Banking regulation and supervision in Japan: Some issues and concerns

Journal of Financial Regulation and Compliance

Volumn 11, Issue 1, 2003, Pages 45-59

  Hall, Maximilian J B ^a  

^a LOUGHBOROUGH UNIVERSITY   (United Kingdom)

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EID: 84995348815     PISSN: 13581988     EISSN: 17400279     Source Type: Journal    
DOI: 10.1108/13581980310810408     Document Type: Article

References (44)

1. See Ministry of Finance (1998) ‘Reform to the financial regulatory system’, Tokyo, April.
2. This was due to public dissatisfaction with the previous performance of the MoF in these areas and, in particular, to the public outcry at the media revelations concerning the Ministry’s involvement in a series of financial scandals (for further details see Hall, M. J. B. (1998) ‘Financial reform in Japan: Causes and consequences’, Edward Elgar Publishing, Chapter 2, pp. 43-47).
3. Hall, M. J. B. (1999) ‘Deposit insurance in Japan: Better late than never?', Journal of Financial Services Research, Vol. 15, No. 3, pp. 211-242, for a discussion and assessment of the evolution of deposit insurance arrangements in Japan.
4. See Ministry of Finance (1998) ‘Outline of the Emergency Powers to Stabilize the Financial System’, Tokyo, February, for further details.
5. A body set up in 1996 to facilitate the smooth disposal of failed credit cooperatives. For further details see Hall (1999) Outline of the Emergency Powers to Stabilize the Financial System. (ref. 3).
6. Financial Reconstruction Commission (FRC) (1999) ‘Basic operating policies for the Financial Reconstruction Commission’, Tokyo, 20th January.
7. A body set up in 1996 to facilitate the resolution of the juse crisis - see
8. Hall (1999). (ref. 3) for further details.
9. Measures first used in October, 1998 to resolve the problems at the Long-Term Credit Bank and, two months later, to resolve the crisis at Nippon Credit Bank.
10. Recapitalisation via the purchase of common stock is available only to banks deemed to be ‘significantly undercapitalised’ (ie those running a risk-adjusted ratio of under 4 per cent (2 per cent on a non-adjusted basis, for those only operating domestically)) or ‘critically undercapitalised’ (ie those running capital ratios of under 2 per cent (1 per cent for domestic operators)). In each case, it is up to the FRC to decide the terms and conditions (as applicable under an agreed restructuring plan, which is likely to include, inter alia, a management reshuffle and suspension of dividend payments - see FRC (1999) ‘Basic viewpoints to the capital injections and results of the examinations of applicant banks’, Tokyo, March (http://www.frc.go.jp)) on which funding will be made available. For the former set of institutions, this would normally involve the government in taking a 50 per cent stake; and for the latter, the government assuming full control for a temporary period (ideally, for less than one year, but with the possibility of ownership lasting up to three years). Meanwhile, recapitalisation via the purchase of financial institutions’ preferred stocks or subordinated bonds, or via making subordinated loans, is usually available only to institutions with riskadjusted capital ratios of at least 4 per cent but less than 8 per cent (2 per cent and 4 per cent respectively, on an unadjusted basis, for those only operating domestically). However, it is available to those institutions with risk-adjusted capital ratios of 8 per cent or above (4 per cent or above for domestic-only operators, on an unadjusted basis) if: (i) such institutions have taken over failed institutions or merged with other financial institutions that have incurred operating difficulties; or (ii) such recapitalisation is deemed essential to avoid ‘an abrupt and substantial credit crunch’.
11. In the event, Y=7.5 trillion was injected through this route into 15 major banks in March, 1999 (see Nakaso, H. (1999) ‘Recent banking sector reforms in Japan’, Economic Policy Review, July, pp. 1-7) with additional sums being injected into nine regional banks plus the Long-Term Credit Bank during the following 18 months. This followed the injection of Y=1.8 trillion into 21 banks in March, 1998 under the Financial Stabilisation Law (see)
12. Deposit Insurance Corporation of Japan (DIC) (2000) ‘Annual Report 1999', ((April, 1999-March, 2000) Tokyo, October, p. 79). And, in June, 2000, the Law for the Early Strengthening of Finan- cial Functions was revised to allow for the recapitalisation of credit cooperatives through this route.
13. For a discussion of the MoF’s further emasculation under the Civil Service reforms implemented in December, 2000 see Euromoney (2001) ‘Bureaucrats give up a great treasure’, February, pp. 103-157.
14. A full cost-benefit analysis of the creation of a single regulator (outside the central bank) is provided in Hall, M. J. B. (2001) ‘The evolution of financial regulation and supervision in the UK: Why we ended up with the Financial Services Authority’, Banca Impresa Società, Vol. XX, No. 3, pp. 377-412.
