ejcjs - Double-Gearing Between Japanese Banks and Insurance Companies: Their Reasons and Future Prospects

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First published in ejcjs on 18 January 2006

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Double Gearing Between Japanese Banks and Insurance Companies

Reasons and Future Prospects

by

TRAN Bich Hanh

Post-Doctoral Fellow
Institute of Economic Research
Kyoto University

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Abstract

It is a common practice in Japan for groups of firms to exchange their equity, this is called 'cross-shareholding'. However, recently a cross-shareholding phenomenon called 'double-gearing' has emerged, characterized by the relationship between Japanese banks and life insurance companies where, in addition to holding each others' shares, they hold each others' subordinated debt and surplus notes. This sort of gimmickry is clearly contrary to the spirit of the Bank for International Settlements (BIS) because it cannot assist in bolstering real capital strength, as the BIS requires. Indeed, the Bank for International Settlements' 2001 Annual Report strongly criticized this practice. However, Japanese government policymakers do not seem to recognize these risks. Therefore, researching this new system of institutional arrangements among Japan's keiretsu is necessary in order to try to avoid the unexpected risks and losses which, as a result, may be being brought to the whole financial system. This paper points out some reasons, besides that of raising capital, that lead to double-gearing between Japanese banks and insurance companies. In addition, it briefly discusses some risks related to double-gearing and looks at the future prospects for such relationships. The paper is organized as follows: Section 2 describes the facts of double-gearing in Japan. Section 3 analyzes the reasons for double-gearing. Section 4 discusses the risks of double-gearing. The future prospects of double-gearing and conclusions are given in Section 5.

Keywords: Double-gearing, Japanese banks, life insurers, capital

JEL Classification Numbers: G21, G22

Acknowledgements

The author is grateful for the valuable suggestions of Prof. ARIGA Kenn, Institute of Economic Research, Kyoto University. The author also sincerely thanks Prof. FUKAO Mitsuhiro, Faculty of Business and Commerce, Keio University and President of Japan Center for Economic Research for help in providing his papers and related information. Financial support from the Kanihoken Bunka Zaidan is gratefully acknowledged.

1. Introduction

It is a common practice in Japan for groups of firms to exchange their equity, this is called 'cross-shareholding'. However, recently a cross-shareholding phenomenon called 'double-gearing' has emerged, characterized by the relationship between Japanese banks and life insurance companies where, in addition to holding each others' shares, they hold each others' subordinated debt and surplus notes. Cross-shareholding between banks and life insurance companies is often stable over the long term (Hanazaki et al, 2004). However, unlike traditional cross-shareholding, which is just an exchange of share equity, double-gearing additionally involves multiple swaps of subordinated debts. The Japanese Ministry of Finance (MOF) gave permission in June 1990 to allow banks to sell up to 2 trillion yen of their subordinated debts. But a major part of these are owned by insurance companies, which may have raised the funds to buy this debt by selling off stock (Wood, 1992). Wood also notes that other buyers of the subordinated debts are the finance subsidiaries of companies in the banks' own financial keiretsu groups. In a typically Japanese arrangement, the banks lend money to these traditional customers at cheap rates and the companies then turn around and lend the banks their own money back at slightly higher interest rates. This sort of gimmickry is clearly contrary to the spirit of the Bank for International Settlements (BIS) because it cannot assist in bolstering real capital strength, as the BIS requires.

Cross-shareholding by banks and firms in general, and particularly double-gearing between banks and their keiretsu-affiliated life insurers, has become a matter of grave concern since the 1990s because the fortunes of banks and insurers are lashed together, and the fact that both have recently been in financial difficulties is an important factor in Japan's protracted financial crisis. Therefore, researching this new system of institutional arrangements among Japan's keiretsu is necessary in order to try to avoid the unexpected risks and losses which, as a result, may be being brought to the whole financial system.

However, surprisingly, there are only a few studies on the double-gearing problem in Japan, such as those by Fukao (2003a) and Kashyap (2002). Fukao (2003a) briefly discusses double-gearing and discovers two important problems: poor-quality capital in Japan's financial sector which increases systemic risk, and the banks' weaker governance structures. Kashyap (2002) additionally stresses that double-gearing makes both banks and insurance companies appear to be better capitalized than is in fact the case. He notes that the banks issue securities that are bought by the life insurance companies, which effectively buy the banks' securities by turning over their own securities. The net effect is that reported capital may be increased but the amount of real money raised is greatly overstated. Fukao (2003a) and Kashyap (2002) point out that banks and life insurers have relied on each other to broadly raise their defined capital. But, there is not yet a unified opinion about the risks of double-gearing. According to Kashyap (2002), most outside analysts take it for granted that double-gearing is dangerous. For example, the Bank for International Settlements' Annual Report for 2001 strongly criticized this practice (2002, p.135) saying, 'These inter-linkages increase systemic risk, particularly considering the weaknesses in the Japanese insurance sector.' However, Japanese government policymakers do not seem to recognize these risks. For example, Shokichi Takagi, Commissioner of the Financial Services Agency (FSA) (Financial Services Agency, 2002), responded to the BIS criticism by saying, 'The nature of the risks is different between insurance companies and banks,' and '...as far as the conventional approach is concerned, the nature of risks is different and therefore the cross-holding of equity is not a big deal. So-called double-gearing is not excluded at this point, as the nature of the risks is different'.

This paper advocates the point of view put forward by Fukao and Kashyap about the purposes for as well as the risks of double-gearing between banks and life insurers in Japan. However, it goes further in it's detail to point out some other reasons, besides that of raising capital, that lead to double-gearing between the two financial entities. It is shown that double-gearing is a way to preserve business relationships between banks and life insurers. Especially, in the case that other sources of funds are limited, double-gearing will provide the best and quickest way to access funds, and thereby bring bilateral benefits to both parties. In addition, the benefits to both banks and life insurers of using subordinated debts (or loans), such as tax-advantages over share equity, creates an increase in retained earnings. The maintenance of ownership, etc. are other reasons leading to their double-gearing relationship. The paper shows an overall picture of the capital deficiency status of banks and life insurers both leading and tying their double-gearing relationship. In addition, the paper discusses some risks related to double-gearing and further analyzes the future prospects for the relationship in terms of the Japanese financial system.

This research brings a deeper understanding about the causes of double-gearing relations and their associated risks. Thus it is hoped that it may assist regulators or policy makers in developing a more appropriate evaluation and appreciation of the dangers of such a relationship between these two financial entities. In addition it is hoped that the paper will assist regulators to develop proper solutions for mitigating losses to the whole financial system.

The rest of the paper is organized as follows. Section 2 describes the facts of double-gearing in Japan. Section 3 analyzes the reasons for double-gearing. Section 4 discusses the risks of double-gearing. The future prospects for double-gearing and conclusions are given in Section 5.

2. The Facts of Double-Gearing in Japan

Banks have played a dominant role in the Japanese financial system for most of the period since World War II. Life insurance firms in Japan, where the average life expectancy is the longest in the world, hold a significant number of assets compared to those in other countries; they are the second largest part of the financial services industry after commercial banks. Property and casualty insurance companies (general insurance) are also significant players in the Japanese financial system, but they are not as important as life insurance companies. In 2004, the total assets of commercial banks was 742 trillion yen (Bank of Japan, 2006a) and the total asset of insurance companies is 191.5 trillion yen, which amounted to approximately 37.9% of GDP (Life Insurance Association of Japan, 2006).

An interesting feature of life insurance companies in Japan is that most large ones are mutual. There are two forms of life insurers: joint stock corporations and mutual companies. At the end of 1985, there were 23 life insurance companies in Japan, where 16 were the mutual type while the other 7 were of the joint stock type (Suzuki , 1987, p. 241). But in terms of how they functioned in their undertakings and in terms of the structure of their earnings, there were hardly any differences among them. Since the second half of the 1990s, 7 private life insurance companies have failed. As of March 2000, 14 out of 46 life insurers in Japan are mutual companies. These 14 companies are so large that they share about 94 percent of the total assets of the life insurance industry (Shikano 2001). Currently, there are 42 life insurance companies.

