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

1. 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

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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

15. 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

16. 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.

17. Thank you.