Mitsuhiro Fukao

Japan's Lost Decade and its Financial System

After briefly explaining the causes of the Japanese asset-price bubble in the 1980s, this paper analyses why the bursting of the bubble developed into a full-fledged financial crisis in the late 1990s. In order to cope with this crisis, the Government has injected capital directly into the banking sector and banks have written off enormous amounts of bad loans. However, the Japanese financial sector remains very weak and Japan still faces a number of problems in its financial system. Firstly, the profit margin of banks is too small to cover the increased default risk following the bursting of the bubble, and there are market distortions created by the government-backed financial institutions and the requirements on new lending to small and medium sized companies. Secondly, banks still have excessive stock investment and crossholding of shares between banks and other companies has weakened the market discipline on entrenched management. Thirdly, the government guarantee of all banking-sector liabilities should be removed. Once the financial system is stabilised, a risk-adjusted deposit insurance premium should be introduced so as to strengthen market discipline on banks, and the huge postal saving system should be privatised to create a level-playing field among deposit taking financial institutions. Besides the foregoing, the weak corporate governance structure of Japanese financial institutions has to be remodelled. The management of banks has shielded themselves by extensive cross-shareholdings, especially with life insurance companies. There has been extensive mutual provision of capital, most large life insurance companies have weak corporate governance, and many of the large shareholders of banks are life insurance companies. This double gearing between banks and life insurance companies has therefore weakened the market control of Japanese financial institutions.

Financial Crisis and the Lost Decade

Japanese banks incurred heavy losses in the early 1990s due to the bursting of the bubble economy of the 1980s. Japanese regulators allowed undercapitalized banks to operate under a very lenient application of capital requirement rules. At first, the regulators did not have strong institutional mechanisms and budgetary funds to take care of weakened banks. Even after obtaining strong power and money in 1988 to tackle the banking problem, the regulators would not nationalize a large number of banks because they could not manage nationalized banks themselves. The recent recovery of the Japanese economy gives the Financial Services Agency a chance to make up for the lost decade of regulatory discipline.

European Sovereign Crisis and Its Implications for Japan: Reducing Budget Deficits Without Damaging Recovery

Japanese government bond interest rates remains very low in spite of the very large budget deficit and very high debt-GDP ratio of the Japanese government. The Japan’s low interest rates make a stark contrast to very high interest rates in the periphery countries of the Euro-zone such as Greece. This is due to the fact that Japan has an independent central bank, the Bank of Japan, and it can maintain zero-interest policy as long as deflation continues. However, the continuation of the status quo is highly risky because the market confidence in Japanese government is gradually eroding. In order to stabilize Japan’s fiscal deficit, it is necessary to raise taxes on a very large scale without hurting the economy recovery. Gradual increase in the indirect taxes with some fiscal investment stimulations and/or the introduction of Gesell tax (thin tax on the balance of safe assets) are proposed as possible policy options.