Bank of Japan to Make Proposals, Including a New Law for Preemptive Bank Capital Infusions


The Bank of Japan, in order to prevent another financial crisis, has begun to lobby the government for a new program to inject public funds into the banks. This is because the current law makes it difficult for such capital infusions before a financial crisis has occurred. Thus under consideration is a new law that would clear the way for such pro-active capital infusions. Finance Minister Masajuro Shiokawa in a press conference on the 25th, indicated a positive attitude toward the pro-active use of public funds. FSA minister Hakuo Yanagisawa continues to insist that �gthere is no financial crisis at present�h and has not changed his cautious stance about another capital infusion for the banks. However, the BOJ and the MOF have begun to move in this direction. There are those within the Koizumi Administration that have begun to study the feasibility of specific policies that can be implemented, including new laws, and the discussions within the government on new financial system stabilization policies including capital infusions has taken on a new urgency.


On the 25th, Yutaka Yamaguchi, Deputy Governor of the BOJ visited the directors of several banks to explain the Bank�fs plan to purchase stocks from the banks. Part of his discussions included a demand of the banks to prepare for accelerated bad loan disposals with more stringent audits of their loan books, and beefed-up bad loan reserves. The object is to shore up bank balance sheets through proactive NPL disposals, including potential losses on doubtful non-performing loans.
Should the banks expand their bad loan countermeasures to include latent losses on non-performing loans, it is inevitable that some of the banks will experience insufficient capital. In such cases, the BOJ believes that selected banks�f whose capital ratios fall below the internationally required 8% regulatory capital ratio should receive additional capital infusions, provided that these banks are deemed viable.


Under the current Deposit Insurance Corporation Law, the government is prevented from using public funds unless the Prime Minister convenes a Financial Crisis Response Committee and declares that there is a �gcrisis�h or �gthe risk of a crisis�h. There are those within the BOJ that the meaning of �gthe risk of crisis�h could be expanded to included preventive capital infusions into the banks. But as such preventive infusions of capital would only be considered as crisis countermeasures and therefore make it difficult for more timely solutions, the growing view within the Bank is that a new law is required.


Behind the growing debate over renewed capital infusions is the deteriorating trust in the financial system itself as bank managements reach the end of their financial ropes. While the issue of further capital infusions also revives the issue of management responsibility, some believe it would be difficult to demand management take responsibility in those cases where the bank has managed to maintain its required 8% capital ratio.
Thus the Bank is in a hurry to focus the debate on new capital infusion methodologies. When the Bank announced its decision to purchases stocks from the banks, it also promised that it would release its basic philosophy regarding the bad loan problem in a separate report. Recent comments by the Bank make it apparent that the background efforts to create a new framework for capital infusions are a central component of their philosophy regarding the bad loan problem.


Finance Minister Has a Constructive Opinion of Capital Infusions


Finance Minister Masajuro Shiokawa stated in a press conference on the 25th that he would like to see further progress in the banks efforts to liquidate the non-performing loans of those borrowers who are financially the weakest. If necessary, he would support the use of public funds for capital injections. Thus his comments revealed a constructive view of bank capital infusions, provided that these capital infusions led to accelerated liquidation of delinquent borrowers. He also expressed the view that public funds should also be used in restructuring regional financial intuitions as well. The Finance Minister emphasized that the MOF would like to see the banks �gto differentiate between the borrowers that need saving and those that do not�h, as he believes that the banks should be a central factor in evaluating each company�fs growth potential and profitability.


For those companies with very poor profit prospects, banks should demand that the companies either undergo dramatic restructuring or merge; upon which the banks would then forgive the debt, which would then clear the way for management restructuring, or form the basis for the bank�fs cessation of financial assistance.
Regarding the current financial condition of the banks, Mr. Shiokawa explained, �gexcluding the deferred tax effects on reported capital ratios, there are some who claim that some banks would have insufficient shareholder capital�h. But if in the process of cleaning up their loan books of dud borrowers through loan forgiveness and other write-offs, a bank experiences insufficient capital, �gwe should not hesitate to use public funds to bolster their capital�h. This notwithstanding, �gthe use of public funds will require the agreement of the Japanese public�h, but if there is noticeable progress in cleaning up the weakest companies, he believes that general opinion would move in favor of using public funds.


Regarding the methods for using public funds to bolster bank capital, he pointed out that there several ways, including direct infusions of capital into the banks, or indirectly, through expanded sales of NPLs to the RCC (Resolution and Collection Corporation�fs).

