Fiscal policy has been strongly expansionary for most of the past decade in Japan. The resulting strain on public finances has made stimulus policies more difficult to maintain. The stance of monetary policy has remained unchanged over the past year. Further progress in resolving banking problems is essential given the plan to remove blanket deposit insurance in April 2002 and to lay the foundation for sustained growth. The paper discusses recent developments in the field of structural reform and deregulation in Japan.


Fiscal policy has been strongly expansionary for most of the past decade in Japan. The resulting strain on public finances has made stimulus policies more difficult to maintain. The stance of monetary policy has remained unchanged over the past year. Further progress in resolving banking problems is essential given the plan to remove blanket deposit insurance in April 2002 and to lay the foundation for sustained growth. The paper discusses recent developments in the field of structural reform and deregulation in Japan.

IV. Financial System Issues1

A. Overview

1. While concerns about systemic risk in the banking sector have continued to recede, bank restructuring remains at an early stage. Under the framework established in 1998, further progress has been made in stabilizing the banking system. Major banks’ average capital adequacy ratio increased to 11¾ percent in March 2000; the two banks nationalized in late 1998 have been or are about to be reprivatized; and four mega-mergers have been announced, with one breaking keiretsu ties. As a result, the Japan premium has remained close to zero since March 1999, apart from a brief rise during the Y2K period (Figure IV.1). However, while the bulk of the bad loan problem may have been addressed by cumulative loan loss charges since 1990 of over ¥50 trillion (10 percent of GDP), concerns remain that the full extent of the deterioration in asset quality has not been recognized and that corporate restructuring will lead to an ongoing flow of new bad loans. In addition, major banks have not yet demonstrated that they have sufficiently ambitious plans to restore core profitability, as reflected in the performance in their stock prices.

Figure IV.1.
Figure IV.1.

Japan: Banking System Strains, 1997–2000

Citation: IMF Staff Country Reports 2000, 143; 10.5089/9781451820546.002.A004

Sources: WEFA; and Bloomberg Financial Markets L.P.1/ Average U.S. dollar UBOR of Fuji Bank. Bank of Tokyo, and Norinortukin bank minus the LIBGR fix.

2. Many regional banks have raised capital over the past year, but weaknesses remain among many second-tier regional banks and cooperative-type institutions. Over the year ended March 2000, more than one third of regional banks raised capital equivalent to 2 percent of their risk-weighted assets, mostly from private sources, increasing the average capital ratio of first-tier regionals to 10 percent and of second-tier regionals to 8 percent as of March 2000. In addition, five regional banks have been intervened. However, a number of the second-tier regionals still have less than 8 percent capital.2 In addition, weaknesses among cooperative-type institutions remain very serious. Credit cooperatives came under the Financial Supervisory Agency’s (FSA) jurisdiction in April 2000; the FSA will be inspecting these institutions through March 2001. The delay in reintroducing limited deposit insurance announced last December was largely related to concerns about weaknesses in this sector.

3. Further progress in resolving banking problems is essential given the planned removal of blanket deposit insurance in April 2002 and to lay the foundation for sustained growth. The new framework for limited deposit insurance—including expedited purchase and assumption operations—is expected to improve market discipline, reduce moral hazard, and limit the burden on the taxpayer. However, uncertainty about the magnitude of banks’ remaining uncovered losses and their future profitability may lead markets to anticipate liquidity problems well ahead of April 2002, so there is in fact little time left for preemptive restructuring. In addition, banks play an especially important role in financial intermediation in Japan, as securities markets are less well developed than in other major industrial countries (see Morsink and Bayoumi, 2000). Until banking problems are fully addressed, banks’ reduced capacity to take on risk will hinder their role in financial intermediation, as reflected in the continued weakness of bank lending.

4. The financial position of the life insurance sector deteriorated further over the past year, reflecting returns on assets that fell short of guaranteed returns paid on policies (negative spreads). Following the implementation of stricter disclosure standards in April 1999, the FSA began in May 1999 on-site inspections of life insurers. After the failure of Toho Mutual Life in June 1999, the FSA intervened in Daihyaku Mutual Life in May 2000. Recently, regulations on the adequacy of policy reserves and triggers for prompt corrective action were tightened, troubled life insurers were allowed to lower future guaranteed rates of return on policies as part of court-supervised reorganization proceedings; demutualization was facilitated; and the government-guaranteed borrowing limit of the Life Insurance Policyholders Protection Fund was raised.

