DP2011-29

The Japanese Financial Sectorʼs Transition
from High Growth to the ʻLost Decadesʼ:A Market Econom y Perspective
Wataru TAKA HASHI

October 24, 2011

The Japanese Financial Sector’s Transition
from High Growth to the ‘Lost Decades’:A Market Economy Perspective 1
Wataru Takahashi
Research Institute for Economics and Business Administration
Kobe University(wtaka@rieb.kobe-u.ac.jp)
Abstract
This paper looks at Japan’s experience in transforming its financial system. While thecountry is considered a model of successful Asian economic development, it has encounteredmany difficulties as introducing market economy. During the 1960s and 1970s, Japan
experienced high economic growth, contributed by its regulated financial sector. Cooperation
among the government, banks and corporations created a strong system, in which mainbanks played an important role. They supported companies and, sometimes, in addition totheir role in the corporate governance of client enterprises, they also rescued troubled
companies. In addition, banks extended loans to businesses in promising sectors, thereby
assuming risks similar to those taken by venture capitalists. However, during the1970s and 1980s, Japan’s financial system, under pressure from the changing economic
environment, was compelled to adjust. Economic growth led to changes in the money flow, asJapanese big business began to lose its appetite for borrowing. Instead, there developed
circumvented financing outside the domestic market that, with the growing bond market
and accumulation of other financial assets, led to financial liberalization.In the late 1980s,
this liberalization resulted in a combination of loose monetary conditions after the Plaza
Agreement, an economic boom, and the bursting of the asset bubble. Then, between 1991
and 2000, Japan experienced a “lost decade.” Now, in order to pull itself out of its economic
malaise, Japan continues to focus on market orientation in a bid to achieve economic reform
but, so far, this has been little benefit. One of the main challenges Japan still faces isdeveloping a new set of institutional complementarities.
Keywords: Institutional Complementarities, Network Capitalism, Personalized System

JEL Classifications:E44, N15, O16

1This paper was presented at the London School of Economics (LSE) workshop on East Asian capitalism.

I would like to thank Kumiko Okazaki and Masazumi Hattori for their helpful discussion and Hiroyuki Oi
for his excellent research assistance. I also appreciate the comments from Jenny Corbett as a discussantand the workshop participants, in particular, Xiaoke Zhang and Andrew Walter for their very thoughtfulcomments on the early draft of the paper.

11. Introduction
Japan emerged as the first successful industrialising nation in East and South Asia, playing a keyrole as the region’s leading capitalist economy following the Meiji Restoration in 1868.
Thereafter, the Japanese government was a major force behind the nation’s industrialisation,
particularly in the early stages of development. The government adopted the strategy ofnurturing new industries by inviting in foreign professionals in order to acquire the modern
production methods and management techniques of modern corporations. Many elements fromthe Western world such as legal and accounting systems were adopted. The establishment ofstate-owned corporations in important industries such as railways, textiles and steel
manufacturing enabled these firms to serve as engines of the nation’s industrialisation. Large
private businesses such as Mitsubishi and Mitsui expanded their scope by working hand in handwith the government. The rapid development which was achieved demonstrates the success ofthe government-led strategy in Japan during this period.
Although the Japanese economy suffered heavy damage in the course of the Second
World War and a new course became necessary, many characteristics of the government’s
development strategy were retained after the war ended. Whereas a significant reform ofpolitical and economic system took place, the government continued to exercise leadership indeveloping the economy. Japan is sometimes regarded as a typical development model of Asian
economies. However, unlike the recent development strategies adopted by Japan’s Asianneighbours, Japan promoted the development of national industries while Asian neighbours
actively invite foreign capitals. This different approach could make the unique Japanese system
in which domestic economic actors are mutually connected and supported, paying less attention
to the global standards.
Japan’s notable economic success during the high-growth period of the 1960s attracted
much attention. By the 1970s, a growing number of scholars from the West were focussing on
Japan amidst a perception that its development represented a challenge to US economic
dominance. Chalmers Johnson, Ronald Dore, Ezra Vogel and others pointed to a ‘Japanesemodel’ of capitalism — distinct from the US and British versions — and laid the foundation forthe literature on the developmental state (see, e.g. Wade, 1990).
Some of the key aspects of this Japanese developmental model, described by Johnson（１９８２） and Woo-Cumings （１９９９） as ‘catch-up nationalism’, included the role of the
Ministry of International Trade and Industry (MITI) as an economic ‘pilot’ agency (Johnson,1982); cooperative and non-hierarchical firm-labour relations (Dore, 1973) and a focus oncontinuous innovation and improvement (Womack, et al., 1900); cooperative relations between
firms, suppliers and banks (the keiretsu system); and a long-term orientated, bank-based system2

of finance (Zysman, 1984).
As is clear from the above, the Japanese economic model can be understood as a
combination of ‘government leadership’ and ‘cooperative relations amongst various economic
agents’. It could also be described as ‘relation dependent’, in that economic agents including thegovernment and banks were networked through the establishment of stable relations.
Focussing on the role of the government in economic development, Noguchi (1995)
described the Japanese model after the Second World War as “the 1940 system’. As capital
markets during the interwar period had been relatively well developed, the economy had moved
towards a market orientation. As the military increased its power, however, the government
restructured and consolidated the economic system to prepare for the wartime economy in thelate 1930s and early 1940s. Under the National General Mobilisation Act in 1938, a planned
economy was introduced and a wide range of government guidance was implemented for allindustries. At the corporation level, consolidation was promoted to enhance the efficiency of
production. Noguchi and others (Okazaki and Okuno-Fujiwara, 1999, and Teranishi, 1994) havesuggested that some of the features of present-day Japanese management, such as the main banksystem, were originally formed during this time.
The banking system in Japan had followed a similar history. After the 1868 Meiji
Restoration, Japan adopted the national bank system modelled on the US practice. With theconsequent loosening of each bank’s reserve requirements to issue banknotes, however, thisdecentralized banking system produced severe inflation. Accordingly, the Bank of Japan wasestablished as the nation’s central bank in 1882 to curb inflation, and currency issuance wasreserved to it alone.
Between the Meiji Period (1868–1912) and the beginning of the wartime regime, thenumber of banks increased and many small banks expanded to a nationwide scale. Under thewartime regime, a number of consolidations in the banking sector took place, and banks wererequired to provide funds to large-scale manufacturers; in particular, military industries weresituated as ‘main banks’ 2 . At the same time, banks fell under the strong control of thegovernment, and the convoy system was established, under which banks were protected by thegovernment.
Noguchi (1995) has suggested that the essence of this pre-war economic system waspreserved under the US occupation following the Second World War, and that the wartime
system bequeathed by the 1940s regime functioned very effectively to promote Japan’s
economic success during the post-war period.
2 In Japan, the number of banks varied dramatically before the Second World War. In termsof commercial banks, it recorded over 1,200 in the late 1920s. It halved after the banking
crisis in the early 1930s. During the wartime period from 1941 to 1945, the number became
one-third from 186 to 61. After the war, the number had not changed until the late 1980s.

