Banking Law of 1981. Copyright Roderick Seeman

EXPLAINING THE 1981 BANKING LAW

Keeping the Lines Clear

Revisions made by the new Law would hardly blur the lines between banks and other types of financial institutions. The Japanese did not desire to mimic the US on this point.

In late October 1981 , both Finance Minister Michio Watanabe and Bank of Japan Governor Haruo Mayekawa warned agaainst "repeating the American experience" as they expressed concern over competition among banks and securities firms in selling new types of high-paying financial instruments.

This was followed shortly by a police raid on Mori Finance, a lending company with 130 branches and lendable funds of 20 billion yen ($90 million). The company borrowed the money from the public and paid out more than 10% interest on those funds while claiming that the interest was the same as dividends to shareholders (like US money market funds). The funds it loaned out bore interest rates of 14 to 60%. The police noted, however, that Article 2 of the Investment law bans all except banks and ordinary financial institutions from receiving money deposits from the public, and this is being strictly enforced in Japan.

The role of banks has been of great importance in Japan. They provided the long term financing that had been the country's key to economic success. Some 90 percent of all funds flow from financial institutions (including the post office savings bank) to corporate and public users, compared to 10% from the securities market. In the early 1980s Japanese banks' assets approached 100 trillion yen, compared to slightly more than 3 trillion yen for the securities companies.

It was the banks which provided the funnel from thrifty Japanese investors to the capital-hungry industries in the growth period of the 1960s, and it was the banks which swallowed two-thirds of the huge Japanese government deficits in the later 1970s by buying national bonds (taking up 90% of the new bank deposits in the process). But their role in the period after the oil crisis was reduced. Corporations increasingly depended on internal financing or the securities markets before they turned to the banks.

Japanese companies were issuing record amounts of stock. In 1980, their public issues reached 1 trillion yen and in 1981 that figure should reach 1.6 trillion yen. This reduced the role of banks vis-a-vis the corporations.

But the vital role of the banks in swallowing the government deficit covering national bonds did not greatly ingratiated them with the Ministry of Finance. They were already captive clients, buying the bonds at face value and either holding them into maturity or selling them to the market at a loss. They coould not sell them to the public. However, securities companies could sell to the public and they had been contriving various vehicles to increase the sales of national bonds.

The MOF greatly appreciated this new assistance to the national treasury. In the 18 months after the securities companies initiated these middle term national bonds mutual funds, which could be cashed in at any time one month after purchase, their assets soared to 427 billion yen. They also paid 6.168 per cent interest, approximating the yields on two-year time deposits at banks but with greater liquidity. The share of individual savings in securities (national bonds, mutual funds, etc) increased by 3.5 trillion yen by the end of March, 1981 to reach 34 trillion yen--and most of that increase was in public bonds. Tax-exempt securities savings accounts increased by 10 trillion yen by August 1981, of which 60 percent was in national bonds. The MOF also soon thereafter approved another national bond mutual fond permitting payment of over 8% (the real market yield) that the securities companies had been wanting to sell.

Moreover, the Japanese banks had already worn out their welcome mat when they pushed the MOF to restrain the growth of savings accounts at the post offices. In another attempt to stem the huge deficit in government spending, the government in March 1981 instituted a system to check on the practice of individuals operating several tax-exempt accounts under bogus names in order to avoid the legal maximum limit.

By January, 1984 a green card system was to be instituted to check the accounts. However, the MOF ordered the banks to start their review process for this in 1983, whereas the post offices decided to wait until after the law went into effect. It was reported that with this incentive, many post offices encouraged depositors to set up several accounts before the deadline. This was topped off when the tax agency found one instance where one party, a retired postmaster, had established 100 different accounts totalling nearly 200 million yen.

The post offices are not subject to the jurisdiction of the MOF and the Bank of Japan. In general, post offices pay higher interest rates which are compounded every 6 months, (unlike banks) and offer time deposits of up to 10 years (as against two to three years from banks). The banks share of individual savings has fallen from 38.8% in 1970 to 32.8% in 1981, while the post office savings accounts increased to 20% from 12.6%. Insurance remained constant and securities increased from 9.2% to 11.2%.

