FSA Newsletter October 2005

Introduction

In accordance with the purposes of the ''Law Concerning the Evaluation of Policies by Administrative Organs,'' which came into force in April 2002, the Financial Services Agency aims to:

	(i)		thoroughly fulfill its accountability to the Japanese people for its financial administration,
	(ii)		deliver efficient and high-quality financial administration that benefits the Japanese people, and
	(iii)		deliver result-oriented financial administration formulated from the people's perspective,

through the implementation of policy evaluation.

Establishment of Policy Evaluation Plan

The FSA first prepared a draft evaluation plan for the fiscal year 2005 in accordance with the ''Program for Further Financial Reform'' (December 2004) and by referring to comments on its policy evaluation and, after making necessary corrections in consideration of the discussions by the Policy Evaluation Advisor Council (July 5, 2005), proceeded to release the finalized plan to the public.

Details of Policy Evaluation Plan

Under the Policy Evaluation Plan for the fiscal year 2005 (period covered by the Plan: from July 1, 2005 to June 30, 2006), performance evaluation, operation evaluation and comprehensive evaluation are scheduled to be conducted. In addition, revision work is also scheduled with the intention to strengthen the link between policy evaluation and budgeting.

(1)		Performance Evaluation Specific policies and objectives to be evaluated for the fiscal year 2005 are as shown in the ''List of Policies and Objectives Subject to Performance Evaluation,'' i.e., ''Basic Objectives,'' ''Priority Objectives,'' ''Policies'' and ''Priority Programs''; the specific details of each priority program are summarized under ''Details etc. of Priority Programs for the fiscal Year 2005.'' In order to deliver better evaluation work in the future, the FSA also seeks comments on the policies to be evaluated, reference indices and evaluation method (public comment procedures).
(2)		Operation Evaluation The items scheduled to be subject to operation evaluation are operations in the area of information etc. (of all the operations requiring budgetary steps, major operations for which new or increased budget is scheduled).
(3)		Comprehensive Evaluation Work of comprehensive evaluation will continue to be done with respect to the evaluation of the ''Financial System Reform (Japanese Big Bang),'' which the FSA has been engaged in since the fiscal year 2004.

Introduction

The Financial Services Agency (FSA) released documents entitled, respectively, ''Sample findings Issues Raised in Financial Inspections'' and ''Collection of Opinions Submitted'' to the public on July 27. What is behind the preparation and public release of both collections is the FSA's pursuit of a kind of financial inspection that focuses particularly on improving the transparency and predictability of financial inspections and having an effect of prompting financial institutions to make voluntary and sustained efforts towards improving their management.

Background Leading up to Preparation of Collections, etc.

(1)

Preparation of Sample findings Issues Raised in Financial Inspections
The ''Program for Further Financial Reform,'' which the FSA released to the public in December of last year, presents the FSA's intention of enhancing the feedback system regarding the results of inspections of financial institutions in an attempt to develop a framework to improve the transparency and predictability of financial administration and achieve full accountability; accordingly, the FSA stated in the ''Provisional Translation'' (March of this year), which was developed pursuant to the Program, its plan to prepare sample findings issues raised in financial inspections and release it, preferably during July of this year, to the public. A document entitled ''Action Program concerning enhancement of Relationship Banking Functions (for fiscal years 2005 to 2006,)'' which the FSA released to the public in March of this year, also contains a plan to give out information on issues raised in inspections that are commonly found in many financial institutions, from a viewpoint of urging financial institutions to, among other actions, strengthen their internal control systems under the principle of self-responsibility. The ''Sample findings Issues Raised in Financial Inspections'' were prepared in accordance with these stated plans.

(2)

Preparation of Collection of Opinions Submitted
The opinion submission system is a system in which financial institutions, subject to on-site inspection, can submit their opinions directly to the Director-General of the Inspection Bureau regarding any issue on which they disagree with inspectors even after holding sufficient discussions; it has been applied since January 2000.
Having accumulated a substantial amount of case examples as a result of the submissions of 295 cases in the five and half years since the introduction of the system up until now, the FSA prepared the ''Collection of Opinions Submitted'' and released it to the public with the same intention as it had for the Sample findings Issues Raised in Financial Inspections.
Also note that, in addition to the preparation of the Collection, the FSA made improvements, applicable as from the program year 2005, on the way the opinion submission system is operated, including: (i) inviting external experts to sit on the Opinion Submission Review Board, which is charged with reviewing opinions submitted, and (ii) expanding the range of topics that are allowed to be submitted under the system, to cover all inspections conducted by the FSA Inspection Bureau, and Local Finance Bureaus etc.

