Unofficial and Provisional Translation
Readers are advised to refer to the original Japanese
text before quoting from this document.

Report on the Framework of the Deposit Insurance System and Resolution of Failed Financial Institutions after the Termination of Special Measures1)

Financial System Council
December 21,1999

1. Introduction
    In order to ensure the stability of the financial system, the Japanese government introduced special measures during the financial years 1996 to 2000 to fully protect deposits by authorizing the Deposit Insurance Corporation (DIC) to extend special financial assistance exceeding the payoff cost (the cost incurred by the DIC to pay off insured deposits (maximum 10 million yen per depositor) of a failed financial institution). The government also enacted the Law concerning Emergency Measures for the Revitalization of the Functions of the Financial System (Financial Revitalization Law) and the Law concerning Emergency Measures for the Early Strengthening of the Financial Functions (Early Strengthening Law) as temporary special measures effective until the end of March 2001, to establish a robust financial system by basically completing the disposal of non-performing loans of financial institutions and cleaning up their balance sheets while deposits were fully protected. In order to promote this task, the DIC was provided with budgetary support such as grant government bonds and government guarantees.

    Under the currently effective legislation, special measures to fully protect deposits are to be terminated at the end of March 2001. From then on, depositors will be required to share a portion of the loss caused by the failure of a financial institution. Under the permanent measures of the Deposit Insurance Law, two methods of resolving failed financial institutions are stipulated: one method is to pay off depositors, the other is to extend financial assistance (to the financial institution that is assuming all business of the failed financial institution, within the limit of the payoff cost).

    The Financial System Council, especially the Second Committee and the Working Group on the Deposit Insurance System, has been working on a "permanent" framework of the deposit insurance system and methods to resolve failed financial institutions, as one of the ways in which to realize "a safe and robust financial system."
In the course of discussion, the Second Committee issued "The Interim Report of the Second Committee of the Financial System Council: Views and Issues Concerning the Deposit Insurance System" on July 6th, 1999 and received opinions from the financial industry, industry at large, labor associations, consumer associations, and others. The Committee also released "Basic Thinking Concerning the Deposit Insurance System after the Lifting of Special Measures" on October 19th, 1999 and elicited public comment from various circles.
    As mentioned, the Financial System Council has exerted great efforts to formulate a basic framework of the deposit insurance system recognizing that it closely affects people's lives. Therefore, following the termination of the temporary special measures, the framework should be presented to the nation as soon as possible. Today taking into account comments from the public, the Council has finally reached the following conclusions.

2. Protection of Depositors through Market Mechanisms

(1) The deposit insurance system aims to protect the depositors of a failed financial institution and it is, as it were, an ex post measure. The protection of depositors should be achieved primarily by ensuring sound and profitable management of financial institutions. Thus, in addition to appropriate accounting practices and improved internal controls which ensure sound management, earnest efforts are called for on the part of individual financial institutions to create innovative financial products and build confidence among customers looking forward to the 21st century. It is also necessary to review the regulatory framework.

(2) After the termination of the temporary special measures, it is crucial in terms of the protection of depositors to prevent the failure of financial institutions. Thus, it is important to identify troubled financial institutions at an early stage and to effect prompt corrective action.
    With respect to the early identification and correction of troubled financial institutions, financial institutions are expected to establish a more effective external audit system utilizing certified public accountants coupled with the enhanced disclosure of information, so that monitoring through market mechanisms will work effectively. At the same time, the supervisory authority should intensify its inspection and monitoring activities and carry out prompt corrective action in an appropriate and timely manner.
    In this connection, sizable financial cooperatives holding more than a certain amount of deposits are currently obliged to undergo external audit employing an outside auditor. This threshold of the size must be significantly lowered.

(3) Payment practices and corporate behavior in the present financial market are based on the assumption that deposits are risk-free. After the termination of the temporary special measures, this assumption needs to be altered. Thus, in creating various ways of investment, funding and payment, the present market practices should be reviewed and made compatible with a financial system that is based on market discipline and the principle of self-responsibility.

