FRBSF Economic Letter
99-14; April 23, 1999
 Economic
Letter Index
The Shrinking of Japanese Branch Business Lending in California
The sluggish economic conditions in Japan during most of the 1990s have
taken a toll on the activities of Japanese banks' California branches
and agencies. Foreign branches and agencies are direct units of foreign
banks and are not separately capitalized. Since 1992, their share of the
total business loans made by banking institutions based in the state has
plunged.
Japanese-owned U.S.-chartered banks headquartered in California, in contrast,
have seen their share of business loans hold fairly steady during this
period. These institutions differ from branches and agencies in that they
are separate legal entities from their parent organizations, and they
maintain their own capital.
In this Economic Letter, I discuss the plunge in Japanese branch
lending and highlight the role of constraints on branches stemming from
the weak financial condition of their parent banks in Japan.
Loss of market share
The experience of Japanese branches in California over the past several
years has differed from that of Japanese-owned U.S.-chartered banks. The
top line of Figure 1 shows
the business loans to U.S. borrowers of Japanese branches and agencies
in California as a proportion of business loans held by California-based
banks and foreign branches and agencies, from 1987 to 1998. The bottom
line shows the comparable series for Japanese-owned banks in California.
California's Japanese branches increased their share of business loans
to U.S. borrowers from all California banking institutions from 1987 up
to 1992, and then lost market share every year, especially so in 1997
and 1998. In contrast, Japanese-owned banks' share has stayed within a
relatively narrow range since 1988.
One recent development affecting the market share of California's Japanese
branches may be a decrease in demand for the branches' services due to
a sharp decline in exports from the state to Japan. In the wake of the
turmoil in East Asia, in 1997 and 1998, exports from California to Japan
fell by 7.7% and 16.4%, respectively. However, the decline of the branches
was well underway before the drop-off in exports, suggesting other forces
at work.
Weak financial conditions at Japanese
parent banks
One force that has been closely aligned with the pullback of Japanese
branches in California has been the deterioration in the financial condition
of their parent banks. During the run-up in stock prices prior to 1989,
banks in Japan enjoyed unrealized gains on their stock holdings of other
corporations. These so-called "hidden reserves" count, at least partially,
as capital for regulatory purposes. When Japanese stock prices declined
sharply between 1989 and 1992, the hidden reserves evaporated. With low
regulatory capital, the Japanese banks were constrained in their capacity
to extend credit. As indicated earlier, foreign branches are not separately
capitalized from their parent banks, so banks in Japan may have deliberately
reduced their activities at the branches in order to increase the parents'
capital ratios or to maintain lending in Japan.
Results from a quarterly Federal Reserve survey of selected branches
and agencies of foreign banks in the U.S. suggest that the Japanese parent
banks' capital ratios were an issue for Japanese branches in 1992. For
example, in August 1992, most of the surveyed Japanese branches and agencies
reported that regulatory capital ratios were only "adequate," and none
reported "very comfortable" capital ratios. In contrast, almost half of
the U.S.-chartered commercial banks, including foreign-owned banks, reported
very comfortable capital ratios, with an additional two-fifths reporting
"fairly comfortable" capital. Most of the branches reporting tight capital
ratios said that they were imposing more restrictive lending standards
and terms as a result. In addition, in a more formal analysis of data
from 1988-1995, Peek and Rosengren (1997) found that Japanese branches
in the U.S. did show a statistically significant decrease in both total
loan growth and business loan growth relative to assets in response to
reductions in their parent banks' risk-based capital ratios. Their results
indicated that in the early 1990s, at least, Japanese-owned banks in the
U.S. were not similarly pulling back on lending. Subsequent research by
those authors suggests that the pullback by the Japanese branches had
at least a temporary effect on the overall availability of credit in the
U.S.
Continuing problems at Japanese banks
As noted above, the decline in the share of business loans at Japanese
branches in California accelerated in 1997 and 1998. The Japanese economy
has suffered throughout the 1990s, and since the onset of the East Asian
financial crisis in the summer of 1997 the situation has only become worse.
Due to a mounting volume of problem loans, the financial condition of
Japanese banks is under even greater strain. Woo (1999) states that with
the rise in problem loans, Japanese banks significantly accelerated their
loan loss provisioning, resulting in substantial net operating losses,
which sharply eroded their capital base.
The problems of the Japanese banks continue to be reflected in the activities
of their branches. Responses to the survey referred to above indicate
that tightening of credit standards and loan terms for business loans
began to become more widespread at Japanese branches in California at
the end of 1997 and became pervasive at the end of 1998. Moreover, respondents
ranked a deterioration of their parent banks' capital as the most important
reason for the tightening. The tightening of credit at the branches was
not mirrored by U.S.-chartered banks, whether Japanese-owned or not.
Given the continuing serious financial problems in Japan and the recent
acceleration in the pullback by Japanese branches from the California
banking market, it is very unlikely that Japanese branches' shares of
business loans in California will recover their former peaks anytime soon.
Meanwhile the stronger, independent capital positions of the Japanese-owned
U.S. banks leave them in a better position to pursue profitable investment
opportunities.
Elizabeth S. Laderman
Economist
References
Peek, Joe, and Eric S. Rosengren. 1997. "The International Transmission
of Financial Shocks: The Case of Japan." American Economic Review
87(4), pp. 495-505.
Woo, David. 1999. "In Search of 'Capital Crunch': Supply Factors behind
the Credit Slowdown in Japan." Working Paper of the International Monetary
Fund 99(3).
Opinions expressed in this newsletter do not necessarily reflect
the views of the management of the Federal Reserve Bank of San Francisco
or of the Board of Governors of the Federal Reserve System. Editorial
comments may be addressed to the editor or to the author. Mail comments
to:
Research Department
Federal Reserve Bank of San Francisco
P.O. Box 7702
San Francisco, CA 94120
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