Japanese banking problems: implications for lending in the United States - Industry Overview

New England Economic Review, Jan-Feb, 1999 by Joe Peek, Eric S. Rosengren

Japanese banking problems have received substantial attention worldwide. Critics of Japanese policymakers have argued that problems at Japanese banks threaten the Japanese economic recovery. They also point out that because Japanese banks have been among the most active in expanding their presence beyond their domestic borders, they could play a major role in prolonging the financial problems in many other Asian and emerging market countries, as well.

Fueled by a high saving rate, active exporting firms, and a booming stock market, Japanese banks expanded aggressively worldwide during the 1980s. By 1988, all of the 10 largest banks in the world were Japanese, with a significant presence in Southeast Asia, Europe, Latin America, and the United States. The penetration into U.S. domestic markets was particularly striking. By the early 1990s, Japanese banks were the dominant foreign banks in the United States, accounting for about 18 percent of all commercial and industrial loans to U.S. addresses.

In the 1990s, however, the tide turned. Japanese banks experienced a significant diminution of capital as a result of sharp declines in the Japanese stock market and substantial increases in nonperforming loans. Increasingly constrained by international capital requirements, Japanese banks began to shrink their international operations while insulating their domestic lending operations. The reduction in foreign lending since 1990 has been substantial, with the Japanese share of the U.S. commercial and industrial lending market falling from roughly 18 percent in late 1991 to under 14 percent by the first quarter of 1998. This decline is likely to continue, as Japanese banks shrink further in order to satisfy capital requirements. Not only have Japanese banks reduced U.S. lending, but they also have announced major restructurings of their U.S. operations, including sales of some of their U.S. subsidiaries and consolidations among their U.S. branches and agencies.

Many of the actions of Japanese banks are being influenced by changes in government policies towards them. In March of 1998 major Japanese banks requested capital infusions from the government. As a condition for receiving the government funds, the banks were required to describe their plans for restructuring. Embedded in many of these proposals were dramatic decreases in their global activities. More recently, the Japanese government has committed 60 trillion yen of public funds to address the banking sector's problems, but it has insisted that poorly capitalized banks take remedial actions, including withdrawing from international operations. Furthermore, the two large banks that failed recently, Hokkaido Takushoku and Long-Term Credit Bank, each announced a cessation of international operations before it was closed or nationalized.

In addition to the plans to shrink operations announced in March 1998, many of the largest banks have subsequently announced withdrawals or plans to withdraw from international activities. For example, Daiwa, Yasuda Trust, Mitsui Trust, and Nippon Credit Bank have all stated that they plan to become purely domestic banks. Thus, while Japanese banks in general have been withdrawing internationally, the most troubled banks have taken the extreme step of completely abandoning their international operations.

This paper examines factors affecting the Japanese banking presence in the United States. In particular, it examines the role that capital requirements played in the decisions by Japanese banks to reduce their lending here. Because U.S. banking markets have been unusually open by international standards, and because of the large penetration by Japanese banks, the experience here provides useful insights into how globally active banks may react in the future to problems in their domestic markets.

The next section describes the dramatic fluctuations in stock market and urban land prices and how sharp declines in these prices could have an effect on other countries through Japanese bank lending. The second section describes the pressures on bank capital ratios resulting from the declines in Japanese asset prices and the response of Japanese banks. The third section describes the importance of lending relationships in Japan and their role in the reduction of Japanese bank lending in other countries. The fourth section describes the implications for U.S. credit markets. The final section discusses some implications of the movement toward more global banking markets.

I. Asset Prices and Japanese Bank Behavior

One of the more dramatic financial events of the second half of the 1980s was the asset inflation in Japan. The subsequent deflation was, perhaps, even more striking. Panel A of Figure 1 shows the extent of the surge in the Nikkei stock index. Even using monthly data that miss the precise peak in the Nikkei, the figure reflects a tripling of the index between January 1986 and December 1989, followed by an equally sharp decline. Panel B shows that the rise and decline in land prices were just as dramatic, with urban land prices tripling and then falling sharply, the peak occurring subsequent to the peak in the Nikkei. Such rapid rises and declines in stock prices and other asset values were unprecedented in Japan.