Finanzmarktkrise, Bankenkrise, Bubbles, Immobilienmarkt, Aktienmarkt, Vergleich, Japan, Vereinigte Staaten, Financial crisis, Banking crisis, Real estate market, Stock market, Comparison, United States

Johannes Mayr

English

Research Papers in Economics

CESifo Forum 4/2008 64
Focus
THE FINANCIAL CRISIS IN
JAPAN – ARE THERE
SIMILARITIES TO THE
CURRENT SITUATION?
JOHANNES MAYR*
In the 1990s Japan experienced a deep financial cri-
sis that lasted for more than a decade and whose
effects strain the Japanese economy even today. In
this article, we give a brief overview of the major
developments that preceded the crisis and describe
the legislative actions that were decided to ease the
markets and to restore confidence in banking.
Employing major financial and economic indicators,
we compare the developments in Japan to the cur-
rent turmoil on the international financial markets
that originated in the US subprime mortgage mar-
ket. The comparison shows that the following phe-
nomena played a crucial role in the run-up to both
crises:
– an expansive monetary policy
– a strong increase of prices on the real estate and
stock markets
– a fall in savings of private households
– high risk propensity and comparable low equity
ratios in the banking sector
– the development of new financial products com-
bined with a comparable low degree of market
regulation
The run-up to the crisis
The economic situation in Japan in the 1980s was
characterized by high GDP growth rates and a
decreasing level of inflation (Figure 1). Following
the Plaza Agreement the Japanese yen appreciated
first gradually and later strongly.1 To prevent a fur-
ther appreciation and to support the exporting sec-
tors of the economy, the Bank of Japan lowered its
interest rates subsequent to the Louvre Agree-
ment to 2.5 percent (Figure 2).2 The expansive
monetary policy and the resulting increase in liq-
uidity led to a boost in prices on the real-estate
and stock markets.
The safety system of the banking sector was initially
characterized by the Convoy System (Hoshi 2002).
Originally, the Convoy System was designed to
rebuild Japan after World War II. Banking supervi-
sion and regulation was conducted such that the via-
bility of the weakest banks was not undermined. It
was implicitly understood that the banking sector
was fail-safe,as the Japanese Ministry of Finance was
expected to step in to find a remedy for any problem
that could threaten the viability of a bank. In return
for protection by the financial authorities, banks
were expected to function as financial intermediaries
* Ifo Institute for Economic Research.
1The Plaza Agreement was signed on 22 September 1985 at the Plaza
Hotel in New York City by 5 nations – France,West Germany,Japan,
the United States and the United Kingdom. The five agreed to
depreciate the US dollar in relation to the Japanese yen and German
deutsche mark by intervening in currency markets.
2 The Louvre Agreement was signed by the then G-6 (France,West
Germany, Japan, Canada, the United States and the United
Kingdom) on 22 February, 1987 in Paris. The goal of the Louvre
Agreement was to stabilize the international currency markets and
halt the continued decline of the US dollar caused by the Plaza
Agreement.
-5
0
5
10
15
20
25
1
9
7
0
1
9
7
2
1
9
7
4
1
9
7
6
1
9
7
8
1
9
8
0
1
9
8
2
1
9
8
4
1
9
8
6
1
9
8
8
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
2
0
0
0
2
0
0
2
2
0
0
4
2
0
0
6
JAPAN
Source: IMF International Financial Statistics; OECD Main Economic Indicators.
Annual real GDP growth rate and annual CPI inflation
in %
GDP
Real effective exchange rate
0
20
40
60
80
100
120
1
9
7
0
1
9
7
2
1
9
7
4
1
9
7
6
1
9
7
8
1
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0
1
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2
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1
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1
9
9
8
2
0
0
0
2
0
0
2
2
0
0
4
2
0
0
6
index
CPI inflation
Figure 1CESifo Forum 4/2008 65
Focus
channelling surplus household savings into the
industrial sector. To guarantee safety for the finan-
cial system, the Deposit Insurance Cooperation
(DIC) provided a payoff in which a failed bank
would be closed down for liquidation and a deposi-
tor with the failed bank would be protected by up to
10 million yen per depositor. Furthermore, the DIC
provided financial assistance by transferring the
