FSA Newsletter November 2005

On August 19, the Financial Services Agency developed and released to the public its (Draft) Comprehensive Guideline for Major Banks, etc., with a view to seeking public comments.
Having substantial influences on Japan's economy and, in many cases, also operating on a global scale, the major banks, etc. (see Note) are expected to offer financial services that are among the best in the world and contribute to the further growth of Japan's economy and the improvement of people's daily lives.

To that end, they need to exercise highly-developed risk management, which is a crucial element in the financial intermediation business, and aim at providing better user protection and enhancing their international competitiveness while practicing appropriate corporate governance suitable in the industry that they operate in.

(Not

e) The major banks, etc. refer to the 11 major banks (The Bank of Tokyo-Mitsubishi, Ltd., Mizuho Bank, Ltd., Mizuho Corporate Bank, Ltd., Sumitomo Mitsui Banking Corporation, UFJ Bank, Limited, Resona Bank, Ltd., The Sumitomo Trust & Banking Co., Ltd., The Chuo Mitsui Trust and Banking Company, Limited, Mizuho Trust & Banking, Mitsubishi Trust and Banking Corporation, and UFJ Trust Bank, limited), as well as Shinsei Bank, Ltd. and Aozora Bank, Ltd.

Based on such a viewpoint and by reference to the contents of the Comprehensive Guideline for Supervision of Small- and Medium-Sized and Regional Financial Institutions, which has already been established, the (Draft) Comprehensive Guideline for Supervision of Major Banks, etc. provides clear and systematic descriptions of the basic ideas for the work of supervision of the major banks, etc., as well as points to note in administrative procedures and items of evaluation in supervision, for the administrative convenience of officials who are charged with supervision of the major banks, etc., all of which were thought out in consideration of what standards would be expected of the world's leading banks.

Taking into account the characteristics, etc. of the major banks, etc., the (Draft) Guideline contains additional items that are not found in the currently-existing ''Comprehensive Guideline for Supervision of Small- and Medium-Sized and Regional Financial Institutions,'' including:

(1)	More extensive descriptions of such subjects as governance, capital adequacy, information disclosure, information technology system risk management, and procedures applicable to new entries into the banking business, and
(2)	New provisions for such subjects as profitability improvement, integrated risk management, credit risk management (including early recognition of non-performing loans and steps to turn them back to health), information technology system integration risk management, Internet banking, overseas operation management, and supervision of Japanese branches of foreign banks.

We are planning to finalize the Guideline by referring to the comments that we receive, and then proceed to release the finalized version to the public.

Summary of (Draft) Comprehensive Guideline for Supervision of Major Banks Etc.(PDF)

On Wednesday, August 24 and Thursday, August 25, the Financial Services Agency hosted the ''Children's Kasumigaseki Visit Day'' program.

''Children's Kasumigaseki Visit Day'' is a program in which ministries and agencies etc., including the Ministry of Education, Culture, Sports, Science and Technology, the organizing ministry, work in collaboration to offer opportunities for families to deepen their connection and for children to learn broadly about society in a hands-on fashion during their summer vacation, as well as to promote more understanding of what each ministry or agency etc. does, by, for instance, providing program participants with explanations of their activities and tours of their premises.

Joining this program since last year, the Financial Services Agency also aims at creating an opportunity for participants to develop a deeper understanding of the workings of finance in their daily lives and what the work of the Financial Services Agency is all about.

This year, we sought applications for participation in the program in advance and welcomed twenty-two children on the 24th and twenty on the 25th, despite the latter having the unfortunate weather conditions of an approaching typhoon.

On both days, the participants were asked to come to the special conference room on the ninth floor at 10:00 a.m., where they received an orientation and explanations of the Agency's activities etc. and sat for a talk given by the Director of the Public Relations Office about the organization of the Financial Services Agency.

Subsequently, they toured the Minister's office where they took pictures and examined the room according to their fancy; some of them sat on the Minister's chair and had pictures taken with the parliament building in the background.

