Unofficial and Provisional
Translation Readers are advised to refer to the original Japanese text before quoting from this document. |
Report on the Framework of the Deposit Insurance System
and Resolution of Failed Financial Institutions after the Termination of Special
Measures1)
Financial System Council
December 21,1999
1. Introduction
In order to ensure the stability of the financial system, the
Japanese government introduced special measures during the financial years 1996
to 2000 to fully protect deposits by authorizing the Deposit Insurance
Corporation (DIC) to extend special financial assistance exceeding the payoff
cost (the cost incurred by the DIC to pay off insured deposits (maximum 10
million yen per depositor) of a failed financial institution). The government
also enacted the Law concerning Emergency Measures for the Revitalization of the
Functions of the Financial System (Financial Revitalization Law) and the Law
concerning Emergency Measures for the Early Strengthening of the Financial
Functions (Early Strengthening Law) as temporary special measures effective
until the end of March 2001, to establish a robust financial system by basically
completing the disposal of non-performing loans of financial institutions and
cleaning up their balance sheets while deposits were fully protected. In order
to promote this task, the DIC was provided with budgetary support such as grant
government bonds and government guarantees.
Under the currently effective legislation, special measures to fully protect deposits are to be terminated at the end of March 2001. From then on, depositors will be required to share a portion of the loss caused by the failure of a financial institution. Under the permanent measures of the Deposit Insurance Law, two methods of resolving failed financial institutions are stipulated: one method is to pay off depositors, the other is to extend financial assistance (to the financial institution that is assuming all business of the failed financial institution, within the limit of the payoff cost).
The Financial System Council, especially the Second
Committee and the Working Group on the Deposit Insurance System, has been
working on a "permanent" framework of the deposit insurance system and
methods to resolve failed financial institutions, as one of the ways in which to
realize "a safe and robust financial system."
In the course of discussion, the Second Committee issued "The Interim
Report of the Second Committee of the Financial System Council: Views and Issues
Concerning the Deposit Insurance System" on July 6th, 1999 and received
opinions from the financial industry, industry at large, labor associations,
consumer associations, and others. The Committee also released "Basic
Thinking Concerning the Deposit Insurance System after the Lifting of Special
Measures" on October 19th, 1999 and elicited public comment from various
circles.
As mentioned, the Financial System Council has exerted great
efforts to formulate a basic framework of the deposit insurance system
recognizing that it closely affects people's lives. Therefore, following the
termination of the temporary special measures, the framework should be presented
to the nation as soon as possible. Today taking into account comments from the
public, the Council has finally reached the following conclusions.
2. Protection of Depositors through Market Mechanisms
(1) The deposit insurance system aims to protect the depositors of a failed financial institution and it is, as it were, an ex post measure. The protection of depositors should be achieved primarily by ensuring sound and profitable management of financial institutions. Thus, in addition to appropriate accounting practices and improved internal controls which ensure sound management, earnest efforts are called for on the part of individual financial institutions to create innovative financial products and build confidence among customers looking forward to the 21st century. It is also necessary to review the regulatory framework. | |
(2) After the termination of the temporary special measures, it is crucial in terms of the protection of depositors to prevent the failure of financial institutions. Thus, it is important to identify troubled financial institutions at an early stage and to effect prompt corrective action. With respect to the early identification and correction of troubled financial institutions, financial institutions are expected to establish a more effective external audit system utilizing certified public accountants coupled with the enhanced disclosure of information, so that monitoring through market mechanisms will work effectively. At the same time, the supervisory authority should intensify its inspection and monitoring activities and carry out prompt corrective action in an appropriate and timely manner. In this connection, sizable financial cooperatives holding more than a certain amount of deposits are currently obliged to undergo external audit employing an outside auditor. This threshold of the size must be significantly lowered. |
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(3) Payment practices and corporate behavior in the present financial market are based on the assumption that deposits are risk-free. After the termination of the temporary special measures, this assumption needs to be altered. Thus, in creating various ways of investment, funding and payment, the present market practices should be reviewed and made compatible with a financial system that is based on market discipline and the principle of self-responsibility. |
3. Framework of Resolution Methods
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1) Basic principles When a financial institution that is not allowed to
continue to exist because of failure is resolved through the use of the deposit
insurance system, the least expensive resolution method should be chosen within
the limit of the payoff cost. At the same time, financial functions such as
payment and lending should be continued to minimize the disruption caused by the
failure. After the termination of temporary special measures, the DIC should, in principle, be responsible for providing liquidity, especially to the failed institution. The Bank of Japan (BOJ), as lender of last resort, is also expected to play an appropriate role, when necessary, in providing temporary credit or "special lending." As a condition for the extension of deposit insurance funds, the management that has led a financial institution to fail should be held strictly responsible with shareholders assuming the loss. Needless to say, it is also important to hold delinquent borrowers responsible and to carry out rigorous debt collection. |
