| 8. Finance |
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Liberalization
of Financial System
The government in Japan has traditionally held tight control
over the scope of the country's financial institutions' business.
The main emphasis of what came to be known as "convoy system"
of financial administration was on preventing any financial
institution from falling behind. From the mid-1980s, however,
the laws strictly regulating the financial system were gradually
liberalized. The main point of Japanese version of the financial
"Big Bang" was to change the style of financial administration
from the previous pattern of advance guidance by the authorities
to one of ex post facto inspection.(*1) This aimed to achieve
drastic reform in the tightly regulated banking, securities,
insurance, and other financial services by 2001.
In April 1998, the Foreign Exchange and Foreign Trade Control
Law(*2) was revised, significantly liberalizing foreign exchange
transactions conducted by corporations and individuals. In June
1998, the Diet passed the Financial System Reform Law, amending
laws on banking, securities transactions, and other financial
activities and allowing banks to conduct over-the-counter investment-trust
sales.(*3)
As a part of financial system reform, the Financial Service
Agency (FSA)(*4) was established in July 2000 by integrating
the Financial Supervisory Agency and the Financial System Planning
Bureau of the Finance Ministry, which was in charge of devising
policies relating to banks and other financial institutions.
In January 2001, the FSA absorbed the Financial Reconstruction
Commission (FRC), which had been primarily responsible for dealing
with failed banks put under state control, and thus became a
chief financial industry "watchdog."
The barriers dividing banks, brokerages and insurance companies
are poised to be lowered further to promote competition. The
FSA is considering deregulation measures to allow banks and
insurance companies to offer brokerage services such as soliciting
stock sales and handling orders as early as 2004. The FSA also
plans to give the go-ahead for banks to market life insurance
policies and cancer insurance as early as spring 2005.
Bad Loans Issue
Following the collapse of the asset-inflated economic bubble
in the early 1990s, a chain of management failures of banks,
securities and insurance companies shook the Japanese economy
to its foundation. Private financial institutions were strained
by massive non-performing loans. Disposal of these bad loans
and implementation of drastic financial reforms have become
the major issues facing Japan's devastated financial system.
Hoping to restore confidence in the financial system, the government
repeatedly injected public funds into leading banks: first ¥1.82
trillion into 21 major banks in March 1998, and then ¥7.46
trillion into 15 major banks in March 1999. By the end of March
2001, public funds were also injected into 16 regional banks.
In May 2003, the government decided to pump public funds into
Resona Bank, a major unit of Resona Holdings, and in effect
nationalize the institution as it became clear that the bank
had fallen into a state of undercapitalization for the fiscal
year ending in March 2003.(*5) This was followed by the government's
decision in November the same year to inject public funds into
the Ashikaga Financial Group, a troubled regional banking group
based in Tochigi Prefecture.(*6) Ashikaga Financial was the
first regional institution ever to be taken over by the government.
In order to protect depositors and policyholders in the event
of bank failures or collapse of life insurance companies, the
Diet passed bills to amend the Deposit Insurance Law and the
Insurance Business Law in May 2000. Through the revision of
these laws, the scale of public funds for the stabilization
of the financial system was expanded to ¥70 trillion. Under
the new laws, unlimited guarantee of deposits ceased in March
2002, and was replaced from April 2002 by a refund limit of
¥10 million per depositor for an ordinary deposit at an
insolvent bank. In order to avert possible turmoil in the financial
system,
the government decided in October 2002 to postpone the scheduled
imposition of a ¥10 million cap on deposit insurance protection
for two years from April 2003 until April 2005.(*7)
Due to the prolonged deflationary pressure and the sluggish
economic activities, the disposal of banks' non-performing loans
has not progressed smoothly. According to the FSA, the amount
of non-performing loans held by all banks in Japan stood at
¥31.6 trillion as of the end of September 2003, accounting
for 6.8% of total lending outstanding.(*8)
To accelerate the bad loans disposal, the government unveiled
a new package of measures in October 2002.(*9) The new package
proposed, among other things, adopting a tougher method of assessing
the quality of bad loans, injecting public money into undercapitalized
banks, and creating a new public entity to purchase loans from
banks and lend money to troubled companies.(*10)
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Banking Industry
As a result of the large-scale realignment in the late 1990s,
the major banks have been regrouped into four large entities:
the Mizuho Financial Group (*1), UFJ Holdings (*2), Sumitomo
Mitsui Financial Group (*3), and Mitsubishi Tokyo Financial
Group.(*4) A number of smaller regional banks, shinkin banks
(*5) and "credit cooperatives" have also merged or
concluded joint venture or tie-up agreements with other Japanese
or foreign financial institutions to ensure their survival.(*6)
All of Japan's seven major banking groups plunged into the red
in fiscal year 2002 due to losses resulting from bad-loan disposals
as well as selling or revaluating shareholdings. The banking
groups were forced to write off more bad loans than they had
expected by the government's new bank reform program announced
in autumn of 2002, which requires banks to reevaluate their
loans using stricter criteria. The adoption of tougher criteria
for asset evaluations and getting nonperforming assets off the
books, as well as sales of cross-shareholdings at losses, are
all painful but positive steps that will eventually lead to
improved balance sheets. Some major banks are separating bad
assets from their loan portfolios and shifting them out to subsidiaries
set up to help troubled businesses regain financial health.