After visiting the Minister's office, the participants moved to the press conference room where a lecture on ''financial and economic education'' was given by Mr. Hiroshi Ikushima, a news anchor, on the 24th and Ms. Mikiko Ariake from the Association for the Promotion of Financial Literacy on the 25th.

On the 24th, Mr. Hiroshi Ikushima appeared to the tune of Mr. Antonio Inoki's ring song and, after encouraging the participants to relax first by doing some hand exercises, spoke about finance and the economy by citing examples of familiar foods, products and companies.

On the 25th, Ms. Mikiko Ariake gave a talk about money in the form of a quiz (for example: ''How much does it cost to print a 10,000-yen bill?'') under the title of ''Check It Out! Relationship Between You and Money.''

After the lecture, the participants moved to a tribunal room where the children each played, by drawing lots, the role of ''administrative law judge,'' ''designated official'' or ''respondent / attorney'' to hold a ''moot tribunal'' to decide whether or not to impose penalties against insider trading etc. The Visit Day was wrapped up with this moot tribunal, which was reported by the media etc. and was highly appreciated by the participants as well.

Over the same two days of August 24 and 25, a total of 51 children showed up in the first floor lobby of the Central Common Government Offices to participate in a get-it-stamped event held there that was organized jointly by ministries and agencies, and they got a Financial Services Agency stamp.

In the questionnaires that we asked the children and accompanying adults to fill out, we received many comments that ''the program was interesting and instructive as a whole,'' with particular references made to the ''moot trial experience'' and ''lecture,'' saying, for example, that they learned a lot or enjoyed themselves.

On the other hand, this also revealed the reality that children learn almost nothing about ''finance'' in their respective schools.

We are intent on delivering the program even better next time so as to make good use of the various voices of the participants that we received this time and also to encourage the children to develop an interest in and have a deeper understanding of the workings of finance and the work done by the Financial Services Agency.

[Background]
Financial institutions in Japan have used tax effect accounting since the fiscal year ended March 1999. Tax effect accounting is designed to adjust the differences between business accounting and tax accounting. These differences result from differences in timing between the recognition of revenues and expenses for business accounting purposes and that of profit and loss for taxable income calculation purposes. Specifically, expenses that are reported for accounting purposes but are not treated as losses for tax purposes (tax-deductible write-off and provisions) reduce tax payments in the future when these expenses are recognized as losses upon generation of taxable income. This portion is treated as deferred tax assets because they are deemed to represent prepayment of taxes. In recent years, the write-off of non-performing loans, mainly by major banks, has accelerated, causing these deferred tax assets to grow.
In light of this situation, the ''Program for Financial Revival'', etc. charged the Financial System Council with the ''task of speedy examination'' to introduce a proper regulatory treatment of deferred tax assets in calculating capital adequacy ratios. In response, the Working Group on the Capital Adequacy Requirements (chaired by Prof. Kazuhito Ikeo of Keio University) within the Second Subcommittee of the Sectional Committee on Financial System, the Financial System Council, held discussions, examining issues from legal, accounting and tax perspectives. After 15 rounds of discussions, the group compiled a report.
The report of the working group was accepted at the 17^th meeting of the Second Subcommittee of the Sectional Committee on Financial System, the Financial System Council, held on June 22, 2004 under the title of Subcommittee Report: ''Regulatory Treatment of Deferred Tax Assets in Calculating Capital Adequacy Ratios and Other Issues related to Capital Adequacy of Banks.''
Regarding the necessity to introduce a proper regulatory treatment of deferred tax assets in calculating capital adequacy ratios, the report stated that the vulnerability of deferred tax assets could not be overlooked from the point of view of depositor protection and that ''there was broad support for the idea that proper regulatory treatment of deferred tax assets in calculating capital adequacy ratios should be introduced as it is important to make capital adequacy ratios serve well as trigger of prompt corrective actions .''
However, the report also made the following three cautionary points that should be heeded in the implementation of such a change:
1. Consistency with macroeconomic policy management, financial system stability and its current situation should be taken into consideration when introducing proper regulatory treatment of deferred tax assets in calculating capital adequacy ratios, and the implementation should be phased in over a reasonable period of time.
2. The change should preferably take effect after the goal of slashing the ratio of non-performing loans in half is met.
3. It is desirable that differences between the tax systems of Japan and those of countries which are believed to use tax-deductible write-off and provisions more extensively are taken into consideration when introducing a proper regulatory treatment of deferred tax assets in calculating capital adequacy ratios.
Based on the contents of the report, the FSA studied the issues of introducing a proper regulatory treatment of deferred tax assets and released the following proposal to revise the requirements on September 22, 2005.

