Introduction

Japan had a “lost decade.” The reason is that the authorities began to work on the banking sector problem seriously and decisively only after the country suffered from a systemic banking crisis in 1997–1998. While the crisis was eventually resolved, this process took about fifteen years after the bursting of Japan's asset price bubbles. In fact, the crisis began in 1991, when a small commercial bank—which was insured by the Japanese government's deposit insurance system—went into bankruptcy for the first time in post-war era Japan, and it ended in 2005 when the nonperforming loan (NPL) ratio of major banks declined to a level below the target set by the government.

In response to the outbreak of the severe financial crisis in the fall of 2008, the United States (US) implemented the Troubled Asset Relief Program (TARP)—its first phase (under Paulson) and the second phase (under Geithner), which included the stress tests of the 19 largest financial firms. Both a successful resolution of “toxic assets” and bank nonperforming loans (NPLs) and adequate capitalization of financial institutions are needed for credit flows to resume and for the economy to achieve a sustained recovery. European authorities have also adopted several measures of government intervention, such as guarantees of bank credits, bank recapitalization, and asset purchases, although they have yet to conduct comprehensive, harmonized stress tests of financial institutions.

The global financial crisis, which originated primarily in the US, proved to be highly contagious and had a rapid ripple effect across different market segments and countries. In sharp contrast with the Japanese banking crisis, the global nature of the current crisis has resulted in a collective sense of urgency and has led to prompt actions by governments worldwide. However, despite massive write-offs by banks, insurance companies, and other institutions to date, the full scale of the losses remains uncertain, as they depend on the timing and speed of the recovery of the real economy.

This paper attempts to present the lessons to be learned from Japan for combating a financial crisis. Japan's experience illustrates that if policymakers underestimate the severity of the crisis, then there could be long-term consequences because of serious negative feedback loops between the financial sector and the real economy. One of the most important lessons derived from Japan's experience is that if government action is delayed, the cost—including output lost—of dealing with a financial crisis could be significantly higher than if addressed promptly.

Although countries have different economic environments, the sequence of their policy responses to financial crises is similar. In many cases, financial crisis management starts with the central bank providing liquidity to banks, and then the government recapitalizing banks with public funds. For banks which heavily rely on wholesale funding, an interbank credit guarantee program is often introduced. Finally, after a detailed assessment of bank balance sheets, often the government introduces an asset purchase scheme.

Responding to the outbreak of the crisis in the summer of 2007, the US authorities initially focused on securitized financial products—including “toxic assets” related to subprime loans—and then shifted attention to bank loans as they were more closely related to the real economy. The experience shows that financial sector conditions—such as NPL ratios and capital bases—are affected by real economic conditions. At the same time, a weak, deteriorating financial sector inhibits healthy credit flows to households and firms, thereby worsening real economic conditions. Accordingly, early, decisive policy responses—based on objectively recognizing the scope of the crisis and establishing an appropriate resolution framework—must be made in order to minimize the negative impact of financial sector problems on the real economy and support the real sector recovery through encouraging a sufficient flow of credits to the real economy.

As Hoshi and Kashap (2008) stated, there is a remarkable similarity in policy responses between Japan's banking sector crisis and the recent US financial crisis. They argued that if the US bank recapitalization program was not meticulously planned, then the US appears to risk facing the same problems that crippled Japanese policymakers.

The organization of the paper is as follows. Section 2 describes the overall development of the Japanese banking crisis and policy responses from 1991 through 2005. Section 3 explains factors behind Japan's delayed policy responses and their economic consequences. Section 4 discusses the relevance of the lessons from Japan to the recent financial crisis, especially in the US. Section 5 briefly evaluates Japan's responses to the 2007–2009 turmoil in the light of its own experience in the 1990s. Section 6 provides our conclusion.

Download this Paper [ PDF 238.6KB| 23 pages ].

Comment(s)

There are [0] comment(s) for this entry. Post a comment.