Non-financial institutions entering banking
business
While traditional banks are struggling to deal with the troublesome
bad loan issue, new banks set up in recent years by non-financial
institutions are beginning to score solid business results.
The IY Bank Company (*7) of domestic retail giant Ito-Yokado
group became the first newcomer bank to chalk up a net profit
for the half-year term ended September 30, 2003. eBank Corporation(*8),
which specializes in settling payments for goods and services
via the internet, also posted about six times the operating
revenue it recorded in the same period a year earlier.
The newcomers to the banking business are supposed to turn a
profit within three years of the start of the operations as
a condition for obtaining a banking license from the government.
The strong midterm results have increased the probability that
both IY Bank and eBank, in their third year of operation will
be able to meet that requirement.
Sony Bank (*9) a financial service unit of Sony Corporation,
was established in 2001 and posted a loss of net ¥547 million
for the fiscal half ended September 30, a significant improvement
from the loss of ¥2.22 billion incurred the same period
a year earlier. Sony announced in October 2003 a plan to set
up a financial holding company in April 2004, under which the
internet-based bank and two other insurance companies will be
placed, in a bid to strengthen its financial services.
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Securities Industry
In 1998, the government introduced a new registration system
to simplify the procedure to establish a securities company
instead of requiring the firms to obtain a license as a part
of market liberalization. Since then, about 30% of securities
companies have been replaced with new players, including those
from overseas as well as other types of businesses. As of January
14, 2004, 269 securities firms were operating in Japan, according
to the Japan Securities Dealers Association.(*1) New entrants
from other types of businesses have been keen to attract some
of Japan's personal financial assets of ¥1,400 trillion
in the wake of the liberalization of commission fees on stock
transactions and on the back of technological innovations for
trading systems.
All the Big Three brokers—Nomura Holdings (*2) , Daiwa
Securities Group (*3) , and Nikko Cordial (*4)—established
holding companies and transformed into brokerage groups in 2001.
The primary reason for this was to enhance specialties in each
securities business, such as retail, wholesale, and asset management,
while utilizing the capital. As a result, no major broker has
integrated its securities business lines, where retail brokering
and wholesale brokering work separately.
Underscoring their success in attracting retail investors on
the back of a marked recovery in the stock market in the summer
of 2003, all of Japan's 19 listed brokerages posted strong earnings
for the fiscal first half ended September 2003, in sharp contrast
with the same period the previous year when only two were in
the black. But factors such as the liberalization of stock commissions
and the proliferation of online brokerages offering cheaper
fees are making it difficult for firms engaging in traditional
stock-selling practices to clear a profit. Japan's major brokerages
now face the formidable task of diversifying their sources of
earnings.
However, these companies failed to match profit levels from
the interim period ended September 2000, at the height of the
information technology stock boom. The daily value of trading
on the Tokyo Stock Exchange between April and September reached
around ¥1 trillion, matching levels last seen in 1989. But
Daiwa Securities Group's commission revenue from handling stocks
for investors touched only about ¥34 billion, a 70% decline
compared to 1989. This shows that brokerages need to drastically
reform their business structures in a bid for survival. The
Nomura group, for example, plans to focus on corporate rehabilitation
businesses, as shown by its plan to assist failed theme-park
operator Huis Ten Bosch.(*5)
Internet trading boom among private investors
Given low transaction fees, a growing number of private investors
are making use of the internet as a way to trade shares as well
as gather the latest stock information, playing a leading role
in the upsurge in the stock market in 2003. According to the
Japan Securities Dealers Association, internet trading accounted
for 71% of all stock transactions by individual investors in
the first fiscal half ended September 2003. Total trading by
private individuals over the internet amounted to ¥31.97
trillion during the first half, a gain of 120% over the same
period a year earlier. This represents an estimated 71% of all
private trading over the six-month period, up from 55% in
the same period the previous year.(*6)
Partly due to the spread of online stock trading, securities
companies are overhauling their sales channels. In 2002, more
than 100 branches were closed, compared with just 12 in 2001.
