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Japanese Financial Market Liberalisation?

Institutional Transparency Before & After the April 1998 'Big Bang'
H. Richard Nakamura
The European Institute of Japanese Studies Stockholm School of Economics P.O. Box 6501 113 83 Stockholm Fax: +46 8 31 30 17 e-mail: richard.nakamura@hhs.se June 2000

Abstract In April 1998, the liberalisation of the Japanese financial markets, the so-called Tokyo Big Bang, came into force. The reform is not the first one; the liberalisation of 1998 is a continuation of the reform process started in the 1970s. With an institutional approach, this paper compares the situation before and after the market reforms and explores the developments after the start of the reforms of 1998: Did they have any immediate effects on the capital markets, or were they a mere paper tiger? Did the information flow become more transparent? What is the attitude of Japanese institutions towards reforms? Despite the industrial policy of export orientation, the Japanese financial markets have been tightly protected by extensive regulations. Only during the 1970s and 1980s, the time-deposit markets, stock trading, money markets and public bond markets were made international and liberalised. But still the necessary structural changes needed to achieve full international competition were left unchanged. In 1996 Ryutaro Hashimoto, then prime minister of Japan, announced broad-ranged structural reforms, called the Tokyo Big Bang, in order to facilitate international financial transactions and strengthen the international competition on the domestic financial markets. These reforms are to be fully implemented by 2001. Significant effects of the Big Bang reform on a macro level are still few, being more apparent on a micro level. But it is dubious whether the reforms will gain momentum before the burden of bad loans inherited from 1980s bubble is completely obliterated and restructuring of the Japanese banking system is carried out thoroughly and information through new accounting practices becomes more transparent. Furthermore, the commitment from bureaucrats and Japanese market actors is also crucial.

Keywords: Tokyo Big Bang, institutionalism, keiretsu, bad loans, liberalisation, transparency

About the author: Richard Nakamura is a doctoral student at the European Institute of Japanese Studies (EIJS) and The Institute of International Business (IIB) at the Stockholm School of Economics. He received his Masters degree in International Economics and Geography from the Stockholm School of Economics in 1998.

1. Introduction In April 1998, the liberalisation of the Japanese financial markets, the so-called Tokyo Big Bang, came into force. The reform is not the first one; the liberalisation of 1998 can actually be viewed as a continuation of a process started in the 1970s, when the Japanese yen was set afloat. As the conditions in the world have continued to change, the institutional regulations on the Japanese financial markets have become more and more outdated. The history of pre-Big Bang era financial regulations can be traced back to the Allied occupation during the first post-war years, when the large bulk of the regulations were enacted and implemented by the National Diet. The aims were then to protect the fragile and inflation-ridden post-war economy, much in the same way as the domestic markets in non-tradable goods and services were protected. But as time went by, these regulations fostered an atmosphere where the agents of the economy grew accustomed to acting in an uncompetitive manner. By the 1980s, many analysts and scholars both in Japan and elsewhere, even thought the intimate relationship between government and business was the clue to the so-called Japanese miracle. But nothing could be more wrong. The government-business fraternisation was not healthy; instead, it helps to explain more of Japans failure than success (Porter et al. 1999):
The problem starts with the governments mistrust of competition [] Companies for their part, take the wrong approach to competition and thus undermine their own profitability. [] Observers looked at these cases (the relatively few successful industries, authors comment), described what happened, and then made the intellectual leap to generalize about the entire countrys success.

What these observers failed to do was to see through the institutions that hindered domestic competition and transparency. Neither a hampering institutional setting nor significant dead-weight losses to the economy due to the institutions are apparent as long as the expansion is strong enough to out-weight the shortcomings, which was the case for Japan. By April 1998, the financial markets were characterised by fixed prices, limited competition and protection from foreign competitors. 2. Institutional structure before the deregulation in 1998 2.1 Early deregulations The financial sector was regulated in virtually all aspects: foreign exchange, bond issuing, interest rates, time deposits, derivatives and lending to and from Japan just to name few examples. As mentioned above, the first steps towards financial regulation was taken in the beginning of 1973, when the pegging of the yen to the U.S. dollar was abandoned due to the debacle of Bretton-Woods system in 1972 and the first oil shock in 1973. During the first decade, reforms were occasional and the primary aims were to internationalise the Japanese currency. The first major reform came in 1980, when an amendment to the Foreign Exchange and Foreign Trade Control Law of 1947 was passed by Diet (Hall, 1998a). In this amendment, all trans-border transactions were made free except for certain cases, that is, effectively transforming the negative control in the 1947 law into a positive one. But not untypical for Japanese political process, a saving clause was included: there was also a provision in the

