Financial Sector

January 2003

Supplementary budget for fiscal 2002 has been approved by the Diet, allocating 3 trillion yen in fresh spending aimed at easing the negative impact of the accelerated disposal of nonperforming loans by banks. Half of the 3 trillion yen in the supplementary budget is allocated to public works projected, and the other half for safety-net measures to deal with the expected surge in unemployment and bankruptcies resulting from the accelerated banking sector cleanup. It also includes 1.2 trillion yen for financing increases in obligatory costs, such as social security spending, and makes up for an expected shortfall in tax revenues of 2.54 trillion yen. The total expenditure comes to 2.46 trillion yen. The spending requires the issuance of 4.97 trillion yen in government bonds, bringing the total bond issuance for the fiscal year ending March 31, to 34.97 trillion yen. (January 31, the Daily Yomiuri, the Nihon Keizai Shimbun)

Japan's major banks won another major victory, as the Tokyo High Court ruled in favor of the lenders' lawsuit against a tax imposed by the Tokyo metropolitan government. The appellate court upheld the Tokyo District Court's ruling last March that the 3% tax on the gross operating revenue of banks operating in Tokyo with at least 5 trillion yen in assets ran counter to the principle and due process of local tax law. The Tokyo High Court ordered the metropolitan government to pay back around 160 billion yen that the banks have paid over the past two years. However, it did not call on the local government to pay damage compensation, which had been included in the lower court ruling. In February 2000, Tokyo Governor Shintaro Ishihara proposed the size-based, five-year tax plan. Despite strong opposition from the central government and the banking industry, the local government enacted the law in April of that year. Having criticized Japanese banks, Ishihara maintained a local government's rights to establish own taxation system. Ishihara's move came after most major banks failed to pay corporate taxes in fiscal 1997 and 1998 after posting losses to write off a host of bad loans. The new formula used gross operating profit as the basis for taxation (profits from core banking operations plus costs) enabling the cash-strapped Tokyo government to assess taxes even on banks posting a net loss. In October 2000, 21 major banks, which at that time included nine city banks, seven trust banks, the Industrial Bank of Japan and four regional banks, filed the lawsuit. Although the banks won, a final victory is likely to require a decision by Japan's Supreme Court, as the Tokyo metropolitan government will likely appeal this ruling. (January 30, Dow Jones)

The Financial Services Agency (FSA) will ease with the remaining regulations on wrap account services provided by securities companies to attract business from individual investors. The proposed deregulation is part of Securities and Exchange Law revisions to be submitted to the current regular Diet session. Changes aimed at revitalizing the securities market by creating an environment friendly to retail investors will be made by the spring of 2004. Unlike a traditional account, in which a commission is charged for each trade, a wrap account involves a brokerage charging the retail investor a management fee based on the balance of assets for providing comprehensive services including trade execution and custodial duties. This account makes it easier for an average investor without much experience or knowledge to participate in the securities market by receiving advice and entrusting asset management duties to the securities house. And for the securities house, growth in the individual's assets under its custody would lead to an increase in earnings. Wrap account services were first deregulated in October 1999 to coincide with allowing securities houses to provide investment advisory services. When securities houses provide the services that include discretionary investment services, they must supply massive volumes of trading statements on paper to their clients. This requirement is aimed at preventing brokerages from using clients' assets to cover their own losses, but also creates a heavy administrative burden. Under the new proposal, the requirement will be eliminated. The FSA hopes that such deregulation will then promote the popularity of wrap accounts and that brokerages will increasingly shift their focus to retail investors. Once the stock market recovers, it could grow into good moneymaking service. Other proposals also focus on bringing stock-related services closer to individual investors. One is to enable credit associations and credit cooperatives to accept stock-trading orders from customers just as banks do and send them to brokerage houses. To build individuals' confidence in the market, the FSA intends to bolster its monitoring of brokerage houses and investment trust companies. The market watchdog will check the appropriateness of shareholders that hold stakes of at least 20% in securities firms and have influence over their operations. (January 28, the Nihon Keizai Shimbun)

