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December 15, 1997
By Michael Hutchison
The economies of East Asia have been buffeted in recent months by bouts of speculative currency attacks, stock and real estate price declines, and banking problems. Media attention has focused on Thailand, Indonesia, Korea, Malaysia and, most recently, Hong Kong.
By far the largest banking problem in the region, however, continues to be faced by Japan. Japan was hit much earlier with a banking and "bad loan" crisis, dating back to the collapse of its "bubble economy" in 1990-92. Since that time the Japanese government has been struggling, with limited success, to deal with its financial problems. Why has Japan failed to resolve its banking problem while several other industrialized countries, facing similar or worse problems, settled them years ago? As governments in other East Asian countries confront and search for solutions to their own banking problems, lessons on how--and how not--to proceed may be gleaned from the Japanese experience.
The burst of Japan's bubble economy in the early 1990s left many financial institutions with a nonperforming loan problem. Nationwide, private estimates of bad loans ranged from around 10 percent to 20 percent of gross domestic product at their peak in 1995.
The Ministry of Finance, the primary regulatory agency, was slow in reacting to the problem in the early 1990s. Its response was a series of uncoordinated actions proceeding on a case-by-case basis, rather than an overall plan. Indeed, this form of discretion in setting and implementing policy is often identified as a hallmark of Japanese bureaucratic prerogative, but the cozy relationship between the ministry and financial institutions led to what amounted to a cover-up of Japan's financial problems.
As the full extent of the crisis became evident--even large institutions were in serious trouble--Japan's regulatory authorities were forced to take a stronger approach. In 1995, the ministry closed some of the lowest quality institutions and created a "bridge bank" to receive the remaining assets of failed smaller institutions. The ministry also encouraged large write-offs by some banks and closed nonbank subsidiaries of financial institutions specializing in housing loans, known as jusen companies.
The first major bank failure occurred in late 1996 and was followed in 1997 by the officially assisted restructuring of Japan's 17th largest bank. Then Hokkaido Takushoku Bank closed its doors--the first large commercial bank to do so. Last week Yamaichi Securities Co. announced that it would also close.
The ministry's initially timid and less-than-candid approach in handling the financial crisis did not work. Most of the burden so far has been placed on healthy financial institutions to support problem institutions through mergers, acquisitions, or injections of capital. Closing bankrupt institutions was forced on ministry officials after these other efforts failed.
The strong reluctance to commit public funds to liquidate insolvent institutions has been a major obstacle in resolving Japan's bank problems. The use of public monies was brought up by the government as part of the jusen resolution plan in late 1995. Although this legislation was eventually passed, it faced strong political opposition despite the fact that only about $5 billion in public funds were involved. This contrasts with the estimated $145 billion committed by the U.S. government to resolve the savings and loan crisis--a banking problem smaller in magnitude than that facing Japan.
Notably, the November 17 announcement of the bankruptcy of Hokkaido Takushoku Bank was welcomed by the market, helping to push up the Nikkei stock index almost 8 percent that day--the fourth largest gain in its history. The announcement was taken as a sign that the authorities at long last are taking the necessary measures to finally resolve a problem that has existed for years.
Recent legislation has set in motion a restructuring of Japan's financial supervisory agencies, and plans are in the works to set up procedures that would allow loan and bank problems to be handled in a speedier and more systematic fashion.
These measures may help Japan avoid future potential bank crises, but Japan still has a long way to go. Only in recent days has the government embarked on an all-out effort to finally resolve the banking crisis. Prime Minister Hashimoto reversed course last week and agreed that public funds would be committed to help resolve the crisis, and both the Bank of Japan and Ministry of Finance issued statements that all necessary measures would be taken to avert a full-scale financial breakdown.
These efforts are late in coming. The piecemeal approach followed by the authorities during the past seven years cast a shadow over the whole Japanese financial system. Perhaps a little light is shining at the end of the tunnel, but the road ahead is likely to be rocky as details of financial mismanagement and other problems are revealed.
Michael Hutchison is a professor of economics and a visiting scholar
at the Federal Reserve Bank of San Francisco. He is coauthor of the new
book The Political Economy of Japanese Monetary Policy, published
by MIT Press. A longer version of this commentary appeared in the bank's
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