amendment where regulations could be reintroduced under emergency conditions. The internationalisation of the yen continued during the 1980s, and by 1989 the euroyen and yen-denominated foreign bond markets were on the whole liberalised. In 1989, even an offshore market for yen (which later proved to be of minor importance) were established in Tokyo after further amendments to the Foreign Exchange and Foreign Trade Control Law (Hall, 1998a). The amendments proved to be also a catalyst for other reforms. In rapid succession, regulations regarding time-deposits, the money-market, CD market, bond market and cross-sectoral entry in the finance industry were liberalised. For example, this contributed to making the Japanese government bond market the second largest treasury bond market in the world with an trading volume of US$ 12 trillion in 1993 (Hamao et al., 1998). The aim was to deepen the domestic financial markets and open up the market for more specialised financial products. Although few would argue against the proposition that liberalisation of markets in general is welfare-enhancing, some of these reforms proved to facilitate the development of the bubble at the end of 1980s. Especially rules regarding the euroyen borrowing by Japanese citizens might have been fuel to fire: short-term lending of euroyen to Japanese residents was allowed 1 June 1984 (Hall, 1998a). Although not being the only source of funds for the Japanese bubble-time speculation, it is a significant contributor to defaults when it is converted to long-term loans (this was the direct cause of the liquidity crises in e.g. Thailand and Korea in 1997). This is a good example of how a piecemeal liberalisation, which the Japanese approach can be labelled, can be rather damaging to a financial system.

Figure 1. Foreign and domestic liabilities vs. Japanese foreign investments during the 1980s. Values indiced. (Source: IMF)

2.2 The keiretsu system and hiding of losses Similarly to the financial regulations, the history of keiretsu dates back to the early occupation period. After the defeat in World War II, the so-called Zaibatsu conglomerates, compromised during the war for their economically beneficial relations with the former Japanese army, were dissolved by SCAPi. Although being looser in its structure than their pre-war counterparts (for example, no holding companies at the top did exist; now, the Big Bang reform allows this again), the keiretsu still maintains strong links within the its own group. Names of Mitsui, Mitsubishi and Sumitomo are famous, but post-war keiretsus have also evolved much around bank groupings (kinyu keiretsu), capital groupings (shihon keiretsu) or industrial groupings (kigyo keiretsu). Of these, the kinyu keiretsu is of largest interest in this paper. Japanese corporate financing has traditionally depended heavily on bank loans, very much like in Germany and in the Nordic countries. But unlike them, the Japanese banks have had extensive stock holdings in the companies they have financed. As long as these bank group companies performed well in the seemingly ever-expanding Japanese economy, this was not a problem. The problems of this system emerged when the bubble burst. Randall Morck and Masao Nakamura have conducted extensive empirical work in their paper Banks and Corporate Control in Japan (Morck et al., 1999). They find that the bank groups differentiate companies outside the group from companies within it. In the former case, banks act primarily in the short-term interest of creditors, while in the latter case, the banks act in the broader interest of a range of stakeholders. This includes the banks themselves, not only as lenders but also as stockholders. Under the pre-Big Bang period, ordinary banks were forbidden to deal in stocks and other forms of securities except for portfolio investments for the banks own account. This leads to the suspicion that the house bank may prop up bank group companies in distress instead of letting them go bankrupt, leading to survival of inefficient companies. In other words, here is an incentive problem and a loss to the society present due to an institution. Propping up was indeed what happened according to Morcks and Nakamuras findings. Doing this, banks made things worse. Heavily engaged in reckless lending for speculation purposes primarily in the real estate sector during the 1980s, the banks were already heavily burdened by bad loans. According to OECD, the cumulative capital losses amounted to one quadrillion yen (over 7.4 trillion US$, calculated by the average exchange rate of the bubble peak year 1991), which represented over 14 per cent of the value of the total assets in Japan at the end of 1989 (OECD, 1998). In length, the banks could disguise the losses trough loopholes in the accounting system. For example, the value of the stocks on banks balance sheets was market value when they were purchased, not the current value. This factor alone made the banks look healthier than they really were. As these losses grew during the 1990s (including huge speculation losses in copper by Sumitomo 1995 and revelation the same year of Daiwa banks US$1.1 billion losses in US Treasury bond trading) not even the most generous accountancy legislation in the world could save the balance sheets of the major banks. Another example illustrating the weaknesses of the accounting practices before the reforms is the failure of the Chuo Audit, which was responsible for the audition of