Details of Collections, etc.

(1)

Sample findings Issues Raised in Financial Inspections
The Sample findings Issues Raised in Financial Inspections presents a total of 174 cases mainly consisting of topics etc. raised in relation to many financial institutions, selected from among all issues that were raised in financial inspections conducted during the program year 2004, which concern topics etc. specified as priority items of inspection under the Basic Guidelines and Plan for Inspections in Program Year (PY) 2004 (July 28, 2004) (hereinafter referred to as the ''Basic Guidelines''). The respective numbers of cases presented by form of operation are shown as follows; note that the cases in relation to deposit-taking financial institutions are presented under three separate groups, i.e., major banks etc. and foreign bank branches, regional banks, and Shinkin Banks and Credit Cooperatives, in accordance with the FSA's practice of raising issues as adapted to the size and characteristics of the financial institution being inspected.
The number of cases presented under a given operation category or topic does not reflect the actual number of issues raised in inspections, and, while most cases presented were chosen to imply general characteristics of a given operation category, it is wrong to conclude that any topic that is presented under a specific operation category has never been raised in other operation categories; therefore, any one who attempts to connect these figures to financial institutions' voluntary and sustained efforts towards improving their management might benefit more by referring to issues raised under other operation categories as well.

	I. Deposit-taking financial institutions		128 cases
	1. Major banks etc. and foreign bank branches		(38 cases)
	2. Regional banks		(39 cases)
	3. Shinkin Banks and Credit Cooperatives		(51 cases)
	II. Insurance companies		31 cases
	III. Securities companies		15 cases

For deposit-taking institutions, the cases presented are categorized according to the rating items as set under the ''Financial Inspection Rating System'' and, for insurance companies and securities companies, they are categorized according to the Inspection Manual.
The ''Financial Inspection Rating System'' will start its trial application from January 2006, and subsequently become fully effective as early as program year 2006.

Some of the 174 cases described in the Sample findings Issues Raised in Financial Inspections are briefly described below for illustrative purposes, organized by business category:

Major banks and foreign bank branches
In accordance with a decision under the Basic Guidelines to treat governance as a priority item in the case of inspecting a major bank, the involvement of the management in dealing with major borrowers is among the issues raised.
Regional banks
In accordance with a decision under the Basic Guidelines to inspect computer system risk management systems etc. subsequent to computer system changes for the purpose of introducing payment and settlement deposits, accountability to customers concerning the introduction of payment and settlement deposits is among the issues raised in relation to regional banks. Another example of an issue raised is the one related to their actions in areas of contribution to small- and medium-sized enterprise business revitalization and regional economy revitalization and activation.
Shinkin Banks and Credit Cooperatives
Hoping that the Collection will serve as a useful reference for Shinkin Banks and Credit Cooperatives to develop internal control systems, we presented a larger number of cases under this operation category, including issues raised in relation to the appropriateness of credit risk management and to liquidity risk management systems etc.
Insurance companies
In accordance with a decision under the Basic Guidelines to list the appropriateness of insurance solicitation activities as a priority item in inspection, a case related to insurance solicitation management systems is among the cases presented under the category of insurance companies; a case related to systems of paying insurance claims etc. is another example.
Securities companies
In accordance with a decision under the Basic Guidelines to treat risk management systems and statutory compliance systems concerning stock trading via the Internet as priority items when inspecting a securities company, the cases presented under the category of securities companies include an issue raised in relation to computer system outsourcing management etc. relevant to the management of a securities trading system via the Internet.

