United States General Accounting Office

GAO Report to the Honorable

Charles E. Schumer

House of Representatives

December 1996 BANK REGULATORY

STRUCTURE

Japan

G O A

years

1921 - 1996

GAO/GGD-97-5

GAO United States

General Accounting Office

Washington, D.C. 20548

General Government Division

B-270597 

December 27, 1996

The Honorable Charles E. Schumer

House of Representatives

Dear Mr. Schumer:

Proposals by various parties to consolidate United States bank regulatory agencies have raised

questions about how other countries structure and carry out their bank oversight

responsibilities and central bank activities. You asked us to provide you with information about

the structure and operations of regulatory and supervisory activities in several countries. This

report presents information on Japan. It describes the Japanese bank regulatory structure and

its key participants, how that structure functions, how banks are supervised in Japan, and how

participants handle other financial system responsibilities.

We are sending copies of this report to Members of the House and Senate banking committees,

other congressional committees and subcommittees, and other interested parties. We will also

make copies available to others on request.

This report was prepared under the direction of Kane A. Wong, Assistant Director, Financial

Institutions and Markets Issues. If you have any questions, please call me on (202) 512-8678.

Other major contributors are listed in appendix II.

Sincerely yours,

James L. Bothwell, Director

Financial Institutions

 and Markets Issues
Executive Summary

Purpose Proposals by various parties to consolidate U.S. bank regulatory agencies

have raised questions about how other countries structure and carry out

their bank oversight responsibilities and central bank activities.

Congressman Charles E. Schumer asked GAO to provide information about

the structure and operations of such activities in several countries.1

 This

report provides information on bank oversight in Japan.

GAO’s objectives were to describe how (1) Japanese bank regulation and

supervision is organized; (2) Japan’s banking oversight structure

functions, particularly with respect to bank licensing, regulation, and

supervision; (3) Japanese banks are monitored by their supervisors; and

(4) participants handle other financial system responsibilities. As with its

reports on the structure of bank regulation and oversight in other

countries, GAO did not attempt to assess the adequacy of bank supervision

in Japan. Most of the information GAO gathered in this report, including

translations and explanations of pertinent laws and recent changes to

those laws, was obtained from Japanese officials and banking industry

representatives.

It is important to note that GAO’s work took place during a period in which

the Japanese system for supervising banks was being revised with the

intent of strengthening oversight. Such revisions continue and reflect an

attempt to respond to problems that became evident when the economic

boom of the 1980s was followed by a period of economic stagnation that

brought significant declines in real estate and stock market prices. These

falling prices helped generate a sizeable inventory of nonperforming loans

across the Japanese financial services industry, estimated by the Ministry

of Finance (MOF) to be 34.8 trillion yen ($326 billion)2

 as of March 1996.

The nonperforming loan problem contributed to the failure of several

financial institutions, including regional banks, credit cooperatives and

seven housing loan companies. The estimated cost of resolving or

disposing of failing institutions over the last 4 years was about 2 trillion

yen ($19 billion) to 2.5 trillion yen ($24 billion), including over $7 billion in

assistance provided by the Japanese Deposit Insurance Fund.

1

For information on GAO’s issued reports on the British, German, French, and Canadian regulatory

systems, see Bank Regulatory Structure: The United Kingdom (GAO/GGD-95-38, Dec. 29, 1994); Bank

Regulatory Structure: The Federal Republic of Germany (GAO/GGD-94-134BR, May 9, 1994; Bank

Regulatory Structure: France (GAO/GGD-95-152, Aug. 31, 1995) and; Bank Regulatory Structure:

Canada (GAO/GGD-95-223, Sept. 28, 1995). We also issued a capping report drawing lessons for the

U.S. regulatory system from the foreign countries, Bank Oversight Structure: U.S. and Foreign

Experience May Offer Lessons for Modernizing U.S. Structure,(GAO/GGD-97-23, Nov. 20, 1996).

2

Exchange rate of 106.6 yen per U.S. dollar, as of Apr. 25, 1996.

Page 2 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Executive Summary

Several additional steps have recently been taken to help address these

problems, including an appropriation of 680 billion yen ($6.4 billion) to aid

in resolving an estimated 6.3 trillion yen ($59 billion) in nonrecoverable

loans for the seven failed housing loan companies. A substantial increase

in the deposit insurance premiums assessed on Japanese banks was also

authorized to provide funds for resolving additional failures expected over

the next 5 years and to help rebuild the deposit insurance fund. In

addition, several laws, enacted in June 1996, were intended to improve the

Japanese oversight of financial institutions. Other reforms were under

consideration at the time GAO concluded its work.

It is also important to note that, while U.S. supervisors rely heavily on

written orders or directives, in Japan, direction and guidance is more often

provided through frequent—almost daily—contacts between bank officials

and officials of MOF and the Bank of Japan (BOJ), the two bodies

responsible for safety and soundness of the banking system. This report

focuses more attention on describing the legal structure within which

Japanese banking oversight has been conducted and less attention on the

methods used to carry out that oversight.

Background The Japanese banking system is a highly segmented structure that includes

various types of private institutions as well as several government

institutions and Japan’s central bank. This structure is a legacy of reforms

originally instituted to promote economic recovery during the post-World

War II period. Since the 1970s, some actions have been taken to eliminate

certain distinctions among the different types of banks and broaden the

markets they serve. Consequently, although important limitations and

prohibitions still apply, banks now can engage in a variety of previously

restricted financial activities. The 1,130 financial institutions operating in

Japan as of March 31, 1995, held 1,148 trillion yen ($10.8 trillion) in

combined assets.

More than half, or 53 percent, of these industry assets were held by

Japan’s “ordinary banks,” which mainly focus on short-term financing. At

the time of GAO’s review, 11 of Japan’s 140 domestically-owned ordinary

banks were large city banks,3

 and 129 were regional banks. Based on total

assets, as of December 1995, the six largest banks in the world were

Japanese city banks. Also categorized as ordinary banks were 90

foreign-owned bank branches operating in Japan, of which 16 were owned

3

As of Apr. 1, 1996, Mitsubishi Bank and the Bank of Tokyo merged, reducing the number of Japanese

city banks to 10.

Page 3 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Executive Summary

by U.S. concerns. The remaining 47 percent of industry assets were held

by specialized financial institutions. Included in this group were 3

long-term credit banks, which are permitted to issue bank debentures with

up to 5-year maturities; 7 trust banks;4

 794 financial institutions serving

small businