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Bank regulation and supervision in bank-dominated financial systems: a comparison between Japan and Germany

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Abstract

This paper compares bank regulation and supervision in Japan and Germany. We consider these countries because they both have bank-dominated financial systems and their banking systems are often lumped together as one model, yet, bank stability differs significantly. We show that Japan and Germany have chosen different approaches to bank regulation and supervision and ask why they made their choices. We argue that bank regulation and supervision were less efficient in Japan than in Germany and that these differences were decisive for bank behavior.

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Notes

  1. Case studies involve data collections through personal interviews, verbal or written reports, or observations; they are holistic, allow for contextuality, take a longitudinal approach and are particularily well suited in cross-cultural settings (Ghauri 2004). For overviews over the case study approach and different qualitative research methods see Yin (2003), Gerring (2004) and the contributions in Marschan-Piekkari and Welch (2004).

  2. During the Meiji era (1868–1912), Japan first tried to adopt French Criminal and Civil Codes because France, at that time, was viewed as having the most sophisticated legal system. With the adoption of a constitution patterned after the Prussian constitution in 1889, however, German influences gained in importance and, in 1899, Japan adopted a German-style civil Code. For details see Luney (1989). On the relevance of the German state as a constitutional model for Meiji Japan see also Lehmbruch (1997).

  3. In 2006, Germany was ranked 16th, Japan was ranked 17th in the Transparency International Corruption Index. See http://www.transparancy.org. Of course, there are still cultural and religious differences between both countries.

  4. Though Germany belongs to the European Monetary Union (EMU), bank regulation and supervision still resides in the individual countries; see Barth et al. (2006).

  5. The historical institutional approach was pioneered by North (1990); see also the overview in Hori (2005).

  6. A notable exception is Vitols (2003) who compares financial reforms intending to foster market-based financing in Japan and Germany. A comparative perspective is also taken in Muramatsu and Naschold (1997) without, however, paying attention to financial markets.

  7. Surveys of the literature on contemporary banking theory and on banking regulation encompass Bhattacharya and Thakor (1993); Freixas and Rochet (1997); Bhattacharya et al. (1998); Santos (2001); Dionne (2003); VanHoose (2006).

  8. Since 1970, there were 117 banking crises in 93 countries and 51 non-systemic runs in 45 countries (Caprio and Klingebiel 2003).

  9. There are other externalities even when no bank run occurs. They arise because of dysfunctional bank-internal capital markets (Dietrich and Vollmer 2006), inefficient cross-subsidization between borrowers (Jakivuolle and Vesala 2007) and implied disincentives for bank-financed firms (Dietrich and Hauck 2007). In addition to these externalities associated with the specifics of the banking business, there are other potential reasons for regulating banks. From political economy view, e.g., there may be political capture, while industrial economics teaches to control market power.

  10. In 1980, only 16 countries had explicit deposit insurance schemes. By 1999, this number was 68 (Garcia 1999; Demirgüç-Kunt and Sobaci 2001).

  11. Avery et al. (1988) and Park (1995) present evidence that large depositors enforce higher interest rates.

  12. Much of the information presented in the following sections stems from Barth et al. (2006) and from personal interviews with representatives of the respective institutions and from their websites. See http://www.fsa.go.jp; http://www.dic.go.jp; http://www.bundesbank.de and http://www.bafin.de.

  13. For a study that exemplifies the history of Japanese banks using the case of Mitsui Bank see Ogura (2002).

  14. As for BoJ, this measure was legitimated as being part of its LLR function which included not only liquidity support but also risk capital provision (Hatakeda 2007). The new bank (“Tōkyō Kyōdō Bank”) was later reorganized into a “bad bank” or “bridge bank”, the Resolution and Collection Bank (RCB), which was designed as the general assuming bank for failed credit cooperatives. In 1999, RCB was reorganized into the Resolution and Collection Corporation (RCC) which was given the capability to purchase bad loans from banks (Nakaso 2001; Hori 2005).

  15. “Law Regarding Emergency Measures for Financial Stabilization”. According to Hori (2005), the provision of public funds to financial institutions before their failure was heavily critizised by opposition parties in the Japanese Parliament (Diet).

  16. These measures were part of the “big bang” reforms initiated by Prime Minister Hashimoto which started with the elimination of foreign exchange controls and included the revision of the Bank of Japan Law which provided BoJ more formal independence from MoE. See Cargill (2001); Ito and Melvin (2001). The Hashimoto reforms applied some “New Public Management” principles to Japan`s central government, namely policy evaluation for ministries and agencification as a means of decentralization. See Yamamoto (2003).

  17. For details on the establishment of FSA see Hori (2005, pp. 121–126).

  18. The Cabinet Office has been created following the Hashimoto reforms to facilitate inner government policy co-ordination efforts (this information is owed to one referee).

  19. For the following information see the annual reports of DIJC.

  20. In the two years from April 2003 to the end of March 2005, the full amount for current deposits, ordinary deposits, and specified deposits was fully protected.

  21. “Law concerning Emergency Measures for the Reconstruction of the Functions of the Financial System”; the law allowed a replacement of the management and a cleaning-up of the balance sheet. The first case was the failure of Long-term Credit Bank of Japan, which was nationalized in October 1998.

