Cabinet Fukuda Does Not Rule Out Resona-style Bailout for Other Banks


(note: the following Tokyo Take comments first appeared the NBR Japan-US discussion forum on 5.20.03)


(TT's Take) The government was correct in insisting there is no "crisis", at least when compared to November 1997, when Japan very nearly
experienced a financial melt-down and serious disruption of the financial payments system.


However, The Early Financial Correction Law that was enacted in 1998 to facilitate "pre-emptive" infusions of public money to bolster
bank capital expired in March 2001. This meant that the government had no other means than to evoke Article 102 of the Deposit Insurance Law ; to do that, Prime Minister Koizumi had to hold the first meeting of the "Financial System Management Council" (where "kiki" in Japanese [crisis/emergency] has been
watered down to "system management") to declare the situation serious enough to evoke Article 102 of the DIC Law. The law was never intended for pre-emptive action, but for real crises, such as November 1997.


When Heizo Takenaka was appointed Financial Services Minister, this oversight (i.e., the inability to proactively inject public funds to bolster bank capital) was recognized, and thus began the debate about pro-active infusions of public money late last year to: a) bolster dangerously thin bank capital, and b) exert more pressure on the banks to clean up their balance sheets, in order to ensure there were no unexpected "shocks" (external or internal) to the financial system. He was stonewalled by the major banks and their supporters in the LDP.


The Financial Revival Program was his answer to address systemic risk to the financial system from the very week balance sheets of the banks, where "deferred tax assets" (i.e., tax credits) are counted as Tier 1 (core) capital. Moreover, his advisory team particularly focused on deferred tax assets (DTAs) as "vapor" capital. As of September 2002, DTAs were a full 76.9% of Resona Holdings' core capital, while it was 88.6% for Mitsui Trust, 58.1% for Sumitomo Mitsui, 54.1% for UFJ, and 51% for Mizuho. Part of the losses the banks reported at the end of March was related to downward revisions in these DTAs. Moreover, the value of DTAs countable for core capital is dependent on 5-year forward projected earnings. Excluding these DTAs, some of the banks before the downward revisions and capital increases essentially had no "real"
capital left.


Citing the case of Resona as evidence of the risk that still exists in the banking system, the FSA now plans to draw up a new law to enable public fund injections before capital shortages occur. The FSA wants to bring back the 1998 law in an "upgraded" version. The cop-out is that, instead of requiring top executives to step down as
a precondition for a bailout, the FSA would oblige them to submit a one- to three-year improvement plan. We all know how these "improvement" plans work, because the banks had to submit similar plans as a precondition for the previous two rounds of "voluntary" capital infusions.


Thus for the bank reform hawks, a small victory in that the FSA has put some teeth in their Financial Revival Program, through the auditors. But the jury is still very much out on whether additional infusions of public funds will actually lead to lasting bank reforms. We have been here before--twice exactly--without alleviating the problem in any meaningful way. In baseball, (even in Japan), if the coach cannot produce a winning team in a couple of years, he is replaced with another coach by the "front office" and the owners. Where are the "front office" and owners of the banks? Asleep at the switch, or in collusion with management of the banks? I disagree with a recent Business Week article giving corporate governance in Japan relatively high marks, at least as far as the majority of companies are concerned. Japan has no effective corporate
governance because the previous de-facto corporate governors--the banks--are now the greatest travesty of corporate governance in Japan.

Over 80% of Japanese Companies Sticking With Statutory Auditor System


A survey of their members (some 766 listed companies of a total 1,194 companies) by the Japan Corporate Auditor's Association (JCAA) shows that 83.5% will stick with the Japanese system of statutory auditors as outlined in Japan's Commercial Code. Only 2.5% of those surveyed either had decided to adopt or are "considering" adoption of US-style audit committees. The JCAA has also sent an opinion letter to the US SEC thanking the SEC for their decision to exempt Japanese companies from two proposed requirements, i.e., a) the independence of audit committee members, and b) audit committee responsibility to select and overse the issuer's independent accountant firm.


Under the Japanese system, corporate auditors are elected at the shareholder's meeting, and their role is to audit the execution of director duties. Each ostensibly operates as an independent organ, and their independence is ostensibly guaranteed. However, the Japanese Commercial Code was amended to further strenghten independence, requiring by 2005 that the number of external auditors be increased from at least one to 50% or more. The JCAA agreed with the SEC in exempting Japanese companies from Proposed Rule (10-A (c)(2)(i), and they saw no need of a sunset date to reconsider the rule.


(TT's Take Japanese auditors, particularly those auditing the banks, have come under pressure from the FSA to more strictly audit bank financials in line with the FSA's Financial Revitalization Program, particularly regarding deferred tax assets (DTA), and are on their best behavior following passage of Sarbanes-Oxely in the US, and a global movement toward increased corporate governance globally. Indeed, it was the auditors who "blew the whistle" on Resona Holdings, forcing them to revalue their DTAs and to take significant valuation losses--and forcing them to seek another infusion of public funds from the government.