The principal reason behind Japan succumbing to this pressure was its dependence on world, especially US, markets to sustain growth. When faced with US opposition to protectionism against Japanese imports, Japanese investors sought to Americanize themselves by acquiring or establishing new production capacity in the US in areas like automobiles. In return for the 'freedom' to export to and invest in the US, Japan had to make some concessions. But the demands made by the US  proved to be  quite damaging. It began by requiring Japan to reverse the depreciation of its currency. Following the celebrated Plaza Accord, arrived at in New York in September 1985, the Japanese yen, which had started to appreciate against the US dollar in February 1985 from a 260 yen-to-the-dollar level, maintained its upward trend to touch 123 yen-to-the-dollar in November 1988. Though the following year saw movements that signalled a strengthening of the dollar relative to the yen, the downturn soon began, resulting in a collapse of the dollar once again from an end-1989 value of 143.45 yen to its April1995 level of below 80. Any economy faced with such a huge appreciation of its currency was bound to stall, more so an export-dependent one like the Japanese one.
 
This trend, which resulted in the hollowing out of Japanese industry, undermined the principal area of business of the banks as well, which were faced with the prospect that some of their past lending could turn non-performing. It was in response to this that the Japanese banks joined the chorus against financial controls, demanding that they be permitted to diversify away from their traditional areas. The government responded by effecting regulatory changes in the form of a revision of the Foreign Exchange Control Law in 1980 and granting permission to commercial banks to create non-bank subsidiaries (jusen) to lend against real estate investments. Besides expanding overseas operations, the main areas into which the banks diversified were lending against real estate and stock market investments. The rate of growth of real estate lending rose from 7 per cent in the second half of the 1970s to 18 per cent in the first half and 20 per cent in the second half of the 1980s.
 
The result was a speculative boom triggered by a mad rush into the new areas. Even as GDP growth was slower in the 1980s as compared to the 1950s and 1960s, the six-largest-cities-index of real estate prices tripled between end-March 1985 and end-March 1990, from 33.6 to 100 (Chart 6). Similarly as Chart 7 shows , there was a massive speculative boom in stock markets, with the yearly high of the Nikkei stock market index rising from 12,500 in 1985 to 38,916 in 1989. By 1989 it was clear that the asset bubble was bound to burst, and in a belated effort to halt the frenzy and respond to householder complaints that acquiring housing was virtually impossible, the Japanese government stepped in by controlling credit and raising interest rates. The net result was a collapse in both real estate and stock markets. The real estate index fell to half its peak level by 1995 and to a third by 2001. And the Nikkei, which registered a high of 38,713 on 4 January 1990, fell soon after to an intra-year low of just above 20,000, continuing its downward slide thereafter right up to 1998. A slight recovery in 1999 was followed by a further fall in 2000.
Chart 6 >> Chart 7 >>
 
As a consequence of this collapse and prolonged decline there was a huge build-up of bad debt with the banking system. At the beginning of 2002, the official estimate of non-performing loans of Japanese banks stood at Yen43 trillion, or 8 per cent of GDP. This, despite the fact that over nine years ending March 2001, Japanese banks had written off Yen 72 trillion in bad loans. There is still a lot of scepticism about official estimates of the extent of bad debts. In September 1997 the Ministry of Finance announced that the banking sector held Yen 28 trillion in non-performing loans, but soon after that, using a 'broader definition', it arrived at a figure of Yen 77 trillion, which amounted to 11 per cent of outstanding private bank loans in Japan and 16 per cent of its GDP. And in 1998 the Financial Supervisory Agency placed problem debt at Yen 87.5 trillion and debt already declared bad at Yen 35.2 trillion, which added up to a total of Yen 123 million. Whatever the figure, in the past this would not have been a problem, as it would have been met by an infusion of government funds in various ways into the banking system. But under the new liberalized, market-based discipline, banks (i) are not getting additional money to finance new NPAs; (ii) are being required to pay back past loans provided by the government; and (iii) are faced with the prospect of a reduction in depositor guarantees, which could see the withdrawal of deposits from them.