July 28, 2004
Financial Services Agency
Announcement of the ''Basic Guidelines and Plan for Financial Inspections for Program Year (PY) 2004''
We are announcing the ''Basic Guidelines and Plan for Financial Inspections for Program Year (PY) 2004'' in the interest of improving transparency of the administrative work associated with financial inspection.
* ''Program year 2004'' refers to the period from July 1, 2004 through June 30, 2005
For further information, please contact:
Mr. Kurosawa (ex. 2502)
Mr. Furuya (ex. 2771)
Mr. Kimura (ex. 2517)
Inspection Coordination Division (03-3506-6000)
Financial Services Agency of Japan
Basic Guidelines and Plan for Financial Inspections for Program Year (PY) 2004
I. Basic Guidelines for Financial Inspections
The goal of Financial Services Agency (FSA) in PY2004 is to consolidate the strength of Japanese financial system, through the completion, by March 2005, of the Program for Financial Revival, which is designed to mark an end to the long standing issue of non-performing loans (NPLs) in major banks, as well as through the enhancement of the Relationship Banking model, under which regional banks are expected to revitalize small- and medium-sized enterprises (SMEs) and activate regional economies, by cultivating their long-term relationships with regional customers. The year 2005 will also mark the final phase in the gradual implementation of the new deposit insurance system, which will become the foundation for an efficient financial system. Among other elements to be factored in are the recent perceived sea changes in market indicators including stock prices and interest rates. A new stage is now being set for Japanese financial institutions.
FSA's guiding principles shall remain unchanged for PY 2004 (July 1, 2004 to June 30, 2005): the pursuit for the best interest of public users of the financial system; the adherence to the market discipline and the concept of self-responsibility; and the enhancement of transparency and fairness in financial administration. In line with the measures undertaken last year, the Agency will carry out financial inspections in both rigorous and effective manners, in order to best respond to the rapidly changing environment of financial institutions, including the NPLs problem, the new deposit insurance system, revitalization of SMEs and regional economies, and changes in market trends.
Finally, the Basic Policies for Economic and Fiscal Management and Structural Reform 2004 envisages the formulation of an Enhanced Program for Financial Revival (tentative title), by end 2004. New measures included in the Program, if judged necessary, will be reflected in the execution of this business plan.
1. Overall Priorities
(1)Establishing a solid and dynamic financial system
Under the ''Program for Financial Revival'', FSA carried out in PY2003 thorough financial inspections to all the major banks, encompassing an in-depth review of restructuring plans for their major debtors. The inspections revealed a depolarizing trend among the debtor companies, where some are successfully improving their financial standing through the restructuring plans, while others continued to see a further deterioration in their financial situation. In view of the trend, the Agency followed up the inspections by placing a strengthened focus on banks' credit risk management on large debtors.
With the approach of the final phase of the ''Program for Financial Revival'', FSA will continue to concentrate its efforts on financial inspections to the major banking groups.
An intensive examination will also be carried out as regards the preparedness on the bank side for the new deposit insurance system, to be introduced in April 2005. The recent changes in market trends also call for a renewed emphasis on market risk management, while the continued attention will be given to the computer system risk management issue.
i) Continued focus on financial inspections to the major banking groups
An adequate asset classification is critical in achieving the goals of the ''Program for Financial Revival''. Inspection Bureau will take all the necessary measures to ensure this, including those aimed at its institutional strengthening, designed to ensure the quality of its inspection.
The following measures will also be taken:
- disclosure of collective data on banks' self-assessment on asset classification, and its gap with the audited results by FSA inspections; - harmonization among the major banks of asset classification for large debtors; and - verification on appropriateness of deferred tax assets.
In addition, FSA will carry out in September 2004 Special Inspections focused on large debtor companies with unstable ratings. The Special Inspection will examine all such large debtors emerging from the screening undertaken on the basis of the most updated data. The Special Inspections will follow up the results of the preceded examinations on bank's credit risk management for large debtors. FSA will also verify viability of the restructuring plans for troubled debtors. The results of the Special Inspection will be followed up, if judged necessary, by another round of inspections focused exclusively on bank's credit risk management for large debtor companies.
