when they were more heavily dependent on Trust Fund Bureau funds:. Government financial institutions in Japan were enjoined not to compete with privatc sector institutions but rather to provide complementary finance and in effect to offer a "pump priming" service that would induce privatc sector lenders to support expanding firns with good projects. Government financial institutions enjoyed extensive managerial autonomy in deciding which firms to support.

Sources of funding. Immediately after the war, policy-based loans that were provided by the Reconstruction Finance Bank (RFB) were effectively financed by central bank credit since the Bank of Japan was the main buyer of the bonds issued by the RFB. This fuelled inflationary pressures but after the implementation of the Dodge Stabilization Plan and the adoption of balanced budgets in the late 1940s, the Japanese authorities decided to fund policy-based loans from stable long-tern savings. A major decision taken at the time was to avoid excessive reliance on overseas borrowings and overseas injection of capital. Thus, both access to foreign debt and foreign direct investment were discouraged. In addition, the view prevailed that as long as the banking system could provide safe and convenient savings facilities, the Japanese public would increase its financial savings, provided inflation was kept under control.

Accumulation of domestic financial savings was encouraged by the restrictions imposed on consumer credit and housing finance and by the high level of indirect taxes imposed on consumer durables that increased their cost and reduced their affordability. The achievement of high rates of economic growth combined with declining rates of fertility contributed to the attainment of very high rates of household saving that found its way in a massive build up of household financial assets in the fonn of savings deposits with all types of banks and especially with the postal savings bank. Postal savings were the main source of funds for policy-based loans.

Level of subsidy. The level of subsidy enjoyed by policy-based loans was low by international standards, although its true level is difficult to determine since policy-based loans were free fiom compensating balance requirements. JDB data on interest rates show that the spread between JDB rates and the long-term prime rate was as high as 3.5% in the mid-1950s, declined to 2.5% in the early 1960s and to less than 2% after the mid-1960s, reaching less than 1% in the 1980s. But if compensating balances added between 1% and 5% to the cost of commercial bank loans, then the true interest rate subsidy would have been much greater.

In many developing countries, preferential loans are extended at very low and fixed rates, which become highly negative because of the loss of monetary control by the authorities and the occurrence of very high rates of inflation. In Japan, policy-based loans were also extended at fixed rates. Highly negative rates of interest on policy-based loans were avoided only because the authorities succeeded in maintaining price stability. In fact, on a couple of occasions when inflation got out of hand, policy-based loans were offered at substantially negative rates in real terms.

**Duration.** One of the arguments in favor of policy-based finance is its ability to overcome the external finance constraint faced by expanding firms. This constraint is more acute in raising term finance as firms with a limited track record find it difficult to obtain long-term loans to finance their investment in plant and machinery and other fixed assets. Modern corporate finance highlights the preference of

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