3This wartime financial system that survived into the post-war period was characterized
by regulations and guidance, under government control. It took the form of a separation ofbusiness amongst banks, securities houses and insurance companies 3 . Each of these players wasprotected by the government, and new entry to the industry was highly restricted. For the
introduction of new financial products, government permission was required. Returns andinterest rates were set low in accordance with government policy. As a result, a substantial
element of ‘financial repression’ took place, in which savings were recycled and household
sector was effectively taxed whilst manufacturing investment was subsidized. Real interest rates
on savings were often negative in Japan in the 1960s and 1970s, although interestingly not in
the 1950s (Chart 1).
Despite the regulated low interest rates on deposits, the fruits of economic success werebroadly shared with the household sector in the form of a rapid increase inincome. On the back of the high savings ratio, the household sector accumulated financial assets
in the form of bank deposits.
As mentioned above, a separation of business was enforced in the financial sector.
However, relations of mutual dependence were also preserved. Even between banks and life
insurance companies, cross-holding of shares took place. Banking was specialized in the formof long-term and short-term credit banks. Despite the smaller number of branches permitted
them, long-term credit banks were allowed to issue bank debentures. By holding these bankdebentures, local banks supported the financing by which long-term credit banks received
higher returns than deposit rates.
Taken as a whole, the Japanese economic system could be characterized as combining
government intervention and mutual support amongst private agents 4 . It could also be describedas network capitalism. By establishing implicit contracts, economic sectors including thegovernment were mutually supported and risks were shared.
As high economic growth was achieved, the economy became more tolerant torisk-taking due to the increase in income and the accumulation of financial assets. The demand
for risk-sharing weakened during the high-growth period, However economic ties amongst
actors became firm. Deregulation and privatization

progressed. Reforms proceeded in the

3 The banks were allowed to underwrite stocks and corporate bonds in the pre-war period. It

was prohibited by the Securities and Exchange Act in 1948. Banks were partially allowed for
securities business by the new Banking Law and the new Securities and Exchange Act in1981 in the stage of financial liberalization ( see also footnote 9).
4Japan’s developmental style of ‘financial repression’ differed from the popularised form. In Japan,
although a wide range of government guidance was observed and direct intervention by the government
played an important role — for example, in the form of the Fiscal Investment and Loan Programme aswell as ordinary public expenditure— the government encouraged the development of private firms. As aresult, the size of government was kept relatively small and the budget was balanced before the early
1970s..

4direction of a market economy. Labour mobility strengthened. The development of capital
markets also showed the weakening of the relations of mutual dependence, as Japan attempted
to move towards a more ‘atomised’ system.
Disruption appeared in the form of the economic bubble, and the long-lasting financial
problems in the wake of its implosion. Although the reforms continue into the present, somemodifications have been implemented. For example, the protection of small firms wasintroduced and a proposal was made to review ‘relationship banking’. The reforms are thus
encountering various types of friction, and a conclusive picture of the future economic system is
not yet apparent. Development remains in progress, although a firm trend is seen in the direction
towards economic integration with the rest of East Asia.
Focussing on the financial aspects of economic developments in Japan, this paper
outlines the changes over time to Japan’s financial sector in recent decades, with attention paid
to the introduction of market mechanisms and its influence on changes in the economic system.
We discuss how the network economy was formed through collaboration under government
leadership. It also discusses why the economy developed more independently and continues todevelop.
In the following sections, we divide the post-war period into three segments: (1) the
1960s to 1974; (2) 1974 to 1989; and (3) the 1990s and after. Interestingly, each of the three
periods for Japan described above is characterised by strikingly different economic performance(Chart 2). Given that financial liberalisation in Japan started in the 1970s, it is appropriate tobegin our outline from the 1960s to better capture changes in the economic environment.
2. The 1960s to 1974
A notable feature of the Japanese economy — prior to the first oil shock and the adoption of thefloating exchange rate in the mid-1970s — is that it achieved high growth through a strong‘organisational’ or ‘relation-dependent’ political and economic system that combined thegovernment, the banking sector, and corporations. In addition to Japan’s well-known main banksystem, many long-term relationships amongst economic actors were widely observable in theeconomy. For instance, in the corporate sector, the system of mutual dependence based on
established business ties (the keiretsu system) — for example, between large assembly makers
and small parts makers and between wholesalers and retailers — had gradually been established.
In labour relations, full-time employment had been established and labour unions became an
important player in corporate management. Employment was guaranteed with wage flexibility
utilising the bonus system. Employees acquired company-specified skills through on-the-job
training, and labour relations were internalized within firms. Many characteristic private-sector
5practices came into being, complemented by government guidance during the period. Thereseems to be no firm conclusion as to when many of these elements such as the keiretsu system,
life-time employment and company unions were established; some of them like the main banksystem can be traced back to the pre-war period. But they became more firmly embedded during
the high-growth period to realize greater efficiency.
In Japan’s financial sector before the 1980s, informal relationships were gradually
institutionalised, and various types of bargaining amongst economic actors took place insideorganisations such as firms and keiretsu firms as the internal market. This system can be broadly
characterised as a system of risk-sharing. Cross-holding of corporate stocks was a device toensure that corporations would provide mutual support, particularly when they encounteredeconomic difficulties. It was important for companies to maintain firm business relationships
and thus ensure their ‘reputation’.
With respect to the relation between banks and corporations during the period, it should
be noted that strong ties were first achieved between large banks and relatively large
corporations, evolving later into the main bank system. As for small and medium-sizedcorporations, their relations with banks remained rather less well defined, although they became
more institutionalised at a later stage after the 1980s, when banks began to lose large businesses
as their dependent borrowers.
The system of income redistribution was also facilitated by another important aspect ofJapan’s economy during this period. In recent years, increasing divergence of incomes and othereconomic conditions has been observed in other Asian economies that are undergoing rapid
economic development, such as China. Japan’s development, on the other hand, was achieved
through income redistribution by means of a number of economic mechanisms, which helped
maintain the stability of the network (Teranishi,1997). Government policy in Japan was a major
contributor through fiscal redistribution. By means of the local allocation tax system, asubstantial portion of central government tax revenues was allocated to local governments. As
explained later, since large banks (city banks) in Japanese urban areas were borrowing funds
from small banks (regional banks) continuously, a smaller part was played by the redistributionof income from large urban groups to small regional ones through the banking sector 5 . During
the Japanese economy’s high-growth period, industrialisation took place mainly in the nation’scentral coastal area, and the labour force shifted from regional localities to central hubs, thus
reducing the potential for economic growth in rural areas. Income redistribution between urban
and rural areas played an important role in softening the shocks engendered by the rapidchanges during the high-growth period. Ironically, with time this mechanism promoting social
5

The magnitude of the income shift in the financial sector was, of course, much smaller than that in thefiscal sector.

6stability during the high-growth era would become an obstacle to systemic change.
Returning to the problems of the Japanese financial system during the period, it proved
to function well in pursuit of the national goal of high economic growth after the Second World
War, particularly in terms of the following:1) savings and protection of small depositors were promoted;
2) bank lending served as low-cost funds for growth; and3) the financial market remained separate from the international market.
During the post-war recovery, priority was placed on the promotion and protection ofsavings, since at that time Japan was impoverished with a low level of financial assets, and mostpeople could not afford to invest in securities. Small savings were protected as bank deposits,
which were deemed to be safer assets than securities that bore risks of price changes 6 .
In addition, banks’ profits were virtually guaranteed by the government. Interest rates
were regulated to generate ‘rent’ at banks, a sufficient margin between lending and depositinterest rates. Competition was also restricted: permission from the government was required tosell a new product or open a new branch. These measures formed what was called the ‘convoy
system’, since the government protected the weakest banks and helped them avoid bankruptcy.
The financial sector was segmented into securities houses, insurance companies, andbanks, and the bank loan market was separated into long- and short-term loans for the long-term
credit banks and the commercial banks such as city banks and regional banks, individually. In
addition, by controlling the numbers of branches, the government essentially controlled thescope of operations of city banks and regional banks.
The bond market in Japan at this time was undeveloped. Strict requirements were
imposed on new bond issuance, and only a limited number of firms were allowed to issue
bonds 7 . At the same time, the government started issuing bonds on an increasing scale in the
1970s, triggering the liberalisation of interest rates on bonds as well as interest rates in general.
In this system, the banks did not need to consider the control of risk in lending.
Basically, there was no market risk with regulated interest rates and no potential for maturity
mismatches in the segmented loan market, and therefore banks could seek to boost their size by

6 The one year time deposit rate was fixed around at 5 or 6 % for nearly 20 years from 1951

to 1970.
These measures protected the banking sector. Even though the issuance of corporate bonds was limited,
long-term credit banks were allowed to issue bank debentures. In addition, in the case of new issuance ofcorporate bonds, main banks maintained their status as bond administrator under the tight separation of
the banking and securities businesses. In Japan’s regulated financial sector, banks were favourably treated(see also footnote 5).

