Provisional translation

Press Conference by FSA Commissioner Takafumi Sato

(Excerpt)

July 28, 2008

[Opening Remarks by FSA Commissioner Sato]

I have no particular statement to make.

[Questions and Answers]

Q.

A bill for the bailout of the two U.S. federal mortgage finance companies is now expected to be enacted. The bill's enactment paves the way for the provision of funds to meet their cash needs and the injection of public funds. Could you tell me again what the FSA (Financial Services Agency) would like the U.S. government to do now?

A.

As you know, the U.S. Senate on July 26 passed a bill to expand the line of credit for the GSEs (government-sponsored enterprises) and make it possible to inject public funds in order to strengthen their capital bases. It is expected to be enacted upon signing by President Bush.

I think that the U.S. government and Congress have taken the recent series of steps in order to quickly subdue the market turmoil, and we welcome these steps as positive moves. Meanwhile, in the global financial markets, a series of data have indicated uncertainty over the prospect of the U.S. economy, so as a whole, strains in the market probably remain.

As the turmoil in the global financial market continues, the FSA will keep a close watch on market developments and their effects on Japanese financial institutions, while maintaining cooperation with other relevant authorities both in Japan and abroad. We hope that in response to market developments and moves by financial institutions, the authorities with the relevant jurisdiction and responsibilities or those most closely involved will take quick and appropriate action.

Q.

I hear that the U.S. Office of the Comptroller of the Currency on July 25 announced the suspension of operations at two regional banks, one in Nevada and the other in California. As a reason for this, it cited a capital shortage caused by declines in the value of their assets and their profits. The bankruptcy of these banks brings the number of U.S. banks that have failed so far this year to seven. The view has emerged that in Japan as well as in the United States, the financial health of regional banks may be threatened if the market turmoil is prolonged. Could you explain your view on the current situation in reference to the implementation status of stress testing, too?

A.

First, I will sort out the facts. I understand that on July 25, the U.S. Office of the Comptroller of the Currency announced the closure of two U.S. regional banks, First Nation Bank of Nevada (Nevada) and First Heritage Bank (California), due to their capital shortage. I am also aware that on the same day, the U.S. Federal Deposit Insurance Corp. (FDIC) announced that all deposits and some assets of these two banks will be taken over by Mutual of Omaha Bank.

As you pointed out, regional financial institutions have recently failed in quick succession in the Untied States. Although the situation may have varied from institution to institution, one common factor underlying all of the failures is probably a sharp deterioration of the value of mortgages and mortgage-backed securities. Of course, behind all this lies a deterioration of the U.S. housing sector, the declining housing prices, the rising mortgage delinquency rate and the growing stocks of unsold houses.

Therefore, the failure of regional banks in the United States is not directly related to the financial health of regional financial institutions in Japan as there are substantial differences between their situations. Few financial institutions in Japan operate on a business model of specializing in housing loans, and Japanese financial institutions generally conduct very rigorous screening when providing housing loans.

Nevertheless, the turmoil in the global financial markets, if prolonged, could lead to the materialization of risks for Japanese financial institutions by affecting the value of securities held by them - valuation losses were recognized and announced in their financial statements for the fiscal year ended in March. Also, if downside risks for the U.S. economy materialize, the Japanese economy will also be affected, and the condition of regional economies in Japan may continue to be unfavourable. These various factors could affect the financial health of regional financial institutions in Japan. However, what I am talking about are effects that may be transmitted to regional financial institutions in Japan through a variety of indirect routes, and I do not expect that the failure of regional banks in the United States will produce a direct impact.

As for risk management by banks and other financial institutions, including regional ones, Japan has introduced the Basel II regime (a new regulation concerning the capital adequacy ratio) ahead of other countries. The second pillar of the Basel II centers on the management of credit concentration risk as well as interest rate risk. Japan is implementing the second pillar in combination with an early warning system. As part of this, we pay attention to financial institutions' stress testing and analysis of scenarios in which a large amount of market risk-related losses arise, when we examine their management of market risk in accordance with the guidelines for supervision. I believe that regional banks are making proper efforts in this regard, in a manner suited to the scale and characteristics of their respective risks.

Q.

Recently, there has been a series of failures of real estate and construction companies. A credit crunch due to a decrease in loans provided by financial institutions has been cited as a reason for this. Could you tell me how you assess the current situation and whether policy actions are necessary?

A.