The Drag from Weak Stock Prices Needs to be Pre-Empted


The Spillover Effects of a Deteriorating US Economy Foster a Sense of Crisis

On the 24th, deputy Bank of Japan governor Yamaguchi spoke with Nikkei reporters regarding the Bank�fs decision to buy stocks held by the major banks, which he describes as �ga decision to reduce as much as possible the direct impact of falling stock prices on the banking system�h. During the process of deliberations on the decision, �gwe seriously considered what could happen to the Japanese financial system given a large external shock from overseas�h, revealing that a growing sense of crisis regarding the continued sell-off in US equities was a large factor in the Bank�fs decision to act.


According to Mr. Yamaguchi, the debate regarding the purchase of stocks by the Bank of Japan had heretofore been within the confines of conventional monetary policy and policy tools, in other words, in terms of price keeping operations (PKO). Mr. Yamaguchi maintained that the BOJ should not be in the business of influencing stock price formation. The BOJ�fs objective this time is to stabilize and minimize the negative impact of stock price volatility on the stability of the financial system, and he strongly denied any implication that the policy is aimed at supporting stock prices. He explained that a large factor in the Bank�fs decision was the unique structure of Japan�fs banking system, i.e., the linkage of the bank�fs balance sheets to the stock market, where falling stock prices further weaken the bank�fs regulatory capital.
In the Bank�fs view, further deterioration in balance sheet quality as the result of even lower stock prices represents a growing risk to the stability of the financial system and could seriously impede the economic recovery. In reaching the decision, the Bank exceeded the bounds of normal monetary policy and pushed the limits of prudence.
Mr. Yamaguchi also revealed that the negative impact of falling US stock prices was also a factor in the decision; �gwe determined that the action was required to pre-empt a possible financial crisis�h. �gAs the uncertainties surrounding the outlook for overseas economies and capital markets increase, what would happen to Japan�fs financial system if no preparations were made for a potentially large external shock?�h According to Mr. Yamaguchi, �gThe decision came about as the result of a serious consideration of such risk�h, as he continued to convey a sense of crisis in his explanations.


Regarding the effectiveness of the new countermeasures, Mr. Yamaguchi admitted that the Bank�fs actions alone would be insufficient to nurse Japan�fs financial system back to health. Indeed, Mr. Yamaguchi pointed out that �ghow the government and the private sector respond with new countermeasures will be a crucial factor.�h He emphasized that the Bank of Japan has effectively tossed the ball over to the government and the financial sector for the next step. As to what the Bank would like to see from the government and the private sector, Mr. Yamaguchi merely explained that, �gwe will be releasing a report outlining our thoughts on the bad debt problem in the near future�h. He did however indicate that the report would include a view on bad loan evaluation and the bank�fs reserves for such bad loans, and the use of public funds for further bank capital infusions.


Decide Not Out of Despair and Panic, But Calmly and Boldly


Mr. Yamaguchi pointed out that a catalyst for the Bank�fs decision was the fact that Prime Minister Koizumi expressed a desire to accelerate the liquidation of non-performing loans after returning from a summit meeting with US leaders. �gBecause the Bank made the decision calmly and boldly and not out of despair and panic, we would like the government and the private sector to carefully consider the importance of our decision.�h, Mr. Yamaguchi emphasized. Regarding the size of the Bank�fs purchases of stocks, Mr. Yamaguchi said the Bank would like the value of purchases to be �gin the trillions�h of yen, but exactly how much is still under consideration, and he asked for a little bit more time in this regard. He also pointed out that the Bank is willing to �gassume the systemic risk of the banking system within the confines of the Bank�fs own financial ability, revealing that the Bank will give careful consideration to the health of its own balance sheet in implementing the policy. He explained that the maximum amount of purchases that can be made by the Bank will be that amount that can be logically explained by the amount of resources available from the Bank�fs own balance sheet. As for the timing of the purchases, Mr. Yamaguchi replied �gas soon as possible�h.


In reply to the generally negative response to the news from overseas central banks and foreign media, Mr. Yamaguchi replied; �gconsidering that the Bank of Japan is willing to assume the significant risk in parts of the financial system, we believe the action is a rational one�h. As regards the response from overseas central banks, �gwhile we have not yet received a detailed reaction, we would like to use the occasion of the meeting of the G7 financial ministers at the end of this week in the US to fully explain our position.�h

Legal Implications of Japan's Non-Performing Loan Mess


Court rulings on two recent cases related to Japan's non-performing loan mess help to define the legal signals being sent to companies. One regards the tax implications of NPLs, and the other involves the legal implications of how NPLs are reported in the financial accounts.


