The activities of Japanese banks in the United Kingdom and in the United states, 1980-88.

This article was prepared by Henry S. Terrell, Division of International Finance, Board of Governors of the Federal Reserve System; Robert S. Dohner, Visiting Professor, Graduate School of Business, Stanford University; and Barbara R. Lowrey, Associate Secretary, Board of Governors.

In recent years banks headquartered in Japan have grown extremely rapidly relative to banks headquartered in other countries. While most of this growth occurred at their domestic offices, international assets of Japanese banks also grew substantially. Between year-end 1984 and year-end 1988, Japanese banks accounted for slightly more than one-half of the measured growth of total international banking activity. International assets of Japanese banks currently represent about two-fifths of measured international banking assets of all banks. A large portion of these international assets of Japanese banks are at their branches in the United Kingdom and their agency and branch offices in the United States.

According to a recent survey, sixteen of the world's twenty-five largest banks, including the seven largest, are headquartered in Japan.[1] When measured by total market capitalization, the figures are even more striking. The average equity market value of shares of the largest Japanese banks is in a range of $50 billion to $80 billion, while the average stock market valuation of the equity of the largest U.S. banks is about $10 billion. (2)

An earlier paper analyzed the faster worldwide growth of assets of the Japanese banks relative to U.S. banks over the longer period from 1972 through 1986.3 The major finding of that study was that domestic currency activities in Japan accounted for a large proportion of the total growth of assets of Japanese banks in that period. In the 1984-86 period, when assets at large Japanese banks increased about 75 percent more than assets at large U.S. banks, roughly four-fifths of this growth differential appeared related to the domestic banking business of Japanese banks and only about one-fifth to their international business. Factors that influenced the rapid domestic asset growth, measured in U.S. dollars, were a fast growing domestic economy, the translation effect of an appreciating currency on the value of yen-denominated assets at domestic offices, and the ability of large Japanese banks to maintain their share of the domestic banking market during a period when the largest U.S. banks were losing domestic market share to the rapidly growing superregional banks.

The financial strength and competitive position of Japanese banks in addition to their absolute size has made them a major presence in overseas markets as well as in their domestic market. The distinction between domestic and international banking activity, however, is not always precise, particularly in a world without capital controls. In such an environment, large multinational banks are managed on a worldwide consolidated basis and have the ability to shift both assets and funding sources to markets that offer greater economic advantages or are less regulated. To the extent that any national banking group shifts its domestic assets, including interbank trading, to offshore markets because of regulations in its domestic market, its measured participation in "international" banking assets will be increased even though the transactions have a definite domestic orientation.

Assets of all foreign branches of Japanese banks, of which those in the United States and the United Kingdom account for nearly three-fourths of the total, increased about 380 percent between December 1981 and year-end 1988, while aggregate domestic office assets increased about 285 percent (table 1). Foreign branch assets grew substantially more than domestic office assets between December 1981 and December 1984 (81 percent compared with 17 percent), in large part because of the translation effect of the decline in the value of the Japanese yen relative to the U.S. dollar on the dollar value of the yen assets of the banks' domestic offices.

By contrast, between year-end 1984 and year-end 1988, the dollar value of assets of foreign branches of Japanese banks increased 166 percent while the dollar value of domestic office assets of Japanese banks increased 229 percent, in light of an appreciation of the Japanese yen. Although less rapid than the growth of domestic offices, growth of offshore branches in this period was extremely rapid relative to the growth of international assets of other countries' banks. Part of this growth reflects the progressive liberalization of the ability of Japanese banks to acquire foreign assets.

This relatively faster growth of offshore activities of Japanese banks compared with that of other banks is shown in table 2, which presents data on the share of total international assets by nationality of bank. Between year-end 1984 and year-end 1988, international assets at Japanese banks more than tripled, and the share of Japanese banks in total international banking assets increased from less than 25 percent in 1984 to almost 40 percent by year-end 1988. International assets of Japanese banks were estimated to be more than two and one-half times as large as international assets of U.S. banks, the second largest national group. Over this four-year period, Japanese banks are estimated to have accounted for approximately one-half of the growth of total international banking activity.

