The Japanese Banking Crisis: Where Did It Come From and How Will It End?

We argue that the deregulation leading up to the Big Bang has played a major role in the current banking problems. This deregulation allowed large corporations to quickly switch from depending on banks to relying on capital market financing. We present evidence showing that large Japanese borrowers, particularly manufacturing firms, have already become almost as independent of banks as comparable U.S. firms. The deregulation was much less favorable for savers and consequently they mostly continued turning their money over to the banks. However, banks were also constrained. They were not given authorization to move out of traditional activities into new lines of business. These developments together meant that the banks retained assets and had to search for new borrowers. Their new lending primarily flowed to small businesses and became much more tied to property than in the past. These loans have not fared well during the 1990s. We discuss the size of the current bad loans problem and conclude that it is quite large (on the order of 7% of GDP). Looking ahead, we argue that the Big Bang will correct the aforementioned regulatory imbalances. This will mean that banks will have to fight to retain deposits. More importantly, we expect even more firms to migrate to capital market financing. Using the U.S. borrowing patterns as a guide, we present estimates showing that this impending shift implies a massive contraction in the size of the Japanese banking sector.

Bank Monitoring and Investment: Evidence from the Changing Structure of Japanese Corporate Banking Relationships

During this decade the structure of corporate finance in Japan has changed dramatically. Japanese firms that once used bank debt as their prime source of financing now rely more heavily on the public capital markets. This trend was facilitated by the substantial deregulation of the Japanese capital markets. In an earlier paper (Moshi, Kashyap, and Scharfstein 1988). we demonstrated that investment by firms with close bank relationships appears to be less liquidity constrained than investment by firms without close bank ties. We interpreted this finding as evidence that bank ties tend to mitigate information problems in the capital market. This paper tracks the investment behavior of firms that have recently weakened their bank ties in favor of greater reliance on the bond market. The results suggest that these firms are now more liquidity constrained. The paper concludes with a discussion of why firms would loosen their bank ties in light of these liquidity costs.

Policy Options for Japan’s Revival

In this report, we identify some specific concrete steps Japan can take to jump start growth. Our recommendations are organized around three broad themes: regulatory reform, opening up the Japanese economy, and improving macroeconomic policies. Section 2 identifies four types of regulatory relief that would improve growth in Japan. One set of changes show how to reduce the cost of conducting business in Japan. Each of these is achievable and together they would modestly improve business conditions and the efficiency of doing business in Japan. We also explain how to stop the protection of zombie firms, and identify several other government regulations that also discourage productivity growth, especially in the non-manufacturing parts of the economy. An approach that Koizumi government tried for deregulation was the creation of structural reform special zones. As our earlier report found, these special zones had mixed results, so we also explain the conditions that a special zone should satisfy to be growth enhancing. Section 3 examines the gains that can be achieved by opening up the Japanese economy. One avenue for doing this is via the Trans-Pacific Partnership (TPP), which Japan has finally decided to join the negotiation. We explain why participating in this deal is desirable. A perpetual road block to trade negotiations in Japan has been the pressure from agricultural interests to protect that sector from competition. Productivity gains in the Japanese agricultural sector have been dismal and we also discuss policies that could help improve that situation. A third path to openness is through increased immigration. We sketch immigration reforms that would be growth enhancing. Section 4 explores the growth impediments resulting from poor macroeconomic policies. The threat of a debt crisis that could cripple Japanese growth is real. We explain why a credible plan for fiscal consolidation is necessary and propose some principles that should be part of such a plan. Monetary policy has also been bad since the Bank of Japan’s legal independence. We identify the type of monetary policy framework that is necessary to end more than a decade long deflationary period. Section 5 offers some brief conclusions

Zombie Lending and Depressed Restructuring in Japan

In this paper, we propose a bank-based explanation for the decade-long Japanese slowdown following the asset price collapse in the early 1990s. We start with the well-known observation that most large Japanese banks were only able to comply with capital standards because regulators were lax in their inspections. To facilitate this forbearance the banks often engaged in sham loan restructurings that kept credit flowing to otherwise insolvent borrowers (that we call zombies). Thus, the normal competitive outcome whereby the zombies would shed workers and lose market share was thwarted. Our model highlights the restructuring implications of the zombie problem. The counterpart of the congestion created by the zombies is a reduction of the profits for healthy firms, which discourages their entry and investment. In this context, even solvent banks do not find good lending opportunities. We confirm our story's key predictions that zombie-dominated industries exhibit more depressed job creation and destruction, and lower productivity. We present firm-level regressions showing that the increase in zombies depressed the investment and employment growth of non-zombies and widened the productivity gap between zombies and non-zombies.

Will the U.S. Bank Recapitalization Succeed? Eight Lessons from Japan

During the financial crisis that started in 2007, the U.S. government has used a variety of tools to try to rehabilitate the U.S. banking industry. Many of those strategies were used also in Japan to combat its banking problems in the 1990s. There are also a surprising number of other similarities between the current U.S. crisis and the recent Japanese crisis. The Japanese policies were only partially successful in recapitalizing the banks until the economy finally started to recover in 2003. From these unsuccessful attempts, we derive eight lessons. In light of these eight lessons, we assess the policies the U.S. has pursued. The U.S. has ignored three of the lessons and it is too early to evaluate the U.S. policies with respect to four of the others. So far the U.S. has avoided Japan’s problem of having impaired banks prop up zombie firms.

Zombie Lending and Depressed Restructuring in Japan

In this paper, we propose a bank-based explanation for the decade-long Japanese slowdown following the asset price collapse in the early 1990s. We start with the wellknown observation that most large Japanese banks were only able to comply with capital standards because regulators were lax in their inspections. To facilitate this forbearance the banks often engaged in sham loan restructurings that kept credit flowing to otherwise insolvent borrowers (that we call zombies). Thus, the normal competitive outcome whereby the zombies would shed workers and lose market share was thwarted. Our model highlights the restructuring implications of the zombie problem. The counterpart of the congestion created by the zombies is a reduction of the profits for healthy firms, which discourages their entry and investment. In this context, even solvent banks will not find good lending opportunities. We confirm our story's key predictions that zombiedominated industries exhibit more depressed job creation and destruction, and lower productivity. We present firm-level regressions showing that the increase in zombies depressed the investment and employment growth of non-zombies and widened the productivity gap between zombies and non-zombies