Bagged for Tax Evasion


The Tokyo Superior court has recently handed down a ruling regarding the treatment of non-performing loans of the now disbanded Jusen's (Housing Loan Corporations) outstanding borrowings from the Industrial Bank of Japan. The legal proceedings became a headache for Mizuho Holdings, the new banking group that absorbed the old Industrial Bank of Japan. While Mizuho Group strongly protested the ruling as being a major impediment to the liquidation of non-performing loans, the court ruled that Mizuho Group owed a massive JPY100 billion in taxes related to the JPY376.1 billion in non-performing loans that were liquidated. In 1996, the Industrial Bank of Japan wrote off these Jusen loans from their books, and recorded the write-off as a loss. However, the Tax Agency refused to allow the write-off, and demanded JPY128.5 billion in taxes in addition to a penalty of JPY19.2billion for underreporting taxable income. IBJ responded by taking the Tax Agency to court. The Tokyo Courts first supported the bank's claim, but in an appeal, the courts ruled in favor of the Tax Agency, stating that "recognition of losses should occur only after an independent determination has been made that the loans were indeed irrecoverable". The hard line approach by the Tax Agency is often cited by the banks a reason for their reluctance to write off bad loans.


Convicted of Materially Misleading Accounting Statements


On the other hand, there is the court ruling related to Long Term Credit Bank (LTCB). The former directors of LTCB were convicted of violations of the Securities Exchange Law for failing to properly report losses of JPY313.1 billion on bad loans to affiliated non-bank financial institutions. In their defense, the former directors had used the fact of the Tax Agency's hard line on the deductibility of such write-offs, and the fact that the tax liability would worsen their reported losses. This defense however did not fly with the Tokyo court. The court ruled that the tax liability related to such NPL losses was fair and reasonable, and that the directors moreover had a legal responsibility to report the true state of the company's finances, and therefore were legally responsible for the failure to disclose such losses. In other words, the responsibility to disclose such material items remained, regardless of the tax implications.


The new wave sweeping corporate boardrooms globally is responsible corporate governance and increased corporate accounting visibility, a fact that senior corporate executives would do well to recognize.

BOJ Could Begin Buying Stocks As Early As October


Mr. Mitani, director of the BOJ in charge of the Financial System, indicated to the Japanese press that the Bank would like to begin purchases of the stock held by Japanese banks as early as October, and that the purchase period could extend into FY2003. The total amount of stock purchased could exceed JPY3~JPY4 trillion, but depends on the BOJ's profit picture in FY2002, FY2003. The BOJ will also release in the near future their basic philosophy regarding Japan's non-performing loan problem, especially their views on whether the current guidelines for reserves against bad credits, whether there should be a general review of the FSA's bank inspection manual, and whether further audits of the banks are necessary. In addition, the BOJ believes that, if the current restrictions preventing additional infusion of public funds into the banks' under article 102 of the Deposit Insurance Law (for which JPY15 trillion has been earmarked as a financial crisis stabilization fund), other measures (such as the BOJ's action) need to be considered, reflecting the Bank's view that additional capital infusions for Japan's banks are required.


The BOJ describes these defacto infusions of bank capital as "preventive measures" to reduce systemic risk in Japan's financial system and to avoid a banking crisis before it happens. The JPY15 trillion set aside for such crisis ostensibly cannot be used until after such a crisis occurs. The Japanese media are speculating that, based on current stock price levels, the banks from which the BOJ would purchase stocks would include;


a) Mizuho Corporate Banking,
b) Mizuho Asset Trust,
c) Mitsui Sumitomo
d) Tokyo Mitsubishi
e) Mitsubishi Trust
f) Chuo Mitsui Trust
g) Sumitomo Trust
h) Bank of Kyoto
i) Ashikaga Bank
j) Hokuriku Bank
k) Fukuoka City Bank


The Bundesbank has been the first central bank to give their opinion on the BOJ's risky move, and it was a negative one. The Bundesbank's governor described the BOJ's action as something that central banks should not do, and that it comprimises the Bank's independence. Japanese strategists attribute the combined weakness in the yen, bonds and stocks following the banks announcement to; a) the damage done to the BOJ's credibility, b) the fact that there was unprecedented insufficient take-up at the latest 10-year JGB issue, and c) the fact that the sell-off in the bond market will create even more unrealized losses for the banks, insurance companies, and regular corporations, on top of the unrealized losses already seen in the stock holdings. In addition, the Fitch credit rating agency has put Japan's sovereign credit rating on negative credit watch and is expected to announce their decision within a week. In November 2001, Fitch lowered Japan's sovereign credit rating from a AA+ to AA.

E Trade Surpasses Matsui Securities in Online Trading


The value of trades by E Trade Japan customers surpassed those of internet trading pioneer Matsui Securities in August. This market share was "bought" by sharply lower trading commissions. For its part, Matsui is baking away from profit-killing commission competition, and instead is concentrating on assets on deposit and new services.