The capital of mutual life insurance companies includes retained earnings from prior years and external funds. Funds are reimbursed to investors from the profits of the life insurers, based on a contractual agreement between the two parties. The funds of life insurance companies are in many cases contributed by banks and vice versa, and much of the capital of banks is also contributed by life insurance companies. In Japan, insurance companies are among the major shareholders of banks; especially they are the dominant shareholders of nationwide banks. The mean shareholdings by insurers of banks are about 10.26%, 9.71% and 5.74% in 1980, 1990, and 2000, respectively (Hanazaki et al, 2004, p. 6). Given that, currently Japanese banks and insurance companies are restricted to holding no more than 5% and 10% of a firm's outstanding shares, respectively (Hanazaki et al 2004). In the same fashion, banks hold a significant amount of insurance company debts (usually in the form of subordinated debts and surplus notes). The ownership of life insurance securities is also a part of the broader tendency for Japanese banks to own corporate equities (Kashyap, 2002). In a similar fashion, Japanese life insurers rank among the top shareholders of banks with which they have traditional business ties or are group affiliates, and banks are big contributors to the mutual life firms' capital base, which is similar to shareholders' equity at banks. They also help beef up each other's financial health. Banks extend subordinated loans to life insurers, which in turn regularly buy debt securities that banks issue to boost their capital. This is particularly helpful for banks under pressure to prevent their capital from being depleted by a plunging stock market. Figures 1 and 2 show the double-gearing between the ten major life insurers and banks in Japan from 1999 to 2002. At the end of fiscal year 2002, banks were the source of surplus notes (similar to non-voting preferred shares of joint-stock companies) and subordinated debts (or loans) to the ten major private life insurers with the total being 1.9 trillion yen. At the same time, the ten life insurers held a total of 6.3 trillion yen of these types of capital belonging to the banks. This number is even larger than the amount of 5.5 trillion yen capital of all private life insurers reported in the fiscal year 2002 (Life Insurance Association of Japan, 2006).

Figure 1: Capital from Banks to Life Insurers

Figure 2: Capital from Life Insurers to Banks

While the banks' stocks held by life insurers have fallen year by year, the subordinated debt amount is quite stable; banks hold about 1 trillion yen and life insurers hold more than 4.5 trillion yen of subordinated debts of the banks. According to Fukao (2004b, p.260), the drop in banks' stocks held by insurers is likely due to the decline in stock prices, not changes in the number of stocks. Therefore, while stock value is decreasing (see Figure 3), the subordinated debts are steady and becoming a main and stable component of double-gearing capital between the two partners. With this finding, in subsequent sections I will analyze other reasons leading to double-gearing, along with the requirement of increasing capital, based on the features of subordinated debts.

Figure 3: Monthly NIKKEI Stock Average (TSE 225 issues)

Tables 1 and 2 below show the statistical information regarding double-gearing between pairs of life insurers and banks. Table 1 shows the amount of shares and subordinated debts of banks held by major life insurance companies. Table 2 shows the amount of surplus notes, shares and subordinated debts of life insurance companies. The two tables show that Nippon, Daiichi and Sumitomo life insurers are the top shareholders of banks, and vice versa, their largest capital investors are banks. Table 1 shows that Sumitomo Financial Group has its largest banking capital held by life insurers. Table 2 shows that Sumitomo Banking Corporation and Mizuho Corporate Banks are the top shareholders of life insurers.

Table 1: Capital of Banks Held by Life Insurers

Table 2: Capital of Life Insurers Held by Banks

3. Reasons for Double-Gearing

i) Double-Gearing to Meet Capital Requirements

Banks and insurance companies have been able to use subordinated debts to meet their capital requirements since 1990. This debt constitutes capital because of its relatively long maturities and funding permanence. It does not qualify as tier 1 or core capital because, unlike common equity, it eventually matures and must be replenished. Subordinated debt must possess several specific features before the regulators accept it as capital. First, debt holders' claims must be subordinated to depositors' claims. If the bank fails, insured depositors are paid first, followed by uninsured depositors, and then subordinated debt holders. Second, only debt with an original weighted average maturity of at least seven years is qualified as capital (Koch, 1995).