3. Framework of Resolution Methods


1) Basic principles
    The inherent purpose of the deposit insurance system is to protect small depositors and thereby maintain financial system stability. To reduce insurance premiums and prevent moral hazard, the deposit insurance system should aim at a "small system" following the termination of special measures.
    However, in past failures the value of assets has often been substantially outstripped by liabilities as a result of resolution. While the early identification of troubled financial institutions and prompt correction through the use of market discipline are the primary objective as discussed in Section 2, in the event of a failure of a financial institution, it is important to minimize depositors' losses and thus the cost to the deposit insurance fund. A financial institution that is not viable should be resolved at the earliest stage possible where the degree of insolvency is minimal.

    When a financial institution that is not allowed to continue to exist because of failure is resolved through the use of the deposit insurance system, the least expensive resolution method should be chosen within the limit of the payoff cost. At the same time, financial functions such as payment and lending should be continued to minimize the disruption caused by the failure.
    In choosing a resolution method, financial assistance in which an assuming financial institution takes over the financial functions of a failed financial institution should be favored. Payoff in which a financial function is diminished should be avoided as much as possible, although both methods involve the trimming of a portion of deposits due to the loss incurred by the failure. Thus, it is necessary to introduce measures that serve to expedite resolution processes as well as provide various resolution methods in accordance with the circumstances of the failure.
    The above consideration suggests that the deposit insurance system must take account of maintaining payment functions and protecting borrowers because it contributes to minimizing resolution cost and leads to protecting depositors.

    After the termination of temporary special measures, the DIC should, in principle, be responsible for providing liquidity, especially to the failed institution. The Bank of Japan (BOJ), as lender of last resort, is also expected to play an appropriate role, when necessary, in providing temporary credit or "special lending."

    As a condition for the extension of deposit insurance funds, the management that has led a financial institution to fail should be held strictly responsible with shareholders assuming the loss. Needless to say, it is also important to hold delinquent borrowers responsible and to carry out rigorous debt collection.


2) Accelerating transfer of business with financial assistance (assisted merger)
    When business of failed institution is transferred under the present financial assistance scheme, the payout of deposits and extension of new loans could be temporarily halted under a business suspension order issued by the supervisory authority or a stay order issued by the court. This could not only greatly affect the depositors but also dramatically erode the franchise value of the financial institution concerned including the utility of payment functions. This could even disrupt the economy and financial system as a whole.
    To minimize such disruption, the financial functions of a failed financial institution should be transferred as soon as possible to an assuming financial institution by speedily implementing the assisted merger.
    As a general principle, bankruptcy proceedings that may deprive a party of private rights, for instance, trimming a portion of a deposit, must be ultimately subject to judicial proceedings. However, in order to expedite the resolution process, the transfer of business should be allowed prior to judicial proceedings. To enable such exceptional arrangements, the following three measures should be put in place.


 Prior preparation
    The resolution of a financial institution involves various legal procedures such as the appointment of a public administrator, agreement with an assuming financial institution on business transfer (the purchase of performing assets and assumption of insured deposits), the DIC's purchase of deposits (determining a tentative ratio of liquidation value to book value), a fit and proper test for the assuming bank under the Deposit Insurance Law, an application to obtain court subrogation authorization on transfer of business in lieu of shareholder votes, and a report to the Fair Trade Commission.
    Thus, with respect to a financial institution that has managerial problems, in order to expedite the resolution process, the supervisory authority and the DIC should work closely together, and, in preparation for a possible failure, make as many prior preparations as possible, such as grouping of deposits held by the same depositor and evaluation of assets prior to closure of the failing financial institution.

    Under the present deposit insurance system, where deposits are protected per depositor up to a certain amount (at present 10 million yen), deposits held by the same depositor must be grouped before resolving failed financial institutions.
    The DIC has already built a computer system to group deposits based on data transferred from financial institutions. Therefore, in terms of the expedition of the resolution process, it is appropriate to ask financial institutions during normal times to prepare deposit data that are needed for the grouping of deposits and the calculation of insured amounts, as well as develop an interface through which to transfer deposit data smoothly to the DIC. In addition, it is also necessary to allow the DIC to review the preparedness of financial institutions' computer systems.
    With a view to avoiding excessive costs on the financial industry, financial institutions are not to be required to group deposits during normal times. However they are encouraged to do so voluntarily as part of customer-oriented services because the grouping of deposits per depositor is a prerequisite of the deposit insurance system.
    In evaluating financial institutions' assets, in addition to utilizing the existing data and information gathered by the supervisory authority via inspection and monitoring, the supervisory authority and the DIC should be authorized to obtain additional information necessary to implement speedy resolution via data requirements and on-site inspections.