Thus at the same time that the utility of the banking business to the government was decreasing, the banks were suffering from a decrease in deposits and losses from absorbing massive amounts of national bonds. In these circumstances, the banks rebelled against the assault on their privileged position presented by the proposed new banking law. Ironically, the most objetionable point, the limitations on banks' securities activities, was not really resolved by the FINANCIAL SYSTEM RESEARCH COUNCIL (FSRC) in its report On the Future of Commercial Banks and Reform of the Banking System, published in June, 1979.

Established in October, 1975, following the scandals after the first oil shock when the banks financed speculation by corporations, leading to major price inflation, the council was set up in order to give the banks greater social responsibility.

It recommended that banks be permitted to sell and buy national bonds in order to foster a large, healthy bond market in the future, but at the same time advised that further study on over-the-counter sales was necessary due to problems in interpretation of the Banking Law and the Securities Exchange Law.

Article 5 of the old Banking Law permitted banking-related business. A 1928 MOF circular specifically stated that banks could engage in securities business, not only in public bonds, but in all securities. However, Article 65 of the post-war Securities Exchange Law stated that banks could not do securities business, making an exception only for transactions in public bonds (paragraph 2). A 1965 memorandum between the banks and the MOF limited their transactions in national bonds to transactions for their own account and prohibited direct sales to the public. This was to help the securities companies, many of which had gone bankrupt in the stock market collapse of that year. That collapse also led to a revision of the Securities Exchange Law, requiring licenses to do securities business, including that related to public bonds.

After the MOF received the report of the committee last year, the bill for the new law kept the licensing requirement and the banks exploded. The losses they were suffering from accepting national bonds put tremendous pressure on them to sell the paper to the public. The furious battle that followed led to the elimination or great dilution of the social responsibility provisions of the original bill, for which the study had originally been initiated, in exchange for the right to sell the bonds to the public. The MOF came out on top however: such permission to sell national bonds to the public required a license and the MOF would not state when it will grant such licenses (he grapevine thought 1983, when it would become necessary to start rolling over many of the bonds already issued, especially the flood that started coming out after the first oil shock).

More important was the dilution of the disclosure provisions. The original bill required that within 3 months of the end of the business year, banks publish their balance sheets and income statements in the newspapers, compared to the previous practice of publishing only the balance sheets (other corporations had to do both).

The new law required that both the balance sheet and the profit and loss statement be published, although the items included in those documents were completely up to the discretion of the banks. The Council's report recommended that the banks make available data showing the state of business operations and assets at the head office and branch offices for public review within 3 months of the end of the business year. This was adopted, but a new provision was added to the original Article 23: "The provisions of Article 293-6 (Right of Shareholders to Inspect the Books) of the Commercial Code shall not apply to the accounting books and documents of banks."

It should be noted that the balance sheet and income statement have always been available in the annual securities report filed with the MOF as required by the Securities Exchange Law. Oddly, such reports were noticeably thinner than those for other companies. They did not include detailed statements on costs, which should be easy to calculate, and the income statements starts at recurring (current) profits, leaving such intermediate stages as gross profits, operating profits and nonoperating profits completely to the imagination.

One of the objectives of increasing the disclosure requirements was to determine how much of their loans was going to large corporations, rather than to small and medium firms. As another measure to encourage loans to small and medium firms, the committee proposed restrictions on the amount of funds loaned to any one corporation. This provision was adopted: however the very important discounting of trade bills was excluded from the calculations of those limitations. (The administrative ceilings at the time were on loans to one corporation of 20% of paid in capital for city banks, 30% for long term credit banks, and 40% for the Bank of Tokyo, are expected to continue in force). Foreign banks were exempted from these restrictions for a period of 5 years.

Other revisions made under the new law include a change from settling accounts twice a year to once a year (although midterm reports will be required) and provision for a five day working week (banks were open for half a day on Saturdays at the time). Domestic buying and selling of commercial paper and certificates of deposit issued abroad were tobe allowed for both banks and securities companies. Credit unions were to be permitted to engage in foreign exchange transactions.

Again, with respect to securities transactions, banks were to be able to make transactions on their own accounts and deal in the market, but they could not make over-the-counter sales to the public until they are licensed to do so by the MOF.