77increasing deposits with little consideration of risk 8 . Due to the vigorous appetite for corporate
investment, there was ample demand for bank credit. Banks could choose customers of good
credit quality and control credit risk with little effort. Thus, in later years, when banks had tooperate in an economic environment of financial liberalisation, they lacked the necessary
experience with risk management, especially where small corporations were concerned.
Low-cost loans were allocated by banks as discretionary rationing. This encouraged
capital expenditure and served as an engine of high economic growth 9 . Bank lending was the
only effective route for corporate financing, as neither the bond nor equity markets were welldeveloped 10 . Most of the credit in the economy was controlled by banks.
The main bank system gradually prevailed across the spectrum from large businessenterprises to small and medium-sized ones. The scope of business of banks in those days wasbroad. In addition to conventional activities such as monitoring and screening, banks conductedinvestment banking activities such as provision of advice and organisation of customers’
businesses as part of their standard services, sometimes even taking the dominant hand inrunning the businesses 11 .
Since money flow was straightforward (Chart 3), banks’ mission at the time was also
simple: the allocation of funds to growing industries such as large manufacturing firms. This canbe depicted as the following.
Households (bank deposits) 12 ⇒ Banks (bank lending) ⇒ Corporations(‘Corporations’ above are typically export sector and large manufacturers.)(Small) Regional banks (interbank market lending) ⇒ (Large) City banks
In addition to the flow of funds from households to corporations, funds flowed fromsmall regional banks to major city banks, with large city banks borrowing funds from small

8 Bank size was important in those days, since the government’s discretionary actions and ‘voluntary’adjustments inside the banking sector were largely determined by referring to the size of the banks’ total
assets and deposits.
9
There is a counter-argument that effective lending rates, which took into account the compensateddeposit balance, were higher than the displayed lending rates. Even so, banks could provide cheap fundby financing low-cost deposits.
10 The equity market was relatively well developed compared to the bond market, but cross-holdings ofshares were used from the 1960s. A substantial portion of equity was thus tied up in financial institutions(banks and life insurance companies). Banks also undertook and purchased corporate bonds.
11
Banks sometime sent their staff to a customer corporation to serve as high-ranking managers. This
happened particularly when a customer firm fell into difficulty. But the investment banking activities
mentioned here were usually provided on a daily basis.
12
During this period, a massive portion of household savings went into bank deposits. This occurredbecause the capital market was under-developed and overseas investment was restricted. However, evenafter liberalisation, households still keep a significant part of their savings in the form of bank deposits.

8

regional banks to satisfy the large investment appetites of the major corporations they served inurban areas. Through this activity, a portion of the profits of large corporations was transferredto the small regional banks.
The banking sector was one of the primary routes through which monetary policy was
implemented. It should be noted that when monetary tightening occurred, it affected city andregional banks differently, with the end effect being a further redistribution.
Thus, in the case of monetary tightening, there born a relatively small increase in theofficial discount rate (ODR) to which lending and deposit rates were linked. By comparison, themonetary operations of the Bank of Japan sometimes caused a relatively large rise in the money
market rates to take place. Since city banks were borrowers and regional banks were lenders in
the money market, profits moved from the city banks to the regional banks in the form of adecrease in profits of the former and an increase in profits at the latter.
This was another necessary condition for the regulated Japanese system. Capital
controls were imposed, although they were only selective and later they were relaxed. Inward
foreign direct investment (FDI) was restricted through controls on foreign ownership andcross-holdings of corporate shares.
Foreign exchange transactions for current accounts (exports and imports) were allowed
and were concentrated at banks with such permission (‘forex banks’). However, forex banks
were controlled by position guidance (the forex position, the sum of the spot and forward rates,
had to be squared by each bank every day). The under-development of the capital markets
helped to keep the markets closed to foreign investors, as it effectively shut down the majorroute for inward investment (including portfolio investment) from overseas ( Table 1)..
3. From 1974 to 1989
Japan’s high-growth period came to an end around the time of the first oil shock, in 1974. The
Japanese economy weathered both this oil shock 13 , despite a subsequent hike in inflation, andthe shock that followed in 1979. This outcome argued for the nation’s superior economic
performance, since other advanced economies suffered higher inflation as well as economic
stagnation at the time.
As the Japanese economic system was implicitly designed assuming continuous highgrowth across many fronts, in facing decelerating growth it was approaching a turning point.
One example of this was in labour relations. As the economy grew more slowly, it became
difficult to maintain the life-time and seniority system because of its upward-sloping cost
13 After the oil shocks, growth slowed. At the same time, the oil shocks led the Japanese economy tobecome more energy-efficient.

9

increase. In addition, as foreign investors began to pay greater attention to Japanese firms, there
was increasing pressure on the firms to boost profitability ratios such as return on equity (ROE).
Japanese corporations could not afford to maintain the past financial standards in order to adjust
to the global financial market. Thus, even as the well-known Japan as Number One was being
published (Vogel, 1979),Japan was encountering difficulty .
Financial liberalisation was carried out in the 1980s. During this period, regulation ofinterest rates and separation of financial businesses were relaxed, and banks were allowed toenter the securities business. Although its pace accelerated in the late 1980s 14 , liberalisation
remained gradual: 15 years were required for liberalisation of interest rates and 34 years forcapital controls to be lifted (Takahashi and Kobayakawa, 2003; see also Tables 1 and 2). The
main reason for the delay was the difficulty of coordinating the interests of players in the
differing financial industries. Banks, securities houses, and life insurance companies weresegmented by the regulations, and vested interests in each segment worked to prevent thecoordination of reform. The conflict of interest amongst government authorities could bepointed to as a reason for the delay: banks, securities houses, and life insurance companies weresupervised by separate bureaus inside the Ministry of Finance. Agricultural financial institutions,
meanwhile, were supervised by the Ministry of Agriculture 15 .
The causes of financial sector liberalisation can be summarised as follows:
1) A structural change in money flow (Chart 3)
This was the basic change in the financial market. In terms of the investment-saving (IS)balance, as economic growth slowed, capital spending decreased and corporate profits
accumulated as corporate saving. The corporate sector turned into a net saver, offsetting the
emergence of the government as a net debtor. Households remained net savers even though
the personal saving rate gradually declined. Overall, the current account increased, whichmeant that the foreign sector was as much of a net debtor as ever.
With the change in the financial position of corporations from net borrowers to net
savers, they became depositors to banks. Banks thus began to lose customers to which tolend. This spurred change in the business of banks.
2) Accumulation of financial assets in the private sector
The increased ability in risk-taking (i.e. households able to engage in portfolio selection)
14

The pace of liberalisation accelerated in the late 1980s. The increasing issuance of government bonds
induced a liberalisation of interest rates to attract investors by offering higher returns. Foreign pressure
intensified due to the increasing external surplus.
15 Some non-bank corporations such as credit card companies and finance lease companies weresupervised by MITI (Ministry of International Trade and Industry). The separation of supervision, which
was named “bureaupluralism” by Aoki(2001), made difficult to coordinate to plan the reform.

10naturally required higher returns and a variety of financial products.
3)

Development of bond markets
This relates to item 1 above. A substantial issuance of Japanese government bonds (JGBs)
became necessary due to an increasing fiscal deficit. Corporate bonds also began to beissued in large amounts. This in turn required the liberalisation of interest rates to attract
investors.

4)

Internationalisation and adoption of the floating exchange rate system
The adoption of floating exchange rates triggered financial liberalisation. Due to arbitrage
between the spot and forward rates, the foreign exchange forward market can work as a
non-regulated market in terms of interest rates. This represented a good investment
opportunity for investors. Non-financial corporations such as trading houses (sogo shosha)
as well as financial corporations became active investors in the market. Thus, after the
adoption of the floating exchange rate system, the process of liberalisation became
inevitable.
The hollowing-out of domestic financial markets became a problem with the
emergence of the euro-yen market. Large Japanese corporations started to issue corporate
bonds in the euro-yen market and Japanese institutional investors (e.g. life insurancecompanies) started to purchase them in the 1970s; in the 1980s, this market boomed 16 . This
led to further relaxation in regulations in the domestic bond market. As a result, large
corporations (the large, reliable customers of banks) reduced the amount they borrowed
from banks, and banks lost their familiar customers in the loan business.