Since subordinated debts can be included in the numerator of the calculated solvency margin ratio, life insurers receive subordinated debts from banks (1 trillion yen in 2002, see Figure 1). Banks provide life insurers equity as the combination of subordinated debts and funds (1.9 trillion yen in 2002). At the same time, life insurers also cooperate in increasing the capital of banks. The life insurance companies had 4.4 trillion yen of subordinated debts of banks in 2002 (see Figure 2).

As shown in Figure 4, Japanese banks had continuous negative net incomes in the period from 1995 (-4,128 billion yen) to 2003 (-600 billion yen). Therefore, the important source of capital of retained earnings had not remained, inevitably leading to the deficiency in the banks' capital. Further, by looking at the real capital position of banks and life insurers, we can understand more clearly why they need double-gearing to increase their capital base.

Figure 4: All Japanese Banks' Net Income/Loss

Table 3: Capital Position of 17 Major Banks

Table 3 shows the weak capital structure of Japanese banks. On the surface, the 17 major banks had 18 trillion yen and 13.1 trillion yen of capital in 2002 and 2003 respectively, however, after subtracting deferred tax, reserve and public capital injection, the net capital amounts were negative.

The Report No.9 by Japan Center for Economic Research (2003a) indicates that the number of banks in negative equity rose from 10 at the end of March 2000 almost three times to 29 at the end of March 2003, as shown in Table 4. In general, the capital ratios of all banks were still far lower than the BIS requirement of 8 %.

Table 4: Distribution of Net Capital/Asset Ratio of Japanese Banks

Keeping high capital adequacy ratios — a measure of financial health — is a hard task for banks now, who are struggling to stem further erosion in operating profit and prevent capital depletion while trying to write off massive non-performing debts. Banks have few options to strengthen their capital because the weak stock market discourages new issuances of equity or convertible bonds, which count towards core capital. Thus in the situation of insufficiency in capital, the banks need to look for other sources of funds, especially from life insurances. In fact, Japanese insurance companies help banks increase the capital ratio, and provide capital without reasonable return to bail out distressed banks.

Life insurers in turn have also relied on banks for funding since they have been in financial trouble starting around the latter half of the 1990s. Not only in Japan, but also in a number of European countries (Denmark, Germany, Netherlands and United Kingdom), the life insurance companies face variants of the problem that they have in the past guaranteed minimum nominal returns to savers (whether contractually or implicitly) which exceed the nominal yields currently available on risk-free assets (Rule, 2001). Furthermore, their large holding of plunging stocks leads to huge losses for life insurers. Seven Japanese life insurance companies declared bankruptcy from 1997 to 2001. They are Nissan Mutual Life in April 1997, Toho Mutual Life in June 1999, Daihyaku Mutual Life and Taisho Limited Liability Company in May 2000, Chiyoda Mutual Life and Kyoei Limited Liability Company in October 2000, and Tokyo Mutual Life in March 2001. Therefore, life insurers in turn also need protection that they can receive from banks.

Table 5: Economic Profits of 10 Major Private Life Insurers

Table 5 shows the Economic Profit of the ten major life insurance companies. The numbers in parentheses are shares of total assets. Economic profit is defined as the increase or decrease in net assets on a market value basis, assuming no dividends were paid out, no increases in capital and no buying back of capital stock (Japan Center for Economic Research, 2003b). This measure indicates the real profitability of the companies for one business year and the negative figure means the real capital is reduced. Table 6 shows that the economic profits of the ten major life insurers were negative for the past three years, meaning that the real capital of these companies has declined.

