RDP 2000-03: Some Structural Causes of Japan's Banking Problems 4. Summary

This paper has traced Japan's current banking problems back to the displacement of the banking system that occurred during the 1980s. It has argued that one key cause of the problem was a trend deterioration in the average quality of borrowers, as large firms experienced a reduced need for bank finance on account of their own natural maturation and the greater accessibility of securities markets.

At the same time, banks became more adventurous in their lending. Their franchise values had declined with their shifting customer base and the deregulation of the wholesale funds markets. They responded with more aggressive loans promotion and less attention to their monitoring and screening of borrowers.

Financial deregulation certainly influenced both processes. By the late 1970s, the internationalisation and domestic liberalisation of Japan's capital markets were overdue. But the evidence presented in this paper highlights the difficulties that the authorities experienced in insulating the banking system against the more harmful effects of necessary reforms.

Macroeconomic policy, and monetary policy in particular, may also have contributed to Japan's banking problems. Although suited to inflationary and exchange rate conditions of the time, monetary policy in the late 1980s was less consistent with stability in the banking system. It contributed to an emerging adverse selection problem in the lending market, and it compressed bank margins in a way that encouraged the preference of banks for risky lending.