Banking Soundness and Monetary Policy
Chapter

Discussion

Editor(s):
Charles Enoch, and J. Green
Published Date:
September 1997
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Mr. Mancera commented on questions raised by discussants on losses resulting from the Mexican financial crisis (Chapter 10). He stressed that depositors were protected from losses, and that in cases of systemic risk, it was not advisable to keep bank depositors uncertain as to the value of their claims on banks. The danger of not protecting depositors in such a situation could be immense. On the other hand, shareholders lost all or a considerable part of their investment. In many cases, shareholders lost control over their bank, and in other cases they were required to recapitalize their bank or lose everything. This was essential to avoid moral hazard, and because of fairness considerations. On moral hazard resulting from the bail out of depositors, Mr. Mancera argued that most depositors do not have the appropriate knowledge to assess bank soundness even if complete information were provided. In many cases, even bank supervisors have difficulties in evaluating the soundness of banks. Financial statements do not necessarily reveal the quality of bank portfolios. Mr. Mancera acknowledged that the cost of the financial crisis in Mexico was borne mostly by the government and shareholders. The costs could have been less had there been more time to deal with the crisis. However, the crisis required prompt action; markets needed to see that the authorities were not hesitant in rescuing the financial sector. Mr. Mancera added that liquidity support by the Bank of Mexico was not inflationary, since all amounts had been sterilized.

Mr. Nagashima confirmed that in Japan depositors were now protected up to the full amount of their deposits for a period of five years (as of 1996), and so far, market creditors had also been protected (Chapter 9). Mr. Nagashima acknowledged that there were certain moral hazard problems relating to depositors and creditors, but stressed that they were nonexistent as regard to shareholders since shareholders were not protected. He argued that the liabilities of Japanese financial institutions had to be protected so that any systemic financial difficulties would not occur. As regards the role of the Bank of Japan, Mr. Nagashima noted that the central bank would continue to play the role of maintaining financial stability in the new framework. He acknowledged that supervision of credit cooperatives, currently supervised by local governments needs to be reinforced. Strengthening measures in this regard would be discussed in connection with the establishment of the new institutional framework.

On enhancing accounting procedures, Mr. Nagashima noted that marking-to-market of assets held on trading accounts was one of the measures to be introduced. On equity holdings of banks, he noted that Japanese banks held equities in corporate and other financial institutions. Since 45 percent of unrealized capital gains of stock holdings could be included in tier II capital, banks experienced high volatility in tier II capital, but the share of this portion in their capital was reduced considerably as they had succeeded in raising other types of tier II capital. On the asset bubble issue, Mr. Nagashima noted that the bubble was certainly recognized early on, and there were voices that monetary policy should be tightened. Regrettably, these voices were not heard seriously due to the stability in general price levels which then prevailed and external pressures to keep Japanese interest rates low. On the current stance of monetary policy Mr. Nagashima stated that the current easiness would be maintained until it became reasonably clear that the ongoing recovery was self-sustaining.

Mr. Nagashima noted that banks in Japan had traditionally used real estate as collateral on the assumption that real estate prices would continue to rise. As a result of the steep decline in real estate prices, Japanese banks became more prudent, though real estate collateral continued to be used. Mr. Nagashima considered that most large banks would be able to resolve their bad loan problems in a few years. He acknowledged that the relationship between external auditors and banks was somewhat “cozy” in the past, and felt that this had now changed.

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