture
Domestic
j .v.
Forestry
Domestic
j .v.
Transportation
Domestic
j -v.
Telecommunication
Domestic
j .v.
Trade
Domestic
j .v.
Other branches of material production
Domestic
j .v.
Municipal economy
Domestic
j .v.
Nonmaterial production
Domestic
j .v.
Total
of which, j.v.
Source:
Domestic and Joint
1.12.1990
30.06.1991
2,769
240
7,014
853
7,698
1,431
2,640
12
5,646
71
7,164
167
83
14
342
48
285
62
10
3
36
4
39
5
86
14
356
67
507
124
18
-
56
5
80
7
1,759
32
8,661
198
12,598
475
2,979
80
7,098
258
5,837
296
76
1
160
6
163
9
1,273
33
3,870
135
4,145
264
11,693
429
33,239
1,645
38,516
2,840
Johnson (1992)
Spolki are firms in which private individuals have at least 51% ownership
Hoshi, Kashyap, Loveman
June 3, 1993
Page 67
Table 3-4
Employment in Unincorporated Firms in Poland
31/12/90
Industry
Construction
Transportat ion
Trade
Catering & restaurant
Other material services
Nonmaterial services
Total
Source:
334,613
165,541
61,368
346,294
22,511
122,099
83,066
1,135,492
30/06/91
339,291
165,428
56,913
456,844
30,443
122,555
100,923
1,272,397
30/9/91
348,803
170,618
60,203
514,778
34,845
124,768
111,629
1,365,644
Official Polish government statistics, see Johnson 1992.
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