[Banks Subject to the Proposed Revision]
Based on the above-described background of deliberation, the ''Major Banks'' are subjected to the proposed revision. The Major Banks reached their goal of halving their non-performing loan ratios in the fiscal year ended March 2005 as had been mandated by the ''Program for Financial Revival.'' The environment is thus considered to be ready for implementation of the change to introduce a proper regulatory treatment of deferred tax assets in calculating capital adequacy ratios.
(Note) The ''Major Banks'' consist of the following banks and bank holding companies:
Mizuho Financial Group, Inc., Mizuho Bank, Ltd., Mizuho Corporate Bank, Ltd., Mizuho Trust & Banking Co., Ltd., Mitsubishi UFJ Financial Group, Bank of Tokyo-Mitsubishi, Ltd., UFJ Bank, Ltd., Mitsubishi UFJ Trust and Banking Corp., Sumitomo Mitsui Financial Group, Sumitomo Mitsui Banking Corp., Resona Holdings, Inc., Resona Bank, Ltd., Mitsui Trust Holdings, Inc., The Chuo Mitsui Trust and Banking Co., Ltd., and The Sumitomo Trust & Banking Co., Ltd.

[Description of introducing proper regulatory treatment of deffered tax assets]
The percentage (upper limit) of deferred tax assets booked in Tier 1 of the equity capital will be gradually reduced to 40% starting with the end of March 2006, 30% starting with the end of March 2007, and 20% starting with the end of March 2008. Any excess above the limit will be deducted from the amount of Tier1.

Please refer to the Primer on Financial Literacy: ''Tier 1'' and ''Tier 2'', found in this Newsletter, for explanation of Tier 1 of the equity capital.

Objective of the Survey of the Status of IT Use

The Program for Further Financial Reform - Japan's Challenge: Moving toward a Financial Services Nation(PDF) was created and released at the end of last year. The Program encompasses the ''study of measures to ensure the transparency of the IT investment process of financial institutions, and to encourage improved cost performance and risk management abilities'' with a view toward strengthening competitiveness of financial institutions with the strategic use of IT. In response, the Work Schedule, released this March, stipulated the ''implementation of a survey to grasp the actual status of IT use by financial institutions, and collection and official announcement of the survey results.''
Based on the contents of the ''Program for Further Financial Reform(PDF) '' and those of the ''Work Schedule(PDF),'' this survey was conducted with the goal of providing financial institutions with useful data for making future investment decisions on IT and constructing business models. At the same time, the survey aims to offer a platform for discussions for the ''exchange of opinions among persons with practical experience and influential individuals about improving the efficiency of IT investment and measures for strategic use of IT'' as described in the ''Work Schedule.''
Needless to say, decisions regarding how to use IT and how to invest in IT are left up to the discretion of individual financial institutions. In the absence of statistical data on IT use in the financial industry, however, collection, compilation and publication of such data by the government are believed to support financial institutions to evaluate the efficiency of their investment in IT and the positioning of IT in their business strategies. Summarization of data that shows the overall picture also makes it possible to compare the reality of IT investment in the Japanese financial sector with situations in foreign countries.
This survey was conducted to collect and subsequently publish data that are difficult for individual corporations or industry organizations to gather. It is our hope that such data will be used by financial institutions in their decision making on future investment in IT.

