Financial Sector

August 2005

FSA To Limit Banks' Deferred Tax Assets To 20% Of Capital By FY07
The Financial Services Agency plans to gradually lower the cap on deferred tax assets booked by big banks to 20% of capital by fiscal 2007. The new restrictions on deferred tax assets, or tax refunds that a company can expect in the future, target major banks and will be enforced starting in fiscal 2005. The aim is to curb the criticized practice of posting large amounts of deferred tax assets to inflate capital bases. The FSA will announce in September proposals to changes in the rules governing how banks calculate their capital adequacy ratios, with a final decision coming as early as October after taking feedback into consideration. Eleven major banking groups will be affected by the new regulations, including Mizuho Financial Group Inc. and Sumitomo Mitsui Financial Group Inc. When deferred tax assets exceed the limit, the FSA will urge a bank to take corrective action. If there are no improvements, the FSA may impose administrative penalties. To ease the burden for the first year after the regulations are introduced in fiscal 2005, deferred tax assets will be allowed to account for 40% of core capital, which includes equity capital and legal reserves. In fiscal 2004, Sumitomo Mitsui and UFJ Holdings Inc. had the highest ratios at about 47%, followed by Mitsui Trust Holdings Inc. with 35%. The average ratio at seven major bank groups was roughly 26%. The FSA then plans to lower the maximum ratio allowed to 30% in fiscal 2006 and 20% in fiscal 2007. Banks with international operations are required to maintain a minimum 8% capital adequacy ratio. The new regulations may lead to a decline in the ratios at financial institutions that hold an excessive amount of deferred tax assets. As a result, a number of banks might be forced to raise capital. Although deferred tax assets have declined as banks turn a corner in dealing with their non-performing loans, the FSA wants to accelerate the process. (The Nihon Keizai Shimbun, Friday, August 26, 2005)

FSA To Call For Better Quake Emergency Plans Among Banks
The Financial Services Agency (FSA) will ask major banks to put systems in place allowing them to continue with at least minimal services in the event of a major earthquake, terrorist attack or similar event. The FSA will take these steps because with the increasing complexity of networks and systems, the halt in operations of even one financial institution can easily lead to ill effects on the market as a whole. It will press banks to verify that backup systems actually function and to strengthen risk management. The agency is responding to the occurrence of terrorist incidents abroad and to growing concerns that a major earthquake may be on the horizon in Japan. American and European financial authorities have been strengthening their own systems and calling for better risk management in the Japanese market since the Sept. 11, 2001, terrorist attacks in the U.S. The FSA will also call for manual updates and practical training to allow for appropriate responses to large-scale power losses, employee kidnappings and other incidents. The agency as well as the Bank of Japan and the Japanese Bankers Association will also cooperate, putting in place a system that will make it possible to transfer funds quickly among banks in cases of emergency. (The Nihon Keizai Shimbun, August 25, 2005)

Banking industry enters new age after shake-up
Japan's postwar industrial revitalization was supported by funds from the government and long-term credit banks. The Reconstruction Finance Bank, established in 1947, provided long-term funds for this task. In the 1950s, the role was taken over by such banks as the Japan Development Bank and Industrial Bank of Japan. The JDB, IBJ and other banks initially provided loans to four core industries - electric power, shipping, coal and steel - and then expanded them to petrochemical, automobile and other industries. Meanwhile, major commercial banks, known as city banks in Japan, supplied short-term funds to real estate, construction, services and other businesses. Indirect financing played a role in the nation's economic revitalization. In the 1970s, the government and the Bank of Japan began promoting the liberalization of Japan's financial system via a series of steps, such as forming a secondary market for government bonds and liberalizing the money market and interest rates on deposits. Japanese financial institutions were caught up in the asset-inflated economic bubble, amid a glut of money in the second half of the 1980s, and were then hit hard by the collapse of the bubble. More than 10 years were needed to resolve the bad loan mess caused by excessive lending by banks and wanton capital spending by companies during the high-flying days. Following the failures of jusen housing loan companies, local financial institutions went under one after another. Furthermore, in 1997, Hokkaido Takushoku Bank collapsed and Yamaichi Securities Co. went out of business. Japan's financial crisis peaked in 1998 when Long-Term Credit Bank of Japan and Nippon Credit Bank went belly up. IBJ, the sole long-term credit bank that survived the crisis, merged with Dai-ichi Kangyo Bank and Fuji Bank to become the Mizuho Financial Group, putting a virtual end to the long-term credit banking system that supported Japan's postwar economy. The creation of the Mizuho group, furthermore, led Japan's financial community to the current "megabank" system by prompting other major banks to integrate their operations.
(The Nikkei Weekly, August 22, 2005)

FSA eyes new rules on company transparency
The Financial Services Agency will begin studies in September on how to increase corporate transparency, FSA officials said Friday. The agency plans to improve transparency by carrying out such measures as requiring listed firms to release quarterly earnings reports, the officials said. The move follows a series of corporate scandals, including the issuance of false financial statements by Kanebo Ltd. and Seibu Railway Co. The FSA also intends to create a system in 2008 that would make it mandatory for firms to reveal the details of daily operations, including procurement and processing of vouchers, on their financial statements. Specifically, top management would be required to prepare reports on such transactions and submit them to certified accountants for examination. The Business Accounting Council, a panel advising the financial services minister, also will begin deliberations in September to work out guidelines for the planned system by referring to U.S. regulations adopted after the Enron Corp. accounting fiasco. The FSA wants listed companies to disclose earnings results on a quarterly basis so their financial statements will more accurately reflect any changes in their businesses. By the end of the year, the financial industry watchdog hopes to have guidelines to help accountants accurately examine companies' quarterly earnings reports. The Tokyo Stock Exchange also plans to require listed companies to disclose quarterly business results. The FSA and TSE hope that by taking steps to improve the reliability of corporate financial statements, the public will regain its trust in them and shift financial assets from deposits to stocks and other investment options. (The Japan Times: August. 20, 2005)

FSA To Make Big Banks Fully Accountable For Financial Products
The Financial Services Agency released draft administrative guidelines for major commercial banks Friday, requiring them to be fully accountable for financial products so to protect customers. The FSA will solicit public opinion before putting the guidelines into force this fall. According to the draft guidelines, major banks would be required to explain the risks of financial instruments in detail, such as the chances of interest-rate hikes on housing loans with floating rates. The guidelines also require banks to explain whether annuity insurance and other individual financial products are suitable for a particular consumer and whether they have established systems to properly deal with customer complaints. Regarding bank financial strength, a bank would be required to disclose whether it has sufficient core capital and how it calculates deferred tax assets and counts them as part of its core capital. (Nihon Keizai Shimbun, August 19, 2005)