(Provisional translation)
Report of the Financial System Council

Measures for Ensuring the Stability of the Payment and Settlement
Functions of Financial Institutions(Executive Summary)
1. Preface
It is desirable for the entire financial system to become efficient through further
serious efforts by financial institutions to improve their financial and managerialbase under appropriate pressure. From this viewpoint, it is appropriate for thedeposit insurance system to return to a partial coverage system to protect small
depositors, i.e. lift the current blanket deposit protection system.
Based on the Prime Minister’s instructions, the Project Team has examined whether
the payment and settlement network is sufficiently solid as a social infrastructure,
and what measures are necessary for ensuring the stability of the payment andsettlement functions of financial institutions.
2. Current state and future agenda for ensuring the stability of the financial
payment and settlement functions(1) Principal consideration in ensuring the stability of the payment and settlement
functions•It is indispensable in the interest of the public to ensure the stability of thepayment and settlement functions performed by financial institutions, as mostof the payments and settlements in our economy are conducted through thischannel.

•In Japan, the mainstream of payments and settlements are made throughdirect debits from accounts opened with financial institutions and accounttransfers between financial institutions. This is very different from othermajor countries in which the cheque is used as the principal means of payment
and settlement. There is a large difference among countries with regard to
the approach to the issue of the stability of the payment and settlement
functions, depending on legislation regarding the protection of deposits and theresolution procedure for failed financial institutions.
1•Therefore, it is necessary to consider the appropriate measures in light of thesituation in Japan, not necessarily modelled after the examples of othercountries.

(2) Measures hitherto taken and the current agenda for ensuring the stability of thepayment and settlement functions○ Measures to reduce payment and settlement risks of financial institutions andsystemic risks within the financial system.
On-site inspections and off-site supervision by the FSA, and examinations by
the BOJ have been implemented for individual financial institutions.
Measures have been implemented to reduce systemic risks in the payment andsettlement systems. It is expected that the development of a new system in thebill clearing system and the domestic money transfer system will reduce therisks of financial institutions and contribute to the smooth completion ofpayments and settlements in the event of a failure of a financial institution.
○Measures the minimise the risk in the event of a failure of a financial institution
・ Prompt procedures to wind down failed financial institutions have been
implemented with an amendment of the Deposit Insurance Law in 2000.
・The status of the system for sorting depositor identification data has beeninspected during on-site inspection; however, there is room for improvementwith respect to data processing in this regard.
3. New measures for ensuring the stability of the payment and settlement functions(1) Basic conditions of the new measures•

In order to ensure the stability of the payment and settlement functions in theevent of a failure of a financial institution, it is essential to provide for early
detection and prompt correction of the situation in the troubled financialinstitution, and to rapidly implement the procedure for winding it down . Suchaction will minimise the effect on the orderly functioning of the institution,including the payment and settlement functions.

•The stability of the payment and settlement functions should be achieved
basically through ensuring the soundness of the financial institutions.
Therefore, the following measures to ensure the stability of the payment andsettlement functions should be designed as measures to prepare for a case inwhich the soundness of the financial institution is impaired in an exceptional
circumstance.

2•

Based on the above, the basic conditions for the measures to ensure thestability of the payment and settlement functions should be to provide for a safeand secure means of payment and settlement other than cash, and to make it
accessible to everyone, as a safety net for payments and settlements involving
financial institutions.

(2) Framework of the measures•

After the termination of the blanket deposit protection system, there can becases in which payment and settlements cannot be conducted in the event of a
failure of a financial institution. There can also be cases in which payment andsettlement transactions cannot be completed for transactions in process, even if
the resolution procedure for failed financial institutions is promptly
accomplished.

•In order to address such concerns, a type of deposit should be provided as a safe
and secure means of payment and settlement, which is a deposit to be protected
fully in the event of a failure of a financial institution (“payment and settlement
deposit”). It is also necessary to prepare measures to ensure the completion of
payment and settlement transactions in process.