B. Policy Developments


5. The FSA recently tightened bank capital rules, but important shortcomings remain. The FSA extended in June 2000 the restriction on double-gearing, which previously applied only to banks’ investment in nonconsolidated temporary subsidiaries in which the bank’s equity stake is above 50 percent, to banks’ investment in all nonconsolidated financial subsidiaries (including insurance companies, securities firms, nonbank financial institutions, leasing companies, and asset management advisors). At the same time, the new rule prohibits the consolidation of insurance subsidiaries, given that banks’ capital requirements are not designed to cover insurance-specific risks. Banks are now required to deduct investment in any financial subsidiary from their capital, on the grounds that such funds are being used to support the business of the subsidiary and are not available to support the bank’s own business.3 By encouraging banks to invest funds more broadly (outside of corporate groups), the new standard is expected to weaken cross-shareholding.

6. The capital adequacy standard for domestic banks is still low and the treatment of deferred tax assets is still generous, by international standards. While banks with international operations—including all major banks—must have capital ratios of at least 8 percent, banks with domestic operations only are required to maintain a capital adequacy ratio of just 4 percent. With regard to deferred tax assets, most countries allow banks to carry assets related to anticipated future tax deductions for loan losses against loans that have already been provisioned against. However, the realization of these assets depends on future taxable income, so regulatory authorities usually impose a ceiling on such assets. In Japan, the ceiling is five years’ taxable profit, while in the United States the ceiling is 10 percent of Tier-1 capital or one year’s taxable profit, whichever is lower.


7. The FSA made further progress in improving bank supervision over the past year. On-site inspections during 1998–99 concentrated on asset quality, particularly the inadequacy of loan classification and provisioning standards, and this led to substantial increases in provisions. Over the past year, banks were inspected on a consolidated basis, including off-shore entities, and inspectors focussed on a broader set of risks—not only credit risks, but also market risks, liquidity risks, and systemic risks, Newly-hired specialists played an important role in helping the FSA to assess banks’ overall risk management frameworks. Starting this fiscal year, the FSA is strengthening off-site monitoring by requiring banks to report every month key financial data, such as risks posed by changes in interest rates and share prices, cash positions, and credit exposures. Based on an analysis of these data, the FSA is prepared to make recommendations.

8. Supervisory resources continued to increase. The number of inspectors based at FSA headquarters rose from 164 in June 1998 (when the FSA was established) to 249 in March 2000, and is expected to increase to 319 by March 2001. About 20–30 specialized inspectors were hired, with skills in such areas as accounting, legal issues, information technology, and market risks, and supervisory agencies in other countries helped to provide training. In addition, 567 inspectors based in local offices recently came under the FSA’s control.

9. The FSA (Financial Supervisory Agency) became the Financial Services Agency in July 2000. The most important change was that responsibility for planning financial system laws shifted from the Ministry of Finance (MOF) to the FSA (Table IV.1). At the same time, the MOF regained a role in bank resolutions and crisis management. Further changes are planned for early 2001, when the FRC will be merged into the FSA.

Table IV.1

Reallocation of Financial Regulatory Functions

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MOF: Ministry of Finance.FRC: Financial Reconstruction Commission.FSA: Financial Supervisory Agency.FSA*: Financial Services Agency.

Public Money

10. Public funds authorized to protect depositors were increased by ¥10 trillion, bringing the total amount of public funds available for dealing with banking system problems to ¥70 trillion (S640 billion or 14 percent of GDP) (Table IV.2).4 Of the extra ¥10 trillion, ¥6 trillion was in the form of a grant to the Deposit Insurance Corporation (DIC), while ¥4 trillion was in additional loan guarantees to the DIC. This recapitalization was necessary as recent failures of major banks essentially exhausted the initial grant of ¥7 trillion for meeting bank closures. However, in other respects, the amount of public funds available for dealing with banking problems remains ample—only about ¥8 trillion has been used to recapitalize weak but solvent banks.

