Japanese Shōwa Financial Crisis of 1927

The Shōwa Financial Crisis of 1927 was a major crisis of the Japanese economy in the interwar period.

Background
Japan was growing dramatically in the late 19th and early 20th century, catching up with the developed western countries in a relatively short period of time.

Two major shortcomings plagued the financial structure of the country: the limited roles of securities markets and foreign capital. An important consequence was the lack of transparency and quality control of the whole financial and product markets. The lack of transparency resulted in the development of great financial holding companies called Zaibatsu and hindered the development of security markets.

The Bank of Japan (BOJ) actively supported the modern financial system. However, the UK and the US opted to return to the gold standard in the twenties after suspending it during the war. The return was at the prewar parities and was preceded by the recovery of the economies of the victors of World War II. Due to the positive inflation policy of BOJ throughout the period, Japanese prices were out of line with its competitors. In the twenties competition intensified in Asia and throughout the world. To maintain its market share and reduce the excess capacity, the governor of BOJ called for a return to the gold standard at prewar parity.

Japan chose not to join the other major countries in returning to gold during the 1920s. Apart from instability in the domestic financial system, policymakers feared that Japan might be unable to sustain gold parity even after returning to the gold standard. Japan recorded a persistent trade deficit during the 1920s after enjoying a massive trade surplus during the First World War. By running the trade deficit, the nation was losing the specie and foreign reserves it had accumulated during the War. The sum of the specie and foreign reserves decreased from 2,179 million yen (13.7 percent of GNP) at the end of 1920 to 1,199 million yen (7.3 percent of GNP) at the end of 1928.

In March 1920, stock prices plunged as investors anticipated a hard-landing for the Japanese economy after the boom of the First World War. In April 1920, Masuda Bill Broker Bank in Osaka failed, triggering a bank run in several regions throughout Japan. The bank had been engaged in the intermediation of interbank transactions, and its customers had included both local banks and large city banks. Then, over the next four months, from April to July 1920, operations were suspended at 21 banks, either permanently or temporarily. The Bank of Japan extended various types of "special loans" to ease tensions within the financial markets in general and stabilize financial markets by relieving specific key industries.

Ishii Corporation, a lumber company engaged in speculative activities, went bankrupt at the end of February 1922, triggering bank runs in Kochi Prefecture (in southwestern part of Japan) and Kansai region (Osaka, Kyoto and their environs). Then, from October through December 1922, bank runs spread far across the country. In 1922, operations were suspended at 15 banks, either permanently or temporarily. The BOJ extended "special loans" to 20 banks from December 1922 to April 1923.

The Great Kanto Earthquake in September 1923 hurt the financial system in Japan, damaging the financial assets of banks, as well as their physical capital such as the bank headquarters buildings and branches. Depositors feared bank losses and delays in the repayment of bank loans.

An emergency ordinance allowed the postponement of payments due from that month onward in the affected districts. The BOJ made special arrangements, including "special loans." Another emergency ordinance indemnified the BOJ for any losses incurred in the re-discounting of bills and certain other papers payable in the stricken areas (Earthquake Casualty Bills, or ECBs), to a ceiling of 100 million yen.

Depositors were relieved by these special measures of the government and BOJ. By the time the moratorium was lifted in October 1923, financial turbulence had been curbed. Meanwhile, large portions of the ECBs had yet to be settled. The date was set for September 30, 1927.

The crisis
In 1927, new legislation was proposed to finally deal with the bad debts incurred by the Great Kanto Earthquake. This legislation allowed the government to issue bonds which could be exchanged with the ECBs. On March 14, in the courses of heated debate on the government’s measures in the Diet, Finance Minister Naoharu Kataoka falsely declared that the Tokyo Watanabe Bank had failed (the bank had not yet failed at the time of this declaration). This statement set off a surge of financial panic in the regions surrounding the two great metropolises, Tokyo and Osaka. On March 23, the Diet approved the legislation, temporarily calming the depositors’ panic.

A nationwide financial panic was sparked when debates in the Diet revealed financial difficulties between the Bank of Taiwan and Suzuki & Co., a big trading house based in Kobe. The Bank of Taiwan had a monopoly in issuing bank notes on Taiwan Island, and close business ties with Suzuki & Co. In response, the Cabinet tried to issue an emergency ordinance authorizing the BOJ to send the Bank of Taiwan relief funds, and indemnifying the BOJ for any losses incurred by this action up to a ceiling of 200 million yen. The Privy Council, the body invested with the authority to approve the emergency ordinance, rejected it on April 17. The Wakatsuki Cabinet resigned and financial panic spread nationwide.

At the peak of panic on April 21, BOJ loans skyrocketed by 57 percent in just one day, to 602 million yen, and bank notes in circulation increased by 38 percent in just one day, to 639 million yen.

Aftermath
A new Banking Act was declared on March 30, 1927, in the midst of the Showa Financial Crisis, to come into power on January 1, 1928. The Act stipulated minimum capital requirements for banks and prohibited banks and bank managers from conducting most non-banking businesses. Under this Act, the authorities reinforced the bank examination and encouraged amalgamation of banks to stabilize the financial system as a whole. The number of banks declined steadily through the 1920s, and the trend accelerated in 1927 with an increase in mergers. By the end of 1920 there were 2,039 banks in Japan, and 1,427 in the year 1927. Then it decreased by 265 in just one year, by the end of 1928. In 1932, the number stood at 650.

The law was predicated on the assumption that competition in the financial sector was the cause and regulated monopoly was the best solution of the problems of stagnation during the twenties and the recurrent financial crises. Perhaps in order to maximize the speed of development, the lack of transparency was perceived as a necessary cost that Japan had to pay to speed up economic development. This policy of benign neglect of transparency continued to prevail until the late nineteen nineties.