Marc Rubenstein’s Net Interest is fast becoming one of the most widely read blogs focussing on the global financial services industry. Rubenstein, a former hedge fund manager himself, in his blogs, dives deep into topical subjects concerning the industry or in-depth analyses of a sub-sector or a company in each of these blogs. This one is about Norinchukin Bank, with its humble beginnings as a Japanese farmers’ co-operative credit union which ended up becoming one of Japan’s largest financial institutions, eventually going on to invest in global assets. And along the way tripping multiple times in its chase for yield – from the Japanese real estate lending bust to the US sub-prime mortgage crisis. Rubenstein does justice to the title implicitly raising questions on banks’ role as custodians of their depositors’ savings (which in Norinchukin’s case would have been wiped out had the Japanese government not bailed it out using taxpayer’s money).
“By 1964, Norinchukin had gathered over 1 trillion yen of deposits; thirty years later, it had over 29 trillion yen. The only problem was that loan demand couldn’t keep up – in 1993, Norinchukin’s loan book was less than half the size of its deposits. It had to find something else to do with them.
Having been a recipient of government funds in its early days, Norinchukin was now able to reciprocate. The bank used its excess deposits to buy government debt. Over the years, it became one of the largest buyers of Japanese national debt as well as a major provider of liquidity in the local interbank market. With prime rates as high as 9.5% during the 1980s, this was a profitable business. Indeed, farmers could earn more on their deposits than they could from farming.
Soon, the bank supplemented its domestic investments with investments abroad. In 1979, it had started buying higher-yielding, low-risk foreign bonds including US treasuries. A change to the law in 1986 allowed it to offer the same services as other commercial banks, paving the way for it to establish an international securities subsidiary in London. And in 1989, it was given permission to make its first investment in equity markets abroad.
By the end of 1989, Japanese banks were the largest in the world and Norinchukin itself was the eleventh largest with over $220 billion in assets, much of which were invested in securities markets. In a full page advert taken out in the Economist in 1991, Norinchukin described itself as “Japan’s top institutional investor”. The advert concluded: “Norinchukin Bank – continuing the search for better ways to respond to our clients’ international needs.” In truth, Japanese farming cooperatives didn’t have much need for an office on London’s Broadgate, but they did have a need for yield and that’s what Norinchukin provided. By offering additional interest on deposits – called incentive money, or shoreikin – Norinchukin promised a yield that required it to take a bit more risk.
Until the end of the 1980s, that wasn’t a problem. Depositors were happy and Norinchukin earned a healthy 21% return on its equity – the highest among Japanese banks – underpinned by a AAA credit rating.
But then the market turned. Japanese banks tumbled from their perch as the largest in the world and Norinchukin wasn’t spared.
…. In the 1970s, housing loan corporations (jusen) emerged as major players on the Japanese real estate finance scene. They had originally been established to offer home mortgage loans but, driven by intense competition from banks during the 1980s, they shifted their focus to real estate developers. Up until 1990, the jusen companies had broad access to funding from a range of financial institutions but in April that year, the Ministry of Finance (MOF) introduced restrictions on lending to the real estate sector, shutting off several funding sources. One source that wasn’t shut off was agricultural cooperatives – the MOF made an exemption for them which they were only too happy to accommodate. With this new source of funds, jusens’ lending to the real estate sector grew sharply over 1990 and 1991.
We know now of course that this coincided with the top in the Japanese real estate market. And it was quite the top! At the height of the market in 1991, all the land in Japan – a country the size of California – was worth about $18 trillion, or almost four times the value of all property in the United States at the time.
When it collapsed, agricultural cooperatives were left holding the bag. On average, jusen companies borrowed 30% of their debts from sponsoring banks, another 30% from non-sponsoring banks, and the remaining 40% from agricultural cooperatives. Initially, there was an expectation that real estate values may recover, and a plan was pursued to restructure the debts. By 1994, it was apparent this was wishful thinking. A Ministry of Finance audit concluded that of a total 13 trillion yen of jusen assets, non-performing loans amounted to 9.6 trillion yen, of which 6.4 trillion yen was considered unrecoverable.
For the agricultural cooperatives, this was clearly very bad news. Many were threatened with bankruptcy, raising fears of a broad financial crisis with reverberations across the wider agriculture sector. To prevent that, authorities stepped in to apportion losses. After a fierce debate in the Diet, a package was approved allowing the use of taxpayers’ money. Parent banks wrote off all their equity stake and loans to these companies (worth 3.5 trillion yen), other creditor banks wrote off about 1.7 trillion yen of loans, and taxpayers took a hit of 680 billion yen – all of which left a burden on the agricultural cooperatives of just 530 billion yen. Their lobbying efforts paid off.”
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