Summary of the Results of the Survey

The status of IT use among Japanese financial institutions was surveyed based on the following four perspectives:

	(i)	Basic statistics about spending for IT.
	(ii)	Current status of IT use, issues and areas of future efforts, viewed in terms of its cost vs. effect
	(iii)	Current status of IT use, issues and areas of future efforts, viewed in terms of its strategic use.
	(iv)	Current status and issues relating to infrastructure for financial transactions. The survey results are summarized and presented along the following four perspectives:

(i)	Overall Picture of IT Spending among Financial Institutions Fig. 1 presents the total picture of IT spending by Japanese financial institutions as of the end of the 2004 fiscal year. It shows that Japanese financial institutions' IT-related spending totaled approximately ¥1,800.0 billion as of the end of the 2004 fiscal year. By business mode, the total is broken down to slightly over 30% spent by the major banks, slightly over 20% by regional banks, and approximately 10% each by major securities corporations, life and non-life insurance companies, and cooperative financial institutions. The graph in Fig. 2 breaks down the total IT-related spending among independent systems, shared systems and outsourced systems. It shows that spending for independent systems amounted to approximately 75% of the total, representing the largest spending segment. It also shows that spending for shared systems was made mainly by regional banks and cooperative financial institutions, although the total amount of such spending represented only a small portion of the total spending.
	(Note) Independent systems refer to systems that are developed, purchased or leased independently by individual financial institutions. Shared systems are business systems that are jointly developed and run by multiple financial institutions. Outsourced systems are systems that are outsourced to vendors (including those that are developed, as well as maintained and run, by vendors).

	Fig. 3 shows the trends of IT-related spending among five spending categories, consisting of software development cost, software lease fees, hardware, network, and maintenance/operation. The graph shows that spending for maintenance and operation represents the largest spending category. By business mode, major banks, major securities corporations, and life and non-life insurers were found to have spent substantially on software development whereas regional banks and cooperative financial institutions spent a great deal for hardware and networks.
(ii)	Current Status of IT Use, Issues and Areas of Future Efforts, Viewed in Terms of its Cost vs. Effect Next, a summary of the results of a survey on the current status, issues and future areas of efforts with respect to the way IT is used, based on the perspective of cost vs. effect is introduced by breaking down the process into the following phases: planning/design, procurement, development, maintenance/operation and post-spending evaluation. Fig. 4 shows the results of a survey on the question of whether or not financial institutions set their IT investment strategies and goals with respect to the effects of their IT investment. The figure reveals that more than 70 percent of financial institutions set strategies for investment in IT, but only approximately half of them established goals for the effects. Regarding the question about ''issues that planning and design face,'' many responded with such answers as ''It is difficult to tell whether the effects of investment are reasonable. (There is no objective external criteria that can be used to evaluate one's company's investment decisions.)'' On the other hand, financial institutions that already had set goals for effects gave such comments as the following: ''Such indicators as ROI, ROA, ROE, internal rate of return, break-even point, net present value, etc. are used as quantitative targets,'' ''Investment projects are classified into four categories (maintenance of status quo, quality improvement, cost reduction, and profit improvement) and expected effects (financial effects, non-financial effects, opportunity loss prevention effects) are established on a category by category basis.''

