Press Conference by the Commissioner

(Excerpt)

3 September, 2001

Q.

Last week, Minister for Financial Services Hakuo Yanagisawa announced a scenario estimating the disposal of non-performing loans (NPLs), which has been interpreted by the market in various ways. Please elaborate on this.

A.

In order to restructure the financial sector as part of Koizumi Cabinet's restructuring package, the Financial Services Agency (FSA) has been explaining its policy to dispose of major banks' existing NPLs classified as ''in danger of bankruptcy'' and below within 2 years and new NPLs as such within 3 years, in the fiscal reform plan ''Structural Reform in the Japanese Economy: Basic Policy for Fiscal and Economic Management and for Economic and Social Structural Reform''. What would be the results? Can financial institutions withstand such disposals? How long will it take for NPLs to be disposed of? To date, we have said that our rough aim is to dispose of these NPLs within 2 or 3 years.

Everything inside the economy is a living thing. As we have always explained, NPLs are correlated with the economy, and it is impossible to forecast economic prospects without making an assumption. Under Mr. Yanagisawa's orders to build a model that simulates the economy -an estimate based on certain assumptions in that respect- we worked on the simulation at the administrative level and publicized the results.

There was limited time to give an explanation. From my point of view, the reports by the mass media were overwhelming and unbelievable in certain aspects. To be honest, I was surprised, especially at an article reporting that the disposal of NPLs would take as long as 7 years. By this, I mean I was surprised at some reports, not all, of course. Based on my understanding, the publicized estimation indicates that the disposal of NPLs would be completed within 3 years.

Firstly, let me discuss about the assumptions in concrete terms, which I believe Mr. Yanagisawa has already explained. The three year period between FY2001 and FY2003 is considered an intensive adjustment period, in which the Japanese economy would undergo radical restructuring but not necessarily full recovery. Accordingly, we assumed that the economic growth rate would be around 0%. In the meantime, how will NPLs emerge? The 16 major banks to which I had referred in March 2001 are now reduced to 15, due to the recent merger, so I will use the term ''15 major banks'' from now on. Now, the question is how the debtor categorization of debts owed to the 15 major banks are likely to change in ratio and in size. In order to estimate this, we looked at the probability of the debtor category transitions in March 2001, that is, the end of FY2001. Since last year, the debts may have jumped from ''Normal'' to ''Needs Attention'', from ''Normal'' to ''Special Attention'', ''Normal'' to ''In Danger of Bankruptcy'', or from ''Normal'' to ''De Facto Bankrupt''. Similarly, the debts may have jumped from ''Needs Attention'' to ''Special Attention'', ''In Danger of Bankruptcy'' or ''De Facto Bankrupt''. Or from ''Special Attention'' to ''In Danger of Bankruptcy'' or ''De Facto Bankrupt''. We assumed that the probability of such transitions would be the same in each period over the next 3 years. We have actually shown you a sample test, indicating that when 12.8% of the debts classified as ''Needs Attention'' jump to ''Normal'', about 8% of the debts classified as ''Needs Attention'' shift to ''In Danger of Bankruptcy'' and below. Considering the estimation of the current transition probability, we are pessimistic in that we believe things will definitely get worse. Once debts classified as ''Normal'' fall to ''Needs Attention'', it will not go back to ''Normal''. Once debts shift from ''Normal'' to ''Needs Attention'', it will end up as ''Special Attention'' and then ''In Danger of Bankruptcy''. We are expecting such a worst-case scenario.

For businesses suffering from structural recession, such as the real estate and construction industries, we assumed that debts categorized as ''Special Attention'' would stay in that category for one year, and then all those debts would shift to ''In Danger of Bankruptcy'' or below. We do not expect debts in the ''Special Attention'' category to climb up to the ''Needs Attention'' category with banks' assistance; we reject such optimism. In reality, however, banks may offer assistance, and we do expect the banks to do so in terms of risk management. Nonetheless, we decided to adopt a pessimistic outlook with respect to the next 3 years for the purpose of estimation.