In summary, in recent years Japanese banks have become the world's largest banks in absolute size. Although most of their absolute growth has occurred at their offices in Japan, Japanese banks did account for about one-half of the growth of total international banking assets in the 1984-88 period, and a large proportion of their international assets are concentrated at their branch offices in the United States and in the United Kingdom. In both markets, Japanese banks have grown rapidly and are by far the largest foreign banks. As of December 1988, Japanese banks accounted for about one-half of the activities of foreign banks in the United States and for about two-fifths of foreign bank activity in London. This article will explore the extent to which the growth of assets of U.K. and of U.S. branches of Japanese banks are related to local market conditions or to the overall growth of Japanese international trade and investment. In addition, the article examines whether these branches are substitutes for head offices in extending commercial and industrial loans to Japan-based companies and in engaging in interbank trading activities that might have taken place in Japan had the domestic market been less regulated. It will also analyze, in the context of a statistical model, some of the factors that have affected the activities of Japanese banks in these two centers.

ACTIVITIES OF JAPANESE BANKS IN THE TWO CENTERS: AN OVERVIEW

Activities in the United Kingdom In considering summary data on the assets of the U.K. branches of Japanese banks, several facts stand out (see table 3). About nine-tenths of the total assets of Japanese banks are denominated in currencies other than sterling. Of that total, more than three-fourths are either claims on overseas residents or Eurocurrency claims on banks domiciled in the United Kingdom. Almost one-half of Japanese banks' total claims on overseas residents represent claims on affiliated offices in other countries. These data confirm anecdotal evidence that little of the activity of Japanese banks in the United Kingdom is oriented toward the U.K. economy. Since year-end 1984, the nonsterling claims of these branches on private U.K. firms have increased (in dollar terms) three-fold, but a large proportion of these claims are on financial affiliates of foreign companies based in the United Kingdom. Such firms include life insurance companies that conduct a multinational business in London and therefore are not closely linked to the local economy.

A roughly similar pattern regarding the business orientation of Japanese banks is apparent on the liabilities side (table 4). Virtually all the funding for the U. K. branches of Japanese banks comes from nonsterling transactions with overseas residents, Eurocurrency liabilities to local banks, and certificates of deposit (CDs). Liabilities to related offices abroad constitute only about one-third of total liabilities to all overseas residents. In recent years, the volume of CDs issued (mainly dollar denominated) by the London branches of Japanese banks has virtually exploded. At year-end 1988, these branches had issued more than $65 billion in Euro-CDs, about one and one-half times the value of Euro-CDs issued by branches of U.S. banks in London. Branches of Japanese banks currently account for about two-fifths of the total issuance of Euro-CDs in London.[4]

In summary, U.K. branches of Japanese banks deal mainly in foreign currencies with non-U.K. residents. These branches are large net borrowers in the interbank Eurocurrency market and are by far the largest issuers of Euro-CDs. A comparison of the data in tables 3 and 4 shows the significant role the London branches play in funding their related offices in other countries, including their head offices in Japan. As of December 1988, these offices in London held more than $50 billion net in claims on related offices.

Activities in the United States

The activities of agencies and branches of Japanese banks in the United States grew by a factor of five over the eight-year period from 1980 to 1988 (table 5). Loans, including customers' liabilities for acceptances, are by far the largest component of assets, accounting for about one-half of the total. Cash and due from banks, largely reflecting clearing and interbank transactions, accounts for about one-third of total assets, while holdings of securities increased from a negligible amount to more than $20 billion by year-end 1988.

In particular, commercial and industrial loans to borrowers with an identified U.S. residence constitute the largest and most rapidly growing component of the loan portfolios of Japanese banks in the United States (table 6). By year-end 1988, commercial and industrial loans to these U.S. borrowers amounted to about $60 billion. By comparison, similar loans to domestic customers by large domestically chartered U.S. banks amounted to about $300 billion. Loans by Japanese agencies and branches to foreign commercial borrowers and to foreign governments were relatively stagnant over this period. Since December 1985, loans secured by real estate have grown rapidly at Japanese agencies and branches and exceed their loans to either foreign commercial borrowers or foreign governments.[5] Japanese banks have also been heavily involved in financing large corporate restructurings in the United States.

An analysis of the major sources of funding for U.S. offices of Japanese banks reveals that, similar to the pattern in the United Kingdom, U.S. offices of Japanese banks are extremely large net borrowers in domestic interbank markets and in recent years have been smaller (but still significant) net borrowers from banks outside the United States (table 7). Deposits from nonbank U.S. residents and nonbank foreign residents constitute a relatively small proportion of their total funding. Unlike the offices of Japanese banks in London, which were net providers of funds to their related offices in other countries, U.S. offices of Japanese banks (at least since 1984) have relied heavily on net advances from related institutions abroad.

A large proportion of activity by Japanese banks is with customers identified as U.S. residents. This geographic identification, however, does not properly account for the fact that many of these customers are affiliates of Japanese entities. As of December 1988, direct claims on Japanese residents by U.S. agencies and branches of Japanese banks were $106 billion out of a total of $307 billion. On a risk-adjusted basis, however, when claims are reallocated to the country of the ultimate parent obligor, the total Japanese risk of the U.S. agencies and branches amounted to $208 billion-a clear indication that U.S. offices of Japanese banks are closely associated with Japan-based customers.[6]

In summary, when compared with their U.K. counterparts, the U.S. offices of Japanese banks show some similarities and as well as certain important differences. The main similarity is that both are large net borrowers in local banking markets. The main difference is that offices of Japanese banks in London serve as an important net funding source for their related offices in other countries, while offices in the United States tend to be net takers of funds from related offices in other countries. In the United States, Japanese banks are heavily concentrated in lending to locally based companies, including U.S. affiliates of Japanese companies, while in the United Kingdom, Japanese banks lend largely to nonlocal borrowers in nonlocal currencies.[7]

THE BANKING AND EXTERNAL ECONOMIC ENVIRONMENT IN JAPAN

The Banking Environment

Large multinational banks are managed and operated on a worldwide consolidated basis. Therefore, branches of nonlocal banks will be influenced by factors specific to their home country as well as to the local environment in which these branches are operating. In some cases, a foreign branch operating in a less regulated environment might engage in activities that otherwise would have been undertaken by the bank's home country office had it been less regulated, particularly in cases of limitations on interest rates or quantitative restraints on particular activities. In fact, Eurocurrency banking largely owes its existence to banks' seeking to avoid regulatory restraints in their domestic banking markets.

Describing the complexity of the de jure and de facto regulatory environment for banking in Japan over these eight years is beyond the scope of this article, but the general situation was summarized in 1986 by Yoshio Suzuki, formerly an Executive Director of the Bank of Japan: Financial innovation and deregulation of interest rates has proceeded only gradually in Japan, so that interest rates on deposits, which make up the bulk of liabilities of financial institutions, remain largely regulated; the exceptions are interest rates on foreign currency deposits and CDs, the latter of which are subject to quantity regulations.[8] Therefore, according to Suzuki, both price and quantity limitations tended to constrain domestic activities of Japanese banks through the mid-1980s. While considerable progress on interest rate liberalization has been undertaken in Japan in recent years, including liberalization of the call money market in late 1988, currently about 40 percent of bank liabilities in Japan are subject to regulated rates.

Data describing the development of the balance sheets of Japanese city banks' offices in Japan over a period of slow interest rate deregulation are shown in table 8.[9] On the asset side, loans and discounts constitute the largest component and accounted for the largest absolute growth of the domestic office assets of Japanese banks. Loans and discounts actually increased slightly as a percentage of total assets, while acceptance financing-largely trade related and perhaps more easily transferred abroad-decreased as a fraction of total assets.

The liability structure of Japanese city banks operating in a gradually deregulated environment changed moderately over the 1980-88 period (table 9). Over the entire period, total deposits actually grew less rapidly than total liabilities did, and the share of deposits in total funding declined nearly 10 percentage points, despite the rapid increase since 1986 in deposits with unregulated interest rates. In fact, all deposit growth since year-end 1986 at domestic offices of Japanese city banks has come from time deposits with liberalized interest rates. Negotiable CDs, with market-determined interest rates, remain a relatively small percentage of domestic office funding because of limits on size, maturity, and until recently, total CD issuance relative to net worth. One source of funding that has been extremely elastic for Japanese city banks over the whole period has been net interoffice liabilities, which in a closed system represent borrowings from Japanese branches in overseas markets that can be used in part to finance loans to local Japanese companies.

The basic picture that emerges is that Japanese city banks, for at least much of the 1980s, were operating in an environment with low and regulated domestic interest rates, on both deposits and interbank borrowings, and therefore were faced with a demand for funds above what they could raise through deposits. That excess demand has grown over time: For example, at year-end 1980 the loan-deposit ratio at Japanese city banks was 0.83; by year-end 1986 that ratio had increased to 1.03 and remained at essentially that level through year-end 1988. Limits on the call money rate in the domestic loan market, as measured by the difference between that rate and either the Euro-yen rate or the market-determined domestic rate on CDs, constrained the Japanese city banks' ability to acquire funds in the domestic interbank market for call money (see chart 1). To meet the excess demand for loans above their ability to acquire domestic funding, Japanese city banks used net borrowings from branches in offshore markets-an unconstrained source of funds in terms of both price and quantity.

