The Shrinking of Japanese Branch Business Lending in California


Elizabeth Laderman

FRBSF Economic Letter 1999-14 | April 23, 1999

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.

Western Banking Quarterly is a review of banking developments in the Twelfth Federal Reserve District, and includes FRBSF’s Regional Banking Tables. It is published in the Economic Letter on the fourth Friday of January, April, July, and October.

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


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).

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