Yamaichi Securities. Chuo Audit, whose chief auditor reportedly audited Yamaichi for 35 years, failed to detect off-book losses of 274 billion yen (about US$ 2.6 billion) and signed off the annual report of Yamaichi just months before its huge bankruptcy. (FEER, 27 January 2000). Summary of the financial industry debacle by 1998: many financial institutions, of which Long Term Credit Bank of Japan (LTCB) and Yamaichi Securities are the most well known, were eventually forced to reveal their huge losses and cease operations. During the period between May 1995 and December 1997, 11 institutions went bankrupt with total losses of 2.2 trillion yen (about US$18.2 billion in 1997 average exchange rate). For another two, one of them Tokuyo City Bank, the excess liability has not even been disclosed to date (OECD, 1998). 2.3 The informal institutions in the banking industry: tight control, entertainment and amakudari Traditionally, the Japanese banking industry has been tightly regulated and very complicated to say the least, in its specialised structure (see table in appendix 1). This has facilitated governmental control through the Ministry of Finance (MoF), the former supervising body of the finance system, but also contributed to obstruction of the transparency of the institutions. MoFs philosophy of governing the Japanese financial sector has been through administrative guidance or more subtle, exhaustive moral suasion as Hall calls it (1998b). This has meant in practice active ministerial interventions in the banking industry. This has over the years developed into a not all healthy relationship between the ministry and the boards of the financial institutions. At the same time as MoF has been exerting its guidance, the major bank groups have on their side continuously exercised considerable lobbying power over governmental officials (Morck et al., 1999). A special feature of Japanese finance has been the amakudariii. These are former officials from MoF and Bank of Japan who upon their retirement have been hired by various financial institutions in order to get more favourable treatment from MoF and Bank of Japan. The amakudari has exercised their old connections at their former workplaces, a habit that eventually became a very strong informal institution, or to use Sven-Erik Sjstrands words [] an infrastructure that facilitate or hinders human co-ordination and the allocation of resources (Sjstrand, 1995). This is indeed true in this case. In order to conceal the huge losses from the public (seldom the often homogeneous and small circle of institutional and individual shareholders) and minimise risk of MoF inspections, the finance companies had been entertaining officials from MoF and Bank of Japan through their amakudari. The stated purpose was to maintain good relationships with the authorities, which in reality meant special favours in form of exemptions and to win bond-underwriting contracts. This lavish entertainment also produced even worse favours: informal warnings of upcoming MoF inspections. In January 1998, the first public revelations surfaced about how the financial companies entertained officials from MoF and Bank of Japan. Public investigators raided MoF, arresting two officials (who later committed suicide) from MoF banking

inspection division; the accusation was bribery in the form of lavish entertainment in Shinjuku red-district area. In return, they gave the banks advance warning of MoF inspection raids (Uriu, 1999). The then finance minister Hiroshi Mitsuzuka was forced to resign, but it did not stop here: Bank of Japan was also involved in dubious treats. The central bank officials gave market-sensitive information on forthcoming money market operations to banks. All this triggered frantic activity on the part of both MoF and Bank of Japan, which resulted in warnings to over 1000 officials at MoF and 600 at Bank of Japan (Hall, 1998a). All these scandals involving bad loans, huge speculation losses and more than intimate contacts between public servants in controlling positions and financial keiretsu made the Japanese public rage against financial and governmental institutions. This was apparent for politicians in July 1998, when the opposition won a landslide victory in the Upper House elections. Although this reaction did coincide with the first steps in the Big Bang reform process, it is questionable if the voters thought that the system had been more transparent by the time of Upper House elections. 3. The Big Bang 3.1 The structure of the reform In 1996, the then Prime Minister Ryutaro Hashimoto announced new initiatives in the economic policy by implementing broad-ranged structural reforms for the financial sector. The name of this reform package, The Big Bang, is dramatic but the date of 1 April 1998 is actually not the starting date for the reform process. As mentioned before, the first shaky steps were taken in 1973, but the difference this time is the more general character of the Tokyo Big Bang package. The first preparatory work was done in July 1997, when trade in options on individual stocks as well as trade and intermediation of unlisted securities by securities companies were finally made legal (Hall, 1998c). The package is supposed to be fully implemented by the end of the fiscal year of 2001iii. The aims of the reforms are to (Hall, 1998c)iv: Prevent the hollowing out of Japans financial markets Enhance the international competitiveness of Japans financial intermediaries Enhance the status of the yen as an international currency Smooth the flow of funds to indigenous growth industries Increase efficiency of the market, that is, to adopt a free market principle Increase transparency and reliability of markets Maximise user benefits in the form of investment returns, freedom of choice of financial products etc.

