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.