Presentation by Mr. Yanagisawa Minister for Financial Services

19 July, 2001
in The Foreign Correspondents' Club of Japan

Prior to going into my main topic, may I just say a few words to introduce my current position. At the time of the reshuffle of the Mori Cabinet, I was appointed once again to the post of the minister in charge of financial services on December 5 last year. And once again with the birth of the new Koizumi Cabinet in April, I was asked to continue to hold on to the same position and it brings me to who I am today.

At the time of my re-appointment to the present position, the most frequently asked question was ''How do you feel now that you have taken the job once again after the interval of one year and two months.'' I have responded by saying that, frankly speaking, as far as my impression goes, during these interval times I thought that each financial institution would have gone very far in resolving and disposing of their non-performing loans. But I have seen that not much change has been witnessed for the outstanding balance. So I said that I was not exactly happy with that situation.

In addition to myself not being very happy about that NPLs situation then, there were many mass media reporting and analysis views, which were brought to my attention, pointing out the fact that we had not seen much in substantial decrease in the outstanding balance. Not only pointing out this fact, some even raised questions about the disposal of non-performing loans in Japan.

The essence of these views, be it the mass media reporting or other views, tended to include the same points, namely, the valuation of the assets of the failed institutions such as LTCB and NCB, macroeconomic analyses, particularly by those affiliated with foreign brokerage houses, on the Japanese non-performing loans. The Democrats have also claimed that the Japanese problem loans would amount to 150 trillion yen.

Of course, I could respond to your questions later, if any, as to whether what has been reported has any validity. It seems that these views converge to one point. Just as advocated by the people in the Democratic Party, they say that once again Japanese financial authorities have to redo the inspection of all the financial institutions simultaneously. They also argue that the Japanese financial institutions should add up the necessary and adequate provisioning against the non-performing loans.

So it seems that mass media reporting, analysts' views and others tend to contain skepticism about the disposal of non-performing loans of Japan. I would argue that, in order to dispel any skepticism, all we have to do is to do what needs to be done in a steady and cool-headed manner.

The first issue I would raise is the recognition of non-performing loans. We call it in Japanese ''satei'' or assessment of non-performing loans.

In our system, as far as the recognition of the non-performing loans is concerned, first of all, each and every bank and financial institution is to perform the self-assessment of assets under the self-responsibility. Then comes the work to be done by external auditors, mainly by auditing firms made up of certified accountants. This will be followed at the end by the Financial Services Agency's supervision, including, in particular, its on-site inspection work. So, as you can see, we have a system of many different layers of checking in order to ensure accurate recognition of the non-performing loans.

There are some people who are suspicious about the correctness of the recognition of the non-performing loans. They advocate that the financial supervisory authorities themselves have to perform the assessment themselves by replacing the banks' role of having to looking into each loan, one by one, for producing any such assessments. However, I am of the view that now that we have already established the new administrative agency and the system that I described to you, the principle of recognition and assessment of non-performing loans should be primarily based on the self-responsibility of the financial institutions and the market discipline. This principle should be the foremost principle, the one we need to uphold very strongly.

Currently, there are strong political and mass media sentiments arguing for a different approach. But I am firmly of the view that financial institutions have to behave under their own responsibility. They have to come up with their own self-assessment to be assisted by the external auditing firms made up by the CPAs, who in turn bear the litigation risk in conducting their responsibility of ascertaining that closing of books have been conducted properly and duly. I am of the view that these principles need not to be and should not be overturned, because back in June 1998 the new Financial Supervisory Agency has been created with a notion to ensure a new tradition to uphold this principle. Whatever the difficulties we might be in at this time, we should uphold this principle, endeavor to work hard to preserve the new tradition.

As I mentioned, a new agency was created to ensure this new tradition in June 1998, but it was not until July 1999, about a year after the agency was established, when the resources were ultimately directed into supporting the new structure by way of the publication of the inspection manual for banks. This financial inspection manual was formulated by taking into consideration the practices and regulations pursued by the FED of the United States as well as the standards established by the Basel Committee as well. In fact, the history has been rather short since we had begun conducting inspection based on that new financial inspection manual. I am not saying that financial institutions' self-assessment work and inspection work done prior to the introduction of this manual have been loose. However, I would like to stress that now that we have this inspection manual, strict and solid inspections, based on this manual, are now being performed rigorously. At the FSA now, under this new financial inspection manual, the work is indeed in progress for the inspections of all the financial institutions.

