Japan: A Rare Country that has Few Home – Host Issues
Japanese and Asian frustrations might also originate from the fact that their voices in the global policy decision - making process do not correspond to
their economic power, which has rapidly developed. It is particularly true of the fi nancial world because there the frustration is derived not only from their small presence in the global policy making process but also from the small presence of the fi nancial industry itself. Its most representative case is Japan. For example, the share of the fi nancial industry in its economy is smaller than 7 percent, compared to 9.4 percent of the UK and 8 percent of the US. Besides, another remarkable feature of Japan is the seclusion of its fi nancial industry from other parts of the world. Indeed, there are very few Japanese banks that have large subsidiaries in other countries, and also very few foreign banks that have large subsidiaries in Japan.
In the discussion of Basel II, one of the most serious issues is the so - called “ home – host ” issue. This issue originated from the fact that the regulators ’ powers cannot easily go beyond their own borders when fi nancial institu- tions increase their global business. In other words, there is a question of which country ’ s regulator should approve the Basel II advanced approaches for a bank that does extensive businesses in country B but of which the parent bank is located in country A. So long as it is the subsidiary that was established in country B, it is, in principle, the regulator of country B that has the prime responsibility for supervising this entity. However, globally active banks in general have a globally integrated risk management system, which tends to be developed and managed by the parent bank. In this case, this bank might have trouble in explaining the same things to the regulators of country A and B to apply for the approval of AIRB of Basel II. Only two countries might not present major problems, but if this number reaches 100, things could get very diffi cult.
Besides, there might be the case in which the subsidiary side does not capture well the details of the management system that was developed by the parent side. In this case, the regulator of country B faces the question of whether or not, and to what extent, it could outsource the assessment of the model to the regulator of country A. In Basel II, it is expected that the home country ’ s regulator would play a major role in this approval process to lessen the burdens of fi nancial institutions, but also that some host coun- try regulators are supposed to share some responsibilities if concerned sub- sidiaries are seen as important from a material point of view (e.g. the size of subsidiary). Some countries, such as eastern European countries, are very sensi- tive to this issue because their own fi nancial markets are often dominated by subsidiaries of US and western European banks.
Fortunately or unfortunately, there are few serious home – host cases in Japan. It is indeed a rare case in the world. Not only in the US and major European countries, but also in East Asian countries, there are at least one or two very serious home – host issues to be discussed. Regulators in East Asian countries usually have the issue of host countries to supervise
166 POST-CRISIS RISK MANAGEMENT subsidiaries of the US and European global fi nancial institutions, but also often have home – host issues among East Asian countries. Meanwhile in Japan, except for new merger cases that occurred in this fi nancial crisis, Japanese banks owning huge subsidiaries in foreign countries is limited to the case of MUFG, which owns UBOC in the US, foreign banks own- ing huge subsidiaries in Japan is limited to Citibank Japan, which has only recently been established.
Reasons for Seclusion
Why doesn ’ t Japan have serious home – host issues? This is mainly because of its very special fi nancial structure. Up to now, Japan has kept an over- banking situation, in which many banks do cutthroat competition in lim- ited business areas, entailing very low profi tability of the banking industry (Shiratori and Oyama 2001). Meanwhile, we have not seen any remarkable shareholder movements to restructure the industry to improve its profi tabil- ity. Moreover, in an environment where there are still many regulations that strictly limit and at the same time protect the areas of business for banks, the Japanese banking industry tends to be seen by shareholders as another utility industry that has a solid and stable business base protected by regu- lations. In this environment, there is not a lot of room for foreign banks that would like to create dynamic businesses with high profi tability. Some exceptions are a part of investment banking and private banking businesses, a kind of niche business that Japanese banks do not do.
In addition, the very special Japanese macroeconomic conditions over the past 15 years have surely infl uenced the situation. A continued defl ation- ary situation during this period put the Japanese banking industry under signifi cantly severe profi t conditions. Defl ation naturally leads the policy interest rate to an extremely low level. In the case of Japan, we had experi- enced a very long period of a zero interest rate policy. On the other hand, we could not reduce the costs of deposits to zero. Even if banks set the deposit interest rate at zero, there must be the fi xed capital to collect deposits and associated costs. So the net profi t margin of deposits (market rate minus total costs of deposit) would usually be negative in a defl ationary situation.
Commercial banks normally enjoy a relatively stable and wide margin on deposits as a core part of their profi ts. In Japan, however, this had long been kept negative, providing a good reason for foreign banks not to have a strong interest in establishing an extensive retail network in Japan. The same is true of the lending side, which has long seen a continuous decline in Japan under defl ation.
The next natural question may be why major Japanese banks did not depart from such an unprofi table market and expand their business into
foreign countries. This is partly because of the after - effects of their failure to expand their businesses actively in foreign countries during the bubble period. Another reason is the shortage of capital that followed the banking crisis. Moreover, the Japanese banks ’ business model is not unique enough to cultivate new markets in foreign countries. Finally, there might be a sense of security so long as they stuck to the Japanese market, which is still the world ’ s number two, despite the hard defl ationary conditions. At any rate, the Japanese fi nancial industry has long been virtually secluded from the other parts of the world, despite no regulation forcing it to be.