We also assumed that land prices would fall by 10% per year over the next three-year period. As the 10% reduction is compound, the fall will actually be more than 30% (in three years), but we simply assumed that land prices would drop by 30%. A 30% drop in the estimated collateral value of real estates would require some provisions accounting for 70%. We therefore assumed that more provisions would be necessary, and that it would continue for 3 years. As mentioned in the ''Structural Reform in the Japanese Economy: Basic Policy for Fiscal and Economic Management and for Economic and Social Structural Reform'', we assumed that all debts categorized as ''In Danger of Bankruptcy'' and below would be written off within 2 or 3 years, or to be more precise, 3 years as existing NPLs would be written off within 2 years, regardless of whether it is during or after the intensive adjustment period. Based on the example we have been showing you, if there are any remaining NPLs in 2007 and thereafter, they will all disappear within 3 years, that is, they will be written off. This is also one of the assumptions.

We suggested to Mr. Yanagisawa that we should adopt such harsh assumptions, which are unrealistic in some aspects. Mr. Yanagisawa made the announcement accordingly, but the administrators stated that the NPL situation would be ''more or less the same.'' Although I have no intention to say that the statement should be corrected to ''NPLs would radically decrease'' during the three-year intensive adjustment period, I do actually believe that there will be radical reduction of NPLs in amount. The transition probability indicates the standing of banks' clients, which cannot be measured based on the concept of debt risk management. Hence, we measured it based on the concept of debts disclosed under the Financial Revitalization Law: the balance of the 16 major banks' NPLs was 18 trillion yen as of the end of March 2001 in terms of the disclosed debts. This would diminish to some 17 trillion in the end of FY2003, that is, March 2004. Due to our lack of confidence to explicitly state that NPLs would decrease by 1 trillion yen within 3 years, we said that the NPL situation would be ''more or less the same''. We do not intend to make any corrections, however. Whilst NPLs should somewhat decrease in amount during the intensive adjustment period, we believe that the NPL problem would be solved from FY2004 onwards, that is, from April 2004, in which full economic recovery is expected to start.

The credit cost ratio for the 16 major banks, which was 1.4% as of the end of March 2001, will fall dramatically during the intensive adjustment period, down to 1% or so. After FY2004, or from April 2004 onwards, the ratio will start to drop and be around 0.3% by March 2005. By March 2005, which is in three years time, the NPL ratio should be between 3% and 4%, and the credit cost ratio should be roughly 0.3%. Accordingly, we believe that the NPL problem would be solved in three years time, or in 2004. We have never said that it would take 7 years to solve the NPL problem. That is my footnote to Mr. Yanagisawa's explanation.

Q.

In your opinion, how will the major banks be affected by the disposal of NPLs based on the worst-case scenario?

A.

In the meantime, net operating profits will play a part. Losses incurred due to the disposal of NPLs are mostly absorbable by net operating profits. It should be noted that we have made a big assumption: the simulation does not take stock price fluctuations into account. The stock price is assumed to be at the level of March 2001, at 12,999.70 yen. As stock prices change daily due to various factors, we cannot place any assumptions. Thus, we used the stock price in March 2001 as an assumption.

As you know, major banks' capital adequacy ratio averaged 11.7% as of March 2001. During the intensive adjustment period, we expect it to be between 12% and 13% as long as stock prices remain stable. Although their capital adequacy ratio should exceed 13% once economic recovery sets in, it would be around 13% due to the repayment of public funds.

My intention was to explain that financial institutions would be able to withstand the disposal of NPLs in such a manner, even in a pessimistic scenario.

Q.

A rapid downward slide in stock prices inevitably causes suspicion that a series of short selling stemming from knock-in prices of Index-linked Bonds might play a major role in the market. Considering the downward slide in the past couple of days, many market players would be inclined to think that there is something unnatural about the pricing. What is your opinion on this?

A.

As you suggested, a downward slide in stock prices may lead to selling and further selling, resulting in speculative trading that further depresses stock prices. This applies especially to Reverse Convertible Bond, known as EB and the aforementioned knock-in prices of linked bonds. Considering the price level and the extent to which prices have been formed as a result of speculation, speculative trading with derivatives is expected to take place, as a matter of course.

In concrete terms, speculative trading is expected to take place in the form of short selling or futures selling. Although the FSA acknowledges their function as tools within the global market, we will not tolerate the use of such tools against any laws or ordinances. Last week, we asked the Securities and Exchange Surveillance Commission to watch out for transactions that violate laws or ordinances. We are confident that the Commission will be thorough in its surveillance efforts in this area.