July 8, 2005
The Financial Services Agency
The Basic Guidelines and Plan for Financial Inspections In Program Year 2005
The FSA announced today its Basic Guidelines and Plan for Financial Inspections in Program Year (PY) 2005.
* ''Program year 2005'' refers to the period from 1 July 2005 through 30 June 2006
For further information, please contact:
Toshitake Kurosawa (ex. 2502)
Takashi Kimura (ex. 2514)
Hiroshi Ohata (ex. 2517)
Inspection Coordination Division (03-3506-6000)
Financial Services Agency
Government of Japan
Basic Guidelines and Plan for Financial Inspections in Program Year 2005
I. Basic Guidelines for Financial Inspections in Program Year (PY) 2005
The Financial Services Agency (FSA) achieved in PY 2004 the targets set forth in its Program for Financial Revival, designed to normalize the non-performing loans (NPLs) problems in major banks. Building upon this achievement, the FSA has announced its new Program for Further Financial Reform, which placed an emphasis on enhancing the protection of customers' interest and the strength of Japanese financial system, through the initiative of the private sector.
The financial inspection shall, in this context, be effected in pursuit of the best interest of public users and of the national economy. FSA's mission shall thus be ensuring efficiency, transparency, and effectiveness of its inspections, while promoting the efforts of financial institutions towards a voluntary and sustained improvement in their managements. To this end, the FSA has developed the Financial Inspection Basic Guidelines (FIBG), and will introduce the Financial Inspection Rating System (FIRST) for deposit-taking financial institutions,
For PY 2005 (1 July 2005 - 30 June 2006), the FSA will, in line with the FIBG and the FIRST, carry out financial inspections in both rigorous and effective manners, in order to ensure soundness and proper management of financial institutions, while paying attention to the environment surrounding them, such as need for customer protection, revival of small- and medium-size enterprises (SMEs) and regional economies, as well as the globalization and other structural changes in financial activities.
1. Framework changes in inspections - FIBG and FIRST
(1)The Financial Inspection Basic Guidelines (FIBG)
FSA inspection will be carried out in line with basic approaches and procedures as laid out by the FIBG.
The emphasis shall be placed on intensifying two-way dialogues between inspectors and financial institutions, in order to motivate the institutions towards self-improvement in their managements, and to enhance process-checking focused on their risk management and compliance to financial regulations.
Also, the Agency shall place, where applicable, greater reliance on internal audit functions of the institutions, so as to encourage financial institutions to improve their own managements and enhance efficiency of financial inspections.
The FSA plans to provide adequate training to all its inspectors in order to allow them to familiarize with the new environment created under the new FIBG.
(2)The Financial Inspection Rating System (FIRST)
The FIRST shall be introduced for deposit-taking financial institutions. It is expected that providing inspection results in the form of graded evaluations (i.e. ratings) would offer significant incentives for management improvement on the part of the financial institutions, and would enhance two-way dialogues between the institutions and the inspectors. Also, by linking ratings to subsequent selective regulatory measures, such as frequencies and scopes of inspections, the relevance of the incentives could be augmented, and efficiency and effectiveness in inspections could be improved.
PY 2005 shall be defined as the preparation period for both inspectors and financial institutions. The FIRST will start its trial application as from January 2006, and subsequently become fully effective as early as PY 2006 (July 2006). During the period of the trial application, each of the rating results will be disclosed to respective financial institutions, although will not be reflected in selective regulatory measures.
In order to achieve convergence in the assessing approach on ratings, the FSA plans to deliver intensive training programs for its inspectors, and extensive dissemination activities for financial institutions.
