Resolution of banking crisis in Japan
In 1980s, the increase in stock market and estate prices were augmented by an extremely loose monetary policy of Japan’s central bank. Japanese banks extended loans for investment in the stock or real estate markets. After a stupendous growth in 1980s, the Japanese economy’s bubble burst in early 1990s.
The extremely high amount of loans advanced to corporations during 1980s and subsequent deterioration of economy in 1990s left many financial institutions with a nonperforming loan problem. The problem was compounded by the fact that Japanese financial world was protected from outside competition and this lend to imprudent loan lending based on connections and not on risk analysis. It is estimated that Japanese banks have recorded loan losses of about 83 trillion yen since 1992 (Brewer III et. al, 2003). And about 32 trillion yen of loans were deemed non-collectible and written off in full (Kashyap, 2002). It was also estimated that bad loans ranged from around 10 percent to 20 percent of gross domestic product at their peak in 1995 (Hutchison).
The continued poor performance by Japanese economy over the last decade has resulted in further deterioration of financial condition of banks. The bank profits have been very low and they are just enough to meet new bad loans and not sufficient to tackle the mountain of bad debts.The losses had a severe negative impact on banks balance sheets and led to the failure of many banks since then. Initially Japan’s Ministry of Finance response was to look on a case-by-case basis. But as the crisis grew larger Japan’s regulatory authorities took a stronger approach.
Methods used to solve bank crisis
In 1995, the Ministry created a bridge bank to liquidate failed banks and receive the assets of failed financial institutions. The liquidation takes place in two stages. First the failed bank will be placed under administration while a merger partner is being sought. Deposit Insurance Corporation of Japan acts as financial administrator. Creditworthy corporate customers of the failed bank would still be provided access to loans to prevent further bankruptcy of businesses. If no buyers were found in five years, the government would then acquire the failed bank. Some of the assets are sold to Resolution and Credit Corporation, a government body. On November 17, 1997, Japanese regulators liquidated Hokkaido Takushoku Bank, a large bank for the first time since the end of World War II. Till the end of 2002, 11 banks and related organizations have been put through bridge bank procedure (DICJ).
Another procedure adopted for failed banks is the scheme involving banks under special public management. Under this DICJ purchases the shares and assets of the failed institution. It also gives monetary grant to run the operations and compensates for losses during operations. The failed institution is subsequently sold off to Resolution and Credit Corporation.
The appropriateness of the methods and lessons learnt
Since 1995, the new and more aggressive approach adopted by Japanese government is better than it used previously to deal with smaller banks. Previously no framework was there to deal with the crisis. Now at least there are proper guidelines to follow and take necessary action. Use of DICJ and RCC also lends credibility to the approach.
At the same time, the utilization of DICJ and RCC is not the whole hearted attempt to clean up the system in one stage. Government tried to delay the full impact of shocks over time. Since the amount of bad loan problem was so severe, the government believed that clearing it in one step may cause severe shocks to whole of the financial system and may undermine whole economy. So it adopted a piecemeal approach of tackling banks one by one, as and when they fail. It didn’t want to commit huge amounts of public funding for recapitalization of banks in one go.
The government also tried to stimulate economy by increasing deficit. It wished that higher economy would itself reduce the proportion of bad loans. But the piecemeal approach hasn’t solved the crisis. Under-capitalisation of banks has resulted in more banks failing over time. What could have been few bank failures has now resulted in wide spread problem. Even so called healthy banks are saddled with large amounts of bad loans. And government’s plan contains no provisions for dealing with the bad loans held by the supposedly healthy banks.
Also to compensate for lower public spending, the government encouraged other private sector actors to privately recapitalize weak banks. This spread the crisis across the financial world. The result was a deep intertwining of the fate of banks with those of other financial institutions. Now new acquirers of failed financial institutions were saddled with bad loan problems.
Moreover by keeping the failed banks under government supervision only, the government has missed on the efficiency that could have been brought by foreign private banks. Foreign banks, not saddled with Japanese culture and more focused on earnings, would have dealt with bad loans more efficiently. Earlier handing over of failed institutions would have also reduced government liabilities. Last but not the least is the lesson learnt in the value of time. Japan took eight years from the onset of severe financial distress to the time when the government started aggressive reforms. Because of this delay, what might have been relatively small costs of clean up turned into staggering costs.
Summary of benefits and outcomes and likely use in future
The use of government agencies to support failed institutions during the search of a suitable merger partner has prevented massive shocks for the economy. The government injects capital to cover losses during the running but not enough capital to completely take care of bad loans. So as such the real cause of failure bad loans still persist. The process has only delayed the result and in doing so, exaggerated the magnitude of the problem.
Looking at Japanese culture, it is likely that the government will keep on using DICJ and RCC in future also. The recent improvement in economy has also given some hope that magnitude of bad loans may remain same if not decrease. Also using DICJ keeps foreign competition at bay.
Tags: bad debts, bank crisis, bank profits, bridge bank, japanese banks, japanese economy, risk analysis