Table IV.2.

Japan: Public Funds Authorized to Deal with Banking Weaknesses

(Trillions of Yen)

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Thus far, about ¥8 trillion has been injected, mostly in the form of convertible preferred shares.

Disposal of Bad Loans

11. The Resolution and Collection Corporation’s (RCC) loan disposal efforts continued to focus exclusively on loan collection, as opposed to asset sales. At the same time, the RCC acquired additional bad loans, including from healthy banks. The large overhang of collateral still available for sale has likely contributed to the depressed state of the real estate market—in most areas, land prices continued to fall. By contrast, some private banks sold bad assets at deep discounts, mostly to foreign investment banks and investment funds. Official data are not available, but private analysts estimated that the face value of distressed assets sold by private banks since 1997 amounted to about ¥25 trillion (Financial Times, April 19, 2000).

Big Bang Reforms

12. The Big Bang financial reforms, which were largely completed in October 1999, are setting the stage for a radical transformation of the Japanese financial system. Brokerage commissions were fully liberalized, remaining restrictions on the stock brokerage business of banks’ securities subsidiaries were lifted, and insurance companies were allowed to enter the banking business through subsidiaries. The main remaining reforms—to permit cross-sectoral competition between banks and insurance companies—will come into effect in October 2000. The reforms are increasing competition between all types of financial institutions and—by increasing the range of financial instruments available to savers, especially households—will likely encourage a shift in financial intermediation itself to securities markets. While households will likely be slow to change the allocation of their financial assets, a shift away from bank deposits and towards higher-yielding, well-diversified investment trusts appears likely.

13. At the same time, the authorities are developing guidelines for the entry of nonfinancial companies into the banking business.5 The FRC and FSA released in May 2000 draft guidelines, which—among other things—require subsidiary banks to regularly submit financial statements of their principal shareholders, and mandate that measures be adopted to stop a principal shareholder’s financial difficulties from spreading to its banking subsidiary. The guidelines, which appear to be broadly in line with best international practice, are expected to be finalized in July 2000; the necessary legal changes are expected to be discussed in early 2001. Sony, the electronics giant, is planning to launch an internet bank, while Ito-Yokado, a supermarket chain, expects to establish a bank focussed on providing settlement services.

Deposit Insurance Reform

14. The removal of blanket deposit insurance—previously scheduled for March 2001—was postponed by one year (see chapter on deposit insurance reform in this year’s Selected Issues paper). The coverage limit of ¥10 million per depositor per bank is now scheduled to go into effect on April 1, 2002. Liquid deposits will be covered in full for an additional year (i.e., until March 2003) in order to avoid the risk of large-scale disruptions (from bank failures) until speedy resolution methods and a variety of private payment services are well-established.6 The postponement reflected in part the lack of preparedness among smaller financial institutions, including some second-tier regional banks and cooperative-type depository institutions, which could have led to a severe credit crunch and a destabilizing deposit shift from weak to strong banks.

C. Major Banks


15. Major banks recorded aggregate net profits in FY1999 (year ending March 2000) for the first time in six years (Figure IV.2 and Table IV.3). Underpinning the improvement were high gains on investment equities, reflecting a buoyant stock market, which helped to offset another year of substantial loan loss charges. Loan loss charges were ¥4.5 trillion—half the level of the previous year, but three times greater than original projections, reflecting higher-than-expected corporate bankruptcies and debt forgiveness, and falling land prices. Net interest revenue declined slightly, as declining yields on securities (mostly government bonds) more than offset a small increase in loan spreads, while overhead costs fell by 5 percent. The average capital ratio increased slightly to 11.8 percent in March 2000.

Figure IV.2.
Figure IV.2.

Japan: Major Banks’ Profits, FY90–99

(In trillions of yen)

Citation: IMF Staff Country Reports 2000, 143; 10.5089/9781451820546.002.A004

Source: Fitch IBCA.
Table IV.3.

Japan: Major Banks’ Performance

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Source: Fitch IBCA.

As defined by the Financial Revitalization Law. Includes claims on borrowers in legal bankruptcy, past due loans in arrears by 3 months or more, and restructured loans.

