WHO NEEDS YEN?:
Liberalizing Foreign-Exchange Transactions

July 16, 1997

A completely revamped Foreign Exchange and Foreign Trade Control Law will come into effect from April 1998 following National Diet passage of an amendment in May. The revisions are expected to bring a number of benefits to businesses and individuals.

For one thing, the foreign-exchange business, which had hitherto been virtually monopolized by banks, will be opened up to anyone who wants to enter it. This will allow trading houses and manufacturers with overseas operations to settle accounts in foreign currencies, without having to go through a bank.

Banks will be forced to significantly lower their commissions to stay in the business. The amendment is the first phase in the Japanese "Big Bang" of sweeping financial reforms, scheduled to be in place by 2001.

Making Banks Obsolete
The revisions to the Foreign Exchange Control Law are likely to have a big impact on how companies involved in foreign trade conduct their business, especially in their settlement methods. Until now, firms in Japan have been required to carry out transactions in yen. But after the revisions come into effect, they may settle accounts in dollars or any other currency.

For instance, a Japanese manufacturer who exports its products through a trading house currently receives payment for those products in yen from the trading firm. The trading house, consequently, must first convert the foreign currency it receives from the importer into yen. Starting next April, though, the exporting manufacturer may choose to receive payment in the local currency, which it can keep in reserve or use to make purchases from foreign suppliers. Eliminating the need to convert currencies means the manufacturer can save on bank commissions.

Another revision to the law will allow groups of companies to settle their trade accounts together, instead of individually, as is required now. Thus, if a corporate group's dollar-denominated exports total 1 billion dollars and imports add up to 800 million dollars, it need only settle the 200-million-dollar difference. This provision will eliminate both hassles and costs and is expected to be actively used by parent companies and their subsidiaries, as well as by groups of affiliated firms.

"If we can take full advantage of the opportunities foreign-exchange liberalization offers," a financial officer of a large trading house commented, "then as a group we'll be able to trim our accounting staff to just 10% to 20% of current levels, and we could save several billion yen in commissions and other costs."

The greater convenience will be accompanied by higher risks, however. Many manufacturers use trading houses for their exports and imports. Since all transactions with the trading firms are in yen, the manufacturers are shielded from exchange-rate risks. But as companies beginsettling transactions in foreign currencies to save on commissions, they will need to hold more nonyen cash assets, exposing the company to the risk of exchange-rate fluctuations.

New Market Players
A license is required to convert foreign currencies. Today, only banks and a limited number of firms, such as travel agencies, are allowed to hold such licenses.

Following liberalization, though, the licensing requirement will be abolished. Already, a number of convenience store chains have announced they will enter this market. Until a system to guard against counterfeit currencies and other risks are instated, however, convenience stores are likely to employ a system of delivering foreign currencies to a local outlet the day after an order is placed.

Banks, meanwhile, are actively stepping up their efforts to retain their foreign exchange business. Japan's 10 "city banks" with branches nationwide plan to increase the number of foreign-exchange branches and to even set up branches exclusively for currency conversion at key locations in greater Tokyo. They will also expand the type of currencies they handle and extend business hours.

Banks are also expected to lower their fees to stay competitive. Most banks today charge around 3 yen for every dollar that they convert to and from yen. A spokesperson for a leading city bank commented that the days when it could dictate the commissions it got are over. "Depending on what our rival banks and new market players charge, we'll probably be forced to significantly lower our fees."

The First Step Toward the Big Bang
The Foreign Exchange Control Law was enacted in 1933. In principle, it banned all foreign-currency transactions owing to the country's shortage of foreign currency reserves at the time. As Japanese businesses expanded and began dealing regularly with foreign companies, the strict controls became unnecessary. In 1980, therefore, the law was amended to ensure "freedom in principle, restrictions as exceptions." A system of authorized foreign-exchange banks was retained, however, giving them a virtual monopoly on the foreign-exchange business. Thus many began calling for complete liberalization through full application of market principles.

The aim of the latest amendment is to enable anyone to hold foreign currencies and to use them in business transactions. It will eliminate all restrictions on financial transactions across national borders.

Japanese financial institutions, which had largely been protected from competition in the domestic market, will hence be compelled to compete head-on with both foreign and domestic rivals. The liberalization of the foreign-exchange market will thus be the initial spark that will eventually touch off the Big Bang in Japan's financial markets.

Japan's financial system is faulted for being expensive and overregulated; the securities transaction tax is hefty, and stock-trading commissions are fixed. Different types of financial activity, moreover, are separated by rigid institutional barriers. Some point out that liberalizing foreign-exchange transactions without first addressing these structural shortcomings will cripple Japanese companies' efforts to provide competitive services and push domestic assets into foreign hands.

But the government is going ahead with the amendment precisely to create a situation where additional reforms and stepped-up competition would become absolutely essential as well as to demonstrate its commitment to the Big Bang reforms.

Ministry of Foreign Affairs

Japan Information Network