5)

Foreign pressure
The pressure to open Japanese markets to foreign financial firms was intensified by the US
authorities (e.g. the Yen-Dollar Committee, 17 set up in the 1980s) and others 18 . Although
Japan adopted a passive approach to the issue in general, since it enjoyed an increasing
trade surplus with the US, the latter resorted to both bilateral and multilateral negotiations
via the World Trade Organisation (WTO) to open Japanese markets.
An asset price bubble developed in Japan in the late 1980s, focussed on real estate and

16 For issuers, the process for euro-bond issuance was simpler than for the domestic bond market, and forinvestors the yield was higher than for bonds from the same Japanese corporations in the Japanese market
This led to the Structural Impediments Initiatives (SII) in 1989, which also triggered larger-scale
deregulation in the 1990s.
18
Foreign pressure intensified in the latter half of the 1980s, but it had started at an early stage; Japan was
requested to increase its purchases of US government bonds in the early 1980s.
1711stocks. Its main causes were as follows:
1) easier monetary conditions following the Plaza Agreement in 1985;
2) overconfidence about the outlook for the Japanese economy;3) poor credit risk management by banks; and4) weak prudential regulation.
The Japanese government’s commitment to achieve domestic demand-led growth to
reduce the trade surplus also played a role in the formation of optimistic expectations, since it
was believed that the government would maintain its stimulus policies as long as Japan
maintained its current account surplus (Hattori, Shin and Takahashi, 2009, p. 38).
As mentioned above, banks lost their long-standing, reliable customers as large
manufacturers lost their appetite for loan-based funding and instead sought bond and equity
financing 19 . Moreover, deposits increased due to new financial instruments (new term deposits
due to financial liberalisation). Manufacturers, which previously had been large borrowers,
turned into large depositors.
In the early stages of liberalisation, each bank sought to enhance its reputation as afinancial partner for large corporations to boost the prospects for future business. Competition
amongst banks grew intense; at the margin, a negative spread between deposit and lending rates
appeared (Chart 4) 20 . In retrospect, given the structural change in money flow, it is clear that theJapanese banking sector grew too large and should have been slimmed down. Contrarily,
however, banks continued to seek an expansion in volume, since it was believed that the
expansion of the customer base was crucially important for future business (Chart 5) 21 .
Banks played a key role in the creation of the asset price bubble. The banks extended
credit to the real estate sector and/or corporations that promoted their investment in real estate
related business, which was regarded as a new base of high-quality borrowers. Although thebanks’ relationships with these new customers were not deep, they extended loans relying onreal estate collateral, which spurred the vicious cycle behind the asset price bubble. Real estate
was believed to be the most reliable form of collateral, since Japan had never experienced aprolonged decline in real estate prices during its period of rapid growth (and would not do sountil the early 1990s). Prior to financial liberalisation, the use of real estate as collateral had notbeen very popular; it became popular after large banks started to expand their loans to new
19 Bond issuance was fully liberalised in 1996, but because of the stagnant economy the primary markets
have not been very active.
20 Original from Figure 27 in Hattori, Shin and Takahashi (2009).
21
In addition, even at this time, the evaluation of a bank and the guidance by the government still
depended on the bank’s loan volume.

12

customers such as small and medium-sized business enterprises and the real estate sector.
From a different angle, the creation of the asset price bubble could be regarded as a
symptom of the friction caused by changing relationships. Although the economy was moving
towards an atomised system characterized by securitisation, banks sought to preserve thetraditional system of relationship banking. Instead of long-standing credibility, banks wantcollateral to prove its reliable relation. This acted to increase demand for real estate as
collateral 22 .
Hattori, Shin and Takahashi (2009) have shown that the interaction between theJapanese banking sector and the manufacturing sector served as the background to Japan’s asset
price bubble in the late 1980s. During the period, large Japanese manufacturers played a role asa kind of shadow banking sector, conducting active financial investment (dubbed zaitech),similar to the key role played by the “shadow banking” during the recent sub-prime crisis.
4. The 1990s and after
The full consequences of the credit boom and associated asset price bubble of the 1980s only
became clear over the course of the subsequent decade. In the 1990s, Japan’s financial sector
accumulated a massive amount of non-performing loans (NPLs), which took banks much time
to resolve. Activity in the nation’s financial sector weakened in terms of not only expansion but
also innovative business creation 23 . Although Japanese banks succeeded in avoiding major
losses in connection with the recent sub-prime related securities, they have lagged European andAmerican financial institutions in the field of securitisation. Until recently, low profitability
plagued the banking and other financial sectors (Bank of Japan, 2010).
Financial and corporate sector deleveraging undoubtedly depressed economic growth,
although other reasons have been cited for Japan’s economic slump since the 1990s. Hayashi
and Prescott (2002), for example, attributed the slump to a decline in productivity due toshortened working hours and other non-financial reasons. From a broad viewpoint, however, it
could be said that Japan’s economic system faced difficulty in adjusting to its new environment.
This process can be understood in several ways.
First, as the economy matured, people’s preferences diversified and the differentiation
22 Aoki (2001) also shows the view that that the friction caused by the transformation of theeconomic system resulted in the creation of bubble. For example, under the progress offinancial liberalization, financial disciplines of banks came loose due to weakening ofgovernment control. At the same time, banks couldn’t establish the well-functioned
corporate governance.
23
Although Japanese banks conducted investment bank type activities prior to the current stage, they did
not enjoy great success in operating investment banking businesses such as M&A, unlike foreign
institutions. In addition, Japanese banks were reluctant to expand their international activities. This
reflected their eroding capital position, which affected their ability to take risks.

13

of products proceeded. As a result, the nation’s established system of mass production became
obsolete. Small-scale production processes compatible with product differentiation were better
suited to respond to changes in consumer preferences. The shift towards this new system of
production in Japan was only gradual. This response was facilitated by the application of new
information and communications technology (ICT). Although other advanced economies
succeeded in adopting the new technology in a quick manner, the threat that this entailed to asignificant proportion of the human skills embedded in long-term employment contracts delayed
adjustment in the Japanese system.
Second, a mismatch appeared in Japan’s financial sector during the course of change inthe economic structure. Previously, the economic system had been based on mutually dependent
relations amongst agents in the system, but gradually it was transformed into an atomised
system in which agents lacked close, long-standing ties. The effectiveness of the risk-sharing
mechanism under the previous system was reduced, and the dual structure of the economy,
consisting of large and small corporations — which had emerged in the high-growth period —became more apparent. From the 1970s, large business enterprises grew more independent of
the banking sector and found it possible to finance their activities using the capital markets. By
contrast, small corporations that found it difficult to access these markets had to rely on bankcredit. For their part, banks expanded credit to small and medium-sized corporations in place oflarge corporations. Owing to the reduced ‘rent’ guaranteed by regulated interest rates, banks
could not afford to absorb as much risk facing their borrowers as before, and could not act like a
traditional main bank in providing cheap funds and rescuing troubled customers. In response,
the government proposed the concept of ‘relationship banking’ for small and/or local banks. In
fact, the government encouraged banks to expand their credit to small and medium-sizedenterprises through enforcement by means of a special law.
The policy trend towards deregulation and reduced government intervention continued
through the 1990s and into the 2000s. The advent of the administration of Prime Minister
Junichiro Koizumi (2001–2006), which drew partly on the economic philosophy of the
Nakasone administration (1982–1987), added fresh momentum to the process of institutional
reform. Japan’s economic performance, however, had not improved a great deal prior to theglobal financial crisis of 2008-2009.
In the field of finance, the comprehensive package of financial liberalization offinancial “Big Bang” was proposed by the government in 1996(Table 3) and a new law
governing financial services, the Financial Instruments and Exchange Act, was enacted in 2007.
A new NASDAQ type stock market was launched in 2000. In addition, a bankruptcy law forbanks was introduced in 2000, formalising the rules for bank bail-outs. Following the Lehman
crisis, it became evident that an equivalent legal framework had yet to be established in the US14and Europe.
Outside Japan’s financial sector, reforms were enacted concerning the corporate system.
A new corporate law characterised as more market-orientated was enacted in 2005, a response
to continued economic under-performance. Japan had fallen into last place amongst the world’s
developed countries in terms of replacing uncompetitive businesses, and to promote innovationsin the economy it was necessary to simplify the processes for starting new businesses andincreasing replacement through measures such as M&A. Corresponding institutional andlegislative changes accompanied these reforms 24 .
During Japan’s third period of economic development (the 1990s and after),institutional reform proceeded, but some cases of reversal were observed in corporate financing.
Although corporations recognised that banks could no longer carry out the traditional role of amain bank in rescuing troubled customers, large business enterprises gradually increased theirdependence on bank finance during the subdued economic expansion from the early 1990s.
Other changes have been made to liberalisation policies in an effort to preserve theinstitutional stability that Japan formerly regarded with pride as the source of its economic
success. With respect to labour contracts, deregulation of temporary workers’ employment was
carried out. Following the Lehman crisis, however, because of the massive scale ofredundancies amongst temporary workers, the government decided to support their employment
by thoroughly reviewing the related regulations. Although this measure will work to increasesocial stability, it might at the same time decrease the mobility and speed of reallocation of theeconomy’s resources.
To sum up, the experience in Japan shows that transformation of the economic system isa difficult task. Personalised or atomised systems are flexible to change and efficient. Under
such systems, business relations can adjust easily, and adjustment in employment is also madeeasier. Compared to a relation-dependent network system, personalised systems are morecost-efficient and thus suitable for the restructuring of corporations. The recent crisis, however,suggests that a return to risk-sharing is called for, even though it might be more costly. The
crisis also indicates the problem of finding the proper trade-off between efficiency and stability.
Although greater efficiency is required under the intensifying competition accompanying the
progress of globalisation, we have not yet attained a clear picture of the ideal balance.
5. A comparison with present-day China