 Enlarging the scope for the DIC where financial assistance is allowed
    The Deposit Insurance Law authorizes the DIC to provide financial assistance only to the assuming financial institution, at the time of the transfer of business, and only in cases where all assets and liabilities of the failed bank are transferred.
    If the DIC were authorized to extend financial assistance in cases other than the above, it would be able to employ a variety of other resolution methods, contributing to a speedy resolution. Thus, the scope for DIC to provide financial assistance should be expanded to cases when only a portion of business (e.g. performing assets and insured deposits) is to be transferred, additional financial assistance after the business is transferred, and financial assistance to a failed bank for the purpose of equalizing dividends among creditors, etc.

    As one way to extend financial assistance, the Resolution and Collection Corporation (RCC) is temporarily entrusted by the DIC to purchase the non-performing assets of failed financial institutions and actively pursue collection. It would be appropriate to continue this framework.


 Expedition and simplification of the transfer of business procedures
    The supervisory authority should, by an administrative order, place the failed financial institution under the management of a public administrator before entering into judicial proceedings. This is for the purpose of smoothly transferring the business of a failed financial institution and avoiding the possibility of the management of the failed financial institution engaging in resolution. To do this, an administratorship, similar to the financial administrator under the Financial Revitalization Law, should be introduced to take control of the management of the failed institution. Regarding this, the DIC, an expert in resolution, should be allowed to become one of the said administrators, just as it is under the present financial administratorship.

    In ordinary cases of business transfer of financial institutions, strict procedures that require a certain period of time must be followed to ensure the protection of the rights of shareholders and creditors. In the case of resolving failed financial institutions, such procedures would delay the business transfer, erode the franchise value of the failed institution, and result in a diminished liquidation value for creditors.
    Thus, it is necessary to expedite and simplify business transfer procedures by 1) introducing (a) the court subrogation authorization in lieu of a majority vote of shareholders, and (b) a measure to accelerate the procedure of protecting creditors, similar to those among the temporary measures under the Financial Revitalization Law, and 2) shortening the period (30 days) during which business transfer is prohibited after notifying the Fair Trade Commission of business transfer in accordance with the Anti-Trust Law.

    With these three measures in place, it will be possible to implement a number of procedures involving preparatory work prior to closure, appointment of a public administrator upon closure, and transfer of a portion or all of the business through the power of the public administrator in a swift manner.
    This resolution method is deemed a desirable prototype following the termination of the temporary special measures. It would operate in a similar fashion to P&A (purchase and assumption), a method frequently used in the U.S.

    The payoff method should be avoided as much as possible since it diminishes the financial functions of failed institutions. However, if it is to be chosen, it should be implemented speedily to minimize disruption. Hence, it is quite important that preparations (discussed in Section 3-(2)-a) are sufficiently made prior to payoff. In addition, the DIC should consider ways to improve its operation such as entrusting the payment of deposit insurance to a third financial institution.


3) Preservation of financial functions (when the transfer of business takes time)
    It is desirable that preserving the financial functions of a failed financial institution should be ensured through speedy resolution. However, in cases where financial institutions fail before prior preparations are completed, the transfer of business may need more time. In such cases, if financial functions such as the repayment of deposits and continuation of loans are suspended, individuals and corporations will be unable to make payments or borrow, which significantly affects the economy as a whole and the financial system.
    Therefore, when the transfer of business takes time, a public administrator should be appointed and judicial proceedings (e.g. Civil Reconstruction Proceedings (Minji-Saisei-Hou)) should be applied in principle, while maintaining certain financial functions as the following, provided that they are consistent with the resolution procedures.