16. Notwithstanding the recent improvement in reported performance, serious concerns remain about capital adequacy and core profitability. There are three main concerns about capital:

  • Adequacy of bad loan recognition and provisioning. The much higher-than-projected loan loss charges in FY1999 suggests that banks may still be failing to accurately discount the weakness of loan quality. Most private analysts expect substantial loan loss charges to persist for several years, reflecting overly optimistic loan classification, especially with regard to the impact of corporate restructuring on loan quality. Also, loss rates may turn out to be higher than historical experience would suggest, especially for special mention (Class 2) loans, as banks become more active in disposing of bad loans.7

  • Quality of Tier-1 capital. Deferred tax assets constitute about one-quarter of major banks’ Tier-1 capital, public funds another one-quarter, and preferred securities issued by banks’ overseas subsidiaries another one tenth. Excluding these items, “pure” common equity stood at just 2.2 percent.

  • Increasing vulnerability to market risk. As banks have realized “hidden reserves” on their equity investments to absorb losses on their bad loans, the aggregate book value of their equity holdings has risen sharply, to the point where it is now roughly equivalent to market value (TOPIX about 1,400). The implementation of mark-to-market accounting in FY2000 implies that valuation losses will immediately impact bank capital.8 The book value of equity holdings amounted to 150 percent of Tier-1 capital as of March 2000, implying that a 30 percent fall in the stock market would reduce Tier-1 capital by about 50 percent. In addition, major banks’ rapidly-growing holdings of long-term government bonds are making them vulnerable to capital losses when interest rates rise.9

17. Major banks’ core profitability remains weak compared to internationally active banks in other industrial countries. For example, return on assets is only about one-third to one-half that of large U.S. banks. Low core profitability is due mainly two factors:

  • Large-scale prime corporate lending, which absorbs capital but produces little revenue. Margins for comparable loans are similar in Japan to those in other industrial countries, but Japanese banks have loan portfolios that are heavily concentrated in low-yielding, big company lending. A significant improvement in banks’ core profitability depends on shifting these loans to securities markets, by repackaging and selling loans to institutional investors and other nonbank institutions, and expanding more profitable operations, such as consumer and small company lending. Weak profitability is not due primarily to high costs: Japanese major banks have relatively low ratios of costs to revenues, reflecting relatively few staff and small branch networks.10 Most market analysts’ assessment is that banks’ existing plans to raise core profitability do not put sufficient emphasis on a reorientation of loan portfolios, as reflected in the weakness of bank stock prices.

  • Large-scale public financial intermediation. The significant roles played by the government’s Housing Loan Corporation in mortgage lending and the Postal Savings System in deposit-taking result in public financial institutions accounting for about one-quarter each of personal financial assets and household borrowing. Postal savings deposits pay attractive rates and are viewed as being backed by the full faith and credit of the government, even though the Postal Savings System pays no taxes or deposit insurance premia, and is not subject to capital adequacy requirements.11 At the same time, the importance of post offices as providers of essential financial services to outlying areas is unclear, as only 9 of Japan’s 3,255 municipal units (cities, towns, and villages) lack any private retail banking facility (see Kuwayama, 1999). The proposed reform of the Fiscal Investment and Loan Program (FILP) only separates its financing from the Postal Savings System and does not address the size of public financial intermediation.

Announced Mergers

18. Daring the past year, four mergers between major banks have been announced, which will create four of the five largest banks in the world in terms of assets.12 Mizuho Bank will combine Dai-Ichi Kangyo Bank, Fuji Bank, and Industrial Bank of Japan; Sumitomo Mitsui Bank will combine Sumitomo Bank and Sakura Bank; Mitsubishi Tokyo Group will combine Bank of Tokyo-Mitsubishi, Mitsubishi Trust, and Nippon Trust; and a yet-to-be-named entity will combine Sanwa Bank, Tokai Bank, and Toyo Trust. With these mergers, the ten city banks that existed before the 1997–98 financial crisis will be reduced to five, not counting Daiwa Bank, which is pursuing a regionally-oriented strategy (Table IV.4). Even though the four merged banks would together comprise more than 80 percent of major banks’ total deposits (Table IV.5), anti-competitive concerns would seem to be limited, as major banks as a whole comprise only about 40 percent of the private banking system in Japan (and only about 30 percent if the postal savings system is included) and the Big Bang financial deregulation is creating more opportunities for both investors and borrowers.