24 Another example is the accounting system. Most countries, including Japan, plan to adopt the new
International Financial Reporting Standards (IFRS). The completion of the reformation of the accounting
system has required reforms in complementary systems such as auditing and general corporate
governance at a minimum.

15

The present Chinese banking system is similar to the Japanese system before liberalisation in
the sense that both show a high degree of regulation: regulation of interest rates, restriction ofcompetition, and substantial control over foreign exchange transactions and cross-border capital
investment.
Given the internal factors such as changes in money flows mentioned previously, theliberalisation of the foreign exchange market triggered financial liberalisation in Japan, and in
this respect present-day China can be likened to Japan in the early 1970s. It is highly likely thatliberalisation of China’s foreign exchange market will work as a trigger for the entire financial
liberalisation process. China’s liberalisation process, however, will not necessarily follow thesteps taken by Japan, because Japan’s prior economic structure and that of today’s China differ
in many respects. In particular, unlike Japan before liberalisation, China faces issues ofinequality in income and living standards between urban and rural areas, even though full
liberalisation has yet to take place. This difference suggests that China’s liberalisation will be
the more challenging.
In China, the banking sector plays a pre-eminent role in promoting economic growththrough the provision of low-cost funds for fixed investment 25 . However, the banking sector’s
relationship with corporations differs somewhat from the situation in Japan. Even though thesector in China has close financial ties with state-owned corporations, such ties with private
enterprises are much weaker. Risk-sharing is also weak in China, and China does not have aredistribution system between urban and local areas acting through the banking sector, unlike inJapan. In China, when the central bank tightens the money supply, it resorts to window guidance
to reduce bank lending or raises the regulated lending rates (and deposit rates,
disproportionately to lending rates) of commercial banks. When China takes the latter policy
action, the increase in money market interest rates is kept small, with the aim of avoiding a
profit squeeze even at large state-owned banks, minimising the efficacy of the money market asa tool for monetary policy. In this respect, the role of the market is much more limited than inJapan’s previous system, and no redistribution has occurred in the banking sector even though
China has large gaps in wealth between its central hubs and outer regions.
In the case of China, the government has devoted much effort to keeping massive
numbers of workers employed at state-run enterprises. This mission was assigned to thestate-owned banks. The relation was designed by the government as had been Japan in the past
under the wartime regime 26 . This is why the Chinese government acted to rescue Chinese banks
25 With growth of more than 10 per cent (even in real terms), lending rates in China have been kept
significantly below those dictated by the rate of growth (Table 4) , which naturally lead to a rapid increasein lending (Chart 5).
26 Despite large volume of bank lending, a significant part of bank lending goes to thestate-owned enterprises. The relationship between banks and private firms has not a16

in the early 2000s and began reforming the banking sector as the final milestone on the path of
economic reform. The role of banks in supporting troubled state enterprises led to the NPL
problem in the early 2000s, and the situation is sometimes compared to Japan in the 1990s.
There is an important difference, however: Japan’s bubble developed during financial
liberalisation, while China’s bubble emerged prior to liberalisation. This implies that we can not
exclude the possibility that China will experience another bubble in the future as financial
liberalisation progresses. Although the process of reform is making headway and major banks
have been listed on the stock market in Hong Kong, the economy has not undergone what could
truly be called liberalisation. Banks remain protected by substantial interest margins throughregulated interest rates 27 .
This has an implication for foreign exchange rate policy. To maintain regulated interest
rates to support the banking sector in China, capital controls are necessary. Although Chinesebanks have developed into major international entities with a significant presence, it is uncertain
how competitive they are against foreign rivals. State-owned banks will be expected to absorb
losses stemming from further economic reforms such as the urbanisation of rural areas. Thismay be one reason that China remains cautious with regard to the liberalisation of its regulated
system and the foreign exchange market.
Okazaki, Hattori and Takahashi (2011) present an overview of the reform of the Chinesebanking sector since China’s policy of opening up began. Although China has conducted boldmeasures such as initial public offerings of large banks in overseas markets, its reform focusses
mainly on institutionalising the banking sector, which comprises several types of banks. Little
has been done to activate the price (interest rate) mechanism.
6. Conclusion
Japan established a relation-dependent economic system during the high-growth period. Owing
to government regulation and the rules and practices of the private sector, the system was robustand economic actors shared risks by establishing long-term relations.
As the economy developed further, its dual structure — such as that obtaining between
large and small business sectors and the central and local economies — became evident. In
addition to the major role played by the fiscal sector, the banking sector functioned during theperiod as a re-distributor of wealth. Social stability was achieved amidst rapid economic growth,
inducing a reluctance to change further during the subsequent period.
spontaneous development as in Japan.
27 This is the main background of China’s investment-led growth. The ‘gap’ between the growth rate andthe interest rate level generates a distortion, which causes a massive inefficiency in investment. This is
one of the most fundamental issues facing China’s economy.

17

The driving forces of liberalisation were both internal and external. As background to
the purely economic factors mentioned in the previous sections, Japanese industries did not
require a high degree of protection as they prospered. Protection became politically problematicin particular after Japan accumulated large external surpluses and as Japanese corporations
started to obtain financing abroad. Foreign pressures for the resolution of increasing tradeimbalances and escalating trade disputes also played a role during liberalisation.
Japan undertook a gradual process of liberalisation. Although the Japanese financial
system was heavily regulated, there was room for discretion in terms of enforcement. The
government sought to review its policies in accordance with changes in the environment. The
redistribution system also contributed to the stability of the system. From a different viewpoint,
this could be characterised as risk-sharing. In this system, risks were diversified and shared
amongst actors. However, the experience of financial crisis showed that this risk-sharing
functioned smoothly only when a limited magnitude of risk obtained. If risk exceeded a certain
threshold, the whole system fell into difficulty. This is in fact what happened during Japan’sbanking crisis after the bubble burst.
In the future, Japan will direct its efforts towards opening up the other economies ofEast Asia to advance the cause of economic integration. This should prove to be both achallenge and an opportunity for Japan’s economy, including its financial sector, sinceintegration will enhance competition with Asian rivals 28 . The process is likely to induce further
changes in the Japanese economy, which, as past experience has shown, will probably involvethe utilisation of market mechanisms, modified to suit Japanese conditions.
References
Aoki.M. (eds) (1984). The Economic Analysis of the Japanese Firms, Amsterdam: North
Holland.
Aoki.M.(2001). Towards A Comparative Institutional Analysis, Cambridge, Massachusetts, MITpress.
Aoki. M. and Hayami. Y. (eds)(2001). Communities and Markets in Economic Development,
Oxford: Oxford University Press.
Aoki. M. and Kim.H.(eds)(1995). Corporate Governance in Transitional Economies; Insider
Control and the Role of Banks, Washington DC, The World Bank.
Aoki.M. Kim.H. and Okuno-Fujiwara.M. (eds)(1997).”The Role of Government in East Asian
Economic Development: Comparative Institutional Analysis”, Oxford, Oxford
28 Japan’s economy is unique in that many large manufacturers co-exist in the automobile and homeelectronics industries. Some foreign observers have pointed out that economic integration between Japanand other countries in East Asia would likely result in an economy similar to that of the European Union,
in which increased competition induced the restructuring of many industries.