sound assets and liabilities to an assuming bank. As
larger banks generally perceived to be protected by
the Convoy System, the DIC insurance fund had a
volume of only 300 billion yen in 1987, what was far
too little in the case of the failure of a major bank
(Nakaso 2001, 3).
As a consequence of the opening of the Japanese
financial markets for foreign investors in the early
1980s,domestic regulation and the by then dominating
main bank system3 came under increasing competitive
pressure. The Japanese banks broadened their shares
of risky portfolio assets in order 
to compensate losses of market
shares and significantly lowered
their equity ratio.This resulted in a
decrease of interest margins and of
the interest spreads between loans
of different ratings. Neglecting
their profitability and riskiness,
loans were extended even at nega-
tive lending spreads and the vol-
ume of credits increased steadily
(Figure 3). Additionally, the banks
widened the range of accepted
securities, especially for mortgage
loans on real estate. This develop-
ment was intensified by the forma-
tion of new mortgage banks out-
side of the traditional banking sector. These so-called
Jusen or housing loan corporations were non-bank
financial institutions that were founded by banks and
other financial institutions in the 1970s to complement
the housing loans offered by banks. In the 1980s, the
Jusen companies shifted their lending towards real-
estate developers. However, the banking supervision
was not adequately adjusted to the new structure of
the financial markets.
The beginning of the crisis
As a reaction to the overheating of the real estate and
stock markets – the Nikkei Index rose from 13,000
points (end of 1985) to 39,000 points (end of 1989) –
numerous measures were implemented to guarantee
a soft landing of the economy. The Bank of Japan
tightened its monetary policy and successively raised
the discount rate from May 1989 to August 1990 from
2.5 to 6 percent. Furthermore, a
tightening of the modalities for
loan granting on the real-estate
market and a tax on speculation
gains were introduced. The rise in
interest rates led to a significant
increase in refinancing costs. To
generate liquidity, investors sold
their assets, and the prices on the
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
0
1
2
3
4
5
6
7
8
9
10
1993 1995 1997 1999 2001 2003 2005 2007
Source: Bank of Japan and Federal Reserve Board.
years
US
Federal funds target rate
1993-2008
INTEREST RATES IN JAPAN AND THE US
Japan
basic discount rate
1978-2001
years
in %
Figure 2
-3
-2
-1
0
1
2
3
-10
-5
0
5
10
15
20
1985 1987 1989 1991 1993 1995 1997 1999 2001
Source: IMF International Financial Statistics.
CREDIT VOLUME AND LENDING SPREAD
LHS: Lending Spread
a) 
a) Average interest rate on loans - CD quotatins (3-month)
RHS: Annual change in volume of loans
in % in %
Figure 3
3 A main bank relationship means that a
firm meets a substantial proportion of its
financial needs through the intermedia-
tion of one bank. In return for the prefer-
ential business that it receives from the
firm, the main bank implicitly undertakes
the monitoring of the firm and bears the
responsibility for organizing expensive
debt workouts in case the firm encounters
financial distress.CESifo Forum 4/2008 66
Focus
real-estate and stock markets dropped sharply until
midyear 1992 by 65 and 75 pecent, respectively
(Figure 4).
Thereupon a considerable part of the overall volume
of credit was rated as NPLs (non-performing loans)
and important credit rating agencies downgraded
the Japanese banks,which again put further pressure
on equity prices.
The height of the crisis
Between 1994 and 1996,a number of major Japanese
banks became insolvent and, following the drop in
real estate prices,a growing number of Jusen compa-
nies encountered difficulties and accumulated losses
that were far beyond the amounts that founder
banks could cover.The financial crisis hit its peak in
November 1997 when major financial institutions
collapsed almost on a weekly basis. As a result, for-
eign financial institutions squeezed their credit limits
to Japanese banks in general and domestic lender
banks increasingly placed their money with the Bank
of Japan instead of offering it on the interbank mar-
ket. As a result, liquidity in the interbank market
dried up and interest rates came under strong
upward pressure. These developments forced the
