Financial Deregulation and Crisis:An ‘Agency-conflict’ Case of Japan

The main focus of this paper is on the ‘agency-conflict’ during financial deregulations in the 1980s as the potential causality of Japanese banking crisis in the 1990s. Agency conflict is defined as the conflict of interest among the policy makers and agencies (e.g. banks) that arises as a combined effect of heteroschedasticity1 of policy shifts at that time and the overall weaknesses of corporate governance of the Japanese banks. This paper theoretically and empirically tests the hypothesis that “agency-conflict” increases short-term profit and can be a potential cause of the subsequent crisis. First part of the theoretical model based on the Bayesian Learning Model explains how agency conflict can increase profit in brief and second part of the theory explains how banks can be vulnerable to crisis at the outset of the bubble. Moreover, the theoretical model is used as the basis of empirical analyses on the causes to the probability of banking crisis. The paper also provides discussion on a number of interrelated structural changes and agency-conflicting issues that occurred in the Japanese financial system. However, the analyses find that the ‘agency-conflict’ is significant to the probability of banking crisis.