15. This was called into question following a number of scandals which dogged the chair of the FRC. For example, Mr Michio Ochi was forced to resign in February, 2000 after promising to be ‘lenient’ to Japanese banks; and a subsequent head, Mr Kimita Kuze, was similarly forced out of office following an alleged bribery scandal. And finally, the last head, Mr Hideyuki Aizawa, earnt a reputation for being lukewarm on reform (eg in November, 2000 he urged banks, contrary to official policy, to refrain from unwinding their cross-shareholdings for fear of damaging the stock market recovery; and he also advised inspectors to take a soft line towards troubled credit cooperatives for fear of damaging the regional economy).
16. For details of the UK arrangements see Bank of England (1998) ‘The Bank of England Act’, Bank of England Quarterly Bulletin, May, pp. 93-99.
17. These and other supervisory reforms were first proposed in Hall, M. J. B. (1999) ‘Supervisory Reform in Japan’, Journal of Financial Regulation and Compliance, Vol. 7, No. 3, pp. 256-269.
18. Hall (1999) ‘Supervisory Reform in Japan’, Journal of Financial Regulation and Compliance, Vol. 7, No. 3, pp. 256-269.
19. FSA (1999) ‘Final Report of the Working Group on Financial Inspection Manuals’, Tokyo, 26th April (http://www.fsa.go.jp).
20. Investor concerns had earlier led the Bank of Tokyo Mitsubishi to employ a widelyrespected firm of western accountants to carry out its audits in the late 1990s. More clearly needs to be done to enhance the training and skills of local auditors if the integrity of external audit is to be restored; and a greater willingness - as evidenced by the actions of the receivers of Yamaichi Securities, the bankrupt Japanese broking house, to sue the firm’s auditors, Chuo Audit, for allegedly failing to spot offbalance- sheet losses - to seek financial compensation from negligent auditors should certainly serve to focus minds.
21. Removal of the MoF from the scene has already helped as the agency’s prior concern for both regulation and accounting standards had led it to slow down the move towards the adoption of internationally- accepted accounting standards. (Such so-called ‘accounting forbearance’ is discussed in Hall, M. J. B. (2000)) ‘What is the truth about the scale of Japanese banks bad debts? Is the situation manageable?', Journal of Financial Services Research, Vol. 17, No. 1, pp. 69-91. However, the banks’ successful lobbying for a delay, until at least April, 2002, in the adoption of ‘marked-to-market’ accounting treatment (which requires marketable securities to be booked at market value if they have dropped by more than 30 per cent of book value, with any unrealised losses being fully deducted from Tier 1 capital) for derivative portfolios indicates that the old ways die hard.
22. The Japanese scheme, which is clearly modelled on the US form of PCA introduced under the Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991 (see Hall, M. J. B. (1993) ‘Banking regulation and supervision:A comparative study of the UK, USA and Japan’, Edward Elgar Publishing) was introduced in April, 1998 (April, 1999 for domestic-only operators) under the Government’s ‘Big Bang’ package of reforms
23. Hall, M. J. B. (1998) ‘Financial reform in Japan: “Big Bang” ', Journal of International Banking Law, Vol. 13, No. 2, pp. 58-70.
24. The 1998 candidates for nationalisation, the Long-Term Credit Bank and the Nippon Credit Bank, were subsequently bought by the US-based Ripplewood Financial Services Group and a consortium led by the Japanese Softbank Group respectively. Banks subsequently reprivatised following public management, which include the Kofuku Bank (May, 1999), the Kokumin Bank (April, 1999), the Tokyo Sowa Bank (June, 1999), the Namihaya Bank (August, 1999) and the Niigata Chuo Bank (October, 1999), were eventually acquired, respectively, by the US-based Wilbur Ross-led Fund, Yachiyo Bank, the US-based Lone Star Fund, Kinki Osaka Bank and, in the case of the Niigata Chuo Bank, by six Japanese regional banks. (For the reprivatisation of shinkin banks and credit cooperatives see DIC (2000) Journal of International Banking Law. (ref. 11), p.69.)
25. Japanese Shadow Financial Regulatory Committee (1998) ‘Urging a Political Decision to Avoid the Japanese Financial Meltdown’, Tokyo.
26. For full details on the type of DIC assistance provided to failed banks up until 8th June, 2000 see DIC (2000) Journal of International Banking Law. (ref. 11), pp. 62-67. (NB 20 banking institutions failed in fiscal 1999 following the 30 cases in fiscal 1998, leading to Y=5.9 trillion of financial assistance being provided by the DIC (Y=5.4 trillion in fiscal 1998).)
27. The imposition of a ‘tough’ restructuring plan can, however, mitigate this to a degree, although toughness has to be balanced against the need to induce a take-up of the new funding mechanism, given the voluntary nature of the scheme.
28. Some critics of the initial disbursements made by the FRC in March, 1998 (see FRC (1999)) Journal of International Banking Law. (ref. 10), argued that they were a device to allow the banks to comply with the Basel Capital Accord’s minimum risk asset ratio requirement of 8 per cent at the end of fiscal 1998 and/or to revive bank lending and hence demand in Japan (see Bank of England (1999) ‘Will bank recapitalisation boost domestic demand in Japan?', Financial Stability Review, pp. 85-93, June).
29. The official reason given for the delay was to allow time for the FSA to conduct financial inspections of smaller financial institutions previously supervised by local government.
30. DIC (2000) Financial Stability Review. (ref. 11).
31. Hall (1999) Financial Stability Review. (ref. 3).
32. Hall, M. J. B. (2001) ‘How good are EU deposit insurance schemes in a bubble environment?', Research in Financial Services: Private and Public Policy, Vol. 13, pp. 145-193.
33. BIS (2001) ‘The financial crisis in Japan during the 1990s: How the Bank of Japan responded and the lessons learnt’, BIS Papers, No. 6, Basel, October.
34. Hall (2000) BIS Papers. (ref. 20).
35. FSA (2001) ‘Non performing loans of all deposit-taking financial institutions (as of the end of March, 2001)', Tokyo, 2 August (http://www.fsa.go.jp).
36. Most banks’ ability to post risk asset ratios in excess of the 8 per cent minimum - collectively, the large five banking groups maintained an average of over 10 per cent during fiscal 2001 - depends heavily on the inclusion of deferred tax assets (which arise from the tax-deductibility of the large specific provisions made) which, arguably, ought to be excluded and, at any rate, may eventually prove to be of lower value than currently stated, and to a lesser degree on previous capital injections received from the DIC which, ultimately, have to be repaid.
37. At end-May 2002, the Nikkei 225 stood at just under 11,800 (compared with an historic peak recorded in the early 1990s of around 40,000) with the Topix index standing at just over 1,120. Given that most analysts suggest unrealised gains on securities holdings disappear at around the 13,000/1,300 levels respectively, the markets have some way to go yet if a positive contribution is to be derived from this source (unrealised losses for the 13 major banks amounted to Y=1.4 trillion at end-March, 2002 (FSA (2002)) ‘The outline of the financial reports as of the end of March 2002 released by the major thirteen banks’, Tokyo, 12th April). Similarly, given the depressed state of the Japanese stock market, new rights issues would prove impossible, leading the major Japanese banks to issue preference shares to affiliates (such as life assurance companies), a policy which unfortunately does little to enhance the stability of the financial system given the parlous state of the latter’s balance sheets.
38. Hall (1998) losses. (ref. 21).
39. Drake, L. and Hall, M. J. B. (2003) ‘Efficiency in Japanese banking: An empirical analysis’, Journal of Banking and Finance (forthcoming).
40. Operating profits for the ‘big five’ amounted to Y=4.2 trillion in fiscal 2001 although, for the deposit-taking sector as a whole, they only amounted to Y=446 billion during fiscal 2000 (Federation of Bankers’ Associations of Japan (FBAJ)) (2001) ‘Japanese banks, 2000', Tokyo.
41. Non-performing loans for the banking industry (excluding cooperatives) had risen by Y=3.2 trillion (10 per cent) in the six months to end-September, 2001, principally due to an increase in ‘restructured loans’ as a result of the application of stricter classification criteria by banks (FSA (2002) ‘The status of non-performing loans as of September 2002', Tokyo, 1st February). This followed a series of FSA inspections, begun in October, 2001, of the 13 major banks’ loan exposures to large borrowers whose market reputations were being called into question (FSA (2002) ‘Results of the special inspections of major banks’, Tokyo, 12th April). It is not yet clear, however, what proportion of the full year increase of Y=8 trillion is due to the application of stricter loan classification criteria and what proportion represents the emergence of new non-performing loans.
42. More precisely, the promise related to the major banks’ non-performing loans (NPLs) which had been classified as ‘in danger of bankruptcy’ or worse, and extended to the removal of such newlyclassified NPLs within three fiscal years of their classification (see FSA (2001) ‘Summary excerpts from the government’s economic measures’, Tokyo, 6th April).
43. Hall, M. J. B. (2002) ‘Banking regulation and supervision in Japan: Some issues and concerns’, Special Paper No. 139, Financial Markets Group. London School of Economics.
44. Liberal Democratic Party (LDP) (1998) ‘Comprehensive plan for financial revitalisation:First version’, Tokyo, June.