(2)

Collection of Opinions Submitted
The Collection of Opinions Submitted provides descriptions of the cases, selected from among the 295 cases, that were submitted up until the program year 2004, which we thought may serve as a useful reference for financial institutions to exercise their risk management etc.; the descriptions are a summary of those cases given without specifying the financial institutions that submitted the opinions, and includes review results and focuses on the points of disagreement.
In selecting cases, we took into account the fact that 272 cases, or approximately 90% of all the cases submitted by financial institutions, are related to credit risks, and accordingly made a selection concentrating on cases concerning borrower classification (seven cases), cases concerning write-off and provision (two cases) and a case concerning collateral appraisal, as well as cases concerning accounting treatments (two cases), thus presenting a total of 12 cases.
For your information, 133 cases out of the 295 cases that had been submitted resulted in the opinions of the submitting financial institutions being accepted.

Future Plans

We intend to summarize on a regular basis the issues raised in inspections during each program year and release the results to the public every year.
While it will have to depend partially on how extensively the opinion submission system will be used in the future, we are hoping to revise the Collection of Opinions Submitted on an approximately yearly basis, taking into account the topics of the times in each revision.

Pursuant to the ''General Guidelines for Small- and Medium-Sized and Regional Financial Institution Supervision,'' which was established in May 2004 (hereinafter referred to as the ''Supervision Handbook''), the Financial Services Agency drew up ''Annual Policies for Small- and Medium-Sized and Regional Financial Institution Supervision for the Administrative Year 2005'' (hereinafter referred to as ''Supervision Policies'') and released it on July 28. An overview of the Supervision Policies is as follows:
(Note) Administrative year 2005: from July 2005 to June 2006

Background

The Supervision Handbook sets forth that ''in order to clarify items of priority in supervision, the FSA will develop and release supervision policies at the beginning of each administrative year, to be applied during the said administrative year.''
Underlying this decision to develop and publicly release such supervision policies every administrative year is the need to show in a standardized fashion basic ideas and items of priority in conducting the work of supervision for each administrative year, as supervising small- and medium-sized and regional financial institutions (RFIs) involves a large number of target RFIs with a great diversity and oversight through Local Finance Bureaus.
In supervising RFIs in the administrative year 2005, the authorities will conduct their off-site monitoring work comprising various interviews including ''Comprehensive Interview,'' in accordance with the Supervision Policies developed for the year.

Composition

The Supervision Policies starts with the presentation of ''Basic Ideas'' that are applied to achieve fundamental objectives of the financial administration under the current circumstances surrounding financial institutions, and then proceeds to sort out ''Items of Priority'' for this administrative year. These are the items that should be given particular attention so as to adequately address the current circumstances surrounding financial institutions, and are arranged into three areas, i.e., ''Further Promotion of Region-Based Relationship Banking,'' ''Adherence to User Protection Rules and Improvement of Convenience'' and ''Further Sophistication of Risk Management.''
A notable aspect of the Supervision Policies is that it clearly sets out, as items of priority, measures to be taken in response to a number of recent developments, that include: establishment of the ''Program for Further Financial Reform'' in December 2004 and, being one of the measures described under it, the establishment of ''Action Program to Promote Further Enhancement of Region-Based Relationship Banking Functions (FY2005-06)'' in March this year; the removal of the blanket guarantee on deposits in April this year; the establishment of customer information losses at financial institutions; and the establishment of counterfeit cash card fraud cases to a serious problem.

Basic Ideas

The ''Basic Ideas'' section describes the current circumstances surrounding RFIs, and the basic ideas that are applied to achieve fundamental objectives of the financial administration under such circumstances.

(1)

Current Circumstances Surrounding RFIs
The current circumstances surrounding RFIs are described as follows:

(i)	Seeing that the phase of financial administration is shifting from one that emphasizes ''financial system stability'' to another that emphasizes ''financial system vitality,'' the ''Program for Further Financial Reform,'' released in December 2004, demanded that basic principles of the authorities responsible for financial administration should be to (a) complement market discipline, (b) establish a ''Code of Conduct'' for financial administration, and (c) develop and enforce user protection rules. From now on, pursuant to the stated basic principles, the authorities must work towards bringing about a financial system with a high level of user satisfaction by drawing on the strengths of the ''private sector.''
(ii)	With regard to regional financing, the ''Program for Further Financial Reform'' stated that region-based relationship banking should be further promoted with the view of revitalizing and activating regional economies, facilitating small- and medium-sized enterprise (SME) financing, and strengthening management functions of RFIs. In order to put this into action, the ''Action Program to Promote Further Promotion of Region-Based Relationship Banking Functions (FY2005-06)'' (hereinafter referred to as the ''new Action Program'') was newly developed and released in March this year to cover FY2005 and FY2006, as successor of the ''Action Program concerning enhancement of Relationship Banking Functions'' (released in March 2003; hereinafter referred to as the ''former Action Program''). While efforts towards enhancement of region-based relationship banking functions under the former Action Program are steadily progressing as a whole, it will inevitably take some time for a good part of these efforts to bring forth a discernible effect; thus, it is likely necessary to continue the existing efforts under the new Action Program in an attempt to further promote region-based relationship banking.
(iii)	With the removal of the blanket guarantee on deposits in April this year, financial institutions are pressed to strive, all-the-more vigilantly, toward strengthening their management functions under market discipline, where further improvement of information disclosure to their users is a key issue. In addition, it is increasingly necessary for financial institutions to ensure user protection: the detection of customer information losses at many financial institutions after the enforcement of the Personal Information Protection Law this April asks for the establishment of appropriate systems to protect customer information, while stricter measures for financial crime prevention purposes are also needed in light of, for instance, a looming problem of counterfeit cash card fraud.

(2)

Basic Ideas
Taking into account the current circumstances surrounding RFIs, as described in (1) above, the Supervision Policies sets forth that strict and effectual supervisory administration should continue in an efficient and effective fashion this administrative year in accordance with the following basic ideas and pursuant to the Supervision Handbook, so that the fundamental objectives of financial administration (i.e., ensuring stability of financial function, protecting users of financial services, and securing smooth financing activities) could be achieved.

The supervisory authorities should:

(i)	Make efforts towards securing sufficient communication with financial institutions while keeping a reserved, yet sound and constructive, relationship, by means of regular meetings and exchanges of views, in order to accurately grasp and analyze information concerning financial institutions' management in an attempt to use the findings in taking timely and appropriate supervisory actions.
(ii)	Pay respect to voluntary efforts by financial institutions in their business administration, in full consideration that authorities' role is to examine in the light of laws and regulations, and prompt any necessary corrections to, corporate decisions that financial institutions make as private entities in accordance with the principle of self-responsibility, and that information disclosure-based discipline should be their main code of conduct.
(iii)	Make efforts to strengthen coordination with the inspection branches, while maintaining mutual independence, by securing sufficient communication by means of ''Inspection/Supervision Coordination Meetings'' and other daily exchange of information, in order to deliver financial supervision with a high level of effectiveness.

Items of Priority

In order to adequately address the current circumstances surrounding RFIs, the Supervision Policies specifies three pillars as ''Items of Priority'' in the work of supervising RFIs for this administrative year, taking into account the fundamental objectives of the financial administration. The pillars are: ''Further Promotion of Region-Based Relationship Banking,'' ''Adherence to User Protection Rules and Improvement of Convenience'' and ''Further Sophistication of Risk Management.''

(1)

Further Promotion of Region-Based Relationship Banking
We expect that financial institutions will, in accordance with the new Action Program, work to further promote region-based relationship banking via ''selection and concentration'' reflecting regional features and user needs as well as improved information disclosure and discipline thereby, so as to respond to financing needs of local SMEs in a more appropriate fashion, and will also secure sound management and gain full trust from regional users. For that purpose, the Supervision Policies requires the authorities to follow up on the progress of unique ''Relationship Banking Promotion Plans'' developed by financial institutions, and also to exercise appropriate supervision focusing on the following points in particular:

(i)	Business revitalization and facilitation of SME financing
(ii)	Strengthening of management functions
(iii)	Enhancement of convenience for regional users

(2)

Adherence to User Protection Rules and Improvement of Convenience
From a viewpoint of protecting users of financial services, the Supervision Policies sets forth that appropriate supervision focusing on the following points in particular should be exercised, working in coordination with the inspection branches. Considering that the delivery of services with a high level of user satisfaction calls for precise understanding of users' comments and complaints by financial institutions, the Supervision Policies also requires that appropriate steps be taken, paying respect to any initiatives on the part of financial institutions.

