Unlike their American counterparts, Japanese banks are allowed to hold substantial amounts of corporate stocks. In 1991, banks held more than 20% of all Japanese corporate equity. Banks usually carry such stock on their books at the purchase price, arguing that the unrealized gains--known as "hidden reserves"--could stabilize lending.
Regulatory changes in the mid-1980s weakened that argument, according to economists Sun Bae Kim and Ramon Moreno, two researchers at the Federal Reserve Bank of San Francisco. In negotiating international capital standards embodied in the so-called Basel Accords, the Bank of Japan won the right for Japanese banks to count 45% of their hidden reserves against the agreement's requirement of an 8% capital-to-assets ratio. At the same time, the central bank backed off its strict oversight of bank lending. The result: Lending by Japanese banks has become far more sensitive to stock market fluctuations. The sharp fall in the Nikkei stock market since early 1989 has slashed banks' hidden reserves by 73%, and that, the researchers say, is a major factor in "the recent episode of sluggish growth in lending in Japan."