The liberalisation of Japan's financial markets: some major themes

Introduction

Japan has risen to great prominence in the financial world in the space of very few years. One rough-and-ready indicator of this is the sharp jump in Japan's share in portfolio capital movements. In the late 1970s, Japan accounted for about 15% of total outflows from the larger industrial countries, well below that of the United States and the European Community. In the first half of the 1980s, however, the United States had been overtaken and, in the second half, Japanese outflows exceeded those of the United States and Europe combined. Only in 1990 did a sharp fall occur.

Behind this remarkable trend lay two key features. The first was the emergence of Japan as the major exporter of capital. With savings well in excess of domestic investment for much of the period, there was a heavy flow of Japanese funds overseas, the cumulative current account surplus during the second half of the 1980s amounting to over $350 billion. The second, partly related, was the greatly increased importance of Japanese financial institutions - banks, securities houses, insurance companies and so on - in international financial markets.

The ample supply of funds and the evident growing expertise of Japanese financial institutions - witness their rapid penetration of foreign markets - might have been expected to make Japanese financial markets particularly attractive for foreign fund-raisers. Yet relatively little foreign fund-raising has occurred in Japan in recent years despite a major programme of deregulation in Japan's financial markets. Moreover, even Japanese corporations have tended to eschew domestic markets, and have instead raised funds - often directly or indirectly from Japanese residents - via international markets. This is something of a paradox, and how far it has reflected residual restrictions in the domestic markets is considered below.

The first half of this paper assesses the extent of change in the traditional, regulated, Japanese market in recent years. It traces the changes in six classical features of the earlier regulated system - rigid exchange controls, the virtual absence of securities markets, financial institution segmentation, interest rate controls, the importance of public sector financial intermediation and a banking system geared to enterprises, not households. The changes have been far-reaching.

One prominent theme that has surfaced in the last couple of years is the so-called "bubble" economy, and its deflation in the early 1990s. Indeed, the marked volatility of asset prices in recent years has, as elsewhere. coincided with the process of deregulation and innovation in financial markets - although it would be a mistake to attribute this solely to liberalisation. The start of the long and steep decline in equity and real estate prices in the early 1990s broke a number of trends established during the previous decade, and subjected financial institutions to considerable strain.

The second half of the paper examines the pattern of internationalisation observed. "Internationalisation" covers many different facets, of course, and this paper looks at the issue from three angles: the extent to which non-residents have been able to use Japanese financial markets to tap excess domestic savings; non-resident interest in Japanese financial assets; and Japanese corporations' extensive use of foreign financial markets. These three topics are considered in successive sections. A penultimate section looks more closely at Japanese banks' international business, with particular emphasis on their sharply rising share in the Euro-markets up to 1989, and their considerable retrenchment since then. A final section draws together some important themes of internationalisation. The conclusions consider the main international and other implications of recent developments in Japanese financial markets.