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% 10% 5% 0% -5% -10% -15% -20% -25% -30% 1993 1994 1995 Source: Bank of Japan 1996 1997 1998 1999 2000 2001 2002 2003 2004
Growth in domestic lending Growth in foreign lending
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% Domestic lending
0%
1%
2%
Source: Bank of Japan
Volatility of Foreign and Domestic Lending (1993-2005)
(100 billion yen) Standard Deviation Foreign Lending Domestic Lending Foreign + Domestic Correlation Coefficient
Source: Bank of Japan
Sharpe Ratio (µ/σ) 5.73 15.12 15.1
14.8 29.9 30.5 0.4
Correlation is positive in bond activity as well
Samurai bonds from Foreign banks vs. from Japanese banks
Billion yen
1600
1400
Foreign Banks Japanese Banks
1200
1000
800
600
400
200
0
2000 2001 Source: International Financing Review
2002
2003
2004
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 -50 -100 -150 -200 -250 -300 -350 1999 2000 2001 2002 2003 2004 2005
… 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