In this connection, the new Civil Reconstruction Proceedings which is a reorganization procedure under bankruptcy proceedings is to replace Liquidation Arrangements under Composition Law (Wagi-Hou). The Special Law Concerning Reorganization of Financial Institutions (Kousei-Tokurei-Hou) that stipulates special bankruptcy proceedings for financial institutions should also incorporate special procedures of Civil Reconstruction Proceedings.


 Ensuring depositors' convenience
    In ensuring depositors' convenience (repayment of deposits and access to payment services), depositors should be able to have their deposits repaid up to a certain amount before the transfer of business even if it takes time after the failure was publicly announced. Thus, the DIC should be authorized to make advance payments and repay deposits up to the insured amount as well as lend necessary funds to the failed financial institution even if bankruptcy proceedings have commenced.
    As for the portion of deposits exceeding the insured amount, the DIC's power to purchase excess deposits2), allowed in the case of payoffs, should also be applied in the above case.


 Liquid deposits (deposits that have no due date mainly used for making payments)
    There are concerns regarding the extent to which speedy resolution can mitigate the hitch in payment when a portion of deposits is subject to trimming at the time of failure. The Financial System Council has considered many viewpoints as demonstrated below.

    Some argue that the deposit insurance system is aimed at protecting small depositors, and the issue of payment should be addressed through speedy resolution and various payment services provided by the private sector. Others argue that when the transfer of business of a failed financial institution takes time, individuals and corporations may be significantly affected. In particular, small and medium-sized corporations may find it difficult to switch from a financial institution that has been providing payment services to another. Thus, they are of the view that liquid deposits that are used for immediate living expenses and business operations should be completely protected. In response to this view, it has been pointed out that complete protection would increase moral hazard. Some also question whether liquid deposits can be specified and technically demarcated from other deposits. Others propose that if complete protection of liquid deposit is necessary, it should be achieved by a means other than the deposit insurance system.
    In addition, as a means to relieve the impact on payment services while avoiding moral hazard, some argue that the DIC should also make speedy repayment of deposits exceeding the insured amount, up to a certain amount at a pre-determined fixed rate. And some propose granting preferred status to all liquid deposits because such money can be considered to be in the process of transfer until the payment is completed.

    With a view to maintaining confidence in the payment functions of financial institutions as well as in recognition that fund transfers in process will interfere with the speedy transfer of business if they are treated the same as other claims, some contend that it suffices to protect only fund transfers in process that are booked as "betsudan yokin" (separately pooled deposits) or "kariuke kin" (temporary receipt of money), via granting them full deposit insurance coverage or preferred status so that the payment can be completed. In response, some point out the fact that small and medium-sized corporations often deposit payment money a few days in advance and so such money is pooled in the ordinary and/or checking accounts of the transacting financial institutions before being processed. Because of this, they question whether it is fair not to protect such payment money. Some also question whether fund transfers in process and other transactions can be demarcated.

    Based on the discussions above, the Council believes that liquid deposits should be protected by some temporary special measures in order to avoid any disruptive impact on the economy as a whole and the financial system caused by interruption of payments of individual and corporations, until speedy resolution methods are well established and a variety of private payment services are newly introduced. In such a case, however, it is necessary to prevent moral hazard as much as possible, for example, by limiting the protection of liquid deposits to those that bear no interest (or setting caps on interest rates) and by charging a higher insurance premium than other deposits so that taxpayers will not be asked to share the cost.


  Protection of borrowers
    Under the present judicial proceedings, when a financial institution fails, even financially sound and bona fide borrowers are not able to obtain additional loans from the failed institution. Although it is desirable that financially sound and bona fide borrowers are protected as a result of speedy resolution, failed financial institutions should also be allowed to make loans under judicial proceedings so as to minimize the resolution cost. However, the deposit insurance system primarily aims to protect depositors and cannot fully deal with this matter alone. The government is expected to take concurrent action to protect borrowers.
    In addition, local governments are expected to act voluntarily to protect borrowers from the viewpoint of mitigating effects on the local economy and ensuring the stability of people's daily life.

