Financial Sector

November 2002

The Financial Services Agency is considering a plan to purchase common stock as the primary mechanism to conduct injections of public funds into banks. Past rounds of public fund injections have been executed through purchases of preferred shares carrying no voting rights. However, the FSA now believes that purchasing common shares with voting rights would give it a stronger voice in banks' management affairs, which would ultimately raise the pressure on banks to undertake more drastic reforms, including even changes in management. The bank recapitalizations conducted in 1998 and 1999 centered on purchases of preferred shares issued by the banks and purchased by the Deposit Insurance Corp. However, criticism is now emerging that the way the fund injections were made was fundamentally flawed. As the financial authorities used shares with no voting rights, they failed to gain sufficient leverage to spur management reform. The FSA is now convinced that it needs a framework that will allow it to keep much closer supervision over bank affairs. As a major holder of common shares, the FSA would have the grounds to call a general shareholders' meeting or propose a change in management. It would also gain direct oversight of executive compensation and retirement allowances. The added pressure of the state as a major shareholder would spur bank management to raise profitability. Moreover, the use of common shares, as opposed to preferred shares, would lighten the dividend payout burden on banks. The Deposit Insurance Law, which provides the legal framework for public fund injections into banks, does not specify what class of shares should be used. In theory the FSA could use either common or preferred shares. The current framework also presumes voluntary filings by banks to receive public funds. If the FSA initiated a common-share-based recapitalization program, banks would avoid signing up out of fear that acceptance would be paramount to opening the door to state interference. The FSA is currently preparing new legislation that would allow preventive fund injections before the actual occurrence of a financial crisis. And the FSA is considering making purchases of common shares the principal mechanism of the new legal framework. (November 12, the Nihon Keizai Shimbun)