18

University Press.
Aoki,M, and Patrick.H. (eds)(1994). The Japanese Main Bank System: Its Relevance forDeveloping and Transforming Economies, Oxford, Oxford University Press.
Aoki.M. and Saxonhouse.G. (eds)(2000). Finance, Governance, and Competiveness in Japan,
Oxford, Oxford University Press.
Bank

of

Japan,(2010).

The

Financial

SystemReport(March2010),

http://www.boj.or.jp/en/research/brp/fsr/fsr10a.htm/.
Brenner. R.(1998). “The Economics of Global Turbulence”, New Left Review, 229.
Calder. K.(1993). Strategic Capitalism, Princeton, Princeton University Press.
Dore, R. (1973). British Factory: Japanese Factory; The Origin of National Diversity

in Industrial Relations, Berkeley, University of California Press.
Gao.B. (2001).Japan's Economic Dilemma: The Institutional Origins of Prosperity

and Stagnation , Cambridge, Cambridge University Press.
Gao.B.(2002). Economic Ideology and Japanese Industrial Policy: Developmentalism from
1931 to 1965, Cambridge, Cambridge University Press.
Hattori, M., Shin, H.S. and Takahashi. W. , (2009). ‘A Financial System Perspective on Japan’s
Experience in the Late 1980s’, IMES Discussion Paper No. 2009-E-19, Institute for
Monetary and Economic Studies, Bank of Japan.
Hayami.Y.and Aoki.M.(1998).The Institutional Foundations of East Asian Economic
Development, London, Macmillan.
Hayashi, F. and Prescott E.C. (2002). ‘The 1990s in Japan: a Lost Decade’, Review of Economic
Dynamics 5 (1), pp. 206–235.
Hellmann.T.,Murdock.K.and Stiglitz.J.(1997).”Financial Restrain: Toward a New Paradigm,” inAoki,Kim, and Okuno-Fujiwara (1997), pp163-207.
Hoshi.T. (1995).”Cleaning up the Balance Sheet: Japanese Experience in the Post War
Reconstruction Period,” in Aoki and Kim(1995),pp303-359.
Hoshi.T.and Kashyap.A.(1999).”The Japanese Banking Crisis: Where Did It Come From And
How Will It End?” NBER Working Paper 7250.
Hoshi. T.Kashyap. A.and Sharfstein,D.(1993).”The Role of Banks in Reducing Costs ofFinancial Distress in Japan,” Journal of Financial Economics,27, pp67-88.
Johnson, C. (1982). MITI and the Japanese Miracle: the Growth of Industrial Policy,
1925-1975, Stanford, Stanford University Press.
Katz.R.(1998). Japan: The System that Soured, New York, M.E.Dharpe.
Koike.K.(1984). “Skill Formation Systems in the U.S. and Japan: Comparative Study,” in Aoki
(1984), pp47-76.
Noguchi, Y. (1995). 1940-nen taisei (the 1940 system), Tokyo, Toyo Keizai Shimposha
19(inJapanese).
Noguchi. Y. (1998). “The 1940 System Japan under the Wartime Economy,” American
Economic Review, 88, pp404-416
Okazaki, T. and Okuno-Fujiwara, M.(eds) (1999). Japanese Economic System and Its Historical
Origins, New York: Oxford University Press,
Okazaki. T., and Okuno-FujiwaraM., .(1998).”Evolution of Economic System: The Case ofJapan,” in Hayami and Aoki (1998), pp482-521
Okazaki. K., Hattori, M. and Takahashi, W. (2011). ‘The Challenges Confronting the Banking
System Reform in China: an Analysis in Light of Japan’s Experience of Financial
Liberalization’, IMES Discussion Paper No. 2011-E-6, Institute for Monetary andEconomic Studies, Bank of Japan.
Rajan, R. G. and Zingales. L.(1998). “Which Capitalism?: Lessons from the East Asian Crisis,”
Journal of Applied Corporate Finance, 47, pp.1367-1400.
Sakakibara. E. (1995). Beyond Capitalism; The Japanese Model of Market Economies, Lenham,
Maryland, University Press of America.
Sakakibara. E. and Noguchi. Y.(1977). “Okurasho-nichigin ocho no bunseki”(An Analysis of
the Dynasty of the Ministry of Finance and the Bank of Japan), Chuuo koron 8 (inJapanese).
Sako. M.(1992). “Training, Productivity, and Quality Control in Japanese Multinational
Companies,” in Aoki and Dore (1992), pp 84-116.
Sheard. P.(1994).”Main Bank and the Governance of Financial Distress,” in Aoki and
Patrick(1994), pp188-230.
Takahashi,W.(2003). “The East Asian Economies after the Financial Crisis:
for the Japanese Yen?”a Rolein Dobson. H., and Hook. G.(eds). Japan and

Britain in the Contemporary World：Response to Common Issues, Routledge
Curzon.
Takahashi, W. and Kobayakawa, S. (2003). ‘Globalization: Role of Institution Building in theJapanese Financial Sector’, Bank of Japan Working Paper No. 03-E-7, Bank of Japan.
Teranishi. J.(1990) “Financial Systems and Industrialization of Japan: 1900-1970,” Banca
Nationale del Lavoro Quarterly Review, 174, pp309-341.
Teranishi.J.(1994)."Loan Syndication in War-time Japan and Origins of the Main Bank
System,” in Aoki and Patrick (1994), Pp51-88.
Teranishi. J.(1997).”Sectorial Resource Transfer, Conflict, and Macrostability in Economic
Development: A Comparative Analysis,” in Aoki, Kim and Okuno-Fujiwara(1997).
Teranishi. J. (2000). “ The Fall of Taisho Economic System,” in Aoki and Saxonhouse(2000),
pp. 43-63.
20

Toya. T. (2000). “The Political Economy of the Japanese Financial Big Bang: Institutional
Change in Finance and Public Policy Making,” Ph.D.thesis, Stanford University.
Vogel, E.F. (1979). Japan as Number One: Lessons for America, Cambridge, Massachusetts:
Harvard University Press.
Wade, R. (1990). Governing the Market: Economic Theory and the Role of Government in East
Asian Industrialization, Princeton, New Jersey: Princeton University Press.
Womack, J. P., Roos,D. and Jones, D.(1990). The Machine That Changed the World, New York,
Rawson Associates,.
Woo-Cumings. M.(eds), The Developmental State, Ithaca, New York, Cornell University Press.
Zysman, J. (1984). Governments, Markets and Growth: Finance and the Politics of Industrial
Change, Ithaca, New York: Cornell University Press.