Since the life insurers own a large quantity of bank-issued debt securities, they are also in a severe financial state, hit by huge stockholding losses including shares of big banks that shed more than 50 percent in value over the past few years. At the same time, banks' debt issues have attractively high returns while the life insurers are seeking high-yielding investments to cover for the losses. Life insurers are caught in a quandary, weighing the benefits of unwinding cross-holdings and keeping close ties with banks. However, the current recovery of Japanese stock markets (Nikkei 225 index reached 16,124 yen on 10 January 2006, considerably higher than the level of 11,500 yen at the end of 2004) may help both the banks and life insurers to achieve a better financial situation and, thus, the cross-holding relationship between the two may have the potential to be unwound.

ii) Double-Gearing to Keep the Business Relationship

Hanazaki and Horiuchi (2003) and Hanazaki et al (2004) argue that insurers are not trustworthy monitors because they wish to protect their current and potential business relationship with banks in which they own shares. Life insurers have been helpful to bank managers when banks were required to strengthen their capital bases in responding to the introduction of the BIS capital adequacy regulations since the end of the 1980s. In turn, insurers actively bought most of the banks' subordinated debts to help the banks increase their capital.

In the Japanese business environment, many representative policyholders are top managers of other companies. Often, a life insurance company owns a significant portion of outstanding stocks of the companies of the managers. Many 'housewives' among representative policyholders are often wives of such managers (Fukao, 2004b, p.254). It implies that personal relationships will be an important influence factor on the business of life insurers.

Moreover, the corporate pension funds are a large and important source of funds to life insurers, so that with such a good relationship with the firms or banks, life insurers can be appointed as trustees of these funds and get benefits from this relationship. The basic schemes of the Japanese corporate pension funds were established in 1960s, aiming at increasing benefits for employees and supplementing public pension funds. They are classified into two types, Kōsei Nenkin Kikin for employees of large companies and Tekikaku Nenkin Kikin for employees of small firms. As of March 1998, total assets of corporate pension funds amount to 67.7 trillion yen, of which Kōsei Nenkin Kikin funds occupy 71% (Suto, 2000) (see Table 6).

Table 6: Total Assets of Corporate Pension Funds and Shares of Trustee

Table 6 shows that life insurance companies (38.7% share in fiscal year 1997) together with trust banks are the main trustees of corporate pension funds. Moreover, the pension funds for employees of large firms provides more than 70% of the total corporate pension funds. These lead to life insurers preserving the relationship with banks as well as corporate firms, especially big banks and firms to employ the benefits from the corporate pension funds.

In addition, life insurers do not only cover pension contracts but also provide insurance coverage against death, sickness and disability. So they also can use the relationship with banks, and other keiretsu members with which the banks and insurance companies have investments, which have huge numbers of employees, to access the benefits of these insurance contracts with the banks' employees. Anecdotal evidence suggests that banks and other keiretsu members allow insurance companies, who are large shareholders, to send their sales representatives inside bank offices to sell insurance policies to the bank's employees. This transaction would obviously be lost once the relationship is terminated. For example, in 1988 when Asahi Life Insurance Company sold out its shareholdings of the Industrial Bank of Japan, the banks' employees terminated their insurance contracts (Komiya, 1994). Given that the size of banks is relatively large with a huge number of employees (e.g. Mizuho Financial Group and UFJ Group has about 30,000 and 25,000 employees in March 2002, respectively), the business that life insurers have with the banks would be substantial. This business could even be more worthwhile to insurers than the capital gains and dividends received as shareholders (Komiya, 1994).

iii) Double-Gearing to Lower Costs and Maintain Ownership

Double-gearing can be regarded as an agreement between the banks and life insurers, so it is easier to obtain and even cheaper than other sources of funds since both banks and life insurers have bilateral benefits from this agreement. Moreover, besides the purpose of increasing capital adequacy and keeping the business relationship, we can see the subordinated debt related reasons leading to the double-gearing relationship between banks and insurers.

