Banking Policy in Japan

American Efforts at Reform During the Occupation

William Tsutsui

• Publisher: Taylor & Francis
• Year: 2010
• eBook ISBN: 9781136928406
• Edition: 1
• Topic: Business
• Subtopic: International Business
• Index: Business

The unique Japanese banking system has contributed greatly to Japan's post-war economic advance by investing aggressively in industry and by supporting close government-business relations. The banking sector might not have come to assume such a significant role, however, had American efforts to reform Japanese finance during the Occupation (1945-52) been successful. How Japan's banking system maintained continuity of development and avoided the occupiers' attempts at "democratisation" and "Americanisation" is the subject of this book. It explores why the Americans were committed to reform, the reasons they failed and how important the maintenance of the financial status quo was to the subsequent development of Japan's "miracle" economy.

1
Background to Reform: The Development of Japanese Banking, 1868–1945

The Japanese banking system which the American occupiers encountered in 1945 was highly developed and well established, not unlike its Western counterparts in essential respects, and yet quite obviously unique as a whole. While in institutional arrangements and basic functions Japan’s financial world showed significant similarities to the American and European systems which had originally served as its models, much seemed alien to MacArthur’s reformers, from the pattern of corporate finance to investment practices, from the legal structure to the fundamental economic philosophy of Japanese bankers, industrialists and civil servants. Perhaps not surprisingly, it was the singular characteristics of Japanese banking, those aspects unfamiliar and sometimes incomprehensible to the occupiers, that were to become the focus of American criticism and the target of reform efforts. An understanding of what the Americans considered the ‘peculiarities’ of Japanese banking, as well as an appreciation of the general nature of the system, is thus necessary as basic background to an analysis of the financial programmes of the Occupation.

Modern banking was introduced into Japan during the Meiji period (1868–1912) under the government’s assertive policy of importing Western practices and organisational forms to support rapid industrialisation. The Japanese had faith in the efficiency of institutional models from the West, yet were flexible in the transfer and subsequent integration of foreign methods into the existing society. Thus the Japanese financial system did not develop as a mere clone of contemporary American and European arrangements but rather evolved under the influence of indigenous traditions, conditions and requirements. The long and often turbulent process of importation and adjustment ultimately produced the distinctive ‘hybrid’ system of banking which the occupiers encountered after the Pacific War.

The evolution of Japanese banking was shaped by innumerable forces: the nation’s geography, patterns of government finance, the course of economic growth and trends in overseas trade, to note but a few. Several factors stand out, however, as being particularly significant, fundamental influences on the pre-1945 development of Japanese finance. First was a general weakness of domestic capital, a condition which derived from Japan’s agrarian, pre-industrial heritage, but which continued well into the years of rapid economic progress. Secondly, a consistently high demand for credit, created by the brisk pace of industrialisation, had profound effects on the development of banking, corporate finance and industrial organisation. Lastly, the rise of militarism and the demands of a wartime economy became pervasive influences upon the growth and adjustment of the financial system after 1930. These were, in short, the basic pressures which forced deviation from the highly developed banking structures, established patterns of finance and conventional standards of operation which prevailed in the West, were provided as ideals for Japan, and yet proved not entirely suited to the unique local conditions.

The first decades of modern banking in Japan were a period of experimentation and seemingly constant flux in the structure of private-sector financial institutions. Although some bank-like organisations had existed prior to the Restoration of 1868, the Meiji leadership considered the formation of entirely new institutions based on Western models the most expedient means of effecting rapid financial modernisation. In banking, as in many other areas of economic innovation, the Meiji government took the lead in importing Western structures and practices but generally left the operation and internal development of the new system to private initiative—a pattern which Hugh Patrick termed ‘governmental encouragement and entrepreneurial response’.¹

The government initially adopted the contemporary American financial system as the model for Japan, and in 1872 put forward regulations allowing for the establishment of currency-issuing ‘national’ banks. The American-styled institutions, which were founded by private capital, did not prove a success, however, even after extensive reform of the system in 1876, as they remained dependent on government assistance and pursued an injudicious policy of issuing bank notes. Under Finance Minister Count Matsukata Masayoshi, the central authorities recognised the weaknesses of the ‘national’ bank arrangements and, apparently content to pursue a process of ‘trial and error’, sought a major reorganisation with the European system of finance as the new ideal. Hence, in 1882, to ‘act as the center for national finance and help harmonize the activities of banks all across the country’,² the Bank of Japan (patterned by Matsukata on the central bank of Belgium) was founded and vested with the exclusive right to issue currency. The structure of commercial banking was reformed under the Bank Act of 1890, which established a single new class of financial institution—the ‘ordinary’ banks— and set out a concise, unified code of rules to regulate the foundation, operation and administration of such organisations. By the turn of the century, when the transition to European forms was complete, national finance had been stabilised, the currency difficulties had been alleviated and the basis for a viable commercial banking structure was in place.