	In the ''procurement'' phase, nearly all financial institutions, regardless of their business modes or sizes, responded that they considered ''cost'' to be important when they were asked about ''important factors to consider when making procurement decisions (multiple answers were permitted).'' On the question of ''efforts to reduce cost when making purchases (multiple answers were permitted),'' answers included ''extensive use of competitive bidding'' (52%), ''purchase of systems that are used by many other companies'' (39%) and ''surveys of other companies in the same industry'' (38%). (The figures in parentheses are percentages of financial institutions that picked respective answers. The same applies in the remainder of this section.) Regarding ''specific issues faced in procurement,'' a number of respondents stated that ''verification of the reasonableness of development man-hours, price, contents, etc. is not possible, due to the fact that systems have been turned into black boxes.'' In the ''development'' phase, on the question of ''efforts to control the development process'', answers included ''periodic reporting to the executive board'' (61%), ''establishment of project control rules'' (45%) and ''introduction of project management tools'' (20%). About ''specific issues experienced in development,'' answers included the following: ''System development has been implemented on a system by system basis under various design concepts instead of taking the concept of overall optimization into consideration. This resulted in high development and maintenance costs and rigidity to change.'' ''Professionals who have expert knowledge and those who have the skills of project management are in short supply or becoming older.'' On the other hand, responses also provided such success stories as the following: ''Project management was successfully carried out by holding regular process meetings, where not only system division members but also members from user divisions and other related groups met together.'' ''Thorough process control was achieved successfully by establishing the 'development process standards' that set rules about planning and design, development and testing, and all the way to verification.'' The largest portion of IT-related spending was made in the ''maintenance and operation'' phase. On the question of ''efforts for the reduction of maintenance and operation cost (multiple answers permitted),'' such answers as ''Use of SLAs (Service Level Agreements)'' (41%) and ''Procurement that is based on life cycle cost'' (28%) were received. These two items were also listed most frequently as the ''items that are hoped to be tackled in the future.'' Regarding ''issues relating to maintenance and operation (multiple answers permitted),'' answers included ''Maintenance requirement is often greater than initially anticipated'' (36%) and ''Maintenance and operation cost far surpasses the initial projections'' (14%). In addition, such answers as ''The support period is short,'' and ''Vender pricing is ambiguous'' were obtained. Lastly, with respect to the ''post-IT investment evaluation'' phase, evaluation efforts are depicted in Fig. 5. The figure shows that slightly less than 70 percent of financial institutions conducted internal evaluation and audits, whereas slightly less than 50% of them used external audits and slightly greater than 20% of them relied on evaluations by outside organizations. Many of the respondents stated that external audits were conducted as part of financial audits by audit firms.

(iii)	Current Status of IT Use, Issues and Areas of Future Efforts, Viewed in Terms of its Strategic Use Regarding the status of IT use for strategic purposes, the current situation and issues were examined for each of the items, consisting of ''an expansion of sales channels,'' ''branch strategies,'' ''improvement of customer convenience and safety,'' and ''risk management.'' Among the objectives that financial institutions rated high as important with respect to their investment in IT, ''improvement of customer convenience and safety'' generally ranked high, a reflection of countermeasures to recent revelation of counterfeit cards and the implementation of the Personal Information Protection Law. Fig. 6 is a summary of whether or not financial institutions have made investment in IT to meet each of the objectives listed. As for the reasons for ''unable to make investment in IT for strategic purposes'', answers included ''shortage of budget, manpower and knowledge,'' ''uneasiness on security'' and ''difficulty in making cost vs. benefit analysis'' were obtained. These answers were pointed out under each of the items.

(iv)	Current Status and Issues Relating to Infrastructure for Financial Transactions Lastly, opinions about IT infrastructure for financial transactions, such as Zengin (All Banks) Network system, Bank of Japan Financial Network System and stock exchange systems, are introduced. The survey revealed that 30.5% of the financial institutions were ''satisfied'' with the ''current situation in terms of cost performance,'' whereas 21.6% were ''unsatisfied.'' ''Neither satisfied nor unsatisfied'' answers accounted for 47.9%. One big reason for the ''unsatisfied'' answers was the ''high cost of network use and limited capacities.'' Many respondents expected that in the future ''networks can be used faster and less costly, and security will be ensured.'' With respect to ''the level of satisfaction from the perspective of strategic use,'' 26.1% of the respondents were ''satisfied,'' whereas 23.1% were ''unsatisfied,'' 50.8% were ''neither satisfied nor unsatisfied.'' These results were similar to the responses to the question about ''the level of satisfaction from the perspective of cost performance.'' Reasons for the ''unsatisfied'' responses were ''inadequate IT infrastructure for business alliances between different business modes, etc.'' and ''the capacity and speed for processing transactions not having reached the levels demanded by customers.'' Looking ahead, respondents hoped for ''establishment of infrastructure which is highly expandable, flexible and applicable to a wide range of uses.''