Subordinated debt offers several advantages to banks and life insurers. The most important one is interest payments of subordinated debt are tax-deductible, so the cost of financing is below that of equity sources and the retained earnings are higher. With greater retained earnings, the shareholders may receive higher dividends; moreover, the capital base can be increased. With this tax-advantage over equity (dividends are not tax-deductible, they must be paid out of after tax-earnings), and given that the interest rate on subordinated debt is 2%, the corporation income tax rate is 30%, and finally, with the subordinated amount outstanding from banks to life insurers of 4.4 trillion yen in 2002, the retained earnings which the life insurance companies can benefit from is 26.4 billion yen; the banks gain a benefit of 0.6 billion yen.

These are not small amounts in comparison with the total capital amounts of the banks and life insurers. With the above simple calculation, we can see that both banks and life insurers get benefits; concretely speaking they can increase their retained earnings. Thus using subordinated debt they can increase their capital base.

Furthermore, a result of a debt instrument's character is that although subordinated debt can be calculated as capital; the holders of subordinated debt are only creditors, not shareholders. So the ownership of the firms is not diluted when using subordinated debt (the same case occurs with surplus notes that are similar to non-voting preferred shares of joint stock companies). It is especially important in the case of banks since they are joint-stock banks. It is partially explainable by the fact that banks have received much capital in the form of subordinated debts from life insurers (4.4 trillion yen of subordinated debts in 2002) while life insurers have received less from banks (1 trillion yen in 2002).

iv) Double-Gearing as a Cushion for Depositors and Insurance Policyholders and Regulators' Encouragement

Debt holders' claims must be subordinated to depositors' claims. If a bank fails, insured depositors are paid first, followed by uninsured depositors, and then subordinated debt holders. Thus, subordinated debt is regarded as a cushion to protect depositors of the bank. With respect to life insurance companies, since surplus notes and subordinated debts constitute equity capital, under the Bankruptcy Law, like claims from banks' depositors, claims from insurance policy holders will be of higher priority than general claims of surplus notes and subordinated debts. The law allows surplus notes, stocks and subordinated debts to act as a cushion for the policyholders and will be written off before reducing insured amounts. In fact, when Chiyoda Life and Kyoei Life failed and went through these proceedings according to the Bankruptcy Law, all surplus notes and subordinated debts were written off (Japan Center for Economic Research, 2003b, p. 44). However, the Insurance Business Law was revised in August 2003. Under this revision, surplus notes, stocks, and subordinated debts will not be likely be able to function as a cushion to policyholders when the life insurers are in financial trouble. Fukao (2004b, p. 267) argues that since major banks provide a large amount of surplus notes and subordinated debts to life insurers, this law would protect banks, the junior claimant, more than policyholders, the senior claimant.

It is also noteworthy that Japanese insurers are deeply involved in the MOF's ad hoc policy to bail out distressed banks by providing the banks with capital without reasonable returns. Sometimes, insurers are required to purchase junior debts or preferred stocks issued by banks to strengthen the banks' capital loss or default losses. Such investment practices are not justified by the standard theory of asset management (Horiuchi, 2000). Analysts argue that compared with insurers, banks have more to lose in cutting their ties. The Basel Committee on Banking Supervision, which sets capital adequacy requirements, urges banks to exclude the shares held by life insurer units and affiliates when calculating their capital adequacy ratios - the so-called double-gearing rule. Japan's Financial Services Agency states that this is not applicable in Japan because banks and life insurers are not in direct affiliation given their relatively low stake holdings, and so banks can count shares held by insurers into their capital. Both banks and life insurers seek and can get benefits from the double-gearing relationship.

