It is widely perceived that Japan’s banking crisis was made worse by the fact that the Japanese government took so long to take decisive action for a clean-up. Successive actions were taken in Japan, but the government and regulators consistently underestimated the depth and breadth of the problem.
Stock prices collapsed first in 1990, followed by a collapse in property prices in 1991, while official land prices did not begin falling until 1992. The Basil Capital Accord dictating minimal capital requirements for banks was implemented in March 1993. This included two tiers of allowable capital, Tier 1 and Tier 2. As the Japanese banks were allowed to count 45% of the market value of their stock holdings as Tier 2, they appeared to have a comfortable capital cushion as well as a significant amount of unrealized gains on marketable securities as well as property holdings.
Like the US, the crisis first began in the non-bank financial sector and in property loans gone sour, with seven housing loan corporations (nicknamed Jusen) that had been financed to a large extent by credit cooperatives on implicit credit guarantees from formal banks.
Phase 1—Collapse of a Shadow Banking System
Until 1995 (five years after the crash in stock prices and real estate), Japan’s financial crisis appeared to be largely within a “shadow banking system” that had been outside the Bank of Japan and financial regulators’ control, and mainly centered on real estate lending, similar to the US experience in 2006~early 2007.
After 1995, however, it became clear that the bank’s problems had considerably worsened beyond the Jusen and the credit cooperatives. Japanese regulators however hesitated to take strong action because of fear of triggering a public panic, because of political resistance by the banks, and because of strong public sentiment against using public funds to help the banks.
The NPLs in the Jusen continued to deteriorate, and the Ministry of Finance (MOF) and credits agreed to dissolve the seven Jusen in August 1995. At the same time, local governments were moving to close down financially troubled credit cooperatives that had become defacto full range banks heavily lending to real estate. By Q3 2005, the MOF also began closing down essentially insolvent regional banks. In order to facilitate this, a Housing Loan Administration Corp. was established in July 1996 to assume the assets/liabilities of the Jusen, with shortfalls to be covered by parent/creditor banks of the Jusen. This resulted in total NPL write-offs of some JPY3.5 trillion to JPY1.7 trillion. At the same time, a Resolution Collection Bank was also established in 1996 to cope with the liquidation/asset recovery of failed Jusen as well as credit cooperatives, and the Deposit Insurance Corporation was strengthened
But Japanese banks were not realizing all of the NPL losses due to loan forebearance and restructuring, and were still able to tap into significant unrealized gains in bonds, stocks and real estate holdings to offset loan losses. Japan still did not have an adequate deposit insurance scheme or a legal framework for bank restructuring, and still did not have a clear measure of the extent of the NPL problem. The regulatory authorities were intervening only after distressed banks became insolvent, and were often taking action once they had no other choice.
Phase 2—Near Collapse of the Formal Banking System
By 1997, however several large and high profile financial institutions in Japan went into effective bankruptcy, aided by a continued deterioration in property as well as stock prices. In April 2007, the MOF shut down Nissan Life Insurance, in November, Sanyo Securities triggered a near melt-down in the money markets by defaulting on call market borrowings. The MOF also shut down Hokkaido Takushoku Bank—all of these actions led to a renewed sell-off in the stock market.
In 1997, the “Law to Ensure the Soundness of Financial Institutions”, or Prompt Corrective Action (PCA) framework was introduced in Japan, but not effective until April 1998. The program,
1) Required to banks to make a self-assessment of their assets on a prudent and realistic basis under well-defined guidelines.
