Bernanke, Ben S., “Nonmonetary Effects of the Financial Crisis in the Propogation of the Great Depression,” American Economic Review. (June 1983), pp. 257-76.
Board of Governors of the Federal Reserve System, “Consolidated Financial Statements for Bank Holding Companies,” various issues.
Goodfriend, Marvin, “Money, Credit, Banking, and Payments System Policy,” in David B. Humphrey, ed., The U.S. Payments System: Efficiency, Risk, and the Role of the Federal Reserve, Kluwer Academic Publishers (1988).
Lummer, Scott and John McConnell, “Further Evidence on the Bank Lending Process and the Capital Market Response to Bank Loan Agreements,” Working Paper (June 1989).
Wolfson, Martin H., and Mary M. McLaughlin, “Recent Developments in the Profitability and Lending Practices of Commercial Banks,” Federal Reserve Bulletin (July 1989), pp. 461-84.
This paper has benefitted from comments by Ulrich Baumgartner, Peter Garber, Morris Goldstein, Ellen Nedde, and Jan van Houten. We accept sole responsibility for any remaining errors.
Reflecting the recent decline in real estate values and the related financial difficulties of property developers, Japanese banks have also encountered a rise in problem loans, although the proportion of organized non-current loans in total bank loans has remained small.
“Good funds” can mean either cash or, in the wholesale market, deposits at the central bank or at banks, items whose delivery always constitutes settlement of a claim for cash.
However, liquidity is costly for reasons other than the fact that the central bank does not pay interest on reserves. After all, no law prevents wholesale market participants from establishing a “bank” that holds Treasury bills and settles payments through purchases and sales of these bills. Treasury bills are just not liquid enough for payments purposes; only reserves will do. In fact, this is what a money market mutual fund does. However, money market mutual funds still hold demand deposits at banks because this is the only way they can provide their customers with the ability to make payments.
It may be argued that a bank must still hold reserves because it is subject to reserve requirements. However, in a market like the United States, wholesale banks have many opportunities to reduce their reserve holdings to their desired level by issuing liabilities not subject to requirements instead of reservable deposits. For example, overnight repurchase agreements have the same characteristics as demand deposits, but they are not subject to reserve requirements.
The commercial paper market ultimately depends on the banking system for liquidity because issuers back their paper with liquidity lines. However, the fact that lines are rarely drawn implies that banks do not need to supply liquidity under normal circumstances (Garber and Weisbrod (1990)).
It is assumed that the banks’ insurance costs are unaffected by the risks they accept, as is the case in most government insurance schemes.
Risk can be taken in other ways as well, for example, by taking a risky trading position in interest rate or currency markets.
U.S. depository institutions include commercial banks, savings and loans, mutual savings banks and credit unions. Japanese depository institutions include financial institutions for small businesses, agriculture, fisheries, and postal savings.
In the United States, money center bank holding companies hold 8.5 percent of all U.S. depository institutions’ domestic deposits, while other large bank holding companies hold 30.4 percent of those deposits. In Japan, city banks and regional banks hold 27.4 percent, and 20.4 percent of all depository institutions’ domestic deposits, respectively.
Bank holding companies that cross state lines are, however, permitted to operate in some 40 states.
Most charts in this paper provide data for regional banks as well. This serves both as a point of comparison, and as a basis for our later discussion of regional banks.
The regulators and Congress have attempted to come to grips with the problem by increasing supervision and attempting to place limits on the Fed’s powers of lender of last resort.
The decline in corporate willingness to hold demand deposits becomes evident by noticing that the value of these deposits actually declined from ¥ 39.2 trillion in 1985 to ¥ 37.9 trillion in 1990.
It is sometimes argued that much of this decline was due to capital gains on cross-corporate equity holdings. However, if we consider close domestic substitutes for bank deposits, it is clear that the relative demand for bank deposits has declined. In 1980 trust accounts equaled 6.5 percent of bank deposits. By 1990 the ratio of trust accounts plus commercial paper (a short-term asset not available in 1980) to bank deposits rose to 24.4 percent.
These figures exclude equity from liabilities.
Many of the government bonds were sold to the trust accounts of banks and investment trusts and therefore held indirectly by the public through trust funds. For example, by 1985 trust accounts and investment trusts held ¥ 16.9 trillion in government bonds compared to ¥ 17.5 trillion on the balance sheets of all banks.
While the ratio between short-term and long-term bank loans is the relevant measure of corporate demand for bank liquidity, the outstanding value of both kind of loans largely increased during the 1980s.
It is noteworthy to point out that not all segments of the Japanese market; in the mid 1970s were as liquid as the corporate market. The call money market, which operates as an interbank market and as a market for loans to securities dealers, was regulated until the Fall of 1978. When it was deregulated, the spread between the rate at which city banks sold and bought funds increased from zero to about 300 basis points. At the same time, call loans at city banks expanded by about 75 percent as banks tried to profit from the lack of liquidity in this market. However, the market was too small to have much of an impact on city banks profitability, and by the end of the 1980s, the spread had disappeared (Table 3).
Net interest margins are affected by interest rate cycles as well as the secular trend. It is sometimes argued that the secular trend has been driven by deposit interest rate deregulation. We suggest that deposit interest rate deregulation is, in fact, endogenous to the decline in demand for liquidity. Banks have attempted to maintain their share of financial assets by reducing their spread. To do this, they had to support deposit deregulation.
The expansion of city banks’ foreign assets occurred at the same time that American banks were making dollar loans to developing countries, so the time would have been right for the Japanese banks to follow the same path if they had so desired. Figure 12 illustrates that they did not do this. The ratio of domestic loans to total loans did not fall by as much as the ratio of domestic deposits to total deposits. (Japanese banks did make some loans to developing countries, but the amount of their exposure is less than their total capital account.)
After a boom in stock prices that peaked in December 1989, the Nikkei stock index fell by 38 percent during 1990 and by 6 percent during 1991. The fall in the index accelerated further during the first four months of 1992 when it fell by over 20 percent.
That is, as a branch becomes larger, operating costs per dollar of deposit decline.
The decline in total deposits relative to household assets did not occur due to the increase in the value of equities directly held by households. In 1980 trust and insurance equalled 29.8 percent of household assets; by 1990 this ratio had risen to 51.9 percent.