Since the early 1980s, the Treasury Department has been pressuring Japan to reform its financial markets so as to ease the competitive disadvantages facing foreign banks and brokers.

In recent talks, Treasury officials put great stress on increasing the financial system's "transparency." In other words, regulatory policies should be in writing and should include objective standards and specific time limits.

If requirements are written down and readily ascertainable, it is assumed, foreign banks and brokers will have a better chance to compete.

A Basic Misunderstanding

The emphasis on transparency, however, is a market. At best, it targets a symptom rather than a cause. At worst, it reflects a fundamental misunderstanding of the Japanese regulatory system.

As a result, while Japanese regulators have made some concessions on the transparency issue, the basic difficulties encountered by U.S. banks and brokers are largely unchanged.

Japan's financial markets are regulated primarily through "administrative guidance."

The Ministry of Finance, the all-powerful financial regulator, conveys positions to banks, brokers, and insurance companies not through published regulations but informally, usually orally. Learning these positions, therefore, requires face-to-face negotiations with the relevant government official.

This encourages a close relationship between the regulator and the regulated. But for those without sufficient access, including many foreign companies, regulatory positions may be difficult to learn.

Certainly no one can quibble about the need to make official positions more clear and accessible. Nonetheless, emphasis on writing things down ignores the fundamental reality of the Japanese financial system.

First, being able to learn existing positions is not the critical problem with the system of financial regulation. Sophisticated foreign banks such as Citibank and Morgan usually have little problem uncovering prevailing ministry views.

The principal difficulty arises from the indecisiveness of the Ministry of Finance whenever it confronts something new. New policies, new products, new practices, all require face-to-face talks with the relevant official.

Invitation to Indecisiveness

Ministry officials act slowly out of a need to form a domestic consensus and for fear that the development will somehow become and embarrassment, damaging their careers. No amount of written regulation would overcome such indecision.

More important, however, lack of transparency, at least in the form of written rules, is only a symptom of the real problem with financial regulation in Japan. This has been the Ministry of Finance's interventionist attitude, not an unwillingness to delineate policy stances.

The ministry has long used its broad authority to retain an iron grip over the financial sector. Banks must clear beforehand any significant development, whether or not clearance is legally required.

This meant sending a bank official to the ministry to discuss the matter. The relevant ministry official suggest changes or even ask that the activity not go forward.

Banks followed such guidance in part because of the perceived consequences of not doing so. Banks are dependent upon the ministry for license to open new branches and for low-cost funds from the Bank of Japan. Noncompliance might prompt curtailment of this largesse or other adverse consequences, such as increased regulatory inspections.

Transparency in itself would not eliminate ministry control. Written regulations would mean little if the ministry continued to insist that banks get government acquiescence even before seeking official approval.

The process of opening representative offices in Japan illustrates the point.

The banking law only requires foreign banks to notify the ministry of an opening. The government has no authority to approve or disapprove a representative office. The system, therefore, is seemingly transparent.

The Real World

That, however, belies reality. Foreign banks dare not open an office without first meeting with ministry officials and obtaining what amounts to oral approval.

A failure to obtain ministry acquiescence might have consequences. U.S. banks could find it more difficult to get approval to upgrade the office to a branch, or funding limits might suddenly develop.

Certainly, inducing the ministry to transform oral positions into express written requirements is an important step in limiting ministry discretion. And as the agency's leverage declines, banks may be willing to accept possible adverse consequences and apply despite guidance to the contrary.

To the extent, however, that U.S. negotiations think emphasis on transparency will soon improve the competitive positions of U.S. banks and broker, they are wrong.

Mr. J. Robert Brown Jr. is associate professor of law at the University of Denver Law School and of counsel with the Holland & Hart law firm. He is working on a book about Japanese financial reform.

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