Submitted by: Salil Aggarwal PGP I, Section: E Brief Case Analysis 2

Submitted to: Dr. Yogesh Maheshwari Finance-I (Oct-Dec 2013) December 10, 2013

The Japanese Financial System: From Postwar to the New Millennium

The Case: Changes in Financial System of a country over several decades due to variety of factors. The Company: The country in question is Japan. Traditionally, Japan has always given a lot of importance to efficiency, equality & safety and the traditional Japanese management style. The financial policies were initially shaped by the US Occupational Forces after WW-II and were revised regularly as required. The postwar era can be broadly classified into (i) Rapid Growth phase (1950s 1970s) (ii) Deregulation and Liberalization (1980s) (iii) Bubble Burst (late 1980s 1990s) and (iv)The Financial System (late 1990s). The Issue(s): The banking system faced three major issues in 1999 (i) Bad Debts and their valuation (ii) Role and functions of FSA and (iii) Effects of the Big Bang deregulation. Also, the issue of free market operations and the measures taken by Japanese government to that end are also discussed. The Analysis: The banking system in Japan had come under severe duress due to the Bubble Burst and the prolonged recession, forcing the three largest banks to merge in the fall of 2000. Taking a look at the history of the financial system in the country, we can point out a few key characteristics: 1. Post war a strong US legacy in finance came in the form of 3 laws that formed the basis of the Japanese financial system: the Securities and Exchange Act (1948), Foreign Exchange Law (1949) and the Temporary Interest Rate Adjustment Law (TIRAL in 1949). 2. Initially Japanese economy was highly regulated. Restrictions on interest rates, foreign investment marked the economy. With time The Japanese Financial system started becoming more open: from Cross shareholding (1953), establishment of keiretsu (a set of firms with interlocked business relations and shareholdings), the establishment of the final guarantor (Ministry of Finance) to futures market in 1987 with Nikkei 225 reaching almost 40,000 in December 1989. 3. Ministry of Finance: The banks and firms were closely monitored by the MOF employees, known as MOF-tan and Old Boys. These were people in charge of ministry relationships or retired officials who assumed executive posts in firms. Also, though it was not explicit, BOJ was under the constraint set up by the MOF due to the Bank of Japan Law. 4. Stringent Controls: In spite of the move towards globalization, the progression of Japanese economy is rooted by the control exerted by the government. The MITI allocated foreign reserves in an autonomous manner. The unwritten rule in the 1950s was that the BOJ could not raise the Official Discount Rate by more than 1 % point at a time and it had to consult with the MOF for this. The issues of Bad debts, FSA establishment and the Big Bang reform outfalls were caused by: 1. Formation of jusen: The large banks created non-banks and transferred all the bad debt to these unregulated financial institutes to show a profit for the large bank. 2. Financial jugglery by banks (refinance loans with new ones); lack of objectivity in system 3. Compensation Payments: The securities firms felt invincible after the October 1987 did not affect them. They would now guarantee the principal and for funding, they would churn the small customers accounts. They began to write off these payments as business expenses, resulting in a scandal. Due to this, they had to pay the big clients, compensations exceeding 200 billion. 4. The FSA: Financial Supervisory Agency (1997) was an independent bank inspection agency, with more powers that its predecessor, SESC. However, it was largely a revamp of MOFs Banking Bureau. 5. Big Bang Reforms: This was the political response to the Bad debt crisis. It comprised of Introduction of Stock Options (1997), Investment Trust Law (1998) and Deregulation of Brokerage Commission (1999). However, the most relevant measure was complete liberalization of foreign transactions.