The Role of Banks in the Corporate Governance - The Experience of Japan -

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The Role of Banks in the Corporate Governance -
The Experience of Japan -

• Masaaki Kaizuka
• Principal Administrator Directorate for
  Financial, Fiscal and Enterprise Affairs, OECD
• 4th Eurasian Roundtable on Corporate Governance
• Bishkek, October 29-30, 2003

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Topics of Discussion

• Two different models of Corporate Governance
• The Experience of Japan as Insider Model
• - focusing on the function of Main Bank System
• Lessons to learn

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Two different models of Corporate Governance

• The Outsider Model (US, UK)
• - Dispersed equity ownership with large
  institutional holdings
• - The recognised primacy of shareholder interest
  in the company law
• - A strong emphasis on the protection of
  minority investors in securities law and
  regulation
• - Relatively strong requirements for disclosure

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Two different models of Corporate Governance

• Corporate Finance and CG in the outsider model
• - Equities tend to represent a high share of
  financial assets with well regulated and liquid
  stock market
• - Low debt equity ratio is the norm for the
  company
• - Banks provides short term finance and maintain
  arms length relationships with corporate clients
• - Buying and selling of company shares
• market for corporate control has been
  established

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Two different models of Corporate Governance

• The Insider Model (Most of other countries)
• - ownership and control held by insiders who
  have longer-term stable relationships with
  company
• - less institutionalization of wealth
• - Securities regulation functions by prohibiting
  speculative activity rather than by insisting on
  strong disclosure

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Two different models of Corporate Governance

• Corporate Finance and CG in the insider model
• - Bank played a dominant role including
  monitoring clients
• - High debt equity ratio of the company
• - Stock market is not sufficiently liquid
  sometimes with cross shareholdings
• - Market for corporate control not functioning

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Traditional characteristics of Japanese Business
Management and its Environment

• Corporate landscape
• - Cross shareholdings
• - Cohesive corporate group (Keiretsu system)
• - Main Bank System
• Employment practice
• - Life time employment
• - Promotion according to seniority
• Government regulations limiting competition

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Main features of Main Bank System

• Largest creditor of the company
• One of the major shareholders as a result of the
  cross shareholding arrangement (up to 5 )
• Principal supplier various financial services to
  the company
• Monitoring the clients company

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Main features of Main Bank System

• Monitoring by main banks
• - Ex Ante Monitoring investment decision
• - Interim Monitoring performance of the
  on-going business and projects
• - Ex Post Monitoring Evaluate financial
  performance when the company in difficulty,
  leading role in providing a
  disproportionately large burden to
  rescue the company

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Rational of Main Bank System

• Client Companies
• - enabling long term investment
• - securing lender of last resort
• - securing stable shareholders
• Banks
• - solution to asymmetry of information
• - rents through long-term relationships (eg.
  Excessive deposits, monopolistic handling of
  employees salary accounts)
• - securing stable shareholders

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Background of Main Bank System

• Huge demand of long term capital for the
  equipment investment
• Lack of robust stock market as a provider of long
  term finance
• Catch up era goal setting was simple
• Substantial Share holdings by banks contributed
  to enhance the risk taking and rescuing capacity
  of banks through ever rising share prices
• Highly regulated banking sector

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Corporate Governance Implications

• Creating Silent Shareholders
• Poor culture of disclosure to the public
• Lagged development of stock market and lack of
  equity culture
• Poor governance of the banks

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Drastic changes in the environments for banking
sector and bank behaviour

• 1980s
• Post Catch up era goal setting has become
  challenging
• Huge drop in the capital demand from client
  companies
• Deregulation in banking sector
• late 1980s
• Huge lending to real estate industry and the
  burst of bubble

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Drastic changes in the environments for banking
sector and bank behaviour

• 1990s
• Downward trends in share price and other assets
  price
• NPL problems
• Credit crunch
• Bank restructuring

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Lessons to learn

• Japanese Insider Model worked well in the period
  of the post war catching up era.
• Japan should have developed its stock market and
  equity culture with proper regulations along with
  its economic growth depending on Insider Model.
• Japanese Banking Regulation should have addressed
  to enhancing bank governance and internal risk
  management

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Lessons to learn

• Governments should be flexible enough to identify
  appropriate model to their countries,
  acknowledging that one size cannot fit all and
  appropriate Model should be changed according to
  the development of the countries.

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Thank you.