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2) Accelerating transfer of business with financial assistance (assisted merger) When business of failed institution is transferred under the present financial assistance scheme, the payout of deposits and extension of new loans could be temporarily halted under a business suspension order issued by the supervisory authority or a stay order issued by the court. This could not only greatly affect the depositors but also dramatically erode the franchise value of the financial institution concerned including the utility of payment functions. This could even disrupt the economy and financial system as a whole. To minimize such disruption, the financial functions of a failed financial institution should be transferred as soon as possible to an assuming financial institution by speedily implementing the assisted merger. As a general principle, bankruptcy proceedings that may deprive a party of private rights, for instance, trimming a portion of a deposit, must be ultimately subject to judicial proceedings. However, in order to expedite the resolution process, the transfer of business should be allowed prior to judicial proceedings. To enable such exceptional arrangements, the following three measures should be put in place. |
a. |
Under the present deposit insurance system, where deposits
are protected per depositor up to a certain amount (at present 10 million yen),
deposits held by the same depositor must be grouped before resolving failed
financial institutions. |
b. |
As one way to extend financial assistance, the Resolution and Collection Corporation (RCC) is temporarily entrusted by the DIC to purchase the non-performing assets of failed financial institutions and actively pursue collection. It would be appropriate to continue this framework. |
c. |
In ordinary cases of business transfer of financial
institutions, strict procedures that require a certain period of time must be
followed to ensure the protection of the rights of shareholders and creditors.
In the case of resolving failed financial institutions, such procedures would
delay the business transfer, erode the franchise value of the failed
institution, and result in a diminished liquidation value for creditors. |
The payoff method should be avoided as much as possible since it diminishes the financial functions of failed institutions. However, if it is to be chosen, it should be implemented speedily to minimize disruption. Hence, it is quite important that preparations (discussed in Section 3-(2)-a) are sufficiently made prior to payoff. In addition, the DIC should consider ways to improve its operation such as entrusting the payment of deposit insurance to a third financial institution. |
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3) Preservation of financial functions (when the transfer of business takes time) It is desirable that preserving the financial functions of a failed financial institution should be ensured through speedy resolution. However, in cases where financial institutions fail before prior preparations are completed, the transfer of business may need more time. In such cases, if financial functions such as the repayment of deposits and continuation of loans are suspended, individuals and corporations will be unable to make payments or borrow, which significantly affects the economy as a whole and the financial system. Therefore, when the transfer of business takes time, a public administrator should be appointed and judicial proceedings (e.g. Civil Reconstruction Proceedings (Minji-Saisei-Hou)) should be applied in principle, while maintaining certain financial functions as the following, provided that they are consistent with the resolution procedures. In this connection, the new Civil Reconstruction Proceedings which is a reorganization procedure under bankruptcy proceedings is to replace Liquidation Arrangements under Composition Law (Wagi-Hou). The Special Law Concerning Reorganization of Financial Institutions (Kousei-Tokurei-Hou) that stipulates special bankruptcy proceedings for financial institutions should also incorporate special procedures of Civil Reconstruction Proceedings. |
a. |
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b. |
Some argue that the deposit insurance system is aimed at
protecting small depositors, and the issue of payment should be addressed
through speedy resolution and various payment services provided by the private
sector. Others argue that when the transfer of business of a failed financial
institution takes time, individuals and corporations may be significantly
affected. In particular, small and medium-sized corporations may find it
difficult to switch from a financial institution that has been providing payment
services to another. Thus, they are of the view that liquid deposits that are
used for immediate living expenses and business operations should be completely
protected. In response to this view, it has been pointed out that complete
protection would increase moral hazard. Some also question whether liquid
deposits can be specified and technically demarcated from other deposits. Others
propose that if complete protection of liquid deposit is necessary, it should be
achieved by a means other than the deposit insurance system. With a view to maintaining confidence in the payment functions of financial institutions as well as in recognition that fund transfers in process will interfere with the speedy transfer of business if they are treated the same as other claims, some contend that it suffices to protect only fund transfers in process that are booked as "betsudan yokin" (separately pooled deposits) or "kariuke kin" (temporary receipt of money), via granting them full deposit insurance coverage or preferred status so that the payment can be completed. In response, some point out the fact that small and medium-sized corporations often deposit payment money a few days in advance and so such money is pooled in the ordinary and/or checking accounts of the transacting financial institutions before being processed. Because of this, they question whether it is fair not to protect such payment money. Some also question whether fund transfers in process and other transactions can be demarcated. Based on the discussions above, the Council believes that liquid deposits should be protected by some temporary special measures in order to avoid any disruptive impact on the economy as a whole and the financial system caused by interruption of payments of individual and corporations, until speedy resolution methods are well established and a variety of private payment services are newly introduced. In such a case, however, it is necessary to prevent moral hazard as much as possible, for example, by limiting the protection of liquid deposits to those that bear no interest (or setting caps on interest rates) and by charging a higher insurance premium than other deposits so that taxpayers will not be asked to share the cost. |