(3) Provide a safe means of payment and settlement○ The “payment and settlement deposit” as a safe means of payment andsettlement
It is appropriate to make the “payment and settlement deposit” widely available,
as a deposit to be used exclusively, in principle, for payment and settlement.
○ Definition of the “payment and settlement deposit” (the basic features aredetermined, and defined by its function)
The “payment and settlement deposit” is defined as a type of deposit meeting thethree conditions below;•••

Deposit redeemable on demand
Provides normally required payment and settlement services
Bearing no interest(Note) As the “payment and settlement deposit” is defined as a legal concept, thequestion of which existing deposit categories are to be classified as “payment andsettlement deposits” i s an issue to be resolved in practice . For instance, the“current deposit” is clearly categorised as a payment and settlement deposit. If
an “ordinary deposit” account yields no interest, it is also categorised as apayment and settlement deposit.
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○ Funding of the full protection
It is appropriate to fund the full protection for the payment and settlement depositby the deposit insurance premium, and differentiate the rate of the premium fromthat for other types of deposits.
○ Ensuring the availability of the payment and settlement deposit in financial
institutions
Financial institutions are urged to provide “payment and settlement
deposits” to depositors requiring them, in view of the public interest and thenetwork characteristics of payment and settlement.
However, it is not
appropriate to impose a legal obligation to provide such deposits, since it may
hamper the entry of financial institutions with innovative business models.
Financial institutions are also strongly urged to promote the appropriate useof “payment and settlement deposits” in order to minimise the risk s of large
payment and settlement transactions.
○ Moral hazard arising from the full protection of “payment and settlementdeposits”
Since zero interest incurs costs to the depositor (including opportunity cost),
there will be a disincentive for depositors to deposit funds in excess of what istruly necessary for payment and settlement.
A higher insurance premium for the “payment and settlement deposit” canalso act as a restraint for financial institutions to collect additional funds throughthis means at no cost.
(4) Another option (an alternative scheme to protect “payment and settlement
deposits” by a narrow bank account)
This is a scheme using a trust account which separates the “payment andsettlement deposit” from other types of deposits, and which limits the investmentof funds in this account to that in safe and liquid assets (such as JGBs). The
advantage of such a scheme is to enable the provision of a safe means of payment
and settlement with lower insurance premium cost. There can be a choice
between this scheme and a system of full protection of those deposits under thedeposit insurance system.
(5) Completion of payment and settlement transactions in process
Based on the above, it is possible to complete an ongoing payment andsettlement transaction smoothly if the funds are kept in a separate deposit
account bearing no interest, since it is fully protected as a “payment andsettlement deposit”.
4However, some funds for payment and settlement transactions in process, suchas those kept as temporary receivables or as a deposit in the name of thefinancial institution, are not covered by the current deposit insurance system, andcannot be used to complete the payment and settlement transaction in the event ofa failure of a financial institution.
Thus, in order to complete such payment and settlement transactions, it isappropriate to clearly segregate the funds for payment and settlement in process,and to take the necessary measures to provide temporary funding such as loans
from the Deposit Insurance Corporation.
(6) Prompt procedures for the resolution of failed financial institutions
In order to ensure the stability of the payment and settlement functions, it is still
important to speed up the procedures for the resolution of failed financialinstitutions. In order to further provide for a smooth and rapid resolution of
failed financial institutions through measures such as an improved sorting systemfor depositor data, it is appropriate to take the necessary measures.
4. Consideration in amending the system(1) Agenda for the future
The need to ensure the stability of the payment and settlement functions is
not temporary. However, it is necessary to review the measures above, as
necessary, based on the principle of a least costly deposit insurance system.
The scheme mentioned above to ensure the safety of the “payment andsettlement deposit” by a trust account is an attractive system which meets theprinciple of a least costly deposit insurance system. However, given the current
earning structure and possible effects on the financial intermediary function offinancial institutions in Japan, this alternative scheme should be considered forpossible implementation in the medium to longer term.
(2) Consideration upon implementation•Sufficient consideration should be made of the need to develop necessary
computer software in financial institutions.

•When making available the payment and settlement deposit, financial
institutions must not impose an undue burden on, or require unnecessary
procedures with their customers, and consider the convenience of theircustomers.

5•In order to prevent any confusion or concern of depositors, financial
institutions must provide adequate explanation to depositors, and thegovernment should actively provide information to the public.
(Note) For many depositors, particularly for individual depositors, it should be madeclear once again that deposits are protected under the small deposit protection
system up to a ceiling of 10 million-yen for the principal, plus the interest thereon,
per depositor even after the lifting of the full protection system.
5. Closing remark
Concerning the payment and settlement system, measures to further reduce
the risks of the domestic money transfer system is under consideration. Inaddition, measures are in progress to enable a more prompt resolution of failed
financial institutions
In addition to such measures, it is anticipated that the stability of thepayment and settlement functions in our economy is further reinforced byproviding for a safe and secure means of payment and settlement as a safety net.

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