Foreign Banks in
Japan
Mark M. Spiegel
Vice President, Economic Research
Federal Reserve Bank of San Francisco
February 17, 2006
Potential impact of foreign banks
Increase competitiveness of domestic
banking sector [Levine (1996)]
Stimulate the underlying bank supervisory
and legal framework [Claessens,
Demirguc Kunt, and Huizinga (2001)]
Increase the domestic supply of capital
Foreign bank lending in Japan has declined
dramatically
- Foreign bank lending in Japan
Trillion yen
12
10
8
6
4
2
0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Source: Bank of Japan
Foreign bank lending has been more volatile than
domestic bank lending during Japan’s slump
Annual Bank lending Growth 1993-2004 (%)
Percent
15%
Growth in domestic lending
Growth in foreign lending
10%
5%
0%
-5%
-10%
-15%
-20%
-25%
-30%
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Source: Bank of Japan
Foreign and domestic lending growth rates
are positively correlated
Foreign and Domestic Bank
Lending growth rates
15%
10%
5%
0%
Foreign lending
-5%
-10%
-15%
-20%
-25%
-30%
-5% -4% -3% -2% -1% 0% 1% 2%
Domestic lending
Source: Bank of Japan
Volatility of Foreign and Domestic
Lending (1993-2005)
(100 billion yen)
Sharpe
Standard Ratio
Deviation (µ/σ)
Foreign Lending 14.8 5.73
Domestic Lending 29.9 15.12
Foreign + Domestic 30.5 15.1
Correlation Coefficient 0.4
Source: Bank of Japan
Correlation is positive in bond activity as well
Samurai bonds from Foreign banks vs. from Japanese banks
Billion yen
1600
Foreign Banks
1400
Japanese Banks
1200
1000
800
600
400
200
0
2000 2001 2002 2003 2004
Source: International Financing Review
Evidence of link between bond
underwriting and lending
Drucker and Puri (2005): Both underwriters and
issuers benefit from concurrent underwriting and
lending relationship
Informational economies of scope
Reduces both underwriting fees and lending spreads
Lenders engender long-term relationships
Disproportionate underwriting activity by foreign
banks leaves them well-placed to capitalize on
these economies
Shinsei profits have grown steadily …
Shinsei net business profits
Billions yen
100
50
0
1998 1999 2000 2001 2002 2003 2004 2005
-50
-100
-150
-200
-250
-300
-350
… and it has moved quickly to clean its
balance sheet
Shinsei outstanding NPLs
Billions yen
2000
1800
1600
1400
1200
1000
800
600
400
200
0
2000 2001 2002 2003 2004 2005
Its capital position has improved as well
Shinsei capital ratios
Percent
25
20
15
10
5
0
1999 2000 2001 2002 2003 2004 2005
Issues going forward
End of quantitative easing
Increased nominal rates may raise monopoly potential
But will also increase average spreads, making market more
desirable to foreign banks
Importance of foreign banks as competitive fringe may increase
Impact of consolidation in Japanese banking
Foreign studies: Mergers adversely impact equity values of
clients of acquired bank, suggesting lost relationship value
Karceski, Ongena, and Smith (2004) for Norway; Carow, Kane,
Narayanan (2005) for U.S.
Clients of acquiring bank often unaffected, or even positively
affected
Some evidence that small and medium enterprises
disproportionately affected
Again, speaks to importance of foreign banks as a competitive
fringe
Conclusion
Foreign banks operating in Japan do not appear to
behave so differently than their domestic counterparts
Activity highly positively correlated with domestic banks
But with developed capital markets, unclear that diversification is
very important
Rather than arguing against allowing foreign banks,
similarities suggest that openness to foreign banks is a
natural policy for a developed banking system like
Japan’s
Domestic banks compete effectively
CDH (2001) profitability of foreign and domestic banks in Japan
1988-1995 about identical
Positive impact on regulation (e.g. Shinsei) and domestic bank
management by providing competition
Fundamentals suggest that value of foreign banks as a
competitive fringe will increase in Japan going forward