1537. Before Main Banks: A Selective Historical Overview of Japan's Prewar Financial System

Frank Packer
(November 1995)

Among lessons learned from Japan's prewar financial system: Business conglomerates that did not remain dependent on government patronage were more successful than others in making the transition to a modern industrial economy. And banks that made a conscious effort to reduce their dependence on central bank credit were more successful than those that did not.

The postwar experience of the Japanese banking system has received considerable attention recently partly because conditions in defeated Japan in 1945 (including high inflation and the need to switch from a military to a civilian economy) are similar to those in transition economies today.

Policymakers in transition economies can learn a good deal from the experiences of Japan's postwar financial system but should remember that Japan also experienced extraordinary industrial growth and financial institution building in the late nineteenth and early twentieth centuries. Lessons to be learned from that experience include the following:

• Business conglomerates that did not continue to depend on government patronage were more successful than others in making the transition to a modern industrial economy.
• Banks that made a conscious effort to reduce their dependence on central bank credit were more successful than those that did not.
• The establishment of procedures for punishing defaulting borrowers helped the development of the payments system.
• Limits on the amount of lending to related parties appear to have contributed to financial stability (and could have contributed more if the newer "zaibatsu" had been as prudent as the older ones).
• Bank bailouts without accompanying reform (such as those the Bank of Japan undertook in 1920 and 1922) probably increased the likelihood of a more serious crisis, such as that of 1927.
• Capital standards --- the minimum capital requirements established in the 1927 law --- were a viable means of encouraging bank consolidation and more prudent lending.
• The public financial system served as a buffer when the banking sector was downsized.

This paper --- a joint product of the Finance and Private Sector Development Division, Policy Research Department, and the Financial Sector Development Department --- was presented at a Bank seminar, "Financial History: Lessons of the Past for Reformers of the Present," and is a chapter in a forthcoming volume, Reforming Finance: Some Lessons from History, edited by Gerard Caprio, Jr. and Dimitri Vittas. Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Daniele Evans, room N9-061, telephone extension 202-473-8526, fax 202-522-1955, Internet address pinfo@worldbank.org. (14 pages)

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