In the course of inspections, attention will also be paid to complex structured transactions, like credit securitization, and debt-equity swaps. Corporate governance will be another area where the Agency will place an increased accent. Finally, FSA will stand prepared to take any actions in timely and adequate manner as the situation may require.
Preparation for the full implementation of the new deposit insurance
To ensure the preparedness of all financial institutions to the full implementation of the new deposit insurance system, the Agency plans to complete, by the end March 2005, the second round inspections to all regional banks, in line with the Inspection Manual for Deposit Taking Institutions. In this context, FSA, in coordination with the Deposit Insurance Corporation, will verify banks' preparedness on data gathering system regarding their depositors. A focus will also be placed on the computer system risk management, arising from the introduction of the new insurance system on a deposit account exclusively usable for settlement.
(2)Assisting the revival of SMEs and of regional economies
In order to help achieve the revival of SMEs and the vitalization of regional economies, FSA inspection will focus on the efforts by regional financial institutions in assisting local SMEs, with due respect to the business reality of such SMEs.
i) Assisting the revival of SMEs
The Agency will examine to what extent regional financial institutions are stepping up their efforts in assisting local SMEs to revive, in line with the Action Program concerning Enhancement of Relationship Banking Functions, and the Supplement to the Financial Inspection Manuals: Treatment of Classifications regarding Credits to Small- and Medium-Sized Enterprises (revision February 2004).
ii) Inspection methodologies taking account of the business reality of SMEs
The Agency will examine asset classification of lending to SMEs, with due regard to the unique business reality of SMEs, as indicated in the Supplement to the Manuals. To this end, FSA intends to benefit, among others, from the following opportunities:
- on-site monitoring will be used to promote a full application of the Supplement; and - training programs for inspectors and public relations strategy will be designed to further disseminate the inspection methodologies specific to SMEs.
(3)Protecting the interest of public users
With a view to ensure the protection of users' interest and improve their convenience, FSA will examine banks' management on customer information protection, responsibility to customers, compliance to obligation to act as a faithful trustee, and a due treatment of public complaints.
i) Protection of customer information
The recent incidents of leakage or mismanagement of customer information in banks call for a tighter control over management of customer information, including computer system management. The tighter control will be required also for customer information shared among the same financial group. In this context, the Law on Protection of Computer Processed Personal Data held by Administrative Organs'' (effective as from April 2005) will also need to be taken into account.
ii) Responsibility to customers (accountability) a) Accountability to depositors, policyholders, and investors
Considering diversification in financial products and services that banks offer, FSA will examine banks' sensitivity to customer suitability, by reviewing for example what contents are informed, how they are informed, how customers' consent is confirmed, and how appropriately the inherent risks are managed.
b) Accountability to borrowers
FSA will also examine how properly banks are discharging their responsibility to be accountable to their borrowers at the time of contract, such as what contents are informed, how they are informed, and how customers' consent is confirmed, as well as how appropriately the inherent risks are managed. The Agency will examine whether banks likewise acted in an accountable manner at the time of review or cancellation of the existing contracts, by checking whether the bank properly explained its decision to alter terms of loan transactions in accordance with its business strategy.
iii) Due treatment of public complaints
There are cases where financial institutions, despite repeated complaints, remain too reluctant in analyzing or investigating their causes, or taking appropriate corrective actions. FSA will examine the effectiveness of banks' management regarding complaints from customers, such as handling of complaints, and adequacy of reporting serious complaints to the senior management.
iv) Hot line for users of financial institutions
FSA intends to start a timely disclosure, at websites of FSA and of Local Finance Bureaus (LFBs), of all the names of financial institutions that are being inspected, thereby encouraging whistleblowers or mistreated users to submit any information that may be of relevance to the financial inspection.