(i)	Establishing customer information protection systems
(ii)	Strengthening and thoroughly implementing measures for prevention of financial crimes
(iii)	Enhancing systems of explanation to customers and functions to deal with consultations and complaints
(iv)	Securing appropriateness in computer system management systems

(3)

Further Sophistication of Risk Management
For financial institutions to have appropriate risk management systems and secure their financial soundness, and thus to gain trust from depositors and users, the Supervision Policies sets forth that appropriate supervision focusing on the following points in particular should continue this administrative year, with a view of achieving further sophistication of risk management at each financial institution, facing the scheduled implementation of Basel II from the end of March 2007.

(i)	Securing reliability in asset appraisal and credit risk management
(ii)	Developing market risk management systems
(iii)	Developing management systems of earnings and improving profitability

What is the ''Lending Crunch and Oppressive Debt Collection Hotline''?

As part of its efforts towards facilitating financing for small- and medium-sized enterprises etc., the Financial Services Agency set up and operated a service called the ''Lending Crunch and Oppressive Debt Collection E-mail and Fax Reporting Program'' (commonly known as the ''Lending Crunch and Oppressive Debt Collection Hotline'') to listen, on a far-reaching scale, to the voices of borrowers, including small- and medium-sized enterprises. The intention behind the establishment of such a fax and e-mail reporting service was to provide small- and medium-sized enterprises with the means of directly reporting to the FSA etc. in the event of, among other types of incident, unfair treatment by a financial institution on the grounds of the Financial Inspection Manual etc.

Establishment of ''Financial Service User Support Line''

The ''Lending Crunch and Oppressive Debt Collection Hotline'' reporting service was recently merged into a new service called ''Financial Service User Support Line,'' which was established on July 19 of this year for the FSA to receive inquires, consultation requests and comments etc. under a one-stop umbrella (hereinafter referred to as the ''Support Line''). While any information concerning lending crunch and oppressive debt collection must now be reported to this ''Support Line,'' case reporting and information use progress will continue to be released to the public as in the past.

Hotline Case Reporting and Information Use Progress (As of July 18, 2005)

(1)

Case Reporting Progress
In accordance with the FSA's practice of releasing to the public, on a quarterly basis, case reporting and information use progress under the ''Lending Crunch and Oppressive Debt Collection Hotline,'' such progress was reported to the public for the tenth time on July 29, 2005 (see Note). In consequence of the ''Support Line'' being established on July 19 of this year, the tenth release contains the progress made between July 1 and July 18, in addition to the information reported up until June 30, or the last day of the regular release period. The accumulated total of the cases that were reported since the October 2002 service establishment up until July 18, 2005 is 1,786.

(2)

Information Use Progress

(i)

As one example of information use on financial institutions on a non-individual basis, the cases reported to the Lending Crunch and Oppressive Debt Collection Hotline were referred to in the work of establishing the ''Administrative Guidelines for Explanation Offering Structures and Consultation and Complaint Handling Functions Regarding Credit Transactions'' (which were subsequently incorporated into the ''General Supervision Guidelines for Small- and Medium-Sized and Regional Financial Institutions'') in July 2003.
Pursuant to the ''Basic Guidelines and Plan for Financial Inspections in Program Year 2004,'' which was established in July of last year, the inspections during the program year 2004 (from July 2004 to June 2005) were conducted with a emphasis placed in particular on, for instance, the status of accountability fulfillment in relation to borrower companies in accordance with the Administrative Guidelines etc. as well.
Furthermore, we have also requested financial institutions, on the basis of the information reported to the Hotline, to make efforts towards, for instance, facilitating small- and medium-sized enterprise financing and establishing adequate explanation offering structures for customers, as well as enhancing their consultation and complaint handling functions.

(

Note) In addition to taking these actions, the FSA has also stated an intention in the ''Financial Inspection Manual Supplementary Issue on Small- and Medium-Sized Enterprise Financing,'' which was revised in February of last year, to take into consideration when conducting inspections how well a financial institution comprehends the business conditions etc. of borrower companies through close-knit communication with them.

