Financial Reconstruction Commission
March 12, 1999

• Since its establishment on December 15, 1998, the Financial Reconstruction Commission (FRC) has spent a total of 32 days studying the issue of the capital injections for banks.
  
  
• On January 20, the FRC finalized and made public a report entitled “The Basic Operating Policy of the Financial Reconstruction Commission”. This was followed on January 25 by the release of “Guidelines on Write-Offs and Provisioning against Bad Debts by Applicants for Capital Injections”, in which the FRC laid down quantitative standards for provisioning against bad debts by internationally active banks applying for the capital injections.
  
  
• In accordance with the Financial Function Early Strengthening Law (Article 4, Section 6), the FRC held hearings with the Bank of Japan and the Deposit Insurance Corporation, and then from January 26, launched a preliminary examination of the fifteen banks expected to apply for the capital injections. ¹
  
  
• In the course of the preliminary examination, the FRC was provided with the results of on-site inspections conducted by the Inspection Department of the Financial Supervisory Agency and the Bank of Japan. The FRC also examined drafts of “the plan for restoring sound management” submitted by the applicant banks and held direct hearings with their representatives. As a result of these preliminary studies, the FRC informed of the banks on February 12 that it agreed to their going ahead with formal procedure for the capital injections.
  
  
• On March 4, the FRC received formal applications from the fifteen banks it had made preliminary examinations of. It then proceeded with its further deliberations including by conducting another hearings with representatives of the applicant banks on March 8. The FRC’s basic viewpoints in its examinations are outlined in the following section.

• To provide sufficient capital injections for the recipient banks to substantially finish disposing of their bad debts, to regain the confidence of the domestic and foreign financial markets, and to restore trust in the Japanese financial system.
  
  
• To promote smooth flows of credit, thereby contributing to the revitalization of the economy such as improvements in business activity and employment.
  
  
• To improve the competitiveness and profitability of the banks, thereby enabling the earliest possible recovery of invested funds through the sale of the preferred stock on the market.
  
  
• In the course of implementing the capital injections, to do away with the “convoy-style” of bank regulation in favor of clearly articulated rules and more transparent administration.

• Examinations of the financial soundness of the fifteen applicant banks confirmed that they were not insolvent and their equity-capital bases were sound at the end of September 1998.
  
  
• The banks were also judged to be capable of raising their equity capital by a substantial margin through self-financing and by using net operating profits even before the injection of public funds in March 1999. Thus, their continued existence was not thought to be “extremely precarious” as defined under the Financial Function Early Strengthening Law the first sentence of Sub-section 2, Section 1, Article 7.

• If Japanese banks are to restore the domestic and foreign confidence, it is deemed essential that they dispose appropriately of their non-performing loans and unrealized losses from securities holdings.
  
  
• For this purpose, internationally active banks at the least should be expected to substantially finish disposing of their non-performing loans by the end of March 1999 through sufficient write-offs and provisioning therefor as required by the “Guidelines on Write-Offs and Provisioning against Bad Debts by Applicants for Capital Injections”.²
  
  
• The banks are encouraged to dispose of unrealized losses from securities holdings as soon as possible with the introduction of mark-to-market accounting in March 2002 in sight. Where the unrealized losses will not be actually disposed of under current accounting standards, the FRC has given to it a favorable consideration in its examination of applied capital injections.
  
  
• According to such an approach, by consolidating their capital bases using government guarantees as well as using net operating profits and raising capital independently from the private sector, the banks should thus be able to ensure sufficient capital accounts even after taking into account the size of disposed non-performing loan　and unrealized losses from securities holdings.³
  
  
• In order to address the problem of credit crunch, the applicant banks are sure to increase lending to domestic firms, especially to small and medium-sized enterprises, in fiscal 1999 (in real terms taking into consideration special factors).

• For domestic and foreign confidence in Japan’s financial system to be restored, the profitability of banks must be improved through business restructuring, rationalization, and realignment of the financial industry. It was with this objective in mind that the FRC examined the applicant banks’ plans for restoring sound management.
  
  
• Business restructuring and rationalization plans are assessed from the viewpoint of the financial market as a whole. Improvements in profitability and implementation of fundamental structural reforms based on clear and specific strategies rather than restructuring across the board is therefore rated highly. Withdrawal from non-profitable operations, including business in overseas markets, is viewed in a particularly positive light.⁴
  
  
• The applicant banks need to create a wasteless and strong management base and thus improve profitability through rationalization including, for example, cutting personnel expenses and other fixed costs. Cutbacks in personnel and non-personnel expenses (barring expenditure on mechanization) and the abolition of posts for senior counselors and advisers are therefore viewed positively.⁵
  
  
• A process of realignment is practically underway in the financial sector, with banks and other institutions merging, forming subsidiaries, and entering tie-ups in terms of capital consolidation or business operations. These moves are viewed positively and are expected to improve the profitability and financial position of the applicant banks.⁶
  
  
• Other improvements made under the plans for restoring sound management which also contribute to the positive assessment of a bank include raising funds independently, developing concrete plans for liquidating non-performing loans, maintaining reliable credit rating system of its own, and cutting dividends and bonuses for directors to minimize the drain on profits.
  
