Since the end of the global crisis, Japan has used quantitative easing to devalue the Yen and kickstart the its economy after languishing for two decades, with promising results so far. But according to Citi analysts Hironari Nozaki and Kana Saito, this isn’t just a case of the Bank of Japan making the most of a lax monetary landscape around the world. Japan’s domestic crisis hit years before Lehman and it may simply be recovering from the regulatory backlash faster.

“Japan experienced a domestic financial crisis from 1997 to 2003 that led to a tightening of financial regulation and supervision centering on tough asset inspections and risk management,” write Nozaki and Saito. “Now that Japanese supervisors have confirmed a recovery in the banking business following a post-crisis tightening of supervision, we think they are less interested in dampening risk appetite than in restoring it under an appropriate risk management framework.”

Aftermath of financial crises look similar

Their argument is that, while financial crises can look very different, their aftermath is similar: the government and financial sector scramble to find stop-gap measures, usually with some public assistance involved, followed by popular anger and a wave of new regulations meant to prevent a repeat performance.

Regulatory easing and liberalization contribute to effective resource allocation and efficient asset price formation via the price mechanism. However, the unrestrained pursuit of profit can trigger systemic risk, leading ultimately to a tightening of regulation in response to the market’s excesses,” write Nozaki and Saito. They argue that the competing pressures of driving profits and securing the financial system push a cycle of regulation and de-regulation, and Japan is simply at a different point in the process.

Japan regulatory tightening curve

Japan’s FSA changes course

Although it’s easy to miss, or to dismiss, Japan’s Financial Services Agency released new guidelines for bank inspections that places on emphasis on reducing regulatory cost and explicitly pays less attention to “small and low risk exposures pertaining to safety and soundness, and banks’ asset classification.”

Of course the US and Europe are moving in the opposite direction right now, busily debating supplementary leverage ratios and getting ready for the full implementation of the Volcker Rule, but it’s hard to argue that as memories of the crisis fade there will be a renewed push for deregulation, especially if the regulations go too far and inhibit banks’ basic operations as they did in Japan.