The most important institutional changes after the reform are: abolition of the earlier strictly divided business areas in the finance industry (e.g. banks are allowed to trade in stocks and sell insurance policies), trading in options on individual stocks, promotion of use and trade in other derivatives, 7

lifting of the ban on trading in unlisted and unregistered securities by securities companies, liberalisation of cross-border transactions for both juridical and natural persons, permission to create holding companies, licensing system for securities companies replaced by a registration system, ending of the special foreign exchange bank system and liberalisation of foreign exchange business by abolition of the Foreign Exchange Bank Law, relaxing of rules separating short-term and long-term financing (i.e. one and the same bank can lend both short-term and long-term), freedom to negotiate on brokerage commissions (earlier set by the government), promotion of electronic money and payment systems, strengthening of the demands on consolidated accounting, accounting standards for financial instruments to be reviewed (e.g. market valuation of stocks and derivatives), auditing practice and system to be more aligned with international standards, including requirements on auditing by independent auditors, broadening of rules concerning insider trading, market manipulation and conflicts of interest, reinforcement of inspection, surveillance and enforcement of rules by surveillance bodies, enhancement of user protection in consumer credit and strengthened anti-money-laundering laws.

Furthermore, a new supervisory body, the Financial Supervisory Agency, was created in June 1998 to take over supervisory duties from MoF and the Bank of Japan. 3.2 The effects of the reform at macro level Even though the Big Bang reform is to be implemented during a three-year period, some significant effects can already be observed. The most noticeable change for ordinary Japanese has been the liberalisation of exchange markets and the creation of universal banks. As seen in figure 2, the foreign exchange reserves fell over 8 per cent in one month, reflecting the fact that the demand for foreign exchange for investments in mostly U.S.-based funds suddenly exploded after Japanese residents were allowed to open portfolio and bank accounts in foreign countries without having to channel funds through authorised channels, something individuals in most western countries have been allowed to do for years. The fall was temporary though, and within a year the reserves was back at the same level as in March 1998 thanks to the surplus in trade balance, which Japan has had during the whole period. If the decade of 1990s is considered, the growth trend was clearly positive for the whole period. By the end of 1999, the foreign exchange reserves were near US$ 300 billion, reaching a new record level.

Figure 2. Foreign exchange reserves January 1997 Jan 2000. (Source: IMF)

Common macroeconomic theory tells us that when the level of uncertainty is reduced, the risk premium on interest rates should fall or even be eliminated. How have the Japanese interest rates, already at low levels, been reacting to the Big Bang reform? The result is meagre, as seen in figure 3. It is hard to see any immediate reactions on money markets or on overnight ratesv. However, the 10-year government bond rates tell another story. The surge started in the end of November 1998 when former Prime Minister Keizo Obuchi announced a huge stimulation package worth 24 trillion yen (about US$ 200 billion), the largest yet (Uriu, 1999). Besides increased governmental spending, the government heeded to U.S. and EU pressures and included tax cuts worth 9 trillion yen (about US$ 74.3 billion) (FEER, 11 March 1999). The only way for the government to finance the package was through massive issuing of government bonds; at the same time investors became more reluctant to invest in Japanese government bonds. The result was a surge in long-term interest rates. The peak of 2.45% was reached in February 1999, which was a development fuelled by expectations at that time that troubled banks would ask for 7 trillion yen (US$ 62 billion) in bailout money from the government and rumours that several big banks were insolvent (FEER, 18 February 1999) (see also section 3.3). The rise was halted after shortterm rates were lowered and institutional investors repurchase of long-term government bonds (Nikkei Weekly, 22 February 1999). The development in bond markets was therefore due to the fiscal policy rather than the Big Bang reform, which had no obvious effects on interest rates. Since then, the interest rates for long-term government bonds seem to have stabilised somewhat. For the short-term money market loans, the interest rates have been extremely stable since May 1999, except for a short three-month period in the end of 1999. This turbulence was a mere reflection of the fears that the recession would start again after a positive performance of the Japanese economy the first two quarters of 1999 (Economist, 11 December 1999). 9