Bank of Japan to pump massive liquidity into the
market.
To restore financial system stability and in order to
avert a run on banks,the Japanese government decided
to introduce further public funds and gave a blanket
guarantee for deposits and other liabilities of financial
institutions for a period of 5 years. From 1992 to 2002,
180 deposit-taking institutions were dissolved under the
deposit insurance system (Figure 5).The DIC provided
financial assistance for the assuming institutions of
about 19 trillion yen.4 More then 10 trillion yen were
paid by the taxpayers and the rest was funded by pri-
vate financial institutions through the deposit insurance
system. Furthermore, the government injected about
12 trillion yen into financial institutions by purchasing
preferred or common stocks and extending subordinat-
ed loans (DICJ 2006).All issues related to capital injec-
tions were handled by the newly created Financial
Crisis Management Committee (FSA).The volume of
NPLs continued to rise and reached its peak of 43 tril-
lion yen or 8.4 percent of the total credit volume of all
banks not until the end of March 2002 (Figure 6).
The aftermath of the crisis
Japanese banks had only limited incentives to remove
their NPLs from the balance sheet.The Bank of Japan
maintained its loose monetary policy, which reduced
the opportunity costs of holding bad loans,and sales of
 0
10 000
20 000
30 000
40 000
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
1 000
4 000
7 000
10 000
13 000
16 000
19 000
22 000
25 000
1993 1995 1997 1999 2001 2003 2005 2007
PRICE INDICES
Source: Dow Jones and Reuters; Ministry of Land (Japan); Office of Federal Housing 
Enterprise Oversights and Standard & Poor's (US).
Stock markets
LHS: Nikkei Index 225 (1 978-2001)
 Real estate markets
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000
-20
-10
0
10
20
1993 1995 1997 1999 2001 2003 2005 2007
Annual rate in %
RHS: Dow Jones
industrial index
(1993 -2008)
US
 Case Shiller house
 price index  (1992-2008)
Japan 
average land
 price index
 (1978-2001)
US
OFHEO house price index
(1993-2008)
years
years
years
years
Figure 4
0
10
20
30
40
50
60
1992 1994 1996 1998 2000 2002 2004 2006
0
1
2
3
4
5
6
FINANCIAL ASSISTANCE 
Source: DICJ Annual report 2006; Financial Services Agency.
JPY Trillion
RHS: Volume of Grants
0
10
20
30
40
50
1999 2000 2001 2002 2003 2004 2005 2006 2007
JPY Trillion
LHS: Number of Cases
number 
VOLUME OF NON PERFORMING LOANS 
(NPLS)
Figure 5
4 The average annual nominal GDP of Japan between 1995 and
1998 was about 500 trillion yen.CESifo Forum 4/2008 67
Focus
bad loans were only possible at deeply discounted
prices.Thus,in order to fulfil short-term profit expecta-
tions the banks used different accounting methods to
cover the total need for write-downs.To accelerate the
process of identifying the bad assets and the disposals
thereof, the FSA conducted several rounds of special
inspections of major banks and later of smaller and
regional institutes from 2001 onwards.Additionally,the
government installed the so-called Resolution and
Collection Cooperation (RCC) to assume failed credit
cooperations and to purchase NPLs from failed finan-
cial institutions as well as from solvent operating banks,
helping them to clean up their balance sheets.
The fall of asset prices implicated
a decline of the equity ratios of
Japanese banks, which tightened
credit conditions for smaller as
well as for large companies to
meet the minimal capital require-
ments agreed upon in the Basel I
accord5 (Figure 6). After their
growth rates had already fallen
sharply since the increase of the interest rates in 1989,
the volumes of total credit declined from the end of
1998 onward.The credit conditions were not gradual-
ly untightened until mid-1999.
Comparison 
A comparison of the Japanese financial crisis with the
current financial and banking crisis shows a number
of similarities (Reinhart and Rogoff 2008). In both
cases, very low interest rates promoted a huge run-up
in prices on the real-estate and stock markets.
As in the current situation, where declining lend-
ing standards in the mortgages markets, an
increase in loan incentives and a long-term trend
of rising housing prices had encouraged US pri-
vate households with a low degree of creditwor-
thiness to assume difficult mortgages and run into
debt, the starting point of the Japanese financial