Table IV.4.

Japan: Changing Banking Landscape

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Table IV.5.

Japan: Deposits of Major Banks 1/

(data are for March 2000)

article image
Source: Fitch IBCA and staff calculations.

Figures include deposits, certificates of deposit, debentures, and commercial paper.

19. The planned mergers hold the promise of accelerating the pace of bank restructuring and generating significant economies of scale and scope. All of the mergers offer the potential for consolidation of spending on information systems, the realization of important synergies between different banking specializations (commercial, investment, and trust banking) and geographical strengths of the component banks, and reductions in employment and overlapping branch networks. By cutting across traditional corporate groupings (keiretsu), the Sumitomo-Sakura merger—which links the historically rival Sumitomo and Mitsui corporate families—could also quicken the pace of corporate restructuring. To the extent that the merger encourages the weakening of keiretsu loyalties, banks could accelerate the process of bad loan disposal and their credit decisions could improve significantly, which would increase pressure on corporates to strengthen their performance.

20. However, the impact of the mergers will depend crucially on how much strategic reorientation and restructuring are actually achieved. While some cost-cutting is desirable, as banks adjust to new competitive pressures such as internet banking, the Japanese banking system already compares favorably with those in other major advanced countries in terms of number of staff or branches. Delivering on existing plans may prove to be more complicated than expected, as past mergers have encountered significant difficulties.13 Finally, the merger plans do not put much emphasis on shifting low-yielding corporate lending to securities markets.

Nationalized Banks

21. The two long-term credit banks that were nationalized in 1998 are being reprivatized.14 Long-Term Credit Bank (LTCB) was sold in March 2000 to a group of investors led by U.S.-based Ripplewood Holdings, which specializes in corporate turnarounds, and was renamed Shinsei (meaning rebirth) Bank in June. The government has reached a tentative agreement on the sale of Nippon Credit Bank (NCB) with a group of investors led by Softbank, which is one of Japan’s most aggressive sponsors of internet businesses and is itself planning a rapid expansion of financial services delivered over the internet.15 The key elements of the agreements reached between the authorities and the private purchasers were as follows:

  • The new banks’ Tier-1 capital includes ordinary voting shares purchased by the investors, convertible preferred shares contributed by the DIC, and the realization of capital gains on equities portfolios.16 Tier-1 capital does not include any deferred tax assets. The new banks’ capital adequacy ratios are about 13 percent.

  • For the first time in Japan, the sales agreements included repurchase agreements, which help to guard against excessive downside risk from further losses on existing loan portfolios. In both cases, the government will bear losses on existing loans greater than 20 percent of book value (net of reserves) for three years.

  • The total cost to the taxpayer of resolving LTCB and NCB is expected to be about ¥7 trillion ($64 billion), although there could eventually be capital gains from sales of the DIC’s convertible shares.

22. The reprivatizations of LTCB and NCB represent important steps forward in the process of resolving major banks’ problems. The head of the FRC said that the Ripplewood and Softbank groups’ offers were chosen over those of rival bidders because they minimized the taxpayer’s burden (least-cost principle). The new Shinsei Bank is expected to focus on fee-generating wholesale operations, such as asset securitization, project finance, and brokering mergers and acquisitions, though foreign investment banks in Japan have reportedly not made much money in these areas. The new NCB is expected to concentrate on making loans to high-tech companies and other start-ups, though this could be an expensive way for Softbank to acquire a banking license. Also, both banks still raise funds primarily through debentures and therefore have weak deposit bases, which may become a problem when interest rates start to rise.