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Insurance Industry
Japan has one of the world's largest life insurance markets,
with nearly 90% of households holding at least one insurance
policy. The aggregate amount of policies in force at the nation's
42 life insurance firms was ¥1,675 trillion in fiscal 2002,
down 3.4% over the previous year.(*1)
The stock market upturn in the fiscal first half ending September
2003 has prompted a substantial improvement in the financial
condition of Japanese insurance companies. However, it remains
difficult for the insurers to boost earnings as low return on
investments, due largely to razor-thin interest rates, brings
about widening negative yield gaps—the difference between
guaranteed rates of return to policyholders and the actual results
of firms' investments. Making matters worse, policy cancellations
continue to increase as households have become more and more
skeptical about insurers' financial health and are reducing
coverage.
The sense of crisis mounted so high that in July 2003 the Diet
passed a revision to the Insurance Business Law (*2), which
allows struggling life insurance firms to reduce the fixed rates
of return guaranteed to policyholders even if the insurers do
not intend to file for bankruptcy.(*3) The Financial Service
Agency (*4), which backed the legislative revision, argued that
while guaranteed yield reductions will lead to reduced coverage
on certain types of policies, policyholders will face less of
a financial blow than if an insurer were forced into bankruptcy.
Fearing that such a move could set off a flurry of policy cancellations
by angry customers, major life insurers immediately declared
they had no plans to resort to this emergency option. If, however,
investment conditions continue to be severe, the companies may
find it virtually impossible to live up to their pledges.
Deregulation and liberalization in the insurance industry have
advanced since the revision of the Insurance Business Law was
enforced in 1996, as a part of Japanese version of financial
"Big Bang" initiatives, and the Japan-US Insurance
Talks. Consequently, both life and non-life insurance companies
have struck a number of operational tie-ups and merger deals,
aiming to improve their financial health and competitiveness.
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The Stock Market
There are five stock exchanges (Tokyo, Osaka, Nagoya, Sapporo,
and Fukuoka) in Japan. After the revision of the Securities
and Exchange Law in 2000, the Osaka Securities Exchange (OSE)(*1),
the Tokyo Stock Exchange (TSE)(*2), and the Nagoya Stock Exchange
(NSE)(*3) demutualized into stock companies in April 2001, November
2001, and April 2002, respectively. In 1999, the TSE established
a new market named "Mothers," intended to provide
startup businesses with access to funds at an early stage of
their development and to provide investors with more diversified
investment oppor-tunities.(*4) As of November 2003, 65 issues
were listed in the Mothers section.(*5)
In June 2000, NASDAQ Japan, a new market specializing in shares
in startup ventures, started operations in the OSE. Following
the collapse of IT bubble and the stagnation of the stock markets,
however, the NASDAQ market did not expand as expected. As of
August 2002, only 98 Japanese companies were listing their stocks
on the NASDAQ market. The tie-up agreement with the OSE was
dissolved in August 2002 (*6), and the OSE took over operation
of the market as Nippon New Market-Hercules in December 2002.(*7)
Foreign Exchange Market
Following the Plaza Accord, reached by the finance ministers
and central bank governors of the Group of Five industrialized
nations in New York in September 1985, the yen began to appreciate
from over ¥240 to the dollar in that month to under ¥120 in
January 1988. In April 1995, the yen reached all-time high of
¥79.75 to the dollar. After that, it began to depreciate. On
August 11, 1998, the yen was traded at ¥147.64 in the Tokyo
foreign exchange market but began to appreciate sharply, reflecting
confusion in the international financial market in the latter
half of the year. In 2001, the yen quickly fell against the
dollar at the turn of the year, as anxiety regarding the Japanese
economy grew. Consequently, the dollar climbed above ¥130 at
the end of December for the first time in about three years.
In 2002, the yen-dollar exchange rate fluctuated throughout
the year.
The dollar traded at around ¥120 at the beginning of 2003, but
kept falling as geopolitical risks, especially the Iraq war,
and concerns grew over the US economic outlook. In mid-May,
the dollar sank close to the ¥115 level, which was seen as the
break-even point for Japanese exporters, prompting Japanese
monetary authorities to engage in massive market interventions.
Their interventions halted the yen's ascent only temporarily.
The yen began to strengthen again after finance ministers and
central bank governors from the Group of Seven nations in September
implicitly warned against Japan's intervention policy. Despite
a series of large-scale yen-selling market interventions totaling
a record ¥20 trillion in 2003, Japanese monetary authorities
have seen the yen continue to gain ground against the dollar.
The yen traded at ¥105.34 to the dollar and ¥135.66 to the euro
as of February 13, 2004.
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