21

Chart 1

Chart 2%
14
12

Real GDP Growth Rate
8.9%
(1960‐1974)

10
8
6

4%
(1974‐1989)

4

1.6%(1990‐2007)

2
0
-2
-4
56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06

22

Chart 3%（ ratio to Nominal GDP）

Flow of Funds

15

Non‐financial corporations
General government
Households
Overseas

105063 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
FY

‐5

‐10

‐15

23

Chart 4
Time Deposit Rates and Prime Lending Rates
10%
Introduction of time deposits
with liberalized interest rates

9%

Abolishment of regulation ontime deposit interest rates

8%
7%
6%
5%
4%
3%
3-6 month time deposit rate(unregulated, new receipts)
Short-term prime lending rate2%

Long-term prime lending rate1%

3 month time deposit rate (regulated,
new receipts)

0%
1980

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

Note: The ‘3–6-month time deposit rate (unregulated, new receipts)’ is the average interest rate on newly
received time deposits with unregulated interest rates of terms between three and six months. ‘3-monthtime deposit rate (regulated, new receipts)’ is the interest rate set by the regulation on newly received
3-month time deposits.
Source: Hattori, Shin and Takahashi (2009)24

Chart 5Comparison between Japan and China:
Ratios of Money Supply (M2 Base) to GDP

Latest data (2009): China 180.8%
Japan 161.2%

Note: The M2 data of China are amounts outstanding at the year-end, while those of Japan are averageamounts outstanding in December.
Sources: Cabinet Office of the Government of Japan, Bank of Japan, National Bureau of Statistics ofChina, People’s Bank of China.

25

Table 1
History of Capital Account Liberalization in Japan
Year

Month

1964

Apr.

Japan accepts IMF Article VIII obligations.
Japan becomes an OECD member.

1968

Feb.

Yen conversion controls introduced to restrict conversion of foreign currencies into
yen and domestic investment in yen.

1971

July

Upper limit on foreign securities purchased by investment trusts and insurancecompanies abolished.

Aug.

United States suspends dollar conversion to gold (the so-called ‘Nixon Shock’).

Dec.

IMF parity changed to ¥308/US$1 (Smithsonian rate) and band widened by+/– 2.5%.

Feb.

Purchase of foreign securities by trust banks liberalized.

Mar.

Purchase of foreign securities by commercial banks liberalized.

June

Outward foreign direct investment liberalized.

Feb.

Floating exchange rate regime introduced.

May

Inward direct investment liberalized with exception of five categories of business.

Dec.

Yen conversion controls on banks partially eased (non-residents permitted to holdyen accounts [except inter-office accounts]).

1974

Jan.

‘Voluntary restraint’, to balance net foreign securities investments by banks,
securities companies, investment trusts, and insurance companies introduced.

1976

Nov.

Conditions attaching to outward long-term bank loans are eased.

1977

Mar.

‘Voluntary restraint’ on foreign securities investments by banks abolished.

June

Acquisition of foreign equities and bonds by residents belonging to foreigncompanies permitted.
Regulations on net open positions of residents abolished.

Jan.

Regulations on acquisition of yen-denominated bonds excluding those withremaining maturity of more than one year by non-residents relaxed.

May

Repo transactions by non-residents liberalized (gensaki market).
CD issuance commenced.

June

Short-term impact loans introduced and regulations on long-term impact loans
lifted.

1980

Dec.

New Foreign Exchange and Foreign Trade Control Law implemented; in-and-out
transactions free in principle.

1984

Apr.

Regulations based on the principle of real demand related to forward foreignexchange transactions abolished.

June

Regulations regarding the conversion of foreign currency-denominated funds into
yen abolished.
Yen-denominated loans to residents contracted in overseas markets liberalized.

1972

1973

1979

Changes in regulations

26

1985

Oct.

Interest rates on large time deposits liberalized.

1986

Dec.

Japan Offshore Market (JOM) established.

1993

June

Interest rates on time deposit fully liberalized.

1994

Oct.

Interest rates on demand deposits (excluding current accounts) liberalized.

1995

June

Restriction on the number of new branches a bank can establish removed.

Aug.

Recycling restrictions on yen-denominated bonds issued by non-residents inoverseas markets abolished.

1996

Nov.

‘Big Bang’ reform of capital market announced.

1997

Dec.

Ban on financial holding companies lifted.

1998

Apr.

Revised Foreign Exchange and Foreign Trade Law enforced.

Source: Takahashi & Kobayakawa (2003).

27

Table 2
History of Interest Rate Liberalization in Japan
Year

Month

1947

Dec.

Temporary Interest Rates Adjustment Law enforced.

1949

Dec.

Foreign Exchange and Foreign Trade Control Law enforced.

1979

Apr.

Call rate liberalized.

May

Negotiable certificates of deposit (CDs) introduced.

Oct.

Trade bill rate liberalized.

Jan.

Medium-term government bond funds introduced.

Dec.

Foreign Exchange and Foreign Trade Control Law amended.

1982

Apr.

New Banking Law enforced.

1984

Apr.

Sales of foreign CDs and CP permitted.

Dec.

Interest rates on short-term euro-yen CDs liberalized.

Mar.

Money market certificates introduced.

JulyInterest rates on medium- and long-term euro-yen CDs liberalized.

Aug.

Large-lot open-end bond investment trusts introduced.

Oct

Interest rates on large time deposits over ¥1 billion liberalized.

1986

Mar.

Long-term government bond funds introduced.

1989

June

Small-lot money market certificates over ¥3 million introduced.

1991

Nov.

Interest rates on time deposit over ¥3 million liberalized

1992

Mar.

Money management funds introduced.

1993

June

Interest rate on time deposits fully liberalized.

1994

Oct.

Interest rates on demand deposits (excluding current accounts) liberalized.

1998

June

CD issue terms fully liberalized.

1980

1985

Changes in regulations

Source: Takahashi & Kobayakawa (2003).

28

Table 3
Japan’s Financial ‘Big Bang’
1. Diversification of investment and financial choices
1998

Apr.

Cross-border capital transaction liberalized.

Sep.

Securitization of loan assets permitted.

Dec.

Securities derivatives fully liberalized.
Sale of investment trusts by banks permitted.
Definition of ‘securities’ expanded and enhanced.

2001

Apr.

Over-the-counter sale of insurance products by banks partly permitted.

2. Improvement of intermediary agent service quality and fostering competition
1998

1999

Mar.

Establishment of financial holding companies permitted.

Dec.

Licensing of securities activities shifted to register system.

May

Range of fund-raising for financial companies diversified.

Oct.

Scope of business widened for subsidiaries of financial institutions.

.

Equity brokerage commissions fully liberalized.

3. Development of user-friendly financial market
1997

July

Sale of unlisted and unregistered equities by securities companies permitted.

1998

Dec.

Stock exchange features improved, and off-exchange equities transactions
permitted.
Over-the-counter market for equities improved (introduction of market
maker and new register system).
Features of financial futures contract improved.

4. Development of credible, fair, and transparent business system
1998

Dec.

Disclosure practices enhanced.

1999

Apr.

Prompt corrective action introduced.

2001

Apr.

Law on Sales of Financial Products enacted.

29

Table 4
Comparison between Japan and China
Interest Rates
China(1)

Japan

8.50

March-end,
2010
1.600(2)(prime rate)(prime rate)

6.25(3)1.475(4)

8.10

4.86

(a)

(prime rate)(prime rate)(six months or less)(six months or less)

Short-term deposits(3-month)(b)(a) – (b)4.00(5)0.388(6)

3.24

1.71

2.25

1.087

4.86

3.15

End of 1970

Long-term lending

Short-term lending

End of 1991

March-end, 2010

9.00

5.40

(1-3 years,
including three
years)(1-3 years,
including three years)

Notes:
1. The legal interest rates (base rates) for renminbi lending and deposit set by the People’s Bank of China.
2. The interest rate adopted and released by Mizuho Corporate Bank.
3. The rate surveyed under the Temporary Interest Rates Adjustment Law.
4. The lowest interest rate adopted by the six city banks. Since January 23, 1989, these banks have
independently set the rate, taking into consideration funding costs and other factors.
5. The Bank of Japan guideline rate.
6. The average interest rate on 3-month time deposits of less than ¥3 million posted at financial
institutions.
Sources: Bank of Japan, People’s Bank of China.