As of April 1 this year, there are 15 what is called major banks in Japan. And out of the 15 already 10 and a half of them have received the inspection based on the said inspection manual. I say 10 and a half because in the meantime two banks have gotten together and inspections have been performed on one of the two. So already 10.5 banks have received the inspection based on the manual. So what remains is the 4.5 major banks.

Of course, this inspection based on the inspection manual has not run its course as far as the major banks are concerned yet. Therefore, a possible gap between the results of the inspection and the result of the financial institutions' self-assessment may exist. Of course, there may be a case where, by looking at the results of the inspection, we could have a case that some self-assessment done by the financial institutions should have been corrected or modified. At this time, I cannot say how large this possible gap may be, because it is too early to say. But I must also make a point that presently Japanese financial institutions are not fully familiarized themselves for conducting the self-assessment entirely based on the notion of the self-responsibility. And also it is a fact that inspections manual is written for some sections in a rather abstract way, so that concrete standards and criteria need to be formulated filling in the actual numbers, or working on further elaborations. Based on those two different reasons, perhaps there would be some gap or a considerably large gap between the results of the self-assessment versus the results of the inspection. But the discrepancy of the gap is not my main point that I would like to appeal to you today. I would say that inspections per se are conducted based on the inspection manual in a very strict way. So we very much hope that, taking into consideration the results of the inspection, the financial institutions will be able to do a good and full job for their self-assessment for the coming fiscal year.

Now let me next talk about the provisioning issue. As mentioned by Vice Chairman of this club, Mr. Takenaka's project team has been established to tackle the issue of the impact of the balance sheet assessment. Professor Kiyohiko Nishimura, who is from University of Tokyo, Economic Department and is an expert in the statistics, is chairing this project team. That project team is actually made up by members such as analysts and the professors of the universities and CPAs. They were about to come up with the challenging point of view, arguing for increasing provisioning against the NPLs. The thrust of the project team's argument is that banks have to allocate provisioning based on the general outlook for the overall economy. But we presented our case, saying that provisioning cannot be done just simply based on the general economic outlook. The provisioning can be made based on the individual concrete specific projections and estimates. That type of provisioning could be acceptable for certain specific individual cases. However, it cannot be done by a general manner, based on rough projections by simply calculating it, say, at the rate of 50% and so forth, as some analysts have mentioned. We have said that the provisioning based on the rough ballpark figure is not an acceptable one. We have argued that provisioning should only be made based on the corporate accounting standards and other appropriate requirements, as incorporated in the commercial code and other regulations in Japan, which constitute the core elements of discipline in the entire system. If the provisioning were to be made arbitrarily, then that might run counter to the shareholders' interest and also it could run counter to the management's accountability as promulgated, for instance, by the commercial code. Elaborate explanations were made from our side to the project team. Then, the project team gradually started to understand our case, fully recognizing the character and nature of the provisioning that we had been talking about. But since their argument was prompted by the possible concern about the risk management. Given the limited role that the provisioning could play in the overall risk management, they pursued the discussions further. Instead of advocating arbitrary provisioning, they have come to favor an alternative risk management techniques, including, for instance, the adjustment of the volume of the lending or some other adjustments on the lending rates, asking for a little bit higher rates for some of the borrowers and so forth. I believe this was precisely how the issues were settled. I presume that all this was also reported to Minister Takenaka as well. Ever since, he has not raised the issue of the provisioning with me.

I have commented on the issues related to the recognition of the NPLs and the validity and the practice of provisioning by financial institutions. I do believe that there should be no place for any skepticism as to the self-assessment done by the financial institutions, auditing performed by the auditing firms, or the inspections carried out by the supervisory authorities. Any skepticism in this regard has to be dispelled, and effectively and quickly at that. As the new team at the FSA begins the new business year on July 1, I have stressed that with the new beginning of the business year, a new working system be established which enables conducting the inspections on the major banks in Japan once in every year. I have also stressed that although the inspection per se is focussed on looking into the past performances of each financial institutions, we have to make sure that results of the inspections need to be reflected duly in their books as they close the coming year's accounts. What has been pointed out in individual inspections has to be duly respected by the financial institutions. Therefore, I am calling for a sort of on-site follow-up visits to major banks to monitor implementation of the inspection results, so that we can make sure that inspection results will be duly reflected in the next coming year's closing of the books. This is what I have instructed.