crisis was the liberalization and deregulation of
the real-estate and mortgage market. In both
cases, these developments came along with an
insufficient adjustment of the financial supervi-
sion to the new structure of the financial and real-
estate markets.
The delayed tightening of monetary conditions lead
in both cases to a strong adjustment of asset prices
resulting in striking contractions in wealth and equi-
ty capital followed by increases in risk spreads and
finally a liquidity crisis.In contrast to the current cri-
sis, where the securitization of debts has lead to an
internationalization of the problem, the Japanese
financial crisis was regionally bound to Japan. As
during the Japanese crisis,banks in the United States
-30
-20
-10
0
10
20
30
40
1
9
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1
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1
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1
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2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
CREDIT CONDITIONS IN JAPAN AND THE US
Source: Bank of Japan; Seniour Loan Officer Opinion Survey.
TANKAN, lending attitude of financial institutions
diffusion index
large companies
 C&I loans
-40
-20
0
20
40
60
80
1
9
9
5
1
9
9
6
1
9
9
7
1
9
9
8
1
9
9
9
2
0
0
0
2
0
0
1
2
0
0
2
2
0
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3
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
in % of banks who tightened their standards for C&I loans
small companies
small
medium and  large
Japan
US
Figure 6
5 Basel I is the round of deliberations by
central bankers from around the world,
and in 1988,the Basel Committee (BCBS)
in Basel, Switzerland, published a set of
minimal capital requirements for banks.
This is also known as the 1988 Basel
Accord and was enforced by law in the
Group of Ten (G-10) countries in 1992,
with Japanese banks permitted an extend-
ed transition period.
02468 1 0 1 2 1 4 1 6 1 8
Japanese Banking Crisis
Nordic Banking Crisis
1990s
Savings&Loans Crisis
1990s
Current Crisis - Realized
losses 
Current Crisis - Worst
Case Estimation 
Source: Oxford Economics (OEF 2008).
LOSSES IN THE BANKING SECTOR
in % of nominal GDP
%
Figure 7CESifo Forum 4/2008 68
Focus
are currently tightening credit conditions in response
to the decline of their equity ratios.
In Japan, the total amount spent in dealing with the
NPL problem grew to 86 trillion yen,roughly 17 per-
cent of nominal GDP (Figure 7). Estimates for the
ultimate scale of aggregate losses in the banking sec-
tor caused by the current crisis range from one to
two trillion US dollars. The latter figure would rep-
resent some 8 percent of US and European nominal
GDP. According to this measurement, the Japanese
crisis was by far the most severe of the listed crisis,
with relative losses exceeding the worst case scenar-
ios of today’s turmoil by far.
References
DICJ (2006), Annual Report 2006,
http://www.dic.go.jp/english/e_annual/e_annual_fy2006.pdf
(accessed 28 October 2008).
Hoshi,T. (2002),“The Convoy System for Insolvent Banks: How It
Originally Worked and Why It Failed in the 1990s”, Japan and the
World Economy 14, 155–180.
Nakaso, H. (2001),“The Financial Crisis in Japan during the 1990s:
How the Bank of Japan Responded and the Lessons Learnt”,
BIS Papers 6.
OEF (2008), After Paulson,Where Next for World Growth?,
http://www.oef.com/OE_FA_Display_Frm.asp?Pg=IntMacSpec&
Txt=International%20Macroeconomics
(accessed 28 October 2008).
Reinhart C. and K. S. Rogoff (2008), Is the 2007 U.S. Sub-Prime Fi-
nancial Crisis So Different? An International Historical Com-
parison, NBER Working Papers 13761.
Tamaki, N. (2008), “Bank Regulation in Japan”, CESifo DICE
Report 6(3), 9–13.

After Paulson,Where Next for World Growth?,

Annual Report

Bank Regulation in Japan”,

Convoy System for Insolvent Banks: How It Originally Worked and Why It Failed

Financial Crisis in Japan during the 1990s: How the Bank of Japan Responded and the Lessons Learnt”,

U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison, NBER Working Papers 13761.

The Financial Crisis in Japan – Are There Similarities to the Current Situation?

http://www.cesifo-group.de/portal/page/portal/DocBase_Content/ZS/ZS-CESifo_Forum/zs-for-2008/zs-for-2008-4/forum4-08-focus10.pdf

The Financial Crisis in Japan – Are There Similarities to the Current Situation?

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