Japan’s bad bank experience
These days, in countries with ailing financial institutions, getting rid of non-performing loans and other loss-generating assets in banks’ balance sheets by shifting positions to so-called bad banks is becoming a habit. The question is what is won with these constructs. In this context, the Japanese example is illuminating.
The first time I heard about a bad bank in Japan in the early 1990s. I have described elsewhere the dramatic consequences of the burst of the speculative bubble which had seized the Japanese economy in the 1980s and the resulting financial sector restructuring. One element of this process was the establishment of a bad bank, the Cooperative Credit Purchasing Company (CCPC).
Founded in January 1993 by 162 banks on the initiative of the Japanese Ministry of Finance, but without direct government participation, the CCPC was a private institution intended to “clean” banks’ balance sheets by buying nonperforming loans from banks and recovering them by selling the property which served as collateral.
The CCPC financed the purchases of the loans by borrowing from the selling banks. The latter received no interest and only got their money back when, and to the extent that, the CCPC managed to sell the underlying collateral. As a consequence, the credit risk stayed with the banks: “If the CCPC incurred a loss when a loan was sold, the original bank was supposed to pay for the additional loss.” (Hoshi 2008)
The incentive for the banks to participate in the scheme was tax relief. In general, Japanese banks were not allowed to deduct loan losses from taxable incomes as long as the borrower had not been officially declared bankrupt. But if the loans were transferred to the CCPC, the banks were allowed to deduct the difference between the book value and the sale price. The latter was supposed to reflect a fair market value. But there was an agreement that the final price of a transaction was determined only after the CCPC had managed to sell the loan. (Kanaya and Woo 2000)
It did not work. All in all, the CCPC bought loans of ¥15.4 trillion (about $146 billion) in face value. This was a small share of nonperforming loans in the system. In the mid-1990s outstanding loans in the Japanese economy amounted to over ¥500 trillion, exceeding nominal GDP (Okina 2009), and there were (conservative) estimates that the share of nonperforming loans was about ¥46 trillion or 10 percent of GDP.
One obstacle was that the banks could not be forced to sell to the CCPC, and many were reluctant to disclose the amount of problem loans they held. Mostly big banks took the opportunity. Up to 1998, the participating banks enjoyed an estimated ¥4.6 trillion of tax benefits. In comparison: At the same time, tax payments of the main banks were about ¥2 trillion. (Patrick Welter 2009)
Asset recovery was slow since real estate prices continued to decline. “Until the late 1990s, the CCPC just warehoused these bad loans without restructuring or selling those.” (Hoshi 2008) The CCPC continued to buy loans until March 2001 and eventually was dissolved in March 2004.
But this was not the only approach to free Japanese banks from the bad loans in their balance sheets. When in December 1994 two credit unions Tokyo Kyowa Credit Union and Anzen Credit Union, failed in Tokyo, an asset management company, Tokyo Kyodo Bank, was set up to deal with their remaining assets (later it also absorbed other failed credit unions). In 1996, Tokyo Kyodo Bank changed its name to Resolution and Collection Bank, RCB (Hoshi and Kashyap 2004).
At about the same time, the Housing Loan Administration Corporation (HLAC) was established. Its task was to collect loans of failed jusen. As Hoshi 2008 explains:
“Jusen companies were mortgage lending institutions created by Japanese banks in the early 1970s with strong encouragement from the Ministry of Finance (MOF) that saw growing importance of financing housing for increased urban population. Increased competition in the financial industry following the deregulation in the late 1980s drove jusen companies to shift away from mortgage financing (where they often had to compete with their parent banks) to more risky loans to real estate developers. The banks often “introduced” very high-risk projects that they were reluctant to finance to the jusen for “finder’s fees.” In this sense, the jusen then resembles the bank affiliated SIVs (structured investment vehicles) of the U.S. banks that invest in securitized sub-prime loans.