(3)Enhancement of transparency, predictability, and efficiency
In addition to the above, the following measures will be taken for the purpose of enhancing transparency, predictability, efficiency and effectiveness of the FSA inspection:
i) To ensure transparency and predictability of inspections and to improve internal control mechanism of financial institutions, useful feedbacks to the institutions will be expanded, including the disclosure of sample findings drawing upon actual FSA inspection reports. ii) The quality control on inspectors will be strengthened in order to ensure appropriate application of FIBG and of the Inspection Manuals. The Inspection Monitoring mechanism will be used more extensively to identify the views of the financial institutions, and the Offsite Inspection Monitoring mechanism will be upgraded by including a formatted questionnaire. iii) The Opinion Submission System (i.e. inspection appeal mechanism) will be improved, with the aim of enhancing neutrality, fairness, as well as trust in FSA inspections. The scope of application will be widened, while outside experts will be invited to participate in the Opinion Submission Review Board (i.e. a body responsible for reviewing appeals submitted by the financial institutions). iv) To increase efficiency in inspections, measures such as a more extensive use of electronic devises will be introduced regarding information exchanges between the FSA and financial institutions. The efficiency is expected to further increase by introducing more flexibility and focuses in inspection planning. v) In order to enhance effectiveness of inspections, a closer coordination shall be sought between the Inspection Bureau and the Supervisory Bureau, as well as between the FSA and the Local Financial Bureaus. The intranet training tools shall be used more extensively with a view to improving the quality of inspection, while standardizing assessing approaches regarding the FIRST rating criteria.
2. Overall Priorities in Inspections
(1)Protecting the interest of public users
For the interest of public users of financial institutions, the FSA inspection will focus on customer protection management of the institutions, especially protection of privacy information, accountability obligation, appropriate execution of contracts, and a due treatment of public complaints. The FSA will also examine obligations of institutions related to disclosure of public information, as well as information security in financial transactions.
i) Protection of privacy information
Despite the recent enactment of the Personal Information Protection Law, incidents of loss or leakage of personal information possessed by financial institutions continue to surface. The FSA will thus examine the privacy information management of the institutions in the context of compliance to the relevant regulations. Equally examined will be the related IT system and operational risk managements, and the extent to which top managements are involved in such structures.
ii) Responsibility to customers (accountability, fulfillment of contracts) a) Accountability
The FSA will examine to what extent the financial institutions are fulfilling the accountability obligations to their customers. In this context, the Agency will examine whether the financial institutions explain to depositors, policyholders and investors about the risks inherent in diversified financial products, and whether the institutions properly explain its decision to alter terms of loan transactions in accordance with its business strategy at the time of review or cancellation of the existing contracts.
b) Fulfillment of contracts
With regard to the fulfillment of contracts, the FSA's focus will be on the adequacy of insurance contract management, including prompt insurance settlement and insurance dividend payment, and the related IT systems of the institutions.
The Agency will also review trust agreements and their management from the aspect of fiduciary duties for property management.
iii) Due treatment of public complaints
Cases have been found where the financial institutions, despite repeated complaints, remain too reluctant in analyzing or investigating their causes, or taking appropriate corrective actions. The FSA will examine the effectiveness of financial institutions' management regarding the complaints from customers, including handling of complaints, and adequacy of reporting serious complaints to the senior management.
iv) Disclosure of information
The full implementation of the new deposit insurance system calls for further disclosure of financial institutions' information, so as to best protect depositors' interest. Given the importance the issue, the FSA will focus on checking the adequacy of such disclosure.
v) Security in financial transactions
The recent incidents, such as bank account abuses and abuses of counterfeit or stolen bank cash cards, require banks to ensure information security in financial transactions. In this context, the FSA will examine to what extent the banks' management functions appropriately to ensure the information security.
(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, the FSA's focus will be 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 Further Enhancement of Relationship Banking Functions'', and ''The Supplement to the Financial Inspection Manual: Treatment of Classifications regarding Credits to Small and Medium-Size Enterprises''.
ii) Inspection methodologies taking account of the business reality of SMEs
The FSA 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 Financial Inspection Manual''. In addition, the Agency intends to further disseminate the inspection methodologies specific to SMEs through the use of the Inspection Monitoring, by which the FSA checks how inspectors apply the Supplement.