(ii)

On an individual financial institution basis, the information has been used in the following fashions:

(a)		The information reported is summarized by the Supervision Bureau every quarter, on the basis of which we conduct interviews with financial institutions to hear about their policies and systems etc. In the case information which its provider etc. agrees to have the company's name etc. disclosed to the financial institution, we have conducted interviews on a case-by-case basis to confirm the fact etc. When it was deemed necessary to check the matter for supervision purposes as a result of such interviews, we proceeded to request a report under, for example, Article 24 of the Banking Law.
(b)		In inspecting a financial institution, we referred to all information reported by the time of the inspection as well as what that financial institution had reported to us, and accordingly examined the status of their accountability fulfillment to borrower companies and complaint handling systems etc. When we deemed that there was a problem with a given financial institution as a result of an inspection, we proceeded to request a report on corrective measures under, for example, Article 24 of the Banking Law.

(iii)

Specific details of the use of reported information are as follows:

(a)		On the basis of the information reported between January 1 and March 31 of this year, the Supervision Bureau conducted interviews with 25 financial institutions. We also requested one of those institutions to file a report, as it was deemed necessary to check the matter for supervision purposes.
(b)		Regarding inspections of 24 financial institutions, which we started between January 1 and March 31 of this year, we referred to the information etc. reported by the time of the inspection and accordingly examined the status of their accountability fulfillment to borrower companies and complaint handling systems etc.

(iv)

In order to use the information reported to the ''Lending Crunch and Oppressive Debt Collection Hotline'' more effectively and take government-wide actions subsequently, we also worked in coordination with the Small and Medium Enterprise Agency and held interagency communication meetings on an as-required basis.

(v)

Although the ''Lending Crunch and Oppressive Debt Collection Hotline'' service was, as has been described above, merged into the ''Support Line,'' which was established on July 19 of this year, the treatment of reported information remains unchanged from the past. In the future, please contact the ''Support Line'' to report any information concerning a lending crunch or oppressive debt collection.

On July 29, the Financial Services Agency (FSA) released to the public the status of non-performing loans as it stood as of the end of March 2005.
A brief explanation of the status of non-performing loans as of the end of March 2005 is given as follows:

The non-performing loan balance of all banks (on the basis of loans subject to disclosure under the Financial Reconstruction Law) totaled 17.9 trillion yen as of the end of March 2005, a drop of 8.7 trillion yen from 26.6 trillion yen recorded in the period ending March 2004.
In terms of non-performing loan ratio, the figures calculated for major banks, regional banks, and all banks dropped significantly in comparison to the figures recorded for the periods ending March 2004 and September 2004, respectively, each marking a record low since data on loans subject to disclosure under the Financial Reconstruction Law began to be released to the public (i.e., since the end of March 1999).

(No	te) Non-performing loan ratio (= non-performing loans (loans subject to disclosure under the Financial Reconstruction Law) / total credit balance)

	Mar. 04	Sept. 04	Mar. 05
Major banks:	5.2%	4.7%	2.9%
Regional banks:	6.9%	6.3%	5.5%
All banks:	5.8%	5.3%	4.0%

What is particularly notable is a fall of the non-performing loan ratio of major banks from 8.4%, as of the end of March 2002, to 2.9%, whereby the objective of halving their non-performing loan ratio, as set in the ''Program for Financial Revival (October 2002), was successfully achieved.

(No	te) Objective of halving their non-performing loan ratio: to lower, by fiscal year 2004 (the period ending March 2005), the non-performing loan ratio of major banks to approximately half the level recorded for the period ending March 2002 (8.4%).

Non-performing loan ratios of regional banks have also been dropping steadily as a whole, as their efforts in the area of relationship banking are generally showing steady progress.
As we find that the implications of having thus succeeded in solving the non-performing loan problem of major banks to recover their normal operation as a result of taking various measures set in the ''Program for Financial Revival'' are quite significant, we will continue to be committed to taking all possible steps in the supervision of financial institutions in the future, lest a non-performing loan problem should reemerge and hobble the Japanese economy.

For further details, please visit the FSA's website and go to either ''End - March, 2005 (released on July 29, 2005)'' under ''Status of Non-Performing Loans,'' or ''The Status of Non Performing Loans as of end-March 2005 (July 29, 2005) '' under ''Press releases.''