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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 performancewhen 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 employee’s 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.