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Japan's Response to the Recent Financial Crisis
Until the fall of 2008, Japanese banks were not affected seriously by the US financial turmoil because they invested relatively small amounts of their portfolios in subprime-related financial products. Rather, they were more seriously affected by capital losses arising from their equity shareholdings as stock prices declined sharply due to the eruption of the global financial crisis. Table 6 [ PDF 46.8KB | 1 page ] shows the impacts of price declines in subprime-related assets and equities on banks' balance sheets. Despite the efforts to reduce the amount of cross-holdings of shares on banks' balance sheets, Japanese banks are still exposed to the volatility caused by equity shareholdings. A decisive measure should be implemented to end banks' shareholdings as such instability repeatedly affects the banking sector. To enhance the resiliency of their capital base, megabanks decided to raise funds more promptly than in the 1990s through the issuance of subordinated bonds, preferred stock, and common shares.
Japan continued to record negative growth, year-over-year, from the second quarter of 2008 through the fourth quarter of 2009. With the contraction of the US economy, the Japanese economy experienced an extraordinarily sharp drop in exports of high-value added manufacturing products—such as automobiles, electronic appliances, machinery and other goods—starting in the fourth quarter of 2008. As a result, Japan saw an unprecedented decline in real economic growth; the economy contracted at an average rate of 6.6% in the first three quarters of 2009 over the same quarters of the previous year. The economic slowdown was associated with a plunge in stock prices, and thus, large losses in bank equity portfolios. Such capital losses and the resultant deterioration of credit quality of bank borrowers severely affected banking profits. All three megabanks, Mitsubishi UFJ, Mizuho, and Sumitomo Mitsui reported net losses in their financial statements on a consolidated group basis for fiscal year 2008, which ended in March 2009. Currently, their NPL ratios remain below 2% and their capital adequacy ratios exceed 10%, but there is a significant risk that they could face a capital shortage.
In December 2008, the government enacted a law that enabled capital injections to be made.13 By March 2009, three regional banks applied to the authorities to obtain capital. In the capital markets, firms had found it difficult to raise funds by issuing bonds or commercial paper (CP) immediately following the collapse of Lehman Brothers. As a result, the government implemented measures such as guarantee programs for exporters, and the Bank of Japan had begun to purchase CP. To date, these measures have been effective in mitigating a serious shortage of liquidity and stabilizing the financial market.
The restructuring of the financial sector in the US has affected Japanese banks and brokers and dealers. Nomura purchased Lehman Brothers' operations in Europe, the Middle East and Asia, which turned out to be a costly affair as reflected in their 2008 financial results. Mitsubishi UFJ acquired around 20% of JPMorgan Chase. Sumitomo Mitsui bought a Japanese subsidiary of Citigroup.
The long-term fundamental quandary of Japanese banks is that their earning power is not adequate enough to cover credit costs. It is widely acknowledged that the lending margins of Japanese banks remained low both before and after the asset price bubble. While this concern apparently led them to purchase some stakes in US banks and brokers and dealers, the challenge for Japanese banks is to develop a long-term management strategy that can enhance profitability.
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