Findings from research and studies conducted at the Financial Research Center (FSA Institute) are organized and published as Discussion Papers to stimulate further discussion and comment.
The views expressed in the papers are those of the authors and do not necessarily reflect the views of the Financial Services Agency or the FSA Institute.
Discussion Papers (FY 2020)
|ESG/Green Investment and Allocation of Portfolio Assets
YOSHINO Naoyuki, YUYAMA Tomonori
Abstract | Full text (PDF:1.66MB)
|Business Rationale of Lifting Regulations: Evidences from Germany
Abstract | Full text (PDF:2.25MB)(Full text is available only in Japanese.)
|Regulation on Banks’ Scope of Business in England
Abstract | Full text (PDF:1.19MB)(Full text is available only in Japanese.)
|The Scope of Business of Banks and Banking Groups in Japan
Abstract | Full text (PDF:930KB)(Full text is available only in Japanese.)
|The Current Financial Regulation Separating Banking and Commerce in the United States
Abstract | Full text (PDF:1.34MB)(Full text is available only in Japanese.)
|Functional Perspective of Financial Intermediation and Its Application to Regulation that Separates Banking and Commerce
Abstract | Full text (PDF:2.03MB)(Full text is available only in Japanese.)
|Banking Regulations in Japan: the Current Situation and Challenges
Abstract | Full text (PDF:847KB)(Full text is available only in Japanese.)
|Analysis of High Frequency Trading (HFT) by an Algorithm Criterion
OHYAMA Atsuyuki, TSUDA Hiroshi
Abstract | Full text (PDF:14.3MB)(Full text is available only in Japanese.)
|Study on the Performance of Corporate Pension Plans: Some Thoughts on Stewardship Behavior
Abstract | Full text (PDF:1.92MB)(Full text is available only in Japanese.)
ESG/Green Investment and Allocation of Portfolio Assets
YOSHINO Naoyuki, Director, Financial Research Center (FSA Institute)
YUYAMA Tomonori, Director, Macroeconomic and Market Analysis Office, Strategy Development and Management Bureau, FSA
The article examines the current portfolio allocation in ESG and Green projects. Traditional investments focus on rates of return and risks associated with investment. Environmental, Social and Governance (ESG) or Green factors are additional components that investors have to pay attention to. Environmental protection is very important. However, as we see the current different definitions of ESG or Green factors lead to distorted allocations in portfolio investments. In order to bring portfolio allocations to a desirable direction, global taxation on pollution or creation of an accurate Green credit rating based on emissions of various pollutants are recommended.
Keywords: ESG (Environmental, Society and Governance); Green investment, Green credit rating; optimal portfolio allocation; and GHG taxation.
Business Rationale of Lifting Regulations: Evidences from Germany
MATSUI Tomoyo, Special Research Fellow, Financial Research Center (FSA Institute)
Europe operates under a universal banking model and no regulatory obstacles seem to exist for banks to conduct business other than banking, in comparison to the U.S. regulatory model, the basis of which is separation of banking and commerce. In Europe, non-banking business is not restricted, but further, advantages from doing such business, for example, banks’ increased competitiveness and firms’ easier fund raising, are highlighted.
On the other hand, ensuring deposits is a common objective for banks globally. In order to protect deposits, when banks operate any business other than banking, they structure the business in the way that capital requirements and other regulations are not affected by it. In operating the business, banks are careful to avoid conflicts of interest and to manage information appropriately. As a result, synergies achieved by doing both banking and non-banking business is restrained, and due to higher regulatory compliance cost, competitiveness from doing both business is lost; so there is skepticism that doing business other than banking may not increase even in the universal banking model.
Recently, maintaining banks’ competitiveness and soundness is a challenge in Japan, especially in terms of firewalls between banks and commercial companies and a level playing field. The universal banking model is facing the need to make modifications, as various regulations are introduced to the entire EU to maintain banks’ soundness. Given such developments, it is useful to analyze how business rationale of banks in Europe is maintained. In theoretical analysis, it is vital to clarify for whose interests banks’ services exist, and the level of profits required in return for those services. For analyses of practical issues, focuses are on questions regarding to what extent other services typically conducted as part of banking business, such as trading, have been sources of profits and synergies, and how much of them were lost in separating banking and commerce, and how to ensure profits from other potential businesses and maintain the safety of deposits at the same time.