23. Shinsei Bank recently made use of its repurchase agreement with the government. LTCB had been an important source of credit for Sogo, a large department store chain, accounting for about ¥200 billion of the retailer’s ¥1.7 trillion debt. These loans remained with Shinsei Bank upon reprivatization, but the bank had the right to sell them to the DIC at face value (along with specific loan loss reserves) if loan quality deteriorated significantly. After facing financial difficulties for several years, Sogo asked its creditors in April 2000 to forgive more than ¥600 billion in debt—the largest such request ever made in Japan. The new management of Shinsei Bank declined to grant the request and exercised its put option with the DIC in late June 2000.

Tokyo Tax

24. The Tokyo municipal government introduced in April 2000 a 3 percent tax on the gross operating profits of large banks. The tax is expected to yield about ¥110 billion in annual tax revenue to the Tokyo government. However, the impact on banks’ after-tax income is expected to be limited, because the new local tax is roughly offset by lower tax obligations on net profits, as the new local tax on gross profits reduces net profits and the tax rate on net profits is reduced by 3 percent.17 The abruptness of the imposition of the tax may have added to the market’s perception of the risk of doing business in Tokyo.

D. Small Banks and Life Insurance

Smaller Deposit-taking Institutions

25. Many second-tier regional banks and cooperative-type financial institutions have asset quality problems that are more severe than those in large banks.18 The summary results of the on-site inspections of second-tier regionals, released in September 1999, showed that bad loan recognition and provisioning were not as advanced as in first-tier regionals. Bad loans (Classes 2–4) at second-tier regionals were found to be 20 percent more than reported in self-assessments, compared to 13 percent more at first-tier regionals. Required loan loss provisions—based on banks’ own loan provisioning standards—for these additional problem loans amounted to 1.1 percent of total credit at second-tier regionals, compared to 0.4 percent at first-tier regionals. Average actual provisions were about 50 percent for Class 3 loans to “in danger of bankruptcy” debtors, compared to the FRC guideline of 70 percent.

26. While a large number of regional banks have raised capital over the past year, capital remains inadequate at many second-tier regionals. More than one third of regional banks raised capital equivalent to 2 percent of their risk-weighted assets, mostly from private sources, increasing the average capital ratio of first-tier regionals to 10 percent and of second-tier regionals to 8 percent as of March 2000. However, a number of the second-tier regionals still have less than 8 percent capital. Small banks might need higher—rather than lower—capital ratios than large banks, because their lending is more geographically concentrated, making them more vulnerable to adverse shocks.

27. The authorities have started addressing problems at weak regional banks, through moral suasion, conditional injections of public funds, and interventions:

  • Consolidation. Reflecting official encouragement, Shonai Bank and Shokusan Bank (both located in the north of Honshu) announced in December 1999 their intention to merge, while North Pacific Bank and Sapporo Bank (both based in Hokkaido) announced in February 2000 a plan to integrate under a holding company.19 There have also been several announcements of joint information technology projects, starting with Bank of Fukuoka and Hiroshima Bank in August 1999.

  • Recapitalization with public funds. Six banks (Ashikaga, Hiroshima-Sogo, Hokkaido, Hokuriku, Kukamoto Family, and Ryukyus) submitted restructuring plans and received a total of ¥335 billion in public funds over the past year. The restructuring plans included employment cuts of 12–16 percent, mostly through attrition and curbs on new hiring, branch reductions of 14–21 percent, declines in bonus payments, cuts in the size of boards of directors, increases in lending margins, and greater lending to small and medium-sized enterprises. The DIC purchased preferred shares, convertible subordinated debt, or a combination thereof, and the banks also raised capital from private sources, raising their capital ratios to above 8 percent.

  • Interventions. Over the past year, the FSA intervened in five banks (Kokumin, Kofuku, Niigata Chuo, Tokyo Sowa, and Namihaya). The government recently reached preliminary agreements to sell both Kofuku and Tokyo Sowa banks to a U.S. investment group.

28. However, consolidation among smaller banks is occurring more slowly than among major banks. Local communities are reluctant to see any change in the status of “their” bank, while zero interest rates reduce the franchise value of “owning” depositors and thus make regional banks less attractive targets for takeovers. Some banks have even persuaded closely-aligned firms to “exchange” deposits for equity, out of concern for the availability of local credit and employment. Also, as in the nonfinancial sector, labor costs are difficult to cut.

