Ichiro Suzuki In 1868, aspiring young samurais founded a new government in Japan, ending Tokugawa Shogun’s two and a half centuries of reign. They had an ambition of making the new government as modern as those in Europe and North America that already took off, going through an industrial revolution. Japan’s nation building started from scratch. At the beginning of the new Meiji era, there was not even a single currency that circulated throughout the country. Feudal lords issued their own notes and coins that were good in their own realm, but not necessarily accepted elsewhere. There were not taxes in a modern sense. Though feudal lords levied a heavy duty on farmers’ rice crops, little was collected from people in other ranks, notably merchants and, of course, samurais. There were money changers, who assessed the value of coins issued by different feudal lords. They lent money often to cash-strapped feudal lords but there were no institutionalized banks. Having learned about the banking system in the West, the new government hastily created banks: commercial banks and not investment banks. Households that successfully rode the wave of a turbulent era of massive changes began to accumulate wealth in the 1870s. Mitsui was already a prosperous merchant and money changer since the 17th century. Sumitomo grew wealthy on a copper mine. Mitsubishi, owned by the house of the Iwasakis, was an upstart in the business world but went through a meteoric rise in the 1870s on their near monopoly in the shipping industry. These households all started their own bank in the new era. As their businesses began to grow sprawlingly into non-related fields, their own banks, not surprisingly, provided funds to them. A group of a variety of businesses under one household eventually came to be called ‘zaibatsu’ (conglomerate). A main holding company controlled zaibatsu, with its bank as at the center of a group to provide credits. The zaibatsu structure probably has sealed how Corporate Japan is financed: bank lending over debt or equity securities sold in the market. The Tokyo Stock Exchange was founded in 1878. The exchange at the outset, however, traded public sector bonds essentially and few reputed companies tried to raise funds by listing their stocks in the market that was seen as a place of speculation. On top of these commercial banks, the government created some specially mandated banks for long-term financing requirements in a country of rampant capital shortage. Industrial Bank of Japan stood above all those specialty banks. Following the end of WWII in 1945, the Occupation Forces led by General Douglas MacArthur ordered Zaibatsu to be dissolved. Thus the main holding companies of Mitsubishi, Mitsui, Sumitomo etc. were dismantled. However, the companies that were under holding companies still formed a network, with a bank on its top wielding considerable power. Financing practices based on bank lending remained essentially unchanged from pre-war years. Zaibatsu did not really die after all. It is believed that the Occupation Force had stepped back from their original hard stance on zaibatsu because of the Cold War in Europe and a hot war in Asia (the Korean War). The U.S. began to understand a weakened Japanese economy would work against its Cold War strategy. Capital was so scarce a commodity in post-war Japan that the Ministry of Finance made sure it flowed into where they wanted it. Heavy-handed regulations made it possible for the MoF to allocate capital according to their plan. It was first grabbed by Industrial Bank of Japan and two other banks focused on long-term financing. Then, capital went to money center banks and there were a dozen of them at one point, including those at the top of major business groups. Scarcity of capital and heavy regulations allowed banks to stand above all the industries. Heavy regulations and too many banks but not too much capital created many problems over the Japanese industries and the economy as a whole. They became manifested in the final 20 years of the 20th century. First and foremost, the domestic Japanese market was crowded with excessive numbers of competitors because of banks. Since each bank wanted its client/ borrower to be a major player in their particular segment, they made the field over-crowded with players. At a time when Japanese car makers were storming the global markets, especially in North America, there were almost ten of them. Fierce and excessive competition in the market made their profit margins thin, resulting in Corporate Japan’s relatively low ROE and hence low valuation. It was once said that competition in the Japanese domestic market was so intense that winners there were able to dominate the global market. That eventually proved to be a false argument, however. Low profitability might have reduced their competitiveness due to their inability to meet ever-growing financing needs. This was especially true in semiconductors, where capital investment requirements rose almost exponentially as chips’ generation progressed. Size mattered and still does since stocks are used as a currency to make acquisitions but unlike in the 1980s Japanese companies were in no position to gobble up foreign competitors. Banks didn’t have much interest in industry consolidation that could strengthen the industry. Fewer companies meant fewer clients. Worse, when borrowers face difficulties, banks had a habit of prolonging the life of troubled clients by providing additional loans, to enable them to keep paying interests on time and stay afloat technically despite their questionable long-term viability. Troubled borrowers could be forced to restructure or file for bankruptcy at a very late stage after all options were exhausted. In the case of financing with debt securities, the market forces the issuer’s management to take actions, and force them to fold with a reasonable speed through higher bond yields (lower prices). Banks were immensely responsible for Japan’s economic stagnation in the 1990s, allowing zombie companies to stay afloat much longer than they should have, thus prolonging deflationary pressure on the economy that persisted until the 2010s. A monumental shift in landscape hit the post-bubble Japanese economy in the 1990s, resulting in consolidation in a variety of industries. The advent of the age of globalization gave a wake-up call to Corporate Japan’s management, which was until then obsessed with competition in the insulated domestic market. The age of globalization also made them realized the importance of scale. Industry consolidation progressed hand in hand with consolidation of banks. Their mountain of bad debt from real estate lending in the 1980s forced them to merge out of the necessity to squeeze costs and boost capital base. At the turn of the 21st century, there were only 3 so-called ‘mega banks’ left. Fewer banks made it easier for them to reduce the number of companies in other industries. Mega banks, by the standards of Japan, are dwarfs in the global market. Mizuho Bank was created out of mergers of three banks, Industrial Bank of Japan, Fuji Bank and Dai-Ichi Kangyo Bank. All of the three were individually on the list of the world’s ten largest bank in the late 1980s, with IBJ on the top of the list. Today, Mizuho is worth mere $29 billion, which reflects their inability to generate profits. Mitsubishi UFJ Bank, the largest of the three, are worth $67 billion. On the other hand, J.P. Morgan, the largest bank on earth today, boasts of equity market capitalization at $320 billion. As amply displayed in their market capitalization, Japanese banks’ competitiveness is relatively limited in today’s financial world that is ruled by the market. In their heyday, their dominance was the result of regulations, and not genuine prowess. Such institutions that wielded power due to regulations kept absorbing a cream of students from the country’s top universities. Such talents perhaps could have blossomed elsewhere rather than being mired in banks’ bureaucracy. This could be a loss for Japan. Finally, it is needless to say that banks’ misjudgment ended up with non-performing loans that resulted in catastrophic damages to the Japanese economy. By the end of the 1980s, banks became so bloated in size that their demise had an outsized effects on the country. As showcased in zombie companies, their reluctance to recognize bad debts and write them off prolonged the economy’s slump that otherwise could have been less severe. Banking crises had always wreaked havoc on economies around the world since the birth of banks. Damages done by Japanese banks turned out to be simply monumental in terms not only of the duration of persisting recessions but also of the breadth of negative effects on the economy and the society as a whole.
About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.
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