I expect that this can be implemented surely. The self-assessment by the financial institutions and the inspections conducted by the financial supervisory authorities are at the core of the Japanese financial system. There should never be a case where anybody would raise skepticism as to the work in this respect. In order to make sure that there should be no such skepticism creeping in, I am saying that this new system and approach will be followed with the beginning of the new business year.

It has taken me longer than expected. So I have brought with me several more topics that I could have covered but maybe I could just add one more point, then open the floor for your questions. My last topic would be whether or not the capital adequacy level of the Japanese financial institutions is really enough to deal with the future issues under the circumstances. This question can be put forward in the reverse way, namely as follows. As the mass media had written about it several times, the issue raised here is whether it is necessary to once again inject public funds into the financial institutions for their capitalization for the third time, taking into account the experiences of the Sazanami Committee in 1998.

Under the current system, if the financial crisis were to occur, then, of course, we would be able to deal with the situation appropriately by taking necessary steps or measures available in the existing laws. Such steps or measures could include injecting public funds into the financial institutions. Presently we do not have any financial crisis in Japan nor are we in the kind of situation that we have seen back in 1997 and 1998. Under such circumstances, is there really a case that there should be a necessity to inject public funds to capitalize private sector financial institutions? As I said at the very outset, if we were to have capital injection in the present circumstances, such an action would only end up relaxing or loosening the market discipline, the very core of the financial system, which we wanted to strengthen in a new tradition in Japan. So, it is inconceivable in my position to see the capital injection at this time, and that is my position.

In any private businesses, corporations are always called upon to build up their capital adequacy. They should accumulate their earnings and profits in order to build up their capital adequacy level. If there is special funding need on the part of the businesses to build up capital, then, they should go out to the markets themselves and try to raise the capital in the market. And that is the basic principle that needs to be upheld. Presently, we are seeing no financial crisis. So, if any of the financial institutions were to go into the situation of under-capitalization, then that financial institutions would have to be aware that they could be called upon to exit eventually from the market.

Otherwise the market discipline that is being strengthened will be undermined and would collapse. The system would return to the convoy system of the past. So, those people who argue for such an action, I would say that they would be just advocating the way back to the past with convoy system mentality. Thank you for your attention.

Questions and Answers

(Q)

Many foreign economists believe that it would be completely impossible for the major banks to write-off bad loans and completely resolve the bad loan problem in two to three years as Mr. Koizumi has promised unless there is an injection of capital funds. In effect, the government faces a choice between time or money. You either wait for ten years for the banks to write-off the loans slowly without government help or you inject public money to do it in two or three years. Faced with that choice between time or money, which one would you choose? It sounds as if you would choose time from your previous comments about capital funds injections.

(A)

The question is very often raised as far as the disposal of the non-performing loans is concerned. For example, I spoke about some analysts in international brokerage firms, who argued that there is this much amount of non-performing loans outstanding. So, in order not to undermine or impair the capital of the financial institutions, the capital injection would be necessary. But that type of argument excludes the time component because so far we have included in our considerations this time component. Every bank is able to generate operating profit and some of that can be used for disposal of the non-performing loans. So, time will be an essential element: operating income generated every year within two to three years could be used for disposing non-performing loans, without causing the impairment of their capital.

Having said that, I would like to really respond to the question which is asked. What do we mean by the resolution of the non-performing loans? There is no way that non-performing loans would be reduced down to zero because financial institutions are taking risk in their business, so there are always some NPLs remaining in any of the institutions. But the issue is to bring down the level of the non-performing loans and disposal of non-performing loans to the normal level. So if all these levels would be normalized, then I would say that it would be the time when we will be able to say that non-performing loans issues have been resolved.

There are certain kinds of benchmarks that we can look to. First is the ratio of the non-performing loans to total lending. Another is the ratio of the loss from or the cost of disposal of non-performing loans to total lending. We have not made public any kind of targets or goals we are looking at numerically, but I would say that we would look for some comparable indicators, such as those used in the United States. For example, in the case of the United States, as far as the non-performing loan ratio goes, they were in the range of 6%, but because of the good economy prevalent in the United States, the ratio came down and stayed at around 1%. But I would say that the desirable state that we would like to see for Japan is the normal level when the level of economic activities is going on normal. I cannot say at this time here which percentage we are looking for. However, as I said, in case of the ratio of the loss from or the cost of on disposal non-performing loans to the total lending as of the fiscal 1999 in the case of the US was around 1.2%. I would say that the Japanese figure is approaching that level quite soon or quickly, but one could also argue that this may be due to the possibility that the tempo of the disposal of the non-performing loans may have been comparatively slow in Japan. I would say that we would need to look not only at the ratio of NPLs to total lending but also at the cost of disposal NPLs to total lending, and would look for the level where these ratios stayed under the normal economic circumstances in the case of the United States.