  22. The threat to be expelled from BoJ’s current account services became very effective since the beginning of the Quantitative Easing Policy in March 2001. According to Baba et al. (2005, p. 16), all financial institutions in Japan became heavily dependent on BoJ’s open market operations because the uncollateralized interbank market has almost collapsed due to low interest rates that did not even cover trading costs. In the meantime, however, the interbank market has recovered.

  23. The Bundesamt was the regulatory authority only for the banking industry; in addition, there were separate regulatory agencies for insurances and security firms.

  24. Members of schemes safeguarding the viability of institutions, i.e., cooperative banks and savings banks, are exempted from compulsory membership in a statutory compensation scheme (Deutsche Bundesbank 2000a).

  25. By law, Deutsche Bundesbank or European Central Bank are not allowed to act as lender of last resort to the deposit insurance scheme. However, it is expected that “in case of a systemic crisis, a political solution will be found” (Deutsche Bundesbank 1992; Beck 2002, p. 706).

  26. Though beeing a separate agency, FSA seems to be independet from governmental directives; see the cases reported in The Japan Times Online (2001); Mulgan (2002) or Negishi (2003). While prior to the reforms MOF was the sole decision making authority, under the new regulatory framework, the “decline in the influence of the Ministry of Finance is offset by an increase in the influence of politicians”, Cargill (2001, p. 159).

  27. Commercial banks sometimes complain high costs and demand that BaFin’s operational costs are borne by the Government, these demands were rejected by the Minister of Finance; see Handelsblatt (2006). The International Monetary Fund (2003b) on the other hand notes concerns that the interests of supervised institutions receive too much weight on the Board (10 out of 21 members are from supervised institutions).

  28. The existing division of labor between BaFin and Bundesbank is currently a matter of a political debate, especially between the Minister of Finance and the Minister of Economic Affairs. While the former wants to strengthen BaFin’s position, the latter prefers a stronger role of Deutsche Bundesbank in supervision; a stronger role of Bundesbank is also demanded by the Council of Economic Advisers (see SVR 2007).

  29. As reported by Beck (2002), problems with SMH-Bank were discovered in the 1980s by the BdB; these problems, however, remained undetected by supervisory offices.

  30. For an in-depth analysis of the German deposit insurance scheme see Beck (2002). Demirgüç-Kunt and Sobaci (2001) compare deposit insurance schemes around the world.

  31. See Gilbert (1992) for a comparison between both methods; whether P&A is less costly than liquidation depends on the premium paid by the assuming bank.

  32. In the case of the recent failure of ‘Privatbank Reithinger’, BaFin in September 2006 declared that this bank was not able anymore to pay out depositors; they were informed and paid out by the deposit insurance scheme of the BdB. For details see the webpage of BdB: http://www.bankenverband.de/channel/101832/art/1836/index.html.

  33. Only the cooperative banking sector maintains such a private resolution company called “Bankaktiengesellschaft Hamm”, which resulted from a failure of a cooperative bank in 1984. In 2003, there was some public discussion to establish a public “bad bank” in Germany but this plan was rejected (Frankfurter Allgemeine Zeitung 2003). Instead, commercial banks increasingly use credit derivatives to hedge risk, especially credit default swaps (see Deutsche Bundesbank 2004a, b).

  34. The methodology is explained in International Monetary Fund (2003b) and in Deutsche Bundesbank (2003).

  35. Most of these studies use the option-pricing model (Merton 1977) that considers deposit insurance as a put option on the bank’ assets.

  36. A regulatory forbearance parameter of ρ = 0.97 (ρ = 1.00) assumes that the book value of a bank’s assets can fall to 97% (100%) of the bank’s debt before the bank is closed by regulators.

  37. For similar results see Laeven (2002a, c).

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Acknowledgments

We would like to thank two anonymous referees for helpful comments (without implicating them). Also, we are indebted to Hiroshi Nakaso (Bank of Japan, Tokyo), Yutaka Nishigaki and Nobusuke Tamaki (both Deposit Insurance Corporation of Japan, Tokyo), and Akihiko Watanabe (Bank of Japan, Osaka Branch). Research assistance by Monika Bucher and proofreading by David Beckstead is also acknowledged. Of course, the usual disclaimer applies. Parts of this research were done while Vollmer was on leave at Kobe University. He wants to thank Kobe University for its hospitality and the Japan Society for the Promotion of Science (JSPS) and Deutscher Akademischer Austauschdienst (DAAD) for financial support.

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  1. Research Institute for Economics and Business Administration (RIEB), Kobe University, Rokko, Nada Kobe, 657-8501, Japan

    Ralf Bebenroth

  2. Halle Institute for Economic Research, Kleine Märkerstraße 8, 06108, Halle (Saale), Germany

    Diemo Dietrich

  3. Economics Department, University of Leipzig, Institute for Theoretical Economics, Marschnerstraße 31, 04109, Leipzig, Germany

    Uwe Vollmer

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  1. Ralf Bebenroth
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Bebenroth, R., Dietrich, D. & Vollmer, U. Bank regulation and supervision in bank-dominated financial systems: a comparison between Japan and Germany. Eur J Law Econ 27, 177–209 (2009). https://doi.org/10.1007/s10657-008-9084-4

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