Keywords: universal banking; and banking business in Germany.
Regulation on Banks’ Scope of Business in England
GOTO Gen, Special Research Fellow, Financial Research Center (FSA Institute)
Traditionally, bank regulation in England was different from Japan in the way that England does not have clear rules stipulating types of business that banks can undertake by law. Also, explicit provisions prohibiting banks from engaging in commercial business (non-financial business) have never existed in England. Yet, banking and commerce have long been separated in reality.
The adoption of the so-called “ring-fencing” rules in 2013 as a part of reforms following the global financial crisis is a departure from the above traditional approach of England. Ring-fencing rules, however, merely prohibit large financial institutions that accept retail deposits from operating investment banking business. In other words, ring-fencing rules do not prohibit banks from engaging in business other than investment banking (including non-financial business). Moreover, banks’ affiliate companies and subsidiaries are permitted to engage in investment banking as well as non-financial business. As such, banking regulation of England regarding banks’ scope of business still differs greatly from that of Japan.
After a brief overview of banking regulation of England, this report analyzes the logic behind the above approach taken in England.
Keywords: English law; regulation on banks’ scope of business; prudential regulation; deposit insurance scheme; and ring-fencing.
The Scope of Business of Banks and Banking Groups in Japan
KOIDE Atsushi, Special Research Fellow, Financial Research Center (FSA Institute)
This report reviews the history and the content of the regulation on the scope of business of banks and banking groups in Japan, and finds that (i) the current regulation prohibits, in principle, banks from conducting businesses other than banking and that (ii) the philosophy behind the regulation is to limit the extension of business of banks and banking groups by a criterion whether there is “relevance” to banks’ core services. Further, this report shows that the aim of prohibiting banks from conducting other business can be summarized as follows: (i) to prevent risks from other business from spreading to banking business; (ii) to ensure that entities who operate banking business, which are of a highly public nature, are committed to it; (iii) to prevent the possibility of conflicts of interest; (iv) to ensure the efficiency of bank supervision; and (v) to prevent banks from dominating industries.
The report then points out that prohibiting banks from operating other business is by itself not the objective of the regulation on the scope of business of banks, and that achieving what the regulation intends is important. In that sense, the extension of the scope of business of banks should not necessarily be determined by a criterion of “relevance” to banks’ core business. In fact, the concept of “relevance” has become relative. As long as the intended effect of prohibiting other business is achieved, there is no need to strictly prohibit banks from operating other business. Based on these discussions, the report makes a proposal on how regulations on the scope of business of banks and banking groups in Japan should be in the future.
Keywords: banking act; the scope of bank business; and prohibition on conducting business other than banking.
The Current Financial Regulation Separating Banking and Commerce in the United States
KATO Takahito, Special Research Fellow, Financial Research Center (FSA Institute)
One of the features of the U.S. financial regulation is that many regulations exist to achieve the objective of “separation of banking and commerce.” This report aims to provide an overview of the U.S. regulation separating banking and commerce and clarify the underlying thinking behind it, focusing on the regulation governing the scope of business of national banks established under the National Bank Act and the regulation under the Bank Holding Company Act. The following findings are obtained.
First, the business of national banks are limited to banking services and other services which are incidental to them, but as widening interpretations of banking services by the Office of the Comptroller of Currency (OCC) accumulate, the concept of banking services is losing its function to limit the scope of national banks’ business. The same can be said, partially, for the Federal Reserve’s interpretation of complementary activities; the Fed’s interpretation indicates the scope of business of financial holding companies.
Second, the framework of the Bank Holding Company Act, which regulates any institution that owns even one bank, demonstrates “separation of banking and commerce.” While there is ongoing discussion about whether commercial companies can own industrial loan companies, movements that could lead to a review of the fundamental framework of the Bank Holding Act are being observed, such as the creation of the Fintech Charter by the OCC, with the rising of Fintech companies.
Keywords: national banks; bank holding companies; financial holding companies; separation of banking and commerce; and Fintech.