Figure 3. Development of selected short-term and long-term interest rates. (Source: The Economist)

3.3 The effects of the reform on micro level The reform has had impact on both corporate and individual levels. The evident institutional change is the creation of universal banks in style with the rest of the western world. Many banks have started dealing in securities and selling insurance policies, as well as brokerage firms that have started financing and investment services. Moreover, virtually anyone who wishes can now start foreign currency exchange business. The requirements of increased transparency in consolidated accounting according the reform package went into force on 31 March 1999. Before that date, only a few healthy companies provided full consolidated accounts (The Economist, 11 April 1999). The banks announced then that all bad loans, worth 10 trillion yen (US$ 76 billion) were gone, something analysts were sceptical of (FEER, 3 June 1999). For example, even though the banks have written off major part of their bad loans, they still have loans for which they have made provisions in their accounts and nobody knows whether these reserves will be sufficient. Apart from tracking debt repayment record, the new accounting rules force the banks to consider borrowers financial health when they are classifying bad loans. The difference between the old and the new rules are striking: under the old rules, the bad loans under FY 1998 amounted to 14 trillion yen (US$ 107 billion), but if they are calculated by the new rules, the bad loans burden will rise by 7 trillion yen to 21 trillion yen (over US$ 160 billion). When the loans written-off for FY 1998 are subtracted, the banks still have about 11 trillion yen of bad loans carrying over to next fiscal year.

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Other factors that will make transition to international competition more difficult for the domestic actors are low-quality university education in finance and deficient knowledge about new technological solutions. Specialised education in finance at the graduate level at Japanese universities has to date been virtually non-existent. The result is university graduates unfamiliar with the more specialised financial products and tailor-made products using derivatives, i.e. so-called financial engineering. Regarding technological solutions within banking, Japanese banks have been behind the times for long time. Only during the last couple of years have Japanese banks started to offer 24-hour service ATMs (though virtually all ATMs still do not accept foreignissued credit cards)vi. In February 1998, Sumitomo also introduced the first Japanese bank internet and telephone banking service, a service which American and European customers have been using for years (FEER, 3 September 1999). So far, in order to capitalise on specialist knowledge at foreign securities companies, several Japanese companies have formed partnership agreement with various U.S. and European financial companies. In turn, these foreign companies objectives have been to use the Japanese companies well-developed retail network in order to make their names known to Japanese consumers. The pattern is very similar to earlier ones by western companies in other industries to break into the Japanese market. At the same time, many Japanese securities firms are on the defensive: Daiwa Bank, Fuji Bank, Hokuriku Bank, Nomura Securities, Nikko Securities and Daiwa Bank have all decided to shut down operations abroad or downsize their international presence radically (FEER, 5 November 1998). In other words, the foreigners are in, the Japanese are out. On the supervisory side, the Financial Supervisory Agency was created to stop MoF way of administrative guidance, which was praised by scholars and observers during the 1980s, but now proved to be more of a cause to the problem. Far Eastern Economic Review reported on 3 September 1998 that the Financial Supervisory Agencys director met with the Sumitomo Trusts president to urge him to absorb the defunct LTCB in a merger; that is, FSA did exactly what governmental agencies were supposed not to do anymore. This should make at least some to question how the commitment of the bureaucrats for the reforms really is. However, FSA have since started to be active in tidying up the financial sector, notably in the insurance sector, where it have ordered weak insurers to cease operations (Economist, 4 December 1999). For individuals, the reform has been clearly visible. Apart from media coverage on the changes of 1 April (reports from discount ticket vendors starting US dollar exchange etc.), the banks have got new inventories in their offices. New counters for insurance and securities investments have appeared; Japanese nationals can open bank accounts and investment portfolios abroad without governmental permission etc. For individuals, the reform of the Foreign Exchange and Foreign Trade Control Law in particular should mean increased welfare and some recapturing of the previously lost consumers surplus. One of the real challenges for both new entrants and domestic actors is to persuade the remaining Japanese who have remained loyal to their old banks and saving forms. Being conservative, Japanese savers are not going to rush over money from postal savings to mutual funds managed by foreign securities companies they have never heard of, even though the returns are much higher there. Furthermore, the savers are