Lastly, if the question was based on the presumption that the amount of non-performing loans would be much larger than what has been published, I would perhaps have to touch upon the results of the inspection conducted by the Financial Supervisory Agency against the self-assessment done by the financial institutions. How much gap is there really? Perhaps I need yield to that point. But as I said, we are still in the process of inspection as we talk. Some people would argue that maybe the gap could be two times or three times fold. But honestly speaking, we only have our tentative results at this time because only part of financial institutions had received such full inspections to this day. Provided that very tentatively the aggregation of the numbers are made, you would ask how much there was as far as the gap of the risk management loans are concerned between the self-assessment and the results of the inspections, I would say that the gap would be about 25%. So, there is no basis in presuming that there is a gap of about two to three times fold between the self-assessment results and the authorities' inspection results. As I said, the inspections are performed strictly based on the inspection manual and the gap you may suspect is not that large.

(Q)

One of the difficulties we have in trying to deal with this problem is definitions. When you were here the last time, on March 29, 1999, I asked you a question about when the banks would start to write-off, meaning eliminate from their balance sheets the bad debts, the non-performing loans, you admitted at that time that they had not started eliminating the bad debts from the balance sheets but speculated that they were going to do so. And when Japanese start doing things they work together and go at it very fastly. Today you have not said anything at all about writing-off the bad debts. You have talked about provisioning for the bad debts which is where we were in 1999. The government policy I thought was to write the bad debts off, not provisioning for them. But you have only talked about provisioning. What is the government policy?

(A)

I was actually prepared to talk about that issue. Since my time had run out, I was urged to cut my speech short, I was not able to touch upon that.

On the topic of write-off, frankly speaking, it was I who started to talk about the write-offs in January, after I became Minister in December last year. Non-performing loans, of course, need to be disposed of and in order to have the financial institutions maintain their soundness, it is not good that they would just come up with provisioning against non-performing loans and stay quiet. Such an attitude would not lead the real revitalization of the Japanese economy, industry or borrowers. When I became Minister this time, Vice-Minister of METI as well as Vice-Minister of Land, Infrastructure and Transport Ministry came to me to congratulate me upon my assuming to the position of Minister. I seized that opportunity right away and said to them, ''Let's work together on this topic.'' The companies themselves who are the borrowers also need to make efforts towards their own revitalization and to go ahead with the workout of their debt and restructure their businesses, distinguish bad portion of business from the viable ones and so forth. Of course, financial institutions are channeling funds into those borrowing companies and losses would be incurred from the non-viable portion of the businesses. We need to think about how that loss should be dealt with. I said that I could to a certain extent try to persuade financial institutions. Of course, I am not in a position to commit financial institutions in accepting any requests or working out any plans for the debt restructuring. But in this manner I started to talk personally about the write-offs. In those days, I used to call this exercise ''off-balancing''. This means, in fact, removing the non-performing loans from the balance sheets of the banks. By and by, the Japanese government has started to give high priorities to the removal of the non-performing loans off the balance sheets of banks. At the very end, actually, it was given the foremost priority in the Japanese priority list. So it is not a technical issue, but it has now become the top priority issue for the national government's policy. That has been the case. We have put into place a scheme leading to this direction. The scheme now has been put into place to have the major banks dispose of the non-performing loans, the loans classified ''in danger of bankruptcy'' or below. They should dispose of these loans within the coming two years for the outstanding non-performing loans and within three years for the newly emerging non-performing loans. Of course, as for those major banks, loans which ranked more than above the ''need attention'' category, the work should be done so that as much as possible the borrowers' business can be revitalized and reach a sound level. And many of the regional banks are working together with the major banks to provide co-financing, so that inevitably regional banks will also be involved in the overall process for the disposal of their non-performing loans. In the coming April, the new deposit insurance system will be put into place. Because regional banks are also competing against the major banks, regional banks alone cannot hold onto their non-performing loans, so they would also make efforts under the market force to get rid of their own non-performing loans as well. There are differences in how the regional banks deal with their clients who are the companies who are borrowing from the regional banks than the dealings that major banks have vis-à-vis their clients. So, these items will be taken into consideration by the regional banks' side and together with the major banks as well, we look forward to seeing the situation where the non-performing loans will be disposed of.