Functional Perspective of Financial Intermediation and Its Application to Regulation that Separates Banking and Commerce
UCHIDA Hirofumi, Special Research Fellow, Financial Research Center (FSA Institute)
The aim of this report is to review the functional perspective of financial intermediation that design financial system based on theoretical studies in economics, and examine regulation on bank entry and the scope of banks’ businesses in Japan, with particular attention to the regulation that separates banking and commerce. To this end, we review the role of banks, problems (market failures) they could potentially cause (which we call bank failures), and public intervention to banks, by referring to theoretical findings in economics, and then provide an overview of the legal system behind the banking system in Japan to identify and consider problems in the banking system. This report is organized into five fairly independent sections: (i) a review of the functional perspective (section 2); (ii) a review of the role of banks and bank failures (section 3); (iii) a review of public intervention to banks (subsection 4.1); (iv) a review of the current regulation on bank entry and the scope of banks’ businesses in Japan (subsection 4.2); (v) an introductory discussion on the procedure to examine the regulation that separates banking and commerce (subsections 5.1 and 5.2); and (vi) an examination of the so-called “level-playing field issue” between banks and commercial firms (subsection 5.3).
Keywords: separation of banking and commerce; functional perspective; the role of banks; and bank failures.
Banking Regulations in Japan: the Current Situation and Challenges
IWAHARA Shinsaku, Special Research Fellow, Financial Research Center (FSA Institute)
Review of regulation concerning the scope of business of banks and affiliated companies and restriction on their shareholding (voting shares) are issues increasingly important for the financial sector, amid continuing banks’ low earnings in super-low interest rates, evolving money transfers and payment methods that do not involve banks with advances in IT, disappearing boundaries between IT industries and financial industries, and growing expectations for banks to contribute more to revitalize regional economies.
Among the aims of the regulation and shareholding restriction, those particularly important today are to prevent losses from banks’ business other than banking to damage the soundness of banks’ core business, and to prevent conflicts of interest between banks’ core business and other business. Looking at regulation abroad, however, countries like Germany, France and England do not have such regulation. Some foreign academics point out that, since Japan’s banking act has rules on banks’ soundness and conflicts of interest, risks to soundness or conflicts of interest should be addressed by beefing up those rules, and should not exclude other industries at entry through the regulation or shareholding restriction to eliminate the risks. As in Germany, France and England, there may be an approach to regulation in Japan in the future where the principles and exceptions are the opposite to the current approach so that the principle is to have no regulation on banks and affiliated companies and no restriction on holding of bank shares by non-financial sectors, and regulation on business and shareholding is implemented limitedly for certain businesses with high risks.
Further scrutiny is needed about whether risks can be sufficiently managed by prudential regulation and conflicts of interest rules alone, and whether supervisory/regulatory system and banks’ liquidations framework can function sufficiently when restriction on the scope of business and on shareholding are lifted in principle. Empirical and practical analyses are also necessary to examine whether improvements in banks’ earnings and banks’ functions to contribute to regional economies can really be achieved by lifting the regulation.
With advances in IT and Fintech, new services are developing in interdisciplinary of financial and non-financial businesses; services in which synergies of the two businesses can be generated. Many of these new services should be permitted as banks’ business given that they are services that are developed using data and skills banks already have, and they are relatively low in risks and unlikely to cause conflicts of interest to banks.
The current Japanese banking act is unbalanced in terms of regulation because, while there are regulation on the scope of business of banks, bank affiliates, bank holding companies and their subsidiaries, no such regulation is imposed on major shareholders of banks. Considering the aim of regulation, it is not rational to differentiate between the two and regulations should be consistent in the future.
Keywords: regulation on the scope of business of banking groups; shareholding (voting rights) restriction on banking groups; restriction on major shareholder of banks; separation of banking and commerce; advancement of IT in financial services; Fintech; and revitalization of regional economies.
Analysis of High Frequency Trading (HFT) by an Algorithm Criterion
OHYAMA Atsuyuki, Research Fellow, Financial Research Center (FSA Institute)
TSUDA Hiroshi, Professor, Faculty of Science and Engineering Department of Mathematical Sciences, Doshisha University
To grasp the situation of high frequency trading (HFT) in Japan, this paper proposes a new criterion for HFT that meets the definition of high speed trading in the Financial Instruments and Exchange Act, namely an “algorithm criterion” determined based on “trade automation” and “proprietary use of virtual servers,” and examines data on trading at the Tokyo Stock Exchange (TSE) for the period between January 2010 and September 2015 for (i) all listed stocks and (ii) an individual stock. Specifically, for (i) trade data of all listed stocks at the TSE, quotation and trade displays of all stocks are reproduced with data on 33 items for all listed stocks with all buy and sell orders for 1405 business days. For (ii) trade data of an individual stock, quotation and trade displays for the stocks of Toyota Mortar Corporation Inc. are reproduced with data on 33 items for the stock with all buy and sell orders for 69 business days (end-month business days). We draw following conclusions from the two analysis.
