Japan's Financial System: Revisiting the Relationship between Corporations and Financial Institutions

The panel discussion comprised two parts. The first half the discussion addressed the issue of relationships between firms and financial institutions, and the second half addressed the issue of the financial system, principally banking.

In the first half the following four points for discussion were put forward by the coordinator.

1. The nature and universality of relationship banking
2. The change in the relationship between firms and financial institutions against the backdrop of such developments as technical innovation, deregulation, and the development of securitization
3. Financing for new types of entities such as NPOs that are not adapted to conventional relationship banking
4. The role of financial institutions in company revitalization

YAMORI Nobuyoshi (Professor, Graduate School of Economics, Nagoya University) reported on such matters as the following. (1) The problem of information asymmetry in SME financing lies in the theoretical background. (2) According to a questionnaire targeting firms in the Kansai area, firms value their relationships with main banks more for securing volumes of funds than as regards interest rates. (3) In spite of the advances that have been made in IT, direct communication is regarded as important.

KAWAKAMI Naotaka (Director for Banks Division II, Supervisory Bureau, Financial Services Agency) commented that after Japan's bubble economy burst, the long-term, close communication between banks and firms lost its substance, and firms' needs became more sophisticated; given this, in 2003 the government mapped out its action program relating to relationship banking.

The comments of FUJII Yoshihiro (Senior Staff Writer, Economic News Department, Editorial Bureau, Nihon Keizai Shimbun, Inc.) included that in the past the function of relationship banking was recognized as being that banks would take risk and provide active support to distressed firms, but that went too far when the bubble economy burst, and rearrangement became necessary. He reported that this is the entire concept of indirect finance, including relationships between large firms and banks.

OKINA Yuri (Chief Senior Economist, Economics Department, The Japan Research Institute, Limited) reported that relationship banking over the past 10 years or so has placed emphasis on the availability of funds, and main bank discipline has not functioned. Among other comments she stated that an essential issue to address in the future is that of ensuring that relationship banking has built-in mechanisms, such as restrictive financial covenants, to bring governance into play.

Mr. Kawakami commented that in the future it would be incumbent upon financial institutions to enhance profitability through relationship banking, and that to achieve that it would be necessary for them to equip themselves with new financial technologies and engage in risk-taking corresponding with the stage of development of each firm.

Mark M. SPIEGEL (Vice President, International Research/Director, Center for Pacific Basin Studies, Federal Reserve Bank of San Francisco) reported that a review of developments since the partial removal of blanket deposit insurance reveals that there has been a decline in deposits in banks that are not rated highly, marking the start of the disciplining of banks by depositors. This constitutes one of the major changes in Japan's financial system in recent years.

Mr. Fujii reported that the tendency of banks to shy away from new lending since uncertainty about the financial system arose has made it difficult to distribute funds to the community; that in the U.S. there are systems to facilitate the flow of funds to NPOs and the community, such as the Community Reinvestment Act and the CDFIs (Community Development Financial Institutions); and that it is essential for cooperative financial institutions to turn their attention more actively to the provision of finance to the community.

After giving a background explanation of the Community Reinvestment Act, Dr. Spiegel pointed out the possibility of damage to the autonomy of the management of financial institutions, and commented on the limits to the role in regional revitalization that private-sector financial institutions are called upon to bear.

Ms. Okina explained the functions fulfilled by the Industrial Revitalization Corporation. As part of this she reported that with respect to the coordination of the rights of corporate stakeholders it was formerly main banks that took responsibility; that as business has become more complex and specialized, banks have become unable to fulfill this task, so that in the future it will be essential for banks to enhance their human resources and networks; and that to further facilitate rapid business revitalization it will be necessary to review the guidelines for voluntary liquidation, financing practices, and the manner of involvement of public finance.

In the second half the coordinator set out the following four points for discussion.

1. The validity of the overbanking theory
2. Governance problems at financial institutions
3. The desirable future form of regulation and supervision
4. The future of banking

Mr. Kawakami commented that there has until now been an excessive concentration of risk in the banking system, and the roles of direct finance and market-based indirect finance would increase in the future, but in view of the problem of asymmetry in SME finance, relationship banking would remain the principal model in this field. He also commented that the government's new action program places emphasis on independent action by individual financial institutions and discipline by regional users, and that overbanking is not a problem of numbers but one of the diversity - from the user's standpoint - of the financial services being provided.

Prof. Yamori commented that in academic circles overbanking is naturally not treated as a problem of numbers, but as the dual problem of excessive bank lending and the concentration of deposits on banks.

Dr. Spiegel reported that when bank mergers occur in the U.S., the supervisory authorities screen them by taking into consideration their impact on the market's competitive environment.

Ms. Okina reported that with regard to bank governance the supervisory authorities have wielded considerable power over the past 10 years, that recently discipline from the direction of the market has begun to function, for example by depositors and shareholders, and that it is essential that there be a switch to that side in the future. On this point she also remarked that it is possible that at cooperative financial institutions and small-scale regional banks this aspect would remain inadequate, and that there is room for further study.

Dr. Spiegel reported that a distinctive development in the Japanese financial markets recently has been the entry of foreign capital, and that the behavior of foreign banks operating in Japan does not differ significantly from that of domestic banks. He added that the granting of broad scope for foreign banks to enter will enhance the efficiency of competition and regulatory supervision, and that this is a natural policy for industrialized countries such as Japan, and also that the value of foreign banks as competitors with domestic banks would increase in the future.

Among further comments by Ms. Okina were those that the elements of the Financial Services Agency's guidance relating to relationship banking should revert to normal mode, and that in the future it will be essential for regional financial institutions to actively disclose information relating to risk management.

Mr. Fujii commented that financial revitalization is a major task, but has resulted in the dilution of the distinctive characteristics of each financial institution; that it will be necessary to take risks when catering to diverse needs in the future; and that in community financing the keyword is the character of the managers and of the business.

Mr. Kawakami's comments included those that three important areas for financial institutions are the exercise of autonomy, selection and concentration, and information disclosure, and that with respect to cooperative financial institutions in particular it is essential that they base themselves on the distinctive characteristics of their organizations, while top management's keen awareness is important for them to be disciplined, adding that in regards to regional banks a rigid business model is not under consideration. He also commented that naturally there should be no discrimination between domestic and overseas capital, but at the same time it appears that some foreign banks are doing business in accordance with discipline that differs from the discipline of their home countries; that presents a problem.

Prof. Yamori commented that he believed that financing is not impossible by institutions other than deposit-taking banks, and it is possible to adopt a narrow banking approach.

Dr. Spiegel added further comments, including that in the past it was almost a matter of course that main banks would lend to financially distressed firms, but that the regulatory framework has changed, calling for individual judgments to be made. As a result, the importance of the relationship between companies and financial institutions and of the information derived from this has in fact increased rather than diminished.

The discussion closed after a final comment by the coordinator concerning the importance of research on the design of the financial system, and the necessity for the formulation of future policy based on that research.