The Bank of Japan Creates a State-Led Monopolistic Banking System

by Taiki Murai and Gunther Schnabl[*]

In the second half of the 1980s, 13 Japanese city banks climbed into the group of the world’s largest banks, boosted by a domestic speculation boom. With the bursting of the Japanese financial “bubble” in the early 1990s, a gradual decline followed. Since then, the Japanese city banks have been driven by Japanese monetary policy into a concentration process, which has produced new giants without increasing efficiency.

In the mid-1980s in response to a strong appreciation of the yen, the Bank of Japan pushed the key interest rate sharply downwards, from 5% in September 1985 to 2.5% two years later. The cheap money did more than stabilize growth. It also fueled a speculation boom in the stock and real estate markets, borne by the immense expansion of loans to the private sector (Figure 1). Often, real estate, where prices had strongly increased, served as collateral.


With the bursting of the financial “bubble” at the beginning of the 1990s, the city banks slipped into a painful crisis because many loans defaulted. The Bank of Japan stabilized the commercial banks by lowering short-term interest rates from 6% in July 1991 to 0.5% in September 1995. The drastic interest rate cuts tempted the city banks to refinance themselves cheaply in Japan and to grant loans at much higher interest rates in the booming Southeast Asian countries (Figure 1). The big crash came with the Asian crisis (1997/98), which caused the Japanese financial market crisis (1998/99), as the city banks now realized new bad loans in Southeast Asia.

The surviving city banks were compulsorily recapitalized with 8.4 trillion yen (about 77 billion dollars) and forced into mergers. Today, there remain four city banks, three of which, together with securities houses and investment banks, have formed huge financial conglomerates. The business model of these so-called “mega-banks” has changed, because the Bank of Japan undermined the traditional lending business of banks. As the Bank of Japan’s persistent low-cost liquidity provision lowered the financing costs for large companies, the city banks’ most important customers reduced their demand for loans. Even more, the margin between deposit and lending rates was compressed from 3.5 percentage points in the 1980s to below one percentage point today.

The purchase of government bonds, which accounted for a 3.1% share of the total assets of the city banks in 1999, served for a while as a rescue anchor. The share of government bonds in the aggregated balance sheet of city banks rose to 27.1% in 2012 (Figure 1). This was possible because the Japanese government debt increased steadily. In particular, from 2008 to 2012 when prime ministers Aso, Hatoyama and Kan launched huge debt-financed Keynesian economic stimulus packages.

Yet since 2013, Prime Minister Abe let the Bank of Japan aggressively purchase government bonds. This has blocked this escape route for the city banks as the interest rates of newly issued government bonds have fallen to or even below zero. The volume of government bonds in the city banks’ balance sheets has drastically fallen and continues to do so (Figure 1). Instead, the city banks’ deposits with the Bank of Japan have grown on the back of the revenues from the sales of government bonds. However, these deposits at the Bank of Japan do not bear any interest; since last year, even negative interest rates are charged. The upshot is that a new business model has to be found again!

The last refuge is found abroad (Figure 1) as the Japanese monetary policy paralyzes domestic investment activity and domestic lending (Schnabl, 2015). Increasing public debt is simply no longer possible because of the existing immense stock of public debt (250% of GDP). The main targets of the expansion of loans are now again Southeast Asia and the U.S., where economic perspectives are still comparatively positive.

Key decision-makers welcome capital outflows. The resulting depreciation of the yen renders easy windfall profits to the export enterprises and short-term growth success to the Prime Minister. But the risks have increased for two reasons. First, the Japanese city banks are subject to growing foreign exchange rate risks, and in particular, when the yen appreciates. Second, the likelihood of speculative exuberances in the financial sector has significantly increased in the global low-interest environment.

If one day a big lending “bubble” bursts, then a new Japanese financial crisis will be the consequence. This will lead to further mergers so that Japan’s banking landscape could be sooner or later dominated by one or two mega-banks. These banks are far away from being efficient as they rely on low-cost liquidity provided by the Bank of Japan. Such a state-led monopolistic banking system does not bode well for future growth in Japan.



Gerstenberger, Juliane / Schnabl, Gunther (2017): The Impact of Japanese Monetary Policy Crisis Management on the Japanese Banking Sector, CESifo Working Paper 6440.