The Bank of Japan (BOJ) Governor Masaru holds out against inflation targeting, which will create a substantial risk of destabilizing the financial market and the overall economy. His remark comes in response to growing calls for the central bank to set a target to stem deflationary pressure. To achieve sustainable economic growth, it is essential to spur private-sector demand through structural reforms in a wide range of areas, including deregulation, taxes and budget allocations, according to Hayami. Regarding banks' bad-debt problems, progress has been made (on reforming) the system, referring to the start of discussions based on the government's financial revitalization program. Hayami welcomed large banking groups' moves to boost their capital bases. Should the accelerated cleanup of bad loans jolt the financial system, the BOJ will take appropriate steps in close cooperation with the government. Concerning the current state of the Japanese economy, he said that it has stopped declining, and that there remains strong uncertainty over the prospect of a recovery. (January 27, the Nihon Keizai Shimbun)

A draft revision of the Insurance Business Law drafted by the Finance Services Agency (FSA) opens the way for insurance companies to enter the banking and securities fields on a limited basis. The FSA will lower barriers blocking insurers from banking. The legislative amendments also feature a provision that would allow insurers to lower guaranteed policy yields before bankruptcy becomes inevitable. In addition, the bill includes the introduction of a corporate governance system that would allow insurers to split their boards into executive officers charged with managing day-to-day operations and directors whose mission is to oversee corporate management. Also prominent are provisions to beef up information disclosure and the extension of a life insurance industry safety net that provides assistance to companies that bail out a failed insurer. Provided that the bill is passed by the Diet, the FSA aims to implement the changes before the end of the year. The primary focus of the legislation is on shoring up the profitability of the struggling insurance industry. Until now, the FSA has blocked insurers from expanding into non-insurance businesses, but it sees the necessity of adjusting for the fact that banks are now allowed to sell insurance policies at their branches. Although the agency is not prepared to allow insurers to make a direct push into the banking market, it will permit insurers to handle banking and brokerage operations as agents for banks or securities firms. The legislation does not specify the concrete businesses that insurers will be allowed to handle. Instead, the FSA will issue approvals based on reviews of applications filed by insurers. The agency, however, is leaning toward allowing insurers to expand the scope of their lending operations and handle sales of trust products. The FSA is prepared to permit insurers to put together lending syndicates for large real estate projects that would include major banks and regional lenders. The current rules make it effectively impossible for insurers to arrange financing for large projects since they are prohibited from including non-insurers in the lending syndicate. In the area of master trusts, where trust banks offer comprehensive administration of pension fund investments, the FSA will allow insurers to act as brokers, earning fees for bringing clients to a trust bank. (January 24, the Nihon Keizai Shimbun、the Mainichi Shimbun)

The government and the ruling coalition are seeking for the introduction of an inflation target by the Bank of Japan (BOJ). Minister Takenaka of Economy and Financial Services stressed how inflation targeting is effective. Zembei Mizoguchi, newly installed vice finance minister for international affairs, also made remarks about setting an inflation target. The BOJ remains cautions about adopting an inflation target. And opinions are divided among market participants over whether inflation targeting is effective. Nevertheless, some in the government and the ruling coalition began to suggest forming a policy accord with the central bank. Taku Yamasaki, secretary-general of the dominant Liberal Democratic Party in the three-party coalition, called for inflation targeting on Jan. 5. Behind the rising calls for an inflation target is desperation among policy-makers, who are left with few policy tools to fight deflation. It is difficult for these policy-makers to devise fresh fiscal and tax measures to stimulate the economy until the fiscal 2003 budget passes the Diet. With the end of BOJ Governor Masaru Hayami's term in March approaching, the government and the coalition are also apparently finding it easier to pressure the central bank into accepting their requests. (January 16, the Nihon Keizai Shimbun)

