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BIS Papers No 6 BIS Papers No 6 The financial crisis in Japan during the 1990s: how the Bank of Japan responded and the lessons learnt Hiroshi Nakaso Monetary and Economic Department October 2001 This volume, number 6 of the BIS Papers series, was written by a member of the Monetary and Economic Department at the BIS. The views expressed in BIS Papers are those of the authors and do not necessarily reflect the views of the BIS or of the institutions represented. Individual papers (or excerpts thereof) may be reproduced or translated with the authorisation of the authors concerned. Requests for copies of publications, or for additions/changes to the mailing list, should be sent to: Bank for International Settlements Information, Press & Library Services CH-4002 Basel, Switzerland E-mail: [email protected] Fax: (+41 61) 280 9100 and (+41 61) 280 8100 This publication is available on the BIS website (www.bis.org). © Bank for International Settlements 2001. All rights reserved. ISSN 1609-0381 ISBN 92-9131-626-1 Table of contents Introduction ..................................................................................................................................... 1 1. Policy responses of the financial authorities ........................................................................ 2 1.1 The early stage, 1991 to mid-1994 ............................................................................ 2 1.2 The beginning of the crisis, mid-1994 to 1996 ........................................................... 4 1.2.1 The failures of Tokyo Kyowa and Anzen ....................................................... 4 1.2.2 Limits of the collective contribution by the private sector .............................. 5 1.2.3 The jusen problem ......................................................................................... 6 1.2.4 Amendment to the Deposit Insurance Law in 1996 ...................................... 7 1.3 The financial crisis of 1997 ......................................................................................... 7 1.3.1 Bailout of Nippon Credit Bank ....................................................................... 7 1.3.2 The financial crisis of autumn 1997 ............................................................... 8 1.3.2.1 The failure of Sanyo Securities ...................................................... 8 1.3.2.2 The failure of Hokkaido Takushoku Bank ...................................... 9 1.3.2.3 The failure of Yamaichi Securities ................................................. 9 1.3.2.4 The market turmoil ......................................................................... 11 1.3.2.5 The introduction of public funds and the first capital injection ....... 11 1.4 The financial crisis of 1998 ......................................................................................... 12 1.4.1 The failure of Long Term Credit Bank of Japan ............................................ 12 1.4.2 Outline of the new laws ................................................................................. 13 1.5 Systematic management of the crisis, late 1998-2000 .............................................. 14 1.5.1 Nationalisation of Nippon Credit Bank (NCB) ............................................... 14 1.5.2 Capital injection into major banks in March 1999 ......................................... 15 1.5.3 More systematic approach ............................................................................ 16 2. Why has it taken so long? .................................................................................................... 17 2.1 A paradigm shift ......................................................................................................... 17 2.2 The central bank’s dilemma ....................................................................................... 17 2.3 Structural problems that allowed a delay in recognition of the seriousness of the NPLs problem ............................................................................................................. 18 BIS Papers No 6 i 2.3.1 Insufficient provisioning ................................................................................. 18 2.3.2 Inadequate public disclosure ......................................................................... 19 2.4 Deterioration in banks’ real capital positions .............................................................. 19 2.5 Negative impact on the economy ............................................................................... 20 2.6 The market’s response ............................................................................................... 21 3. Lender of last resort function of the central bank ................................................................. 21 3.1 Purpose of the LoLR function ..................................................................................... 22 3.2 Classification of the LoLR function ............................................................................. 22 3.2.1 Type 1: Emergency liquidity assistance to a failed deposit-taking institution 23 3.2.2 Type 2: Provision of liquidity to interbank markets ........................................ 23 3.2.3 Type 3: Emergency liquidity assistance to a failed non-bank financial institution ........................................................................................................ 23 3.2.4 Type 4: Provision of risk capital to a financial institution ............................... 25 3.2.5 Type 5: Emergency liquidity assistance to a temporarily illiquid institution (where solvency is questioned) ..................................................................... 25 3.2.6 Collateral and provisioning policy with regard to LoLR assistance ............... 26 3.3 Other institutional frameworks involving the central bank .......................................... 26 3.3.1 The lending to the DIC ................................................................................... 27 3.3.2 The lending arrangements to the Investors Protection Fund and the Policyholders Protection Corporation ............................................................ 27 3.4 Principles governing the exercise of LoLR assistance ............................................... 28 3.5 Information necessary for the provision of LoLR assistance ...................................... 29 3.6 Summary .................................................................................................................... 29 4. International comparison ...................................................................................................... 30 4.1 Size of non-performing loans ...................................................................................... 30 4.2 LoLR assistance ......................................................................................................... 31 4.3 Utilisation of public funds ............................................................................................ 31 4.3.1 Timing ............................................................................................................ 32 4.3.2 Scale .............................................................................................................. 32 4.4 Who was protected and to what extent? .................................................................... 33 4.5 Other forms of central bank involvement .................................................................... 33 ii BIS Papers No 6 4.6 Credit crunch .............................................................................................................. 35 5. Signs of financial instability .................................................................................................. 36 5.1 Changes in bank behaviour ....................................................................................... 36 5.2 Expected default probabilities .................................................................................... 37 5.3 Summary .................................................................................................................... 38 6. The new safety net ............................................................................................................... 38 6.1 Purchase and assumption (P&A) ............................................................................... 39 6.2 Systemic risk exception .............................................................................................. 40 6.3 The Bank of Japan’s involvement in the new safety net ............................................ 40 7. Future challenges ................................................................................................................. 41 7.1 Reinforcing the central bank’s research capacity ...................................................... 42 7.2 Early intervention and LoLR function of the central bank .......................................... 43 7.3 Robust payment and settlement systems .................................................................. 44 7.4 Enhancing the efficiency of the capital market ........................................................... 45 7.5 Need for continued structural reforms in the banking sector ..................................... 46 7.6 Minimising moral hazard ............................................................................................ 46 7.7 Clear demarcation of the roles played by different agencies
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