30

31

1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007

Period

17.9
10.0
14.5
21.8
19.3
10.5
12.3
11.4
10.1
8.4
8.4
7.4
4.9
4.1
6.7
6.6
4.7
4.3
6.9
7.0
7.5
6.6
2.8
0.9
0.8
1.4
2.2
2.2
-2.0
-1.4
1.1
-1.0
-1.3
-0.2
1.6
0.7
1.4
1.3

(change, %)Nominal GDP

10.3
4.4
8.4
8.0
-1.2
3.1
4.0
4.4
5.3
5.5
2.8
3.2
3.1
2.3
3.9
4.4
2.9
4.2
6.2
4.8
5.1
3.8
1.0
0.3
0.6
2.0
2.7
1.6
-2.0
-0.1
2.9
0.2
0.3
1.4
2.7
1.9
2.4
2.1

(change, %)Real GDP

-0.8
1.6
15.7
27.5
2.8
5.5
3.3
-0.5
5.0
14.9
1.4
0.4
-0.6
0.1
-0.8
-4.7
-3.1
-0.5
1.9
1.5
1.0
-0.9
-1.6
-1.6
-0.8
-1.7
0.7
-1.5
-1.5
0.0
-2.3
-2.1
-0.8
1.3
1.7
2.2
1.8

(change, %)Consumer
Price
Index

6.3
5.0
11.6
23.2
11.7
9.4
8.1
4.2
3.7
7.8
4.9
2.7
1.9
2.3
2.0
0.6
0.1
0.6
2.3
3.1
3.3
1.7
1.3
0.7
-0.1
0.1
1.8
0.7
-0.3
-0.7
-0.8
-0.9
-0.2
0.0
-0.3
0.2
0.1

(change, %)Corporate
Goods
Price Index

16.5
12.4
30.9
32.4
-9.2
0.5
1.5
2.5
5.2
10.0
9.6
7.4
4.7
3.0
2.4
2.6
7.7
21.7
8.3
16.6
11.3
-4.6
-8.4
-5.6
-3.0
-4.0
-2.9
-2.4
-4.6
-4.9
-4.9
-5.9
-6.4
-6.2
-5.0
-2.8
0.4

(change, %)Average

20.3
14.8
33.3
34.7
-8.9
0.8
1.9
3.3
6.5
12.3
11.4
8.3
5.1
3.0
2.2
2.2
7.6
25.0
7.9
17.0
10.7
-5.6
-8.7
-4.7
-1.6
-2.6
-1.6
-1.4
-3.8
-4.1
-4.2
-5.2
-5.8
-5.7
-4.6
-2.7
0.1

(change, %)Residential

15.2
10.8
23.9
28.4
-9.5
0.1
0.7
1.0
2.7
6.2
6.5
5.5
3.7
2.3
1.8
1.7
2.8
10.4
9.3
15.2
13.5
-0.4
-4.7
-3.7
-2.3
-3.6
-2.8
-2.4
-4.3
-5.0
-5.5
-7.4
-8.5
-8.7
-7.4
-4.9
-1.8

(change, %)Industrial

Land Price
Total

7.4
6.4
23.7
23.6
-9.3
0.1
0.8
1.3
3.1
6.7
6.7
5.8
4.0
3.5
3.8
5.1
13.4
21.9
10.3
16.7
12.9
-4.0
-11.4
-11.3
-10.0
-9.8
-7.8
-6.1
-8.1
-8.0
-7.5
-8.3
-8.0
-7.4
-5.6
-2.7
2.3

7,333
20,714
20,797-342-13,824-2,085
11,20729,56636,236-20,481-26,801
11,92818,454
51,58386,836
119,773
142,527
121,939
101,525
87,16864,777
91,815
142,439
146,782
133,509
103,927
71,533
117,337
155,277
130,522
128,754
106,524
141,397
157,668
186,184
182,591
198,488247,938(change, %) (100 million yen)

Commercial

1.0
2.5
2.2
0.0
-1.0
-0.1
0.7
1.6
1.7
-0.9
-1.1
0.5
0.7
1.8
2.8
3.7
4.2
3.4
2.7
2.1
1.5
2.0
3.0
3.0
2.7
2.1
1.4
2.3
3.1
2.6
2.6
2.1
2.9
3.2
3.7
3.6
3.9
4.8

(%)

Ratio to Nominal
GDP

Current Balance

14,377
27,19327,482
10,160
4,667
15,12629,563
46,29052,381
3,655
3,504
45,551
46,15375,892
106,881
133,150
155,492
136,031
121,458
113,509103,349
132,856
162,189
159,159
151,454
126,908
88,485
120,980
157,524
137,785
123,719
84,015
115,503119,766
139,022103,348
94,643
123,225(100 million yen)

Trade Balance

Key Economic Indicators

360.0
315.0
301.7
280.3
301.0
305.2
293.1
240.0
194.3
240.3
203.1
219.8
234.7
231.7
251.6
200.3
158.3
121.3
125.1
143.8
135.8
124.9
124.9
111.9
99.6
103.5
116.4
130.2
113.6
102.5
114.8
131.4
118.7
106.9
102.5
117.5
118.9
112.0

(yen)

7.1
7.9
8.6
8.8
9.5
17.0
25.8
30.8
28.0
29.7
26.4
26.4
18.0
16.7
17.0
21.8
28.5
19.1
19.5
14.2
17.8
19.6
25.9
17.6
12.1
25.6
26.8
19.8
31.2
32.5
43.5
61.0
61.1
96.0

(dollar)Yen - U.S. Dollar Crude Oil Price
Exchange Rate
(WTI)
(%)

18.8
20.5
26.5
22.7
11.9
13.1
15.1
11.4
11.7
11.9
9.2
8.9
9.2
7.4
7.8
8.4
8.7
10.4
11.2
9.9
11.7
3.6
0.6
1.1
2.1
3.0
3.3
3.1
4.0
3.6
2.1
2.8
3.3
1.7
1.9
1.8
1.1
1.6

M2+CD
(%)

8.0
5.5
4.7
10.5
13.5
8.0
7.1
5.0
4.6
8.0
9.4
6.6
6.7
6.3
6.4
7.9
4.4
4.0
4.0
6.3
8.2
6.2
3.8
2.4
2.2
0.40
0.43
0.40
0.24
0.010
0.230
0.001
0.001
0.001
0.001
0.001
0.21
0.45

Overnight
Call Rate

6.72
7.30
8.41
8.23
8.23
6.68
6.18
7.79
8.23
8.37
7.97
7.70
6.97
6.58
5.45
5.00
4.81
5.31
6.80
5.84
4.76
3.47
4.55
2.91
2.75
1.99
0.97
1.84
1.66
1.31
1.01
1.38
1.45
1.46
1.63
1.48

(%)

1,987
2,714
5,208
4,307
3,837
4,342
4,991
4,866
6,002
6,569
7,063
7,682
8,017
9,894
11,54313,083
18,821
21,56430,15938,916
23,84922,984
16,925
17,417
19,723
19,86819,361
15,25913,842
18,934
13,786
10,543
8,579
10,677
11,48916,111
17,22615,308(yen)

Japanese Government
Stock Price
Bond (10 years)
Index
Yeilds to(Nikkei 225)
Subscribers

7.2
4.7
4.4
8.7
10.5
5.8
5.0
5.5
7.9
11.2
13.4
16.4
12.3
9.1
10.2
8.1
6.8
6.7
7.6
9.2
8.1
5.7
3.5
3.0
4.2
5.8
5.3
5.5
5.4
5.0
6.2
3.9
1.7
1.1
1.3
3.2
5.0
5.0

(%)

U.S. FF Rate

7.3
6.2
6.2
6.8
7.6
8.0
7.6
7.4
8.4
9.4
11.5
13.9
13.0
11.1
12.4
10.6
7.7
8.4
8.8
8.5
8.6
7.9
7.0
5.9
7.1
6.6
6.4
6.4
5.3
5.6
6.0
5.0
4.6
4.0
4.3
4.3
4.8
4.6

(%)

U.S. Government
Bond (10 years)