The regulation of interest rates in Japan also impeded the growth of domestic offices of Japanese banks relative to other financial intermediaries whose liabilities and assets have been less constrained. While other factors, such as rising income and an aging population mix, have affected the choice of financial instruments in Japan, as well as in other industrial countries, the decline in Japanese banks' share in total financial assets in Japan since 1981 has been much more rapid than could be reasonably explained by growing wealth or demographic changes (chart 2). The World Economic Outlook published by the International Monetary Fund interprets these data by noting the following:

In Japan, the shift of asset composition toward nonbank institutional investors is also related to the relatively high interest rates they offer to savers under the current regulated interest rate structure. With interest rate deregulation proceeding rapidly, however, that factor will be less important in the future.(10) Banks in Japan, therefore, because of their regulated status, have been losing ground to other financial institutions as well as facing an excess demand for loans.

The Japanese External Economic Environment

Since the beginning of the 1980s, Japan has run a current account surplus (table 10). From 1983 through 1987, the current account surplus rose steadily, and between 1986 and 1988 averaged about $85 billion a year. During this period, net long-term capital outflows exceeded the current account surplus in every year from 1981 through 1988 (except for 1983); from 1986 through 1988, the cumulative long-term capital outflow was approximately $150 billion greater than the cumulative current account surplus. A large proportion of the Japanese demand for long-term assets has reflected the acquisition of foreign securities by nonbank investors such as insurance companies and pension funds.

The large portfolio investments by Japanese nonbank financial firms in foreign securities results in part from regulatory changes in Japan, beginning in the late 1970s, that allowed nonbank institutions to diversify and to seek higher rates of return abroad as restrictions on holding assets denominated in foreign currencies were gradually lifted. In 1979, pension trusts were permitted to hold foreign-currency assets of up to 10 percent of their total assets in accounts at trust banks. In 1986, this proportion was raised to 25 percent and then to 30 percent. This liberalization permitted a substantial increase in holdings of foreign securities in pension trusts in 1986 and 1987. The proportion of assets denominated in foreign currencies that was permitted for many types of insurance companies was also raised in 1986, from 10 percent of total assets to 25 percent and then to 30 percent. Finally, in 1987, a similar limit on assets denominated in foreign currencies held by the Postal Life Insurance Fund was raised from 10 percent to 20 percent. The net effect of these and other liberalizing measures was a substantial increase in the holdings of assets denominated in foreign currencies by Japanese institutional investors.

While net long-term capital outflows have been very large, net short-term capital inflows have been positive during this period. Short-term inflows through the banking system became noticeable in 1984 and 1985 and grew to a substantial amount in 1986 and 1987 when other financial intermediaries were actively investing abroad (table 10). As noted earlier, these short-term inflows were largely net borrowings by Japanese banks from their overseas branches, particularly their branches in London. Because of its position as a short-term borrower and long-term net lender, Japan is playing a role of international financial intermediary as well as serving as a net source of world savings.

In summary, it appears that the activities of Japanese banks abroad from 1980 to 1988 were linked to the financial regulatory climate in Japan. The deregulation of nonbank intermediaries and of foreign activities of Japanese banks, compared with the slower de facto deregulation of deposits at banks in Japan, rendered Japanese banks relatively less competitive in seeking domestic sources of funds and relatively more dependent on their overseas branches to fund their domestic lending.

THE EMPIRICAL MODEL

The previous sections have described the U.K. and U.S. activities of Japanese banks and the financial and regulatory environment in which they operate in Japan. The authors have estimated some preliminary statistical relationships to see which factors appear related to growth of assets of the branches of Japanese banks in these two overseas markets.(11)

The explanatory variables included factors in the overseas markets that may be influencing the growth of assets of these branches as well as factors specific to the Japanese domestic economy. The variables included cyclical factors, in both home and foreign markets, as measured by capacity utilization, the value of Japanese merchandise exports plus imports because of the importance of foreign branches in financing trade, and seasonal dummies to capture possible seasonal "window dressing." Also, two measures of the degree of financial restraint in Japan were used: (1) the difference between the unregulated domestic rate on CDs and the rate on call money in the interbank market, and (2) the difference between loans and deposits at city banks in Japan. (12) These two variables attempted to capture the effect of both price and quantity restraints on the ability of Japanese banks in Japan to fund their loan demand directly from local sources or to trade in interbank markets at market-clearing prices. The empirical model did not include specific variables for the cost of funding or capital for Japanese banks relative to the costs for banks headquartered in other countries. While these factors may be important over time, they were not included for two reasons. First, deriving satisfactory measures of the cost of funds for different national banking groups operating in worldwide markets is notoriously difficult and beyond the scope of this article. Second, factors affecting global funding costs are unlikely to explain growth in the U.K. and U.S. markets as satisfactorily as local market factors.