(3)Focus on process-checking
For the past years, the FSA's inspections had placed a strong focus on asset quality of financial institutions. Now that the major banks' NPLs problem has been all but normalized, the FSA intends to shift its focus to a wider perspective, i.e. process-checking on overall management quality, including compliance of regulations and risk management, while giving due regard to the unique business reality of each financial institution.
i) The focus shall be more on process-checking on overall risk management, and less on reviewing appropriateness of each transaction. For a financial institution with a significantly limited problem of NPLs, the FSA would effect a simplified version of asset quality verification, while paying more attention to preventive aspect of NPLs, such as verification of adequacy in restructuring plans for its large debtor companies and increase in non-recourse real estate loans. In this context, corporate governance issue may also be examined, where necessary. ii) The inspection shall cover, taking account of the nature and profile of each financial institution, a wide range of risk management issues, rather than being concentrated on management of specific risk. For instance, when the Agency reviews the financial soundness of an institution, the examination may extend beyond the credit risk management issue, onto its market risk management, to the extent that it deals with complex investment activities involving structured notes. Moreover, the integrated bank-wide risk management will be examined, in accordance with the institution's size, risk profile, and risk management structure. For insurance companies, the FSA inspection will examine asset-liability management including investment risk management, risk management on insurance underwriting, and adequacy of policy reserves.
(4)Globalization and structural changes in financial activities
In order to best respond to the globalization and structural changes in financial activities, the FSA will take the following actions:
i) The FSA will inspect financial institutions in line with the Guidelines for Financial Conglomerate Supervision. Joint inspections with the Securities and Exchange Surveillance Commission will be carried out, if judged necessary. Furthermore, the Agency will strengthen its coordination with foreign regulatory authorities. ii) Taking into account the implementation of the Forty Recommendations by Financial Action Task Force on Money Laundering (FATF), emphasis will be placed on compliance to anti-money laundering laws and regulations. iii) The FSA will continue its effort towards institutional strengthening, which could respond to new financial transactions and products. Also, the Agency will promptly adapt itself to the new environment created by the revision of Trust Business Law and the Insurance Business Law. iv) In view of the implementation of the new Basel II Framework in March 2007, the FSA will consider the revision of its Inspection Manuals as well as inspection methodologies.
3. Sectoral Priorities
In financial inspections, the FSA will make efforts to implement the following policies in each of the following financial sectors, in addition to the priority policies as stated above.
(1)Deposit-taking financial institutions
For deposit-taking financial institutions, according to the situation of each institution, sectoral priorities will be placed upon:
- credit risk management, with a view to achieve a prompt detection and prevention of NPLs; - market risk management, taking account of complex structured notes owned by some financial institutions; - integrated bank-wide risk management; - operational risk management, taking account of privacy information protection, and increasing cases of IT system integrations among institutions; and - compliance to regulations, including the Know-Your-Customers (KYC) policy law.
(2)Trust banks and trust companies
The FSA inspections on trust banks and companies will pay attention to the following areas:
- risk management, particularly on trust businesses such as fulfillment of their fiduciary duties; and - new trust businesses, based on the revised Trust Business Law.
The FSA will carry out inspections on insurance companies, taking account of the diversification of their channels in insurance sales, and of insurance products. Its focus will be on:
- protection of customers, such as insurance sales management (the suitability issue), including insurance agents and adequacy of insurance payments; - risk management on insurance underwriting; - investment risk management; - adequacy of policy reserves; - quality of corporate governance on all the relevant issues as stated above; and - companies offering short-term and small sum of insurance products, deregulated under the revised Insurance Business Law.
(4)Foreign financial institutions
The FSA will inspect foreign financial institutions in line with sectoral priorities set out above. The inspections will focus on adequacy of the complex structured global transactions, and compliance to the regulations. Moreover, the examination will verify the institution's risk management as a whole group, as well as its management regarding the KYC policy law.
(5)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, the FSA will inspect adequacy in their reserves for guarantee money.
(6)Government financial agencies and Japan Post
The 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
|These inspection numbers may be changed as necessary.
|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.
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