29. The tools for addressing problems in credit cooperatives are now being put into place. Credit cooperatives came under the jurisdiction of the FSA in April 2000. The FSA— in cooperation with local finance bureaus—plans to conduct on-site inspections of all credit cooperatives by March 2001. Legislation was recently enacted that allows credit cooperatives to issue preferred equity securities (similar to preferred shares issued by banks) and to apply for public funds (until March 2002). Related legislation allows the use of reorganization proceedings under the Commercial Code to deal with failed institutions.

Life Insurance

30. The overall financial strength of the life insurance sector has continued to deteriorate, reflecting ongoing negative spreads. Premium income, net investment income, and insurance in force all fell in FY1999. The Japan Rating and Information Service, which rates the claims-paying ability of most large and medium-sized life insurers, assigned investment grades to almost all large life insurers, but to fewer than half of medium-sized life insurers (Table IV.6). Some companies have announced plans to reorient their business from term life products to taking care of the retirement and healthcare needs of an aging population.

Table IV.6.

Ratings of Life Insurance Companies

(ranked by size)

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Source: Japan Rating and Investment Service, as reported in the Nikkei Weekly, 9/13/1999.

31. The authorities have made progress in addressing the problems of life insurance companies. Following the implementation of stricter disclosure standards in April 1999, the FSA began on-site inspections of loan portfolios using stronger examination standards in May 1999, which is leading to more realistic recognition of and provisioning for bad loans. The FSA intervened in Toho Mutual Life in June 1999 and in Daihyaku Mutual Life in May 2000. According to press reports, the FSA also ordered Taisho Life Insurance Company to submit a rehabilitation plan, after the inspection revealed serious weaknesses. Toho’s negative net worth (about ¥650 billion) was covered by the Life Insurance Policyholders Protection Corporation (about ¥380 billion) and a reduction in future guaranteed rates of return on life insurance policies (about ¥270 billion). GE Edison Life took over Toho’s policies in March 2000. Separately, Aoba Life—the successor of Nissan Mutual Life, which failed in April 1997—was sold in November 1999 to Artemis, the holding company of the French retail group Pinault-Printemps-Redoute.

32. Legislation was enacted that strengthens the regulation of life insurers and allows them to apply for court-supervised rehabilitation. Under the new law, life insurers are required to project over five years the main components of their balance sheets and report these to the FSA. At the same time, life insurers are allowed to apply for reorganization under the Corporate Rehabilitation Law and—with court approval—to lower future guaranteed rates of return on policies. The legislation also facilitates the procedures for mutual insurance companies, which are owned by their policyholders (making it difficult for management to raise capital or sell the business), to reorganize as ordinary stock corporations (demutualization). Finally, the legislation increased the government-guaranteed borrowing limit of the Life Insurance Policyholders Protection Corporation by ¥500 billion, as its notional resources have been exhausted by the failure of Toho, and made the guarantee permanent. The government’s guarantee of the fund’s borrowing—enacted in December 1998—is expected to be withdrawn in March 2001, as originally planned.

33. The sale of some insurance products through banks, which will be allowed as of April 2001, is expected to increase competition and link the reorganization of the insurance industry with that of the banking sector.20 Hitherto, life insurers have sold policies mostly through salespeople. Anticipating the regulatory change, some insurers have begun strengthening ties with banks, so that these banks will sell their insurance products. The reorganization of marketing systems, especially in-house sales staff, is expected to be key to long-term survival.


  • Atkinson, David, Tomishi Ishida, and Hideyuki Ishii, “City Bank Profitability in the 1990s,” Goldman Sachs Investment Research, February 2000.

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  • International Monetary Fund, Japan: Economic and Policy Developments, IMF Staff Country Report No. 99/114, October 1999.

  • Kuwayama, Patricia Hagan, Postal Banking in the United States and Japan: A Comparative Analysis, Bank of Japan, Institute for Monetary and Economic Studies, Discussion Paper No. 99-E-18, June 1999.

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  • Morsink, James, and Tamim Bayoumi, “Monetary Policy Transmission in Japan,” in Tamim Bayoumi and Charles Collyns (eds.), Post Bubble Blues: How Japan Responded to Asset Price Collapse, Washington: IMF, 2000.