While the Meiji government showed considerable interest in establishing a solid, permanent financial structure, it exhibited considerably less concern about the internal operations of the private banks. English commercial banking, the most highly developed of the day, was widely held as an ideal for the operation of Japanese institutions,³ but Western standards of practice were neither legislated by the government nor rigorously adhered to by bankers themselves. The 1890 Bank Act, for example, set no minimum capitalisation for financial institutions, put no restrictions on the outside business activities of banks and, as revised in 1895, established no statutory limits on advances to a single customer.⁴ Without strict legal regulations, Japanese bankers, who did not innately espouse the relatively conservative, safety-minded attitudes of their Western counterparts, were not particularly inclined to maintain the financial practices held as sound and essential in Britain or the United States.

Not surprisingly, commercial banking was often in a precarious financial position during the Meiji period and beyond. Under the 1890 regulations, the number of ‘ordinary’ banks increased rapidly, peaking in 1901 at a total of 1,867 institutions. The vast majority of these were poorly-capitalised unit banks (though branching was not legally forbidden or even regulated by the government) and the average size was very small.⁵ Almost none of the banks was competently managed by contemporary Western standards, as techniques of accounting and portfolio analysis were relatively slow to develop. Loan practices were often patently unsound as banks engaged in speculative advances, made extensive loans to directors and frequently concentrated their lending on one customer.⁶ At the very extreme, ‘organ’ banks—institutions founded or managed solely to provide funds for a single client—were not uncommon in Japan prior to World War I.⁷ Such banks were never entirely stable, as the young Japanese economy was volatile and crises were frequent, causing difficulties for commercial and industrial firms which could, in turn, put extreme pressure on the banks which were closely tied to them.

In addition to the common lack of diversification in loan portfolios, the Meiji banks were generally aggressive in their credit practices and tended to extend loans beyond their financial capacity. The term ‘overloan’ has been widely used in studies of Japanese banking to refer to the condition where financial institutions (individually or collectively) have allowed advances to exceed deposits.⁸ Such a situation has historically been rare in the West, but was common in Meiji Japan, at least until the turn of the century. The private sector’s demand for credit was seemingly infinite—funds for expansion in booms, advances to cover shortfalls in recessions—and the Meiji banks tried to be solicitous, even if this required the compromise of sound banking practice. The long-term ‘overloan’ observed in Japan was only possible because of a permissive official attitude, the government apparently believing that financial expansion would promote rapid industrial development. Thus, ‘ordinary’ banks which encountered liquidity problems arising from aggressive lending policies were given easy accommodation by the Bank of Japan, providing a financial lifeline of discounts and direct loans which sustained many over-extended institutions during the Meiji period.⁹

Despite their frequent internal difficulties, the Japanese banks were called upon to play a major role in the financing of development. Commercial and industrial firms were reliant on external funding, as retained earnings were seldom sufficient to cover the financial needs of rapid economic growth. From the beginnings of industrialisation in the Meiji period, corporate finance in Japan has been predominantly ‘indirect’, that is, firms have tended to raise investment funds from financial intermediaries (especially banks) rather than by obtaining the required capital ‘directly’ through the sale of equities to individual savers. While Japanese industrial concerns were typically founded on the joint-stock form of organisation and stock exchanges had been established as early as 1878, firms found acquiring investment funds through bank credit easier and more dependable than through the issuance of securities. The emission of stock and corporate bonds became an increasingly important means of raising capital as the Japanese economy expanded during the first decades of this century, but the commercial banks, rather than individual investors, were responsible for taking up or indirectly financing the purchase of the majority of these new issues.¹⁰ Individual shareholding was uncommon and the underdeveloped stock markets remained forums for speculation, as Japanese savers clearly preferred to entrust their money to the relatively secure financial institutions.¹¹

The Japanese banks, called upon by business to provide the majority of investment funds, thus did not develop as purely commercial institutions. In striking contrast to the English model, the Japanese adopted what one author termed the ‘department store method of banking’.¹² Rather than concentrating on the discounting of commercial bills, as the London clearing banks traditionally have, the Japanese institutions took on a wide range of financial activities—like the ‘universal’ banks of Central Europe—providing long-term loans for fixed investment and subscribing to corporate securities in addition to engaging in short-term commercial financing.¹³ The extent of long-term lending by Japan’s nominally commercial banks has proven hard to quantify, but statistics from the Meiji and the 1920s suggest that the ‘ordinary’ banks were heavily committed to such investment.¹⁴ The practice of granting long-term credit, though apparently conducive to rapid industrial growth,¹⁵ contributed to the critical interdependence of banks and their corporate clients, thus increasing the vulnerability of finance in Japan’s unsettled economy.