    A problem is pointed out in offsetting. In a commonly used loan agreement, loans to borrowers are subject to the acceleration clause in the event of their default or filing of a petition for bankruptcy proceedings against them, while deposits of financial institutions are not subject to the acceleration clause upon their failure. The following points are noted in respect to this problem:

(i)   It is important that financial institutions build contractual relationship more favorable to their borrowers who are also their depositors, in terms of reviewing the terms of the deposit contract, for example, by allowing borrowers to offset their borrowings with their deposits that are not due at the time of insured event under the Deposit Insurance Law.
(ii)   It is acceptable that in light of the present practice of offsetting loans, such an alteration would in effect grant preferred status to a depositor who is also a borrower.

    When a borrower holds deposits at the time of failure, transferring both deposits and loans to the assuming financial institution is desirable for both parties from the standpoint of maintaining ongoing business relationships. Since such transfer would not impair the interest of other creditors, it is desirable also for protection of borrowers that deposits up to the amount of the loans are allowed to be transferred to the assuming financial institution, together with the loans.

    Some issues discussed in this section 3-(3) are relevant to the issues in Section 3-(2). Therefore, the measures discussed in this section, such as the purchase of deposits and the protection of borrowers should also be incorporated in the speedy resolution method (or "a desirable prototype").


4) Assuming financial institutions
    Under the present system, the DIC is authorized to provide financial assistance to assuming financial institution. However, past experience in Japan indicates that assuming banks may not come forward at once. For speedy resolution, an environment that encourages financial institutions to become more willing to assume the business of a failed financial institution should be developed. Moreover, alternative resolution methods should be made available in the event no financial institution is willing to assume the business of a failed institution.


Development of an environment encouraging financial institutions to assume the business of failed institutions
    Two of the reasons pointed out why financial institutions are reluctant to assume the business of a failed institution are that there is uncertainty regarding the value of the assets to be assumed, and additional costs associated with the assumption of assets and the transfer of business may result in a decrease of their own capital adequacy ratio.
    For these reasons, the DIC should be able to share a portion of the losses on the acquired assets for a certain period of time if the value of the assets deteriorates after the transfer of business (loss-sharing). If the assuming institution gains profits due to an increase in the asset value, then the DIC should be entitled to a portion of such profits (profit-sharing).
    Capital enhancement measures should also be available to compensate for the decrease in capital adequacy ratio as a consequence of assuming the assets of a failed financial institution. To maintain the value of the enhanced capital, the assuming financial institution should at least be required to submit a plan on how it will ensure funds to redeem preferred stocks and other capital instruments.

    Under the present law, only financial institutions and bank holding companies which are covered by deposit insurance are able to assume the business of failed financial institutions with financial assistance. When financial assistance is provided through the purchase of stocks however, there is no economic rationale for limiting an assuming party to financial institutions and bank holding companies. Thus, the range of possible assuming institutions should be widened.

b. Measures applicable to cases where no assuming institution is found
    Introducing a bridge bank scheme, similar to the one under the Financial Revitalization Law, is necessary to secure enough time until an appropriate assuming institution comes forward. Under the scheme, the bridge bank needs to be established speedily, followed by a swift business transfer. It is also necessary to provide the bridge bank with an exceptional treatment to business transfer procedures for a newly created company (ex post facto establishment procedures), in addition to the measures to expedite and simplify transfer of business as described in (2)(c).
    It is also necessary to maintain the role of the Resolution and Collection Corporation ("Agreement Bank") as an assuming institution, which is prescribed in the supplementary provisions of the Deposit Insurance Law, with a view to secure the last-resort assumer of the business of a failed financial institution.

4. Measures Applicable to Cases where a Crisis Situation is Foreseeable


1) Need for systemic risk exception
    After the termination of the special measures to fully protect deposits, the cost of resolving failed financial institutions is not allowed to exceed the payoff cost. However, when a failure could disrupt the overall financial stability and affect the stability of the national and local economies ("systemic risk"), the standard resolution methods may not be adequate.
    In the US, the Federal Deposit Insurance Corporation (FDIC) must choose the least costly to the deposit insurance fund of all possible methods when resolving financial institution failures ("the least-cost resolution"). However, the FDIC can disregard the "least-cost resolution" principle in exceptional cases if it is determined through rigorous procedure that "choosing a resolution method under the principle would have serious adverse effects on the economic conditions or financial stability, while such outcome could be avoided with other methods."
    In Japan, the possibility of systemic risk cannot be denied even after the financial system stabilizes as a result of the present special temporary measures. Thus, it is necessary to prepare exceptional measures for the rarest of cases, while avoiding moral hazard by establishing rigorous procedures.


