Japan’s Shadow Banks

Japan remains overbanked…
For those who go back a long time, Japanese banking used to be characterized by “overborrowing”, “overlending” and “overbanking” – high debt/equity ratios in the corporate sector, and borrowing too much money from the Bank of Japan, all in the days when there was no bond market. There was also a lot of competition, with mutual savings banks and credit associations lending to small firms, regional banks to mid-tier firms and the “city banks” to large ones. This is nicely documented in an open-access paper by Takeo Hoshi and Anil Kashyap, Japan’s Financial and Economic Stagnation in the Journal of Economic Perspectives 18:1 (2004), 3-24.
Then there are Japan’s “shadow banks.” By this I don’t mean the range of off-books, unregulated institutions that the Financial Stability Board set up by the G-20 says accounts for US$67 trillion in activity (as reported by Bloomberg). It’s not that those don’t exist in Japan, it’s that there’s another source of shadow lending: government financial institutions. The Japan Post Bank [its current incarnation] was long the largest deposit-taking institution in the world (though it was prohibited from lending to the private sector). This undermined the banking sector because there is a post office in every village and urban neighborhood across Japan, 24,000 in all, that in the past was allowed to pay depositors a higher interest rate than regular banks. (On the lending side, funds were lent to the government, including purchases of bond issues for local infrastructure projects that might have no identifiable revenue stream. No unfair competition here, as even at their worst Japanese banks wouldn’t lend to those sorts of borrowers!)
Now an article in the [online] Yomiuri Shinbun traces the final evolution of this system: one in which poorly governed financial institutions can compete directly with commercial banks in lending. (No, I don’t mean the quango of Tokyo’s mayor Ishihara that has cost taxpayers over ¥100 billion.) Rather, here its the Norinchukin Bank, an umbrella bank for Japan’s semi-governmental agricultural cooperatives. (See 農林中金、成長分野向けに総額5千億円の融資枠 [Norinchukin Bank to devote ¥500 billion to enter growth sectors].)
Now Norinchukin and a group of small-business oriented banks are already lending to the private sector; historically the small business banks did this through local small business banks. This pushed down interest rates and discouraged regular banks from aggressively pursuing such business, which is sufficiently profitable in the US to lead to the continued founding of new community banks. But this article suggests direct, aggressive direct lending for perceived growth sectors of “food” and “pharma” with subsidized interest rates.

Meanwhile, what’s happening in the “straight” banking sector? Hoshi & Kashyap documented the large size of the sector, given the post-bubble decline in lending. They predicted it would shrink. They also called on Japanese banks to move away from straight lending into fee-oriented businesses – the core of the US “shadow banking” boom. To my knowledge, the big Japanese banks remain overstaffed and unduly bureaucratic, losing market share to smaller regional banks, such as Chiba Bank and the Bank of Yokohama. [Not all such banks are faring well, with several forced mergers of failing regional banks.] So there are still too many banks. Nor is their fee business large, and their attempt to move into that segment (buying up the large personal finance companies that had their origins in loan sharking) has led to huge losses. I’ve not (yet?) tried to revisit this issue, but my suspicion is that there’s still a lot of restructuring to go, and that the overall environment remains one that leaves the banking sector as a whole weak in profitability. I’m 99% sure that Japan remains overbanked.
…The Prof (mike smitka)…

2 thoughts on “Japan’s Shadow Banks

  1. reed

    How do you think the banking system will consolidate its excess banks? If the large banks are already too big, it would be counterproductive for them to buy up smaller banks, and the regional banks don’t want to get bloated on bureaucracy or they will have the same problem as the large banks do now? Are you suggesting that some of Japan’s banks will flat out fail/collapse? What are the implications of this for confidence in the financial system in Japan?

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  2. wilburns

    Perhaps they should go in the opposite direction and split the banks, hopefully to avoid the ‘too big to fail’ problem we faced here in this country in 2008. Though that likely wouldn’t solve the overborrowing problem. But, personally, it seems like the BOJ is getting too involved with private banks and they have gotten complacent, always knowing in the back of their mind that no matter how much they screw up the BOJ will always be able to lend them money. Perhaps letting a few fail to scare them into line could be helpful in the long run.

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