c. |
A problem is pointed out in offsetting. In a commonly used loan agreement, loans to borrowers are subject to the acceleration clause in the event of their default or filing of a petition for bankruptcy proceedings against them, while deposits of financial institutions are not subject to the acceleration clause upon their failure. The following points are noted in respect to this problem: |
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(i) | It is important that financial institutions build contractual relationship more favorable to their borrowers who are also their depositors, in terms of reviewing the terms of the deposit contract, for example, by allowing borrowers to offset their borrowings with their deposits that are not due at the time of insured event under the Deposit Insurance Law. | ||
(ii) | It is acceptable that in light of the present practice of offsetting loans, such an alteration would in effect grant preferred status to a depositor who is also a borrower. | ||
When a borrower holds deposits at the time of failure, transferring both deposits and loans to the assuming financial institution is desirable for both parties from the standpoint of maintaining ongoing business relationships. Since such transfer would not impair the interest of other creditors, it is desirable also for protection of borrowers that deposits up to the amount of the loans are allowed to be transferred to the assuming financial institution, together with the loans. |
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Some issues discussed in this section 3-(3) are relevant to the issues in Section 3-(2). Therefore, the measures discussed in this section, such as the purchase of deposits and the protection of borrowers should also be incorporated in the speedy resolution method (or "a desirable prototype"). |
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4) Assuming financial institutions Under the present system, the DIC is authorized to provide financial assistance to assuming financial institution. However, past experience in Japan indicates that assuming banks may not come forward at once. For speedy resolution, an environment that encourages financial institutions to become more willing to assume the business of a failed financial institution should be developed. Moreover, alternative resolution methods should be made available in the event no financial institution is willing to assume the business of a failed institution. |
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a. |
Under the present law, only financial institutions and bank holding companies which are covered by deposit insurance are able to assume the business of failed financial institutions with financial assistance. When financial assistance is provided through the purchase of stocks however, there is no economic rationale for limiting an assuming party to financial institutions and bank holding companies. Thus, the range of possible assuming institutions should be widened. |
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b. | Measures applicable to cases where no assuming institution is found Introducing a bridge bank scheme, similar to the one under the Financial Revitalization Law, is necessary to secure enough time until an appropriate assuming institution comes forward. Under the scheme, the bridge bank needs to be established speedily, followed by a swift business transfer. It is also necessary to provide the bridge bank with an exceptional treatment to business transfer procedures for a newly created company (ex post facto establishment procedures), in addition to the measures to expedite and simplify transfer of business as described in (2)(c). It is also necessary to maintain the role of the Resolution and Collection Corporation ("Agreement Bank") as an assuming institution, which is prescribed in the supplementary provisions of the Deposit Insurance Law, with a view to secure the last-resort assumer of the business of a failed financial institution. |
4. Measures Applicable to Cases where a Crisis Situation is Foreseeable
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1) Need for systemic risk exception |
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The losses incurred by exceptional measures cannot be covered by the regular insurance premium, nor should taxpayers' money be easily utilized. Thus, a special contribution should be required from financial institutions, apart from the regular premium. However, since financial and payment systems are the infrastructure of the economy, not only financial institutions and depositors but also the national economy as a whole depend upon the stability of these systems. Therefore, in cases where the stability of the financial system could be disrupted unless exceptional measures are taken, the government may need to provide appropriate fiscal measures, in effect, tapping taxpayers who are the indirect beneficiaries of the systems, as the cost of ensuring the stability of the economy as a whole, on the condition that financial institutions make special contributions. Funds (liquidity) needed to carry out exceptional measures should be financed by the DIC's borrowing guaranteed by the government or loans from the Bank of Japan. |
5. Other Issues Concerning the Deposit Insurance System
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1) Insured deposits |
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widely used by the public as a basic savings instrument | |
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repayment of the principal is guaranteed | |
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holders are identifiable and deposits are non-negotiable | |
In terms of preventing depositor panic and speeding the resolution process, the following instruments should also be eligible while abiding by the above criteria. Needless to say, financial institutions are required to inform depositors whether individual instruments are insured or not. |
a. |
Bank debentures At present, bank debentures are not eligible for deposit insurance on the grounds that they are negotiable securities and are technically difficult to group by the holder's name. However, bank debentures which fulfill the above three criteria can be considered as virtually equivalent to time deposits. In the case where bank debentures are marketed to individuals as saving instruments, they should be made eligible for deposit insurance. |
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b. |