To ease market concern about the sound banking system, the Financial Services Agency (FSA) plans to be flexible about when to invoke the program designed to help undercapitalized banks and allow them to wait for recapitalization until next fiscal year. The FSA will keep watching major banks to bolster their loan assessments, for increasing their loan loss reserves before the end of the current fiscal year. The agency is concerned that the use of the special program will trigger market anxiety prior to the March 31 book-closing. The special aid framework consists of measures for allowing major banks to carry out the disposal of nonperforming loans without having to worry about their financial strength. Incorporated into the financial revitalization program compiled by the FSA in October 2002, these measures are based on special emergency loans from the Bank of Japan (BOJ) and public fund injections. The FSA and the BOJ will continue to negotiate the details of the program. Immediately after the framework was announced, bank stocks plunged, reflecting market participants' growing concerns about banking operations. Subsequently, Economics and Financial Services Minister Takenaka had to reassure the market that Japan's banking system is healthy and that he didn't feel that there are problems with the financial soundness of major banks. Even if stricter loan assessments are used, the possibility that special aid measures will be used is small, according to FSA. The FSA plans in January to carry out special inspections of banks. The banks are poised to consider whether to boost their loan loss reserves when they close their books for the March fiscal year-end. Whether they generate huge losses that could threaten to eat away at their equity capital as a result of their bad-loan disposals may depend on the extent to which they increase their loan loss reserves. But the special inspection results will not be compiled until at least April. And the banks' loan loss reserves will not be determined until between April and May. The FSA also plans to assess how business improvement plans and planned capital increases unveiled by banks are proceeding. Takenaka is said to be extremely concerned that market fears of a "March crisis" could wreck havoc on the financial system. The consensus is that the FSA, which wants to avoid financial system confusion at any cost, will not likely institute the special aid framework within this fiscal year. However, whether to invoke the BOJ's emergency loan program also remains a question. To prevent the economy from falling through the bottom, the FSA believes that these emergency loans are necessary along with the special aid framework to support the funding of major banks. However, BOJ officials are concerned that if a bank were to fail, the emergency loans to that institution would not be recovered, creating a loss for the central bank. Until the April 2002 reintroduction of caps on deposit insurance protection for time deposits, the government fully guaranteed the repayment of deposits held by financial institutions. It is liable for just a small portion. Thus, the BOJ has to consider the potential for losses in its special loans if a borrower bank fails. The FSA and the BOJ plan to flesh out the details of the conditions that would apply to the provision of emergency loans. With BOJ Governor Masaru Hayami's five-year term set to expire in March, Takenaka is already expressing hope that the new BOJ governor will reconsider monetary policy. The BOJ's new structure could have a significant impact on its cooperation with the FSA in ensuring financial system stability. (January 15, the Nihon Keizai Shimbun )

Major banks have begun negotiating with client companies and institutional investors in order to issue new shares or preferred subscription certificates in the current fiscal year through March 31. They are trying to raise their capital adequacy ratios, now that the Financial Services Agency is due to begin inspections on their loan portfolios later this month. The results of the probes are expected to increase the banks' losses from bad loan disposals above their projected figures. UFJ Holdings Inc. has asked Toyota Motor Corp. and its affiliates to purchase about 30 billion yen worth of preferred subscription certificates. UFJ intends to make similar requests to other companies in an effort to raise a maximum of 50 billion yen. Earlier, Merrill Lynch & Co. agreed to purchase 100 billion yen of preferred stock in a new subsidiary that will take over nonperforming loans from UFJ Bank in fiscal 2002. If UFJ manages to issue preferred subscription certificates as planned, the proceeds and share sales to Merrill Lynch are expected to raise the group's consolidated capital adequacy ratio by 0.4-0.6 percentage point. Mizuho Financial Group plans to issue preferred stock that can be converted into common stock after a certain period. After obtaining approval at a shareholdings meeting scheduled for early February, the group intends to issue some 100 billion yen of such stock in fiscal 2002. Mizuho Corporate Bank and Mizuho Bank are now sounding out corporate clients about their intentions to purchase the new stock. While Dai-ichi Mutual Life Insurance Co., Mizuho's leading shareholder, is expected to buy it, Mizuho wants to sell the new shares to as many firms as possible. Sumitomo Mitsui Financial Group Inc., which is now negotiating an attempted takeover of Aozora Bank, is considering issuing 100 billion yen of shares to both domestic and foreign institutional investors. Since Resona Group, comprising Daiwa Bank and Asahi Bank, is also expected to issue new shares in the current business year, that means all of the major banking groups, except for Mitsubishi Tokyo Financial Group Inc., will boost their capital in fiscal 2002. To raise their capital adequacy ratios, banks have to either increase capital or reduce loans. Banks apparently are avoiding the latter option for fear of being criticized for denying struggling firms desperately needed funds. The situation, however, remains fluctuating, as their depressed stock prices make it difficult for banks to raise the desired amounts of funds. (January 14, the Nihon Keizai Shimbun)