Large exposure to the real estate sector made the jusen the first casualty of the collapse of land prices. In 1991, the MOF put together a rescue attempt that included loan forgiveness and interest concessions by founder banks to help the jusen, their borrowers, and agricultural coops, which were their important lenders. The financial situation of the jusen, however, did not improve, and the MOF put together the second rescue plan in 1993. Both of these plans were based on the assumption that land prices in Japan would recover soon. The MOF hoped the financial assistance would allow jusen to survive the temporary shock without resorting to fire sales of the properties that backed their loans and without imposing losses to agricultural coops. The land prices did not recover. By 1995, when the jusen were finally closed, the total write-offs were … much larger than the estimated amount of total non-performing loans in 1991 …”
In April 1999, the RCB and the HLAC merged into a new entity, the Resolution and Collection Corporation (RCC):
The RCC was a subsidiary of the Deposit Insurance Corporation of Japan (DICJ), an authorised corporation of the Japanese government. In contrast to RCB and HLAC, the RCC was allowed to buy nonperforming loans from both failed and solvent banks (as well as from failed insurance companies and agricultural cooperations). Compared to the CCPC, the RCC was quite successful. Hoshi and Kashyap 2004 wrote:
“Unlike the CCPC, the RCC does not have recourse against originator banks for losses incurred when selling any collateral associated with a loan. As of the end of March 2004, the RCC had acquired ¥9.311 trillion of loans (appraised value) from failed financial institutions (including those inherited from RCB and HLAC), of which ¥6.892 trillion (74%) were collected. The RCC has also purchased ¥327 billion of non-performing loans (appraised value) from solvent banks, of which ¥222 billion (68%) have been collected.”
The following table shows the results as of March 2009. Two aspects are worth mentioning. The first is the gain the RCC made from cumulative recoveries. The second is bulk of loans which were still purchased from failed institutions. As Richard Koo, Chief Economist at the Nomura Research Institute, and co-author Masaya Sasaki note: “This serves as a reminder of how easy it is to remove bad assets from the balance sheets of failed financial institutions and how difficult it is to remove assets on which large losses must be booked from the balance sheets of healthy institutions.” (Koo and Sasaki 2010)
The RCC still exists. As of September 2011 (the latest publicly available data I found), the purchase of assets from failed institutions had risen to ¥6,535.1 billion with cumulative recoveries amounting to ¥7,488.3 billion. From sound institutions the amount was an unchanged ¥353.3 billion, with cumulative recoveries risen to ¥681.2 billion (DICJ).
A comparison of the private (CCPC) and public (RCC) solutions might suggest that the public variant is the superior one calling for vigorous government intervention elsewhere, too. But this conclusion would appear premature.
First of all, given the estimated combined initial amounts of bad loans of banks and jusen in the Japanese system, the RCC, too, apparently still covers only a small share. Furthermore, the Japanese bad-bank approach is only one instrument among a wide variety of measures to digest the aftereffects of the bubble, and regarding it isolated does not make much sense.
But, above all, too many special influences stand against a direct comparison of countries: The uniqueness of Japan’s bubble economy and the following dramatic economic decline, the structure and characteristics of the Japanese financial system, the historically grown links between banks and industrial conglomerates in Japan – and between industry, administration and policy – with the resulting special advantages and obligations, and the long tradition of “administrative guidance” (Reszat 1997) opening channels of influence that do not exist in this way elsewhere. On the other side, there are also similarities. Sorting out the differences and discovering the common features in order to learn from the Japanese experience might be worth the effort.
The paper by Takeo Hoshi and Anil K Kashyap of 2004 is on Solutions to Japan’s Banking Problems: What might work and what definitely will fail
An early evaluation of the Japanese experience is the IMF Working Paper by Akihiro Kanaya and David Woo on The Japanese Banking Crisis of the 1990s: Sources and Lessons of January 2000.
An in-depth general discussion of variants of private and official bad-bank solutions can be found in a McKinsey study of 2009 on Bad Banks: Finding The Right Exit From The Financial Crisis.
I once analysed the extent of the crisis in Japan and related early policy strategies in this German-language report of 1995: Japan’s Banken in der Krise.
Patrick Welter described the mixed experiences of Japan with the bad bank concept for Frankfurter Allgemeine Zeitung in 2009: Gemischte Erfahrungen mit der „Bad Bank“
Another interesting paper is A Proposal for The Japanese Non-Performing Loans Problem: Securitization as a Solution by Kay Ellen Herr and Goe Miyazaki.
There was some overlap between the activities of the RCC and the Industrial Revitalization Corporation of Japan (IRCJ). See for the latter Yuri Okina (2009): Activity of IRCJ and Banking Crisis in Japan
The paper by Richard Koo and Masaya Sasaki (2010) is on Japan’s disposal of bad loans: failure or success?
Data and information about the DICJ and the RCC can be found on the DICJ site.
Finally I would like to draw your attention to two earlier posts on this blog on Japan’s banking structure and on Fukushima – the burdens of Japan’s financial system.