2) Specific measures and procedures
    There are three kinds of exceptional measures to be taken when systemic risk is determined: 1) provide capital injection directly to a troubled financial institution in order to prevent failure, 2) extend financial assistance to an assuming financial institution in an amount exceeding the payoff cost, and 3) place a troubled financial institution under the special public administration (temporary nationalization) established under the Financial Revitalization Law. Among these options, special public administration requires the forced transfer of stock and thus should be regarded as the last resort.
    When taking exceptional measures, rigorous procedures should be followed. Specifically, after the presence of systemic risk as well as the necessity of exceptional measures are acknowledged, the invocation of exceptional measures will be discussed at the Conference for Financial Crisis (headed by the Prime Minister, to be established in January 2001 as part of a major reorganizing of ministries and agencies) and then be finally decided. In addition, post factum accounting would be required regarding the indispensability of the measures taken.

    The losses incurred by exceptional measures cannot be covered by the regular insurance premium, nor should taxpayers' money be easily utilized. Thus, a special contribution should be required from financial institutions, apart from the regular premium. However, since financial and payment systems are the infrastructure of the economy, not only financial institutions and depositors but also the national economy as a whole depend upon the stability of these systems. Therefore, in cases where the stability of the financial system could be disrupted unless exceptional measures are taken, the government may need to provide appropriate fiscal measures, in effect, tapping taxpayers who are the indirect beneficiaries of the systems, as the cost of ensuring the stability of the economy as a whole, on the condition that financial institutions make special contributions. Funds (liquidity) needed to carry out exceptional measures should be financed by the DIC's borrowing guaranteed by the government or loans from the Bank of Japan.

5. Other Issues Concerning the Deposit Insurance System


1) Insured deposits
    To date, deposits have been considered eligible for deposit insurance when they have satisfied the following criteria:


 widely used by the public as a basic savings instrument


 repayment of the principal is guaranteed


 holders are identifiable and deposits are non-negotiable
    In terms of preventing depositor panic and speeding the resolution process, the following instruments should also be eligible while abiding by the above criteria. Needless to say, financial institutions are required to inform depositors whether individual instruments are insured or not.


Bank debentures
    At present, bank debentures are not eligible for deposit insurance on the grounds that they are negotiable securities and are technically difficult to group by the holder's name. However, bank debentures which fulfill the above three criteria can be considered as virtually equivalent to time deposits. In the case where bank debentures are marketed to individuals as saving instruments, they should be made eligible for deposit insurance.


Deposits of public funds and deposits of corporations established under special laws
    At present, deposits of public funds and the like (including deposits held by institutions engaged in treasury receipts and disbursements of the national government) are not eligible for deposit insurance on the grounds that holders are not general depositors and the protection of up to 10 million yen is virtually meaningless for these deposits. However, deposits of public funds should be made eligible for deposit insurance for two reasons: first, it is illogical to differentiate deposits of public funds from those of private corporations; second, if special protection for liquid deposits is temporarily introduced, deposit insurance coverage would provide practical advantages to receipts and disbursements of pubic money.


Interest on deposits
    At present, interest on deposits is not eligible for deposit insurance on the grounds that such protection may create moral hazard on the part of financial institutions as well as depositors, and make the determination of insured amounts a complicated task. However, protecting interest could make small depositors feel safe, thus preventing the unnecessary shift of funds. Moreover, it would contribute to prompt bankruptcy proceedings, and would bring bank deposits in line with postal savings. For these reasons, interest on deposits should be made eligible for deposit insurance. As for moral hazard, a certain degree of discipline should be imposed within the framework of prompt corrective action, prohibiting or restricting the solicitation of deposits by offering high interest rates.
    Foreign currency deposits should continue to be ineligible for deposit insurance since they are exposed to foreign exchange risks and are not widely used by the public as basic saving instruments.


