Japanese interest rate regulations lose effect

Japanese interest rate regulations lose effect

Thus government bonds served as a way to destroy the regulated segmentation between banks and securities firms. But government bonds also served as a tool that undermined the regulation of interest rates. This is because government bonds, which are risk-free and highly liquid, served as the perfect medium for repurchase agreements.

Under repurchase agreements, a person sells an item such as a government bond to another party and receives cash for the sale. The purchaser and seller have an agreement so that the purchaser will resell the same bonds back to the initial seller at a higher price. The original seller in effect receives a short-term cash loan from the original purchaser, and the original purchaser is compensated for this loan by receiving a higher price on the resale.

These repurchase agreements, known as gensaki in Japan, had been the only market open to anyone where market forces, rather than government regulations, set interest rates. With the increase in suitable instruments - government bonds - the unregulated gensaki and other money markets increased.

Acknowledging that a significant unregulated money market had appeared, the MoF allowed banks to compete with the gensaki market in 1979. This is the year that banks began issuing negotiable certificates of deposits (NCDs) which offered market rates of interest. NCDs initially were allowed only for a term of three to six months and required a large deposit of ¥500 million. NCDs thus were suitable only for corporations or rich individuals. However, during the 1980s the minimum size of NCDs continually shrank and the maturities became more flexible. By 1988 depositors could receive NCD rates from deposits of ¥50 million and maturities ranged from two weeks to two years. NCDs were particularly attractive because they paid a much higher rate of interest than regulated demand deposits. For example, in 1986, regulated demand deposits yielded a miserable 0.26 percent while three month NCDs yielded 4.59 percent annually.

Besides NCDs, banks were granted authority to accept deposits for money market certificates (MMCs). MMCs were intended for smaller investors. For example, when MMCs initially came out in 1985, the minimum deposit required for an NCD was ¥100 million, but for an MMC it was only ¥50 million. MMCs were required by regulation to yield 0.75 percent less than NCDs, but this rate was still much higher than the demand deposit rate and the MMC yield would change according to market conditions.

Because of the obvious attractiveness of NCDs and MMCs over regulated deposits, and as minimum deposit requirements fell, the percentage of bank deposits that paid market rates of interest increased.

Share of deposits with deregulated rates of interest :

1986 1987 1988 1989
City banks 16% 25% 40% 52%
Regional banks 10 14 21 32

Note how the city banks, which obtain large deposits from interest-rate sensitive corporations, saw a greater increase in deregulated deposits than did the regional banks that depend on smaller depositors for funds.