4. Risks of Double-Gearing

It is clear that the use of subordinated debts benefits both banks and insurance companies. However, subordinated debts bring out shortcomings. Interests and principal payments are mandatory and, if missed, constitute default. Moreover, from the regulators' perspective, debt is worse than equity because it has fixed maturities and banks cannot charge losses against it. It imposes an interest expense on the bank when earnings are low. Further, one more problem is that both banks and insurance companies hold each others' capital. Since double-gearing is related by not only subordinated debts but also surplus notes and equities, some of the following risks may be incurred:

Double-gearing limits shareholders' governance. Because double-gearing often creates a friendly relationship, major shareholders are often silent. In other words, without effective oversight by shareholders of corporate operations and managerial performance, managers have little incentive to maximize profit. Hanazaki et al (2004) empirically find that banks and insurance companies are among the largest shareholders but they are passive in governance of banks in Japan. Banks and insurance companies collude with the bank management.
Double-gearing represents an offsetting exchange of equity between the two financial entities, in most cases entailing no injection of new outside capital. Therefore, third-party investors in both firms might be made worse off in that their ownership share in the equity of the firm has been diluted by the increase in the number of shares without a corresponding increase in the earning capacity of the shares from investment.
Double-gearing is criticized as having negative effects on the stock market because it creates interdependency on the prices of firm shares.

5. Future Prospects and Conclusions

Life insurers provide insurances covering against death, sickness and disability: often embedded in long- or medium-term savings products, such as pensions. The insurer receives either a large single payment or a series of regular payments and invests the funds either to yield a regular income to the policyholder or a capital gain at some future date. In Japan, the life insurance companies mostly sell whole-life insurance policies with a term rider, 10- to 20- year endowment plans, and personal pension policies. In addition, they sell term insurance policies to corporate employees as group plans. Except for the group life insurance policies, most other contracts involve long-term savings components (Fukao, 2004b, p. 253). In order to hedge risks for such long-term contracts, the insurance companies tend to invest in very long term bonds such as 20-year government bonds. With long-term and fixed rate characteristics, subordinated debt is a suitable choice for insurers to use, together with other long-term assets, to diversify their investment portfolios. If we look at the liability side of the life insurers in long-term liabilities, it is clear that the life insurers are the best persons who can provide long-term funds for Japanese banks in the bank's perspective.

Table 7 shows that in the Japanese individuals' investment portfolio, time deposits are decreasing while cash holdings are increasing. It reflects the fact that crises in the Japanese banking system in the 1990s caused Japanese individuals to worry about the risks when putting their money in banks. Holding of stocks is also decreasing along with the depreciation of stock prices, whereas, the percentage of insurances and pensions is gradually increasing from 20.9% in 1990 to 28% in 2003. This seems to be a trend that Japanese individuals switched from direct holding of securities and time deposits at banks to indirect holding through life insurers, reflecting the concerns of a maturing and aging society. Therefore, banks still need life insurers to mobilize indirectly the funds from Japanese individuals and households. It seems that double-gearing is still demanded by both partners, and especially is more strongly demanded from the banks' side.

Table 7: Financial Assets of Japanese Individuals

Clearly, double-gearing brings bilateral benefits for both banks and life insurers, but at the same time, it creates risks for the whole financial system; thus the relation should be terminated. However, Japanese (and also German) corporate governance systems are generally characterized as 'relationship-oriented' systems, and cross-shareholding continues to provide implicit relational contracts — a function that still has a role in Japanese business society (Scher, 2001). Thus double-gearing relations may not be avoidable as long as both financial entities can get benefits from it and the regulators explicitly (and/or implicitly) encourage the relationship.

This research describes and analyses the overall and details of the double-gearing relationship between the two biggest financial entities. It may help regulators and policy makers to make more appropriate evaluations on the problem and to avoid the risks which this type of relation may bring to the whole financial system.

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TRAN Bich Hanh is currently Japan Society for the Promotion of Science (JSPS) Post-Doctoral Fellow at the Institute of Economic Research, Kyoto University, Japan. She obtained a Master of Science degree in Financial Management from the University of London in 1998 sponsored by the Swedish International Development Cooperation Agency (SIDA). From 2001 to 2004 she was awarded a Japanese Government Ministry of Education Scholarship at the Graduate School of Economics, Kyoto University, where she gained her PhD in Economics. Since then she became Research Associate at the Institute of Economic Research, Kyoto University and since September 2004, she has been a post-doctoral fellow doing research at the Institute. Her major research interests include financial economics, monetary economics, banking and finance, corporate finance, macroeconomics and applied economics.

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