2) Insured financial institutions
    At present, financial institutions insured by the DIC and thus eligible for its financial assistance include city banks, long-term credit banks, trust banks, regional banks, regional banks II, shinkin banks, credit cooperatives, and labor cooperatives. In order to increase the number of possible assuming institutions, the Zenshinren and other federations of cooperative financial institutions, which are excluded from the present DIC protection, should be made eligible for deposit insurance.

    At present, branches of foreign banks in Japan are not covered by deposit insurance on the grounds that jurisdictional problems might hinder Japanese authorities in taking prompt and appropriate action against them at the time of resolution. However, from the viewpoint of depositor protection, and given the fact that branches of foreign banks are compelled to participate in deposit insurance schemes in most of the major countries, it would be desirable to make those branches in Japan eligible for deposit insurance in the future.
    However, before reaching a conclusion, the issue must be discussed in line with other issues regarding the branches of foreign banks, including regulation, inspection, supervision, and failure resolution.


3) Insurance limit and advance payments


 Insurance limit
    At present, deposits are insured up to 10 million yen (without the temporary special measures). In light of per capita savings in Japan, the level of depositor protection in other countries, and the premium burden on insured institutions, it does not seem necessary to increase the insurance limit from the present level.


 Tentative advance payments
    The relative importance of tentative advance payments will be reduced when resolution process is expedited. However, to prepare for the cases where tentative advance payments become necessary, the maximum amount of payments should be significantly increased from the current level of 200,000 yen for the purpose of alleviating depositor's anxiety.


4) Purchase of deposits and other liabilities by the DIC
    At present, the DIC is authorized to purchase deposits and other claims insured by the DIC. Some argue that the DIC should be authorized to purchase a wider range of claims in order to ensure the liquidity of uninsured deposits and other uninsured claims, as well as to enable speedy bankruptcy proceedings by reducing the number of creditors. However, many uninsured claims are unsuitable for standardized treatment because of the complexity. Thus, purchase of these claims is not likely to speed up bankruptcy proceedings. Moreover, if the DIC suffers losses from these uninsured claims, the General Account of the DIC, which is financed by insurance premiums, would have to bear the losses.
    Therefore, the DIC's purchasing authority should be widened on the conditions, for example, that claims and creditors are clearly identifiable.


5) Insurance premium
    At present, the outstanding amount of borrowings by the DIC's General Account is very high (1,332.1 billion yen at the end of November 1999). With the planned resolution of several financial institutions that have been declared insolvent, this amount is expected to increase by trillions. To ensure public confidence in the deposit insurance system, General Account borrowings should be repaid as soon as possible, and a certain level of reserve held for future events. The level of insurance premium after the termination of the special temporary measures should be considered, bearing these facts in mind.
    The present insurance premium (including special insurance premium), which was set in consideration of the funding needs for the special temporary measures on the one hand and the financial conditions of insured institutions on the other, is seven times as high as the level applied in fiscal 1995.* After the termination of the special temporary measures, the insurance premium will have to be studied, referring to the present level, in view of the need to repay General Account borrowings as soon as possible.


 insurance premium
Before fiscal 1995 0.012%
From fiscal 1996 to 2000 0.048% + 0.036% (special insurance premium)

    A variable insurance premium where insurance premium are determined in connection with the financial conditions of individual insured institutions is adopted or under consideration in other countries. Such a risk-based insurance premium is, in principle, desirable in terms of supplementing market discipline. However, if adopted this time when the General Account needs to repay substantial borrowings as early as possible, the insurance premium of financially troubled institutions would inevitably be very high, further affecting their weakened conditions. Although the framework of a risk-based insurance premium should be studied at an early opportunity, the application of the framework is not feasible at this juncture.