  

• Instruments such as convertible preferred stock, which can be credited to capital accounts, are to be used rather than subordinated debentures or loans as the main means for the capital injection, considering that the injected funds are actually earmarked to the disposal of bad debts.
  
  
• The terms for underwriting such instruments require that dividend yields be determined in accordance with the “Basic Policy for Dividend Yield of Preferred Stock” issued on December 17, 1998, and are based on the following basic principles:
  
  

  -	In principle, total yield on the Financial Function Early Strengthening Account should be such as not to fall below the account’s financing costs.
  -	The dividend yield on the preferred stock of each individual bank should be the same as, or higher than the official discount rate, this being the minimum financing rate of the Financial Function Early Strengthening Account.
  -	The dividend yield on the ordinary stock of each individual bank should not in principle exceed the dividend yield on the preferred stock.
  -	The dividend yield on the preferred stock should reflect each individual bank’s allowable financing costs.

• After thorough examinations of the applications and plans for restoring sound management of the fifteen applicant banks, with the basic viewpoints outlined so far, the FRC concluded that their applications should be approved. The capital injections will therefore be carried out at the end of March once the necessary procedures have been completed, and this should serve to restore domestic and foreign confidence in the Japanese financial system.
  
  
• The banks that receive the capital injection will be expected to practice sound management and improve their profitability in line with the objectives of capital injections and in accordance with their plans for restoring sound management. In the event of a recipient bank’s failure without good cause (such as a significant worsening of the economy) to implement important fundamental parts of its plan for restore sound management, managerial responsibility should be clarified.
  
  
• Under the Financial Function Early Strengthening Law(Article 5, Section 4), the recipient banks will be required to report to the FRC on, inter alia, steps being taken toward business restructuring, rationalization, and adaptation to financial realignment as committed in their plans for restoring sound management, and to make the reports public. This should encourage the banks to commit themselves firmly to make improvements.
  
  
• If a bank finds a positive reason for doing so (e.g. stepping up its effort for business restructuring or adaptation to financial realignment efforts), it may be allowed to revise its plan for restoring sound management.
  
  
• If the above reports indicate that a recipient bank lacks an intention to properly implement its plan for restoring sound management, then the FRC will take appropriate measures stipulated in the Banking Law, as necessary, under the Financial Function Early Strengthening Law (Article 20, Section 2).
  
  
• The capital injections on this occasion will substantially complete disposing the bad debts at the leading banks. Furthermore, by helping a new round of financial realignment associated with the capital injections which proceeds simultaneously with the realignment caused by the Japan’s financial “Big Bang”, the FRC will contribute to the improvement of the financial system’s efficiency.

Debt forgiveness should be carried out only after due consideration is given to such factors as business rationality (e.g. if this would improve the chances of recovering remaining claims), clarification of the locus of managerial responsibility at the borrowing firm, and the social influence of the borrower. The banks are encouraged to make sufficient prior provision to cover the projected amount of forgiven claims.

Subtracting the remaining unrealized losses from securities holdings from the amount of equity capital after the injections of capital are received would give the applicant banks real capital adequacy ratios of around 10%.

The plans for restoring sound management of the applicant banks provide for complete withdrawal from overseas operations by regional banks, the closure of non-profitable overseas branches, and reform of branch business structures (See Material 12).

5

The plans for restoring sound management of the applicant banks require cuts in personnel and non-personnel expenses, cutbacks in the number of directors, and the abolition of adviser positions (See Material 13).

6

Specific instances of such developments include mergers between trust banks, the establishment of subsidiaries or joint investments involving city and trust banks, and inter-regional and inter-sectoral business tie-ups (See Material 14).

7

The dividend yields on preferred stock tend to be lower than that on subordinated debentures and loans, since it is closer to pure capital. The dividend yield on a preferred stock that represents a better investment for investors (e.g. because the minimum conversion price is sufficiently lower than the market price, the initial conversion price is set at the time of issuance rather than when conversion begins, or the conversion period starts early) likewise is lower than that on other preferred stock.

8

(1) and (2) above are based on common market practice, while (3) incorporates as exogenous factors the results of assessments made in accordance with certain criteria of improvements made under applicant banks’ plans for restoring sound management.

---

next

	MENU
	HOME