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potentially even more careful after having lost large sums of money back in the 1980s. If the securities companies succeed, they can harvest a big reward for their efforts: the personal saving amounted to 1200 trillion yen (US$ 9.2 trillion) last year. 4. Conclusions The Tokyo Big Bang still has a long way to go; the reform program is to be fully implemented by 2001. But it is not the implementation itself that is problematic; it is the how the actors in the economy will react to the institutional change. In this analysis, it is shown that inertia exists at all levels of the society: at government level, at corporate level and at individual level. An apparent question here is whether the actors within the financial industry should have got used to the reforms by now. After all, it has been a continuing process since the 1970s. The answer is obviously no. The early reforms were done on piecemeal basis, and no change was done to the most important feature on a fair, internationally competitive market: the transparency. The obstacles on the way to make the Japanese financial markets competitive are many. The most important of all is to get rid of all bad, non-performing loans from the bubble era of 1980s. Even though Japanese bankers have repeatedly been announcing that all non-performing loans have been written off, it is obvious that they were wrong, if not outright untruthful. As long as the bad loans are hidden, the burden of inefficient companies on the economy as whole will continue. Stimulation packages will not be sufficient, and the planners at governmental level will continue to miscalculate the effects. As these packages do not have the promised effects, the public trust in both the political system and the economy as a whole will further deteriorate, which in turn worsens the economic outlook for the country. The much-celebrated Japanese model has been much to blame. This climate has fostered unhealthy relations between government and companies, which in turn have created protected sectors in the economy. The ways to escape transparency have been many; apart from the mentioned deficiency in rules for consolidated accounting, the managers of the financial institutions could in the short run simply lobby and bribe their way out. Even though the officials and corporate managers are replaced by others, the practices are still in the walls of the Japanese financial companies, MoF and Bank of Japan. As Edward J. Lincoln writes: Among bureaucrats and politicians there remains a strong faith in the Japanese style of capitalism and a resistance to truly liberating financial markets (Lincoln, 1998). This is proved by the behaviour of the Financial Supervisory Agency in 1998. Thus, the commitment of the bureaucrats and the Japanese market actors is also crucial for the success of the Big Bang reform. So far, the concrete effects of the Big Bang reform on the macroeconomic level are mostly short-term. The volatility in interest rates depended on indirect effects of the fiscal policy rather than the reform. On micro level, the changes have been more obvious. The range of investment choices for consumers, as well as the possibilities for companies to do sound risk management, has increased dramatically since April 1, 1998. This has probably increased the welfare for the market actors and made capital

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allocation more efficient. Foreign competitors have also become more visible compared to the situation before the reform. It is now imperative for politicians to keep up the good work of reforming the domestic economy and not to halt the pace of the reform after the Big Bang. The financial industry has not been the only protected sector; there are still regulated sectors of the economy such as the transport industry and the agricultural industry. Inefficiencies due to regulation cost money, not only to the individual Japanese, but also to the society as whole. The scope should envelop the whole economy, and to carry out institutional reform on a piecemeal basis will probably prolong the depression-like economic performance of Japan. Summing up, Japan has once again to be good pupils of the West and learn its practices in order to clean up the institutional mess caused by itself. This includes moves natural in the West but hard-digested in Japan, such as letting inefficient companies go bankrupt, forcing the investors take the losses and free the factors of production so they can be put into productive use. Japan has made profound changes before in its history, and if the aim this time is to make Japan an internationally competitive economy, the hard lessons of deregulation have to be learned.