Deposits of public funds and deposits of corporations established under special laws At present, deposits of public funds and the like (including deposits held by institutions engaged in treasury receipts and disbursements of the national government) are not eligible for deposit insurance on the grounds that holders are not general depositors and the protection of up to 10 million yen is virtually meaningless for these deposits. However, deposits of public funds should be made eligible for deposit insurance for two reasons: first, it is illogical to differentiate deposits of public funds from those of private corporations; second, if special protection for liquid deposits is temporarily introduced, deposit insurance coverage would provide practical advantages to receipts and disbursements of pubic money. |
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c. |
Interest on deposits At present, interest on deposits is not eligible for deposit insurance on the grounds that such protection may create moral hazard on the part of financial institutions as well as depositors, and make the determination of insured amounts a complicated task. However, protecting interest could make small depositors feel safe, thus preventing the unnecessary shift of funds. Moreover, it would contribute to prompt bankruptcy proceedings, and would bring bank deposits in line with postal savings. For these reasons, interest on deposits should be made eligible for deposit insurance. As for moral hazard, a certain degree of discipline should be imposed within the framework of prompt corrective action, prohibiting or restricting the solicitation of deposits by offering high interest rates. Foreign currency deposits should continue to be ineligible for deposit insurance since they are exposed to foreign exchange risks and are not widely used by the public as basic saving instruments. |
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At present, branches of foreign banks in Japan are not
covered by deposit insurance on the grounds that jurisdictional problems might
hinder Japanese authorities in taking prompt and appropriate action against them
at the time of resolution. However, from the viewpoint of depositor protection,
and given the fact that branches of foreign banks are compelled to participate
in deposit insurance schemes in most of the major countries, it would be
desirable to make those branches in Japan eligible for deposit insurance in the
future. |
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a. |
Insurance limit At present, deposits are insured up to 10 million yen (without the temporary special measures). In light of per capita savings in Japan, the level of depositor protection in other countries, and the premium burden on insured institutions, it does not seem necessary to increase the insurance limit from the present level. |
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b. |
Tentative advance payments The relative importance of tentative advance payments will be reduced when resolution process is expedited. However, to prepare for the cases where tentative advance payments become necessary, the maximum amount of payments should be significantly increased from the current level of 200,000 yen for the purpose of alleviating depositor's anxiety. |
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* DIC |
insurance premium |
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Before fiscal 1995 | 0.012% | ||
From fiscal 1996 to 2000 | 0.048% + 0.036% (special insurance premium) |
A variable insurance premium where insurance premium are determined in connection with the financial conditions of individual insured institutions is adopted or under consideration in other countries. Such a risk-based insurance premium is, in principle, desirable in terms of supplementing market discipline. However, if adopted this time when the General Account needs to repay substantial borrowings as early as possible, the insurance premium of financially troubled institutions would inevitably be very high, further affecting their weakened conditions. Although the framework of a risk-based insurance premium should be studied at an early opportunity, the application of the framework is not feasible at this juncture. |
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Now that a permanent framework of deposit insurance and resolution methods is being designed, the savings insurance system for agricultural and fishery co-operatives should also be reorganized in a basically parallel manner, taking into account the special features of those financial institutions. |
6. Environment to be Developed before the Termination of Special Temporary Measures
The Financial System Research Council said in its report
published on December 22, 1995: "At the moment, the Japanese financial
system is not ready for payoff since 1) the financial sector is in the process
of improving disclosure, thus to ask depositors to assume responsibility is not
appropriate, and 2) the present situation in which financial institutions are
greatly burdened by non-performing assets may cause financial unrest."
Since then, preparation for the termination of the special
temporary measures has been made as follows.
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1) Disclosure by financial institutions Since the accounting period ending March 1999, city banks,
long-term credit banks, and trust banks have disclosed the outcome of the
self-evaluation of assets imposed by the Financial Revitalization Law. From the
accounting period ending March 2000, other depository institutions will follow
suit. Individual financial institutions are expected to not only disclose legally required information on their activities and assets as well as the deposit insurance eligibility of financial instruments, but also provide depositors with an understandable explanation of their financial and managerial conditions as well as accurate information on the deposit insurance system as a whole. |
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1) | Following this report by the Financial System Council, on December 29, 1999, the coalition of the ruling parties decided to postpone the termination of special measures by one year (until the end of March 2002). The coalition also decided that liquid deposits would be fully protected for another year (until the end of March 2003) under temporary special measures. Following the decision, the Ministry of Finance is preparing necessary legislation, which is planned to be submitted to the ordinary session of the Diet starting from January 2000. |
2) | "Purchase of deposits" is a means to ensure depositors liquidity and smooth judicial proceedings by empowering the DIC to purchase a portion of insured deposits exceeding the insured amount (at present those in excess of 10 million yen) at a certain ratio (estimated liquidation value). |