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Prepared by James Morsink (ext. 37875).


Banks with exclusively domestic operations are required to hold 4 percent capital, does not include 45 percent of unrealized gains on securities.


Another firm is a subsidiary if the bank’s equity stake is above 20 percent but below 50 percent, or if the stake is below 20 percent but the bank wields effective control. If the bank’s stake is above 50 percent, the other firm (except insurance companies) must be consolidated.


In October 1998, the total amount of public funds available to deal with banking problems had been set at ¥60 trillion, of which ¥25 trillion was targeted at the recapitalization of weak but solvent banks, ¥18 trillion at nationalization and bridge banks, and ¥17 trillion at protecting depositors (see Chapter IV in IMF, 1999).


No new banking license has been issued for fifty years.


Liquid deposits are defined as those used for transactions purposes. They include checking and savings deposits, but not time deposits or certificates of deposit.


Major banks’ total Class 2 loans amounted to ¥37.7 trillion as of September 1999, according to the summary information released by the FSA on banks’ self-assessments of asset quality, which is another source of information on the extent of bad loans.


At present, most banks report the value of their equity holdings at the cost of acquisition, which limits the downside exposure of their balance sheets, though banks using this valuation method may not include any unrealized gains as part of capital.


A 100 bps rise in JGB yields—as occurred between October 1998 and January 1999— would lead to a valuation loss at major banks of about ¥1.1 trillion (about one-third of operating profits or less than 5 percent of Tier-1 capital). By comparison, a 1,000 point fall in the Nikkei stock price index would reduce the market value of equity holdings by about ¥2.2 trillion.


The average ratio of operating costs to revenues (excluding realized gains on investment bonds) was 61 percent for Japanese city banks in 1999, compared to 68 percent for U.S. money center banks (see Atkinson, Ishida, and Ishii 2000).


Long-term savings deposits are in fact very liquid, as they can be redeemed without penalty after six months, which provides an attractive hedge against an increase in interest rates. Although the interest rate on postal savings deposits is set as a fraction (usually about 90 percent) of the average 3-year deposit rate at private banks, the differential is not sufficient—especially when interest rates are low—to compensate for the nonpecuniary benefits of postal savings deposits.


The previously-announced merger between Chuo Trust and Mitsui Trust took place as planned in April 2000, creating Chuo Mitsui Trust Bank.


For example, DKB, the product of a 1971 merger between Dai-Ichi Bank and Nippon Kangyo Bank, reportedly remains divided between its two constituent camps. More recent mergers, including Sakura Bank (Mitsui Bank and Taiyo Kobe Bank in 1990), Asahi Bank (Kyowa Bank and Saitama Bank in 1991), and Bank of Tokyo-Mitsubishi (Bank of Tokyo and Mitsubishi Bank in 1996), also are also said to have had trouble paring staff and operations, and melding different business cultures.


Both banks were nationalized in part because their franchises as providers of long-term credit to the industrial sector had largely disappeared.


The other main members of the group are Tokio Marine and Fire Insurance Company and Orix Corporation, a large leasing firm.


The equities portfolios were sold to the DIC, which placed them back with the banks. This arrangement (i) allowed the realization of capital gains, which improved capitalization, (ii) removed the new banks’ exposures to the stock market, and (iii) allowed the new banks to retain control of the assets, which protected the franchises that the banks possessed through mutual cross-shareholdings with corporate borrowers.


Consider the following example: gross profits are ¥500 and expenses are ¥300. Absent the Tokyo tax, net profits are ¥200, the tax on net profits is ¥84 (42 percent), so net income is ¥116. With the Tokyo tax (3 percent of gross profits generated in Tokyo, say 50 percent), net profits are ¥193, the tax on net profits is ¥75 (39 percent), so net income is ¥117.


Second-tier regional banks and cooperative-type financial institutions together account for 40 percent of deposits.


Regional banks generally have higher expense ratios than major banks, mostly because of more extensive branch networks (relative to asset size), so there could be scope to cut costs.


For example, banks will be allowed to sell life insurance products linked to mortgages and fire insurance for home owners.

Japan: Economic and Policy Developments
Author: International Monetary Fund