2001 Reports

From cozy regulation to competitive markets: The regime shift of Japan's financial system

Patrick, Hugh T.

The Japanese banking and financial systems arc substantially along the transformation process of shifting from one regime to a new one. The "postwar" financial regime was characterized by extraordinarily high priority placed by the Japanese regulators on financial system safety. To that end they restricted capital market development, and established the conditions in which no bank could fail: deposits and loans to business as the predominant financial instruments; wide interest rate spreads; no entry and no exit mechanisms; close, informal, opaque, administrative guidance by the Ministry of Finance with little disclosure, is what evolved into a cozy, collusive, nontransparent relationship between regulator and those regulated... in other words, the cliche "bank convoy system." This protected system gradually dissolved once growth in the Japanese economy in the mid 1970s shifted from being supply constrained to inadequate aggregate demand constrained. With credit becoming easily available, deregulation began its very slow, piecemeal, gradual process, evolving to the new financial system regime today based in principle on open, free, competitive financial markets. The transformation was complicated and made much more expensive by the stock and urban real estate bubbles of the late 1980s, the bursting of which destroyed the collateral value of loans, compounded by Japan's miserable economic performance of the 1990s. Today Japan's financial system rests on highly competitive capital and loan markets, with Japanese financial institutions weak and engaged in consolidation, and many major foreign financial institutions as active players in many Japanese wholesale financial markets.