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References Bank of Japan: Research and statistics department (1999), Economic statistics monthly, No. 624 March 1999, Tokyo: Bank of Japan, p. v. The Economist, Financial Indicators, issues June 1997-August 1999. The Economist, selected issues 1998-1999. Far Eastern Economic Review, selected issues 1998-2000. Hall, Alexander J. B. (1998a), Financial Reform in Japan: Causes and consequences, Cheltenham: Edward Elgar, ch. 2-4. Hall, Alexander J. B. (1998b), Supervisory Reform in Japan, Longhborough University Banking Centre Research Paper No. 128/98 November. Hall, Alexander J. B. (1998c), Financial Reform in Japan: Japans Big Bang, Longhborough University Banking Centre Research Paper No. 1119/98 January. Hamao, Yasushi and Narasimhan Jegadeesh, An analysis of bidding in the Japanese Government Bond Auctions, The Journal of Finance, Vol. LIII, No. 2, April 1998, pp. 755-772. Kodansha Encyclopedia of Japan (1983), Vol. 1, Tokyo: Kodansha, pp. 137-140. Lincoln, Edward J., Japans Financial Mess, Foreign Affairs, Vol. 77, No. 3, May/June 1998, pp. 57-66. Morck, Randall and Masao Nakamura, Banks and Corporate Control in Japan, The Journal of Finance, Vol. LVI, No. 1, February 1999, pp. 319-339. Nikkei Weekly, selected issues 1999. OECD, OECD Economic Surveys 1997-1998 Japan, Paris: OECD (1998), pp. 45-46, pp. 64-65. Porter, Michael E. and Hirotaka Takeuchi, Fixing What Really Ails Japan, Foreign Affairs, Vol. 78, No. 3, May/June 1999, pp. 66-81. Sjstrand, Sven-Erik et al. (1995), On Economic Institutions: Theory and applications, Hants: Edward Elgar, p. 21. Uriu, Robert, Japan in 1998: Nowhere to Go but Up?, Asian Survey, Vol. XXXIX, No. 1, January/February 1999, pp.114-124.

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Appendix 1: An overview of the pre-reform Japanese banking system. Central bank Private financial institutions Bank of Japan (Nippon Ginko) Ordinary banks

Specialised financial institutions

Financial institution for international finance Financial institution for long-term credit

Financial institution for small business

Other financial institutions

Financial institution for agriculture, forestry and fishery Insurance companies

City banks (toshi ginko) Regional banks (chiho ginko) Regional banks, members of second association of regional banks Foreign banks Specialised foreign exchange bankvii Long-term credit banks (choki shinyo ginko) Trust banks (shintaku ginko) Mutual savings and loan banks (sogo ginko) Credit associations (shinyo kinko) Credit cooperatives (shinyo kumiai) Shoko Chukin Bankviii Norin Chukin Bankix

Life insurance companies (seimei hokengaisha) Non-life insurance companies (songai hokengaisha) Securities companies (shoken gaisha) Housing finance companies

Table 1. (Source: Bank of Japan, 1999, Kodansha, 1983 and Hall, 1998a)

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Governmental financial institutions

Banks

Public corporations

Others

Export-Import Bank of Japan (Nihon Yushutsunyu Ginko) Japan Development Bank (Nihon Kaihatsu Ginko) Includes among others: Peoples Finance Corporation (Kokumin kinyu koko) Small Business Finance corporation (Chusho kigyo kinyu koko) Small Business Credit Insurance Corporation (Chusho kigyo shinyo hoken koko) Housing Loan Corporation (Jutaku kikyu koko) Environmental Sanitation Business Finance Corporation (Kankyo eisei kinyu koko) Agriculture, Forestry and Fishery Finance Corporation (Noringyogyo kinyu koko) Japan Finance Corporation of Municipal Enterprises (Koei kigyo kinyu koko) Hokkaido and Tohoku Development Corporation (Hokkaido Tohoku kaihatsu koko) Okinawa Development Finance Corporation (Okinawa shinkyo kaihatsu kinyu koko) Postal Saving Overseas Economic Cooperation Fund Trust Fund Bureau (Shikin unyubu)

Table 1. (continued)

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SCAP = Supreme Command of Allied Powers, the Allied Occupation Administration in Japan 19451952. ii Literary descendants from heaven. iii The Japanese fiscal year begins 1 April and ends 31 March each year. iv See Hall, 1998c for exact details of the reform. v The slump in unsecured, overnight lending rates to 0.01% was a result of an official change in the money-market policy of Bank of Japan in February and BOJ Governor Hayamis statement that the central bank would allow the overnight rates to fall to 0% if necessary. Thus, the record-low overnight call rates were a result of a policy decision rather than the reform itself. vi Though still in limited scale. vii There was only one such bank under the pre-reform era: Bank of Tokyo, later Tokyo-Mitsubishi Bank. viii Called Central bank for Commercial and Industrial Co-operatives in English, it provides financial assistance to the unions of small and medium-sized companies and rectifies temporary local fund imbalances between them. ix In English Central Co-operative Bank for Agriculture and Forestry. Although co-operative in nature and owned by over 4500 agriculture co-operatives, it works as an ordinary bank but only for agriculture co-operatives.

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