Schnabl, Gunther (2015): Monetary Policy and Structural Decline: Lessons from Japan for the European Crisis, Asian Economic Papers 14, 1, 124-150.


[*] Taiki Murai is a graduate student at Leipzig University & student assistant at Leipzig’s Institute for Economic Policy. Gunther Schnabl is professor for international economics and economic policy. He is the director of Leipzig University’s Institute for Economic Policy.

4 thoughts on “The Bank of Japan Creates a State-Led Monopolistic Banking System

  1. Japanese banks distress is caused by both immediate and long-term problems. Speculative lending in Japan during the bubble years of the 1980s created a severe domestic bad-loan problem. And the magnitude of the bad-loan problem in the early 1990s was more severe than the U.S. S&L crisis. I think it’s important to create an agency to monitor the banks. And banks need to increase transparency and competition. Moreover, getting inflation and interest rates higher will promote economic stability by increasing the BOJ’s ability to respond to future recessions.

  2. Dear Maggeien,

    Thanks for your comment. I fully agree on the need of transparency and competition among banks.

    As far as the watchdog of Japanese banks is concerned, the Ministry of Finance very strictly oversaw banks until June 1998 (the Financial Services Agency was created as a watchdog of banks at that time). The problem was rather non-bank housing loan corporations (jūsen), which were created by the Ministry of Finance to support the housing loan business of GHLC (Governmental Housing Loan Corporation) because commercial banks were less interested in this field. Jūsen did exceptionally not fall under the jurisdiction of any public agency at that time and the Ministry of Finance simply believed that former MOF officials who received second carrier opportunities at jūsen would unofficially oversee jūsen. The difference of regulations among the several institutions is surely part of the story behind the Japanese bubble economy.

    Taiki Murai

  3. Hello Mr. Murai,
    I enjoyed reading your articles.
    (1) I think the biggest reason why the bank of Japan pushed the interest rate downwards sharply to 2.5% is 1987’s Black Monday in the U.S. At that time, Japanese economy was so good and the bank of Japan didn’t have to conduct policy interest cut, however, Japanese government did it because probably they had some convention with American government about falling value of Japanese yen. I think as a result, There were more and more speculative stock transactions.
    (2) As you mentioned, Japanese banking system is managed not by itself but by Japanese government especially before the central government reform in 2001 and there was the Ministry of Finance, Okurasyo( 大蔵省). I think Okurasyo had truly wrong ideas about the influence of collapse of bubble economy, because they thought the amount of non performing loans was 30 trillion yen, but practically, the amount was 150 trillion yen. Since then, the government and the Bank of Japan always had taken bad strategies before the Prime minister Abe and the Governor of the Bank of Japan Kuroda. In Japan, there are a lot of regulations on the banks compared to the U.S. because the Ministry of Finance ( not the Financial Service Agency) still holds on to vested interest. It makes commercial banks unable to produce new business model.

  4. Hello Ms. Nishizawa,

    I’m glad that you read our post and thank you for your comment.

    1. The Plaza Accord is the origin of the yen appreciation from the mid 1980s. The BOJ’s central concern should have been the adverse impact of the increasing value of the yen on the international competitiveness of Japanese export industries. The increase in tax revenue through the rise of export industries and asset prices is also naturally in the interests of politicians. In this context (in my personal opinion though), the stock market crush in the U.S. back then gave the BOJ a good reason for postponing the rate hike or cutting it further despite the rising the rising value of asset prices. I support the view that the low interest rate environment is the breeding ground of any type of asset price bubble. The co-author of this article, Prof. Gunther Schnabl, published several papers regarding this relationship.

    2. Indeed, the Ministry of Finance may have underestimated the consequence of the stock and real estate bubble. Kobayashi (2015: The Two “Lost Decades” and Macroeconomics: Changing Economic Policies) provides interesting episodes regarding the statements of the Ministry of Finance in that time. What do you mean by “because the Ministry of Finance (not the Financial Service Agency) still holds on to vested interest.”? The FSA is officially responsible for the regulations on banking sector. How can today’s Ministry of Finance influence the way commercial banks come up with new business model? In my opinion, the monetary policy of the BOJ is the determinant of the evolution of commercial banks’ business model.

    We tried to explain the role of regulations by taking a closer look at the development of the Shinkin banks. I would be very pleased if you would also read our new article (

    Best regards and have a great week,
    Taiki Murai

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