(4)Institutional strengthening of FSA
FSA will continue its effort towards institutional strengthening.
i) A new regulation on inspection procedures
To enhance transparency and fairness in administration, FSA plans to draft new guidelines in the form of a new regulation on inspection procedures.
ii) Focus and flexibility in inspection response
FSA will continue to respond to changing environment with sufficient focus and flexibility in its inspection.
iii) Dialogue with senior management of banks
Given the importance of business management (corporate governance) in banks, emphasis will be placed on further deepening of dialogue with senior management of banks.
iv) Institutional strengthening a) Enhancing quality control on inspectors
In order to maintain the quality of individual inspectors, FSA plans to strengthen its support to inspectors, via both on-sight and off-sight training methods.
b) Closer coordination with the supervisory division
In order to enhance effectiveness of inspections, FSA intends to strengthen ties between inspection and supervisory departments, by means of an inspection-supervision coordination committee, and ad-hoc information exchanges.
c) Closer coordination with LFBs
FSA Inspection Bureau will strengthen its coordination framework with LFBs, by various means including regular Inspection Administrators' meetings.
d) Joint inspection with the Securities and Exchange Surveillance Commission (SESC)
The Agency will carry out joint inspections with the SESC, and prepare for the integrated inspection slated for 2006
v) Adapting to the new Basel II Framework
In view of the implementation of the new Basel II Framework in 2006, FSA will embark on transition phase towards the full adaptation.
2. Sectoral Priorities
In financial inspection, FSA will make efforts to implement enforcement based on the following priority issues in each financial area, in addition to the priority policies stated above.
(1)Deposit-taking financial institutions (commercial banks, cooperatives)
For deposit-taking financial institutions, sectoral priorities will be placed upon:
- risk management adequacy, particularly on market risks; - compliance to regulations, including Know-Your- Customers (KYC) policy law; - management over complex transactions; and - the quality of corporate governance on all relevant risk management issues.
FSA will carry out inspections on trust banks, taking into account unique features of the trust business. Its focus will be on adequacy of transactions between their banking and trust accounts, as well as on fulfillment of their fiduciary duties.
Priority areas for inspections on insurance companies will include:
- the quality of corporate governance; - the adequacy of insurance sales (suitability issue); - risk management on insurance underwriting, including reinsurance risk management in non-life insurance companies; and - asset-liability management, including investment risk management, and adequacy of policy reserves.
FSA inspections on securities firms will pay attention to the following areas:
- adequate account segregation between client and corporate assets; - accuracy of capital adequacy ratios; - compliance to applicable rules and regulations; and - adequacy in risk management regarding online securities transactions.
(5)Investment trust management companies, and investment advisory services
Main focus will be on their fulfillment of fiduciary duties, such as:
- securing the appropriateness of investment; - investment risk management; - duty of faithful trustees; and - compliance to relevant regulations, including duty to provide documents to their clients.
(6)Foreign financial institutions
FSA will inspect foreign financial institutions (including banks and securities firms), as a conglomerated group, and in line with sectoral priorities set out above. The inspections will focus on quality of their risk management and compliance to regulations, including anti-money laundering law, and suitability issue regarding complex transactions.
(7)Other financial institutions
For non-banking money lenders, the Agency will focus on compliance to regulations regarding lending rate caps and loan collection behaviors. As for the issuers of prepaid cards, FSA will inspect, inter alia, adequacy in their reserves for guarantee money.
(8)Government financial agencies and Postal Agency
FSA will carry out financial inspections on these entities, taking account of their unique characters, yet in line with the Inspection Manual for Deposit-Taking Institutions, the Inspection Manual for Insurance Companies and other manuals applied to private institutions.
II. Basic Plan for Financial Inspections
|Note: (1)||These inspection numbers may be changed as necessary.|
|(2)||Under the year-round inspections and inspections by specialized sections, the FSA has been implementing inspections more than once to a number of major banks and holding companies of major banking groups; i.e., as ordinary inspections, as special inspections, and so on. Nonetheless, those inspections to one company are counted as one inspection.|
|(3)||Figures on the ''Banks'' are the aggregated amounts of inspected banks and inspected bank holding companies. Those of ''Insurance companies'' are also the aggregated amounts of inspected insurance companies and inspected insurance holding companies, and ''Securities firms'' includes aggregated amounts of inspected securities companies and inspected securities holding companies.|
|(4)||In addition to the above, one stock exchange was also inspected in the PY2003.|
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