Japanese banking problems: implications for lending in the United States - Industry Overview

New England Economic Review,  Jan-Feb, 1999  by Joe Peek,  Eric S. Rosengren

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Research on lending relationships in Japan has provided evidence that supports the importance of such relationships. First, a firm's investment is affected by the health of its main bank (Gibson 1995; Kang and Stulz 1998). Second, keiretsu members and nongroup members with a strong main bank relationship are affected less by financial distress or tight credit conditions than other nongroup members (Hoshi, Kashyap, and Scharfstein 1990, 1991; Hoshi, Scharfstein, and Singleton 1993). In fact, city banks responded to the binding capital constraints caused by the sharp decline in Japanese stock prices by reducing both lending to and stock holdings of firms with which they did not anticipate having a continuing long-term relationship (Frankel and Morgan 1992).

The evidence in Figure 2, which shows the overall loan growth for domestic operations of Japanese banks from 1987 to 1997, supports the view that close lending relationships made it difficult for Japanese banks to reduce credit availability to their domestic customers. Even though Japan fell into a prolonged recession in the early 1990s, domestic loan growth at Japanese banks continued throughout the period, albeit at a slower rate after the sharp declines in Japanese asset values. In contrast, overseas lending by branches of Japanese banks exhibited a much sharper reversal, growing on average twice as fast as domestic lending during the late 1980s before slowing and reaching a peak in 1992. The subsequent decline in loans overseas occurred even though the economic conditions were good in many of the foreign markets most important for Japanese banks, with the United States recovering from its recession in the early 1990s and GDP growth in Asia remaining strong until 1997.

That declines in lending were concentrated in overseas rather than domestic operations is consistent with Japanese banks valuing historical lending relationships at home more than those in more recently established foreign markets. While some of the decline in overseas loans, measured in yen, can be explained by the appreciation of the yen during this period, the extent of the decline suggests that Japanese banks improved their capital ratios in part by shrinking their large overseas presence. Thus, the large overseas operations of Japanese banking organizations allowed Japanese banks to insulate domestic customers from much of the shrinkage that was required to restore capital ratios.

IV. Implications for U.S. Credit Markets

While Japan had many large banks historically, it was only in the past decade that they came to dominate the list of the world's largest banks. As recently as 1980, only one Japanese bank, Dai-Ichi Kangyo Bank Ltd., was among the world's 10 largest banking organizations (Table 1). However, with a booming stock market, low domestic interest rates, and a strong yen, Japanese banks expanded aggressively during the late 1980s. By 1988, all of the world's 10 largest banking organizations were headquartered in Japan. Despite the sharp decline in the Nikkei and asset shrinkage at many Japanese banks in the early 1990s, the 10 largest banking organizations in the world, and 13 of the 15 largest, were still headquartered in Japan as of the end of 1994. However, since 1994, bank consolidation has continued in the United States and Europe, while Japanese banks have retrenched. As a result, only seven of the 15 largest banks in 1997 were Japanese.(3)