Rare kinda did their own thing and skirted the rules set by Nintendo. Nintendo did what they could to reign them in, but Rare just pushed through anyways.
Please also check out the tits on the melon girl in Banjo-Kazooie and how hot the witch is in the game over screen. Not to mention the native american chick. And the tits on the flower in Conker (plus the character called Jugga)
And for what it's worth, it's Nintendo of America that censors everything, not Nintendo of Japan.
For example, did you know the reason why the old man in the first Gen Pokémon games was passed out in the middle of the road? He was absolutely hammered. In the American version, he's throwing a tantrum because he hasn't had his coffee yet. And that's just one such example. There's thousands more. NOA loves to censor everything.
And the comparatively recent shift in Sony policy about what content is acceptable is because who makes those decisions moved from the Japanese office to the US one and the US is full of various flavors of prudes.
The story behind the melon girl is that she originally had HUGE tits which all the developers thought was hilarious, but Nintendo made rare make them smaller, so instead they had her carry a fruit tray with giant melons on them