From the results of the analysis for (i) all listed stocks, we confirm a group of HFT institutions that conduct standard HFT (high frequency and high speed orders) based on the new criterion for HFT that we proposed, and notably during 2014-2015 in the observation period, these HFT institutions own approximately 65 percent of all virtual servers, and account for approximately 70 percent of all trade orders, and approximately 45 percent of trading values. Further, HFT institutions trade throughout the TSE’s trading hours, and while they trade in a wide range of issues they do not make margin transactions. HFT institutions prefer cancelation orders and general investors tend to prefer alteration orders. Those that make immediate-or-cancel (IOC) orders are limited to a group of HFT institutions with high-level algorithm capacity, and amongst HFT institutions those with both high algorithm capacity and high frequency capacity take advantage of short selling, and perform market making activities (more market-make orders and less take-orders) regardless of market situations.
As for the analysis of individual stocks (Toyota Mortar Inc.), we find that, while HFT institutions provide liquidity notwithstanding market situations, they tend to put orders thinly around best bids offers (BBOs), and this tendency strengthens in the price ranges where a tick (a minimum change in price) for stock prices is small. During the observation period in 2014-2015, given that almost 30 percent of BBOs are made only by HTF institutions, BBO spreads can widen in 30 percent of quotation and trade displays if HFT institutions do not trade in the stock market. Further, our study on trading behavior in the downward and upward price movements reveals that, in all kinds of market situations, active engagement of HFT institutions to lower stock prices is not observed, and rather trading activity of general investors has more influence on stock prices.
Keywords: high speed trading (HST); high frequency trading (HFT); virtual servers; algorithm trading; manual processing of orders; market orders; market-making orders; market-taking orders; immediate-or-cancel (IOC) orders; liquidity; quotation and trade displays; best bid offer (BBO); depth in quotation boards; and offer tick.
Study on the Performance of Corporate Pension Plans: Some Thoughts on Stewardship BehaviorISHIDA Hidekazu, Special Research Fellow, Financial Research Center (FSA Institute)
This paper firstly takes up four de facto observations about Japan’s corporate pension plans, identifying inconsistency in corporate behavior relating to pension investment through the framework of functional and structural finance (FSF) and brings up the issue that Japan’s limited disclosure system is one of the reasons why investment capability of asset owners is constrained. Secondly, to demonstrate the relationship between the disclosure practices and investment behavior, this paper introduces a ‘stewardship-game’ model based on game theory, in which asset owners and investment management companies mutually interact, and indicates that the limited disclosure practice might be encouraging risk-averse investment behavior in multi-tiered investment decision/operational structures. This behavioral tendency ubiquitously observed among corporate pensions in Japan becomes firmly fixed when a recognition that “lowering target return of pension investment does not necessarily induce an accusation” prevails and is taken for granted. Thirdly, the paper reviews preceding studies, focusing on empirical studies that looked at funded status and unrecognized actuarial difference under the limited disclosure practice, and formulates hypotheses about relationships between portfolio returns and corporate values by classifying the funded status into two components, i.e., portfolio returns and the size of retirement benefit obligations using ranking-order data prepared by the author regarding expected portfolio returns of corporate pensions. This paper demonstrates that, if we focus on the period when risk/return profiles of capital markets function well, enhancing pension portfolio return can contribute to improving the funded status and corporate value itself as opposed to the view mentioned above, i.e., risk-averse behavior is not necessarily an optimal action. If a ranking of corporate pension returns is disclosed to public, it is expected to work as a catalyst such that firms and investment management companies would adjust their investment behavior corresponding to the feedbacks from the market.
Keywords: Basel; corporate pension plans; retirement benefit accounting system; retirement benefits trust; the Stewardship Code; and functional and structural finance (FSF).