6) DIC's funding
    The Deposit Insurance Law stipulates that the DIC first borrow for the General Account from the Bank of Japan (BOJ). When it renews borrowing, it is expected to borrow, in principle, from private financial institutions and repay BOJ because BOJ loans are temporary liquidity support by nature.
    With respect to other accounts, the DIC is allowed to borrow from the private sector from the beginning, and in fact the DIC is borrowing from the private sector to the fullest extent possible. Thus, there seems to be no need to restrict the initial funding of the General Account to BOJ loans and hence the DIC should make efforts to raise funds for the General Account from the private sector to the extent possible.

    Now that a permanent framework of deposit insurance and resolution methods is being designed, the savings insurance system for agricultural and fishery co-operatives should also be reorganized in a basically parallel manner, taking into account the special features of those financial institutions.

6. Environment to be Developed before the Termination of Special Temporary Measures

    The Financial System Research Council said in its report published on December 22, 1995: "At the moment, the Japanese financial system is not ready for payoff since 1) the financial sector is in the process of improving disclosure, thus to ask depositors to assume responsibility is not appropriate, and 2) the present situation in which financial institutions are greatly burdened by non-performing assets may cause financial unrest."
    Since then, preparation for the termination of the special temporary measures has been made as follows.


1) Disclosure by financial institutions
    The enhancement of disclosure by financial institutions is critically important because: it increases the transparency of their management, financial institutions are urged to correct their behavior through market discipline, and it will provide a foundation of self-responsibility on the part of depositors.
    Based on this philosophy, information disclosure by financial institutions has been enhanced in a number of ways. In the accounting period ending March 1998*, financial institutions started disclosing information on their non-performing assets according to standards equivalent to the ones set by the Securities and Exchange Commission of the United States. Since the accounting period ending March 1999, financial institutions are legally required to disclose matters concerning their activities and assets on a consolidated basis, as specifically prescribed by laws and regulations, with possible penalties for non-compliance.
    * Co-operative financial institutions started such disclosure in the accounting period ending March 1999.

    Since the accounting period ending March 1999, city banks, long-term credit banks, and trust banks have disclosed the outcome of the self-evaluation of assets imposed by the Financial Revitalization Law. From the accounting period ending March 2000, other depository institutions will follow suit.
    As the importance of market discipline increases, it would be appropriate for financial institutions to disclose information concerning their management and financial conditions in a timely manner ("timely disclosure") regardless of payment term.

    Individual financial institutions are expected to not only disclose legally required information on their activities and assets as well as the deposit insurance eligibility of financial instruments, but also provide depositors with an understandable explanation of their financial and managerial conditions as well as accurate information on the deposit insurance system as a whole.


2) Financial system stability
    The temporary instability of the financial system in Japan is being dissolved by the adequate application of a legal framework. The Financial Revitalization Law and the Early Strengthening Law, in addition to the Deposit Insurance Law, are the two pillars of this legal framework.
    Until March 2001, the administrative authorities as well as the financial industry are expected to continue efforts to ensure the stability of the financial system by using this framework and other available means. Moreover, individual financial institutions are urged to strengthen a competitive management base by increasing profitability and reinforcing their capital base.


3) Other
    There is a widespread misunderstanding that deposits exceeding the insurance limit of 10 million yen will be totally lost under the pay-off system. As a result, depositors appear to feel uneasy about the termination of the special temporary measures. In order to remove such uncertainty, it is crucial to deepen the general public's understanding of the deposit insurance system. The Government, the DIC, the financial industry, and all relevant parties are expected to take further steps to enhance public understanding of the deposit insurance system.


1) Following this report by the Financial System Council, on December 29, 1999, the coalition of the ruling parties decided to postpone the termination of special measures by one year (until the end of March 2002). The coalition also decided that liquid deposits would be fully protected for another year (until the end of March 2003) under temporary special measures. Following the decision, the Ministry of Finance is preparing necessary legislation, which is planned to be submitted to the ordinary session of the Diet starting from January 2000.
2) "Purchase of deposits" is a means to ensure depositors liquidity and smooth judicial proceedings by empowering the DIC to purchase a portion of insured deposits exceeding the insured amount (at present those in excess of 10 million yen) at a certain ratio (estimated liquidation value).

[Financial System]

[Financial System Reform]