Conclusion

In the preceding paragraphs, the results of the Survey of the Status of IT Use by Financial Institutions were presented concisely. The survey revealed that such IT use-related items by financial institutions as ''establishment of information security'' and ''improvement of operational efficiency'' generally received higher priority over such items that are aimed at profit growth as ''branch strategies'' and ''an expansion of sales channels.'' The survey also found that a number of financial institutions consider that the creation of criteria to determine the effect of pre- and post-IT investment and the establishment of company-wide project management techniques to achieve overall, instead of partial, optimization are challenges that should be tackled in the future.
It is believed that IT will play a significant role as Japan targets for a ''desirable financial system that offers high levels of satisfaction to users'' as advocated for in the ''Program for Further Financial Reform.'' With a view toward realizing the ''desirable financial system'', we will appreciate if the results of this survey will support financial institutions as they examine and execute plans for the strategic use of IT in accordance with their respective business models.

Incorporation of IT in administrative services in the past was limited to what could be done on the basis of existing services and programs. Adequate efforts were not expended to re-examine the services from the systems and operational points of view before their computerization. Construction and operation of systems that respond to new ways of processing work based on such a re-examination was non-existent. Neither were the services and programs optimized with the adoption of IT, as demonstrated by the creation and operation of separate systems by different ministries with respect to common or similar types of services that were handled among all the ministries although efforts were made by individual ministries to establish consistency with the established legal systems.
Recognizing such a situation, the government released its electronic government construction plan on July 17, 2003, which was subsequently revised on June 14, 2004. The plan called for the creation of an optimization plan that encompasses such tasks as re-examination of services and programs, standardization and centralization of computer systems, and outsourcing of services in connection with services and systems that are common among ministries, as well as other services and systems that are specific to individual ministries. The optimization plan will also have to show a (projected) quantitative impact of the plan execution in reducing the time and cost that are currently required to complete the services. The deadline for the creation of the optimization plan is the end of the 2005 fiscal year.
In addition, policies on the re-examination of the services and systems that encompass the basic philosophy of optimization and specific reform items must be devised as a preliminary step toward the establishment of an optimization plan for services and systems by June 2005 at the latest so as to reveal the overall picture of specific steps involved in the service and system optimization for the entire government.
In response, the FSA established the following service and system re-examination plan on June 29, 2005:

Type of Service	System Name
Financial inspections and supervision services	Financial Inspection and Supervision Data System Monitoring System
Services relating to oversight of securities trading, etc.	Integrated Securities System
Services relating to reporting of suspicious transactions.	Specified Financial Information Database System
Services relating to securities reports, etc.	EDINET (Electronic Disclosure for Investors' NETwork)

Some of the features of the plan are the sharing of appropriate information among relevant departments and strengthened coordination among systems in the areas of ''financial inspections and supervision services'' and ''services relating to oversight of securities trading, etc.''; computerization of administrative work and stepped-up analysis functions in the area of ''services relating to reporting of suspicious transactions''; and improvement of convenience to users with the adoption of XBRL (eXtensivle Business Reporting Language: a computer language that is capable of efficiently using financial information) in the area of ''services relating to securities reports, etc.''
With respect to policies on service and system re-examination, security-related operation and systems will be closely examined on an ongoing basis from a professional point of view, and necessary action will be taken in the areas of systems and operations while recognizing the social demand and technical trends about information security.
Looking ahead, we plan to establish the service and system optimization plan, which translates the policies on service and system re-examination into specific steps, at an earliest possible time before the end of the 2005 fiscal year.

(i)	To furnish opinions about financial administration; and
(ii)	To participate in spreading information about financial administration, such as on efforts to disseminate financial knowledge and educate the public about finance and economy, as well as user protection measures and promotion of Region-Based Relationship Banking