In examining the determinants of the activities of Japanese banks in the United Kingdom, the focus was on the value of total nonsterling assets of Japanese branches because these assets are the primary component of total assets. This focus on nonsterling assets suggested that cyclical effects from the U.K. economy would be largely irrelevant and that the size of the local market could best be measured by the Eurocurrency lending of all banks in London rather than by GNP or some other demand variable in the United Kingdom. The results of the model indicated that important determinants of nonsterling assets of Japanese branches are (1) the size of the total Eurocurrency banking market in London, excluding assets of Japanese banks, (2) the value of Japanese total trade, (3) the level of capacity utilization in Japan (where higher degrees of capacity utilization cause Japanese banks to focus on lending in Japan rather than abroad), (4) seasonal window dressing, and (5) the effect of financial restraint in Japan as measured by the difference between loans and deposits.

For the activities of Japanese banks in the United States, similar equations were estimated. Besides considering the determinants of total assets, the determinants of commercial and industrial (C & I) loans and interbank claims were analyzed to see if they differed. For these three separate measures, the activities of Japanese banks in the United States were assumed to be influenced by U.S. GNP and by the total amount of Japanese trade, which is largely financed by Japanese banking offices in the United States. Besides the cyclical variable for capacity utilization in Japan, a cyclical variable for the United States was also used because a large proportion of Japanese lending in the United States appears related to the U.S. economy. Seasonal dummies were included, as were the two different measures of financial restraint in Japan.

For total assets of Japanese banks in the United States, all of the explanatory variables, except for Japanese capacity utilization, were estimated to be statistically important determinants. The equations for C & I loans and for interbank claims showed similar results for seasonal influences and for the effect of capacity utilization in both the United States and Japan, as well as the effect of financial restraint in Japan. However, significant differences were apparent in terms of the effect of U.S. GNP and Japanese trade on these two categories of banking activity. Japanese trade was a significant determinant for C & I loans, which underscores the importance of U.S. offices in financing Japanese trade, while this variable was not statistically significant for claims on banks. On the other hand, U.S. GNP was found to be a significant determinant of interbank claims but not of C & I loans. This lack of a statistical relationship was somewhat surprising given how actively Japanese banks compete for domestic business lending opportunities in the United States, including purchasing loans from U.S. banks. The lack of a relationship may result from a strong correlation between U.S. GNP and other variables in the model.

In summary, U.S. activities of Japanese banks during this period appeared strongly related to Japanese domestic financial variables as well as to conditions in the U.S. market. Commercial and industrial loans at these offices responded both to expansions in Japanese trade and to restraints on domestic Japanese interest rates, while interbank trading at U.S. offices of Japanese banks responded to both price and quantity restraints on domestic Japanese banking activity.

SUMMARY AND CONCLUSIONS

Japanese banks have become active competitors in major international markets. Their competitive success appears to result from a variety of factors, including the expansion of Japan as a trading nation and the ability of Japanese banks to fund their activities at very attractive rates in some markets. Japanese bank expansion in the U.K. and U.S. markets is also influenced by local market opportunities. Besides these factors, activities in both markets appear in part directed toward operating in less regulated environments, particularly with respect to funding. In response to domestic restrictions on prices and on the volume of certain activities during most of the 1980-88 period, Japanese banks appear to have shifted some of their commercial lending, as well as some of their interbank trading, to the United States. The U.K. branches appear to have been used as a flexible net source of funding for loans by the home offices.

The implications of these findings are twofold. First, to the extent that Japanese bank activities in these two centers have represented a response to domestic Japanese restraints, the concern in other countries about local market penetration based on percentages of loans or assets in these two markets may have been overstated. Second, the continued deregulation of banking in Japan, such as the removal of the restraints on interest rates in the interbank market for call money in late 1988, should lead to some repatriation of what is currently counted as international banking business back to the domestic banking market in Japan. If such a repatriation occurs, it could lead to a slowing or possible reversal of the trend toward an increase in the share of Japanese banks in measured international banking aggregates. SELECTED BIBLIOGRAPHY 

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