Although certain generalisations can be made regarding the early Japanese commercial banks, there was certainly notable diversity amongst them. Most obviously (and significantly in the long term), during the first decades of this century a class of distinctive institutions emerged from the mass of small, unevenly managed and unstable ‘ordinary’ banks as the virtually unrivalled leaders of Japanese finance. These were the banks associated with the zaibatsu, Japan’s great ‘financial cliques’, which were to become a dominant force not just in the world of banking, but in the economy as a whole.

The zaibatsu were a uniquely Japanese development in economic organisation: vast horizontal conglomerates, presided over by semi-feudal family dynasties, each with a holding company (honsha), trading firm and bank at the centre of an extended group of concerns encompassing numerous sectors of industry, commerce and finance, These widely diversified combines were held together by mutual stockholding, personnel ties (such as interlocking directorates), financial bonds and business relationships. The four largest groups— Mitsubishi, Mitsui, Sumitomo and Yasuda—had diverse origins, although their characteristic organisations developed simultaneously during the Meiji period and they were, for the most part, propelled into positions of economic leadership through government patronage. From a solid base in one industry the zaibatsu were able to accumulate sufficient capital to expand into further economic sectors, with the ultimate result that by the late 1920s, the heyday of the ‘Big Four’, most modern industries in Japan were dominated by zaibatsu interests.¹⁶

The centralisation and manipulation of financial power was a key element in the zaibatsu model of organisation. The bank was a central, vital component of each zaibatsu structure, supplying capital to associated enterprises and employing excess combine funds in productive uses. If the honsha could be likened to the nerve centre of a zaibatsu its brain, then the bank would have fulfilled the role of the conglomerate’s heart, circulating funds through the organisation and co-ordinating operations by the allocation of credit. The bank also served to ‘cement’ the combine together, both through the pervasive internal financial arrangements which it managed and, like a secondary honsha, through substantial holdings of the securities of associated firms.

In addition, the zaibatsu banks were a major source of profits for the combine organisations. As Nakamura Takafusa has shown, the mining, trading and financial concerns were responsible for the majority of profits in the ‘Big Four’, with subsidiary manufacturing firms contributing a more variable, though consistently smaller share.¹⁷ The banks also assumed the leading role in extending the activities and influence of the zaibatsu, as financial leverage was widely used to draw new firms into the conglomerates. Since the zaibatsu preferred to expand by absorbing existing productive concerns rather than by creating entirely new ones, the banks’ role in leading the growth of the combines, and indeed in ensuring their very survival in the volatile economic environment, was of fundamental importance.¹⁸

While the zaibatsu institutions were the largest and most stable Japanese commercial banks in the first decades of the 20th century, they did not enjoy a clearly oligopolistic position. By 1914, the five largest banks controlled approximately one-fifth of loans and deposits in the ‘ordinary’ banking system, a proportion which only increased gradually in the years before the rise of militarism.¹⁹ Nevertheless, the four combine banks were clearly the cream of Japanese finance, enjoying special relationships with the most successful industrial firms of the day, nationwide branch networks (at a time when unit banking was still the norm) and a dominant position in securities dealings, The ‘Big Four’ did not engage in strikingly different practices from other Japanese banks, yet due to their sheer size and prestige were not nearly as vulnerable as the hundreds of smaller ‘ordinary’ institutions. Thus, the zaibatsu banks were able to weather, and indeed profit from, the most severe economic crises of the day, invariably emerging as islands of stability during financial emergencies.

While Japan’s s private banking structure was, from its foundation, centred on the commercial banks, a range of specialised financial institutions appeared during the Meiji period. Hoping to make provision for the diverse financial services available in the West, the government published regulations for savings banks in 1893 and established the legal foundations for trust banking in 1900. The new types of institutions were not initially a great success, however, as, lacking a clearly defined role in the Japanese system, their activities overlapped with the ‘ordinary’ banks. Unsound practices and the abuse of privileges were so common that in 1922, after repeated crises, the authorities introduced legislation which delineated stricter standards and more specific functions for both savings and trust banking. Zaibatsu interests rapidly came to dominate the reforme...

Table of contents

• Contents
• General Editor’s Preface
• Acknowledgements
• Abbreviations Used in the Text
• Introduction
• 1 Background to Reform: The Development of Japanese Banking, 1868–1945
• 2 ‘Financial Demilitarisation’, 1945–8
• 3 The Banks and the Antitrust Programme, 1945–8
• 4 Legal Reform of the Financial System, 1948–50
• 5 Finance Under the Dodge Line, 1949–52
• 6 Conclusions
• Notes
• Bibliography
• Index