As for the assessment of the current situation, the FSA last month held hearings regarding the state of financing for small- and medium-size enterprises. Through the hearings, we have recognized a severe fund-raising situation faced by some real estate companies saddled with bad inventories amid the increase in the stocks of unsold condominiums and delays in construction starts following the enactment of the amended Building Standards Act. I understand that financial institutions have tightened their loan screening criteria against companies facing severe business conditions. Financial institutions should provide loans based on their own management decision, so it is important that with appropriate risk management as the precondition, they fully perform their financial intermediary functions under their own responsibility and make their own management decisions.

As for policy actions, we have already implemented some measures. First, we have compiled and distributed a pamphlet intended to facilitate financing for small- and medium-size enterprises, for example. Secondly, we are holding briefings across the country regarding the supplement to the Financial Inspection Manual that concerns financing for small- and medium-size enterprises, and we are distributing the pamphlet I spoke of and trying to make it well known. Thirdly, - this is in response to allegations that the FSA's inspection and supervision are affecting loans to real estate-related sectors - we are making it clear, through our Web site, for example, that the FSA never issues instructions for curbing loans to particular business sectors. Fourthly, we are engaging in a campaign to collect the opinions of borrowers through the hotlines for consultations about smooth financing in cooperation with local chambers of commerce and industry. Fifthly, we have asked financial institutions to review their arrangements and procedures for providing explanations to customers. Theses are the measures we have implemented.

Q.

Last week, the FSA issued business improvement orders to three banks due to problems with their profitability. In light of the view that the profitability of some regional banks has recently been declining again, what are your opinions about future improvement plans and about how to monitor banks into which public funds have been injected?

A.

As you know, we require that banks, whose capital base has been strengthened through the injection of public funds under the Act concerning Emergency Measures for Early Strengthening of Financial Functions, draw up management enhancement plans that include measures to secure the financial resources necessary for the repayment of public funds. Our basic approach is to encourage financial institutions to exercise self-discipline by requiring the submission of reports on the implementation of such plans and by disclosing the results. According to the guidelines concerning management enhancement plans, if a financial institution fails to meet targets included in its plan - for example, if its net profit is more than 30% lower than the target - the FSA will demand the submission of a report explaining reasons for the shortfall and other matters and consider the possibility of issuing a business improvement order based on close examination of the report. The three banks you asked me about, Aozora Bank, Bank of the Ryukus and Gifu Bank, fit the criteria I spoke of, so we issued business improvement orders on Friday, July 25, requiring that they draw up and implement business improvement plans including urgent profit improvement measures.

The FSA hopes that these banks will enhance their profitability and ensure the repayment of public funds, by drawing up and steadily implementing business improvement plans that include effective profit improvement measures.

While the profitability of regional financial institutions is liable to be affected by the economic condition of their regions, the FSA will keep a close watch on the profitability of banks into which public funds have been injected, from the viewpoint of securing the repayment of public funds. Now, we are waiting for these three banks to draw up business improvement plans and submit reports.

Q.

I would likely to ask you again about the size - as grasped by the FSA - of Japanese financial institutions' holdings of GSE-related bonds and the effects of such holdings on the institutions.

A.

I am aware that there have been various media reports regarding the holdings of GSE bonds, and those reports apparently focused on the holdings of such bonds by major banks and insurance companies in Japan. As major banks and insurance companies together hold assets totaling around 800 trillion to 900 trillion yen, they naturally have diversified asset portfolios comprising a variety of financial products and loan claims, and the characteristics and structure of the portfolios vary from institution to institution. The reported amount of GSE bonds held by these financial institutions represents only a small part of their total assets totaling as much as 800 trillion to 900 trillion yen. Therefore, I believe that it would not be necessarily appropriate for us regulators to focus exclusively on a particular asset category and announce the status of asset holdings in that category.

Of course, it is very important to grasp the risk management status and the risk exposure status of individual financial institutions in a timely manner, so we are holding hearings and exchanging information as necessary with financial institutions that we supervised. For the moment, however, we do not intend to compile and announce data regarding the holdings of GSE bonds in particular.

So far, we have compiled and disclosed data regarding the holdings of subprime-related securitized products with due consideration of special factors such as the gravity of the subprime mortgage problem, the intensity of its impact and the extremely high loss rate of such products. However, I am not sure whether it would be appropriate to expand the scope of disclosure to cover various other asset categories. In addition, the creditworthiness of GSE bonds has been reconfirmed by the recent steps taken by the U.S. government and Congress. Of course, as I said earlier, I understand that there are not only positive factors but also negative ones and that, as a whole, tensions remain in the global financial markets. However, it would be safe to assume that the possibility of risks being transmitted to Japan through GSE bonds has diminished.

(End)