Local Prefectural Governments Woo Individual Investors with Small-Lot Bond Offerings


The total value "mini public offerings" to local investors and individuals is expected to explode 6-fold above that originally expected, to JPY120 billion in FY2002. The Cabinet Office projects that total market offerings of bonds will increase JPY150 billion to JPY2.9 trillion, with two-thirds of the increase coming from such mini public offerings. The offerings are a good match to increasingly risk-adverse individual investors and the funding needs of local governments.


The Mini bond offerings are prefectural bonds marketed by securities companies and banks. Compared to "normal" bond issues, issue lots are noticeably smaller, at several tens of billions of yen. Minimum trading lots are also smaller, between JPY10,000 and several hundred thousand yen. Gumma Prefecture was the first to issue such bonds in March of this year. According to initial plans, Hyogo Prefecture, Aomori Prefecture and Sapporo City and a total of 20 local agencies were planning to issue about JPY20 billion, but the Tokyo government jumped on the bandwagon with a JPY20 billion issue of Tokyo Revitalization Bonds. When the Tokyo bonds went on sale, they were sold out in just one hour and twenty minutes. Hoping that such issues will help the local governments' image with their constituents, the Cabinet Office is also helping to promote these issues.

Japan's REITs Are a Dud with Individual Investors


It's been one year since Japan's REITs (real estate investment trusts) hit the market, with the hope of drawing their fair share of individual Japanese investors dollars. As it turns out, the new market so far has been a dud. While price movements have been more stable than tanking stock prices and yields are superior to those available through other investments, concern about the future direction of real estate prices and poor liquidity are behind the lack of popularity with individual investors. Even financial institutions are starting to back away from the market.


On the first year anniversary of the REIT market, Chuo Mitsui Trust Bank and Ken Corporation, the owners of Premier Corporation, will be listing their REIT, making it only the sixth REIT to be listed. The offering price of the Premier REIT was JPY480,000, a little above the net asset value of JPY460,000 per unit. Japan Building Fund, which listed a year ago, has seen its market price fall from its IPO level of JPY625,000 to JPY550,000. The apparent listlessness of the market is characterized by the dearth of new listings. Goldman Sachs had planned a REIT listing last December, but it has yet to reach the market. Tokyu Group has disbanded their tie-up with Lend-Lease. While Mizuho Group was early in planning a management company, they have recently decided to forego its establishment.


Trading volumes in the REITs are tepid. Japan Building Fund and Japan Real Estate REITs had trading volumes of JPY20 billion when first listed, but recent trading value of the whole group of listed REITs is recently down to JPY500 million, versus market capitalization of more like JPY420 billion, which itself is a mere 17% of the real estate sector market capitalization. Buying interest by individual investors is particularly slow, Japan Building Fund individual ownership is 16%, while Japan Estate's is 20% and Japan Prime Realty's is about 27%.


The slow market activity is despite stated yields of 4%~6% as investors ignore nominal returns and focus on a very uncertain future for real estate prices. This has the REIT issuers looking for ways to stimulate market demand. Japan Prime Realty has split their stock 2:5 and reduced their net asset value per share to JPY200,000 in order to make it easier for smaller investors to participate. One area of expected demand was OTC sales by the banks, which has not materialized because of bank's are cautious about IT investments.

Accounting Commission Says Stocks Should be Valued at Current Values When Securitizing Debt


The Corporate Accounting Standards Board, a private organization that determines Japan's accounting standards, has determined accounting standards for debt securitization. The main feature of the policy is that when financial institutions securitize debt from the owners of the debt, the securities of the securitized debt should be purchased at market values. The rule is aimed at realizing unrealized losses for banks, as these rules apply to debt>equity swaps. Debt>equity swaps not only allow the company to reduce its debt, but it also increases the stated value of the company's shareholder equity. Heretofore, however, there were no specific accounting rules that applied to debt>equity swaps. During September, the organization will invite comments on the new policy, and make its final determination in October. Securitized debt from October will be required to adhere to the new accounting standard. For stocks purchased to March of this year (2002), the organization will determine detailed valuation standards by next spring (ostensibly before the end of the accounting year).


Should the market value of the securities of securitized debt be below the book value of the debt, valuation losses will be recorded net of bad debt allowances. In principle, the current value of the securities will be the same as their market value. If there is no market quote an aggregate assessment of the financial instituion's support for the company and the achievability of the company's restructuring plan will be taken into consideration. Banks heretofore had been issuing preferred shares with the same face value as the debt, and recording the securities at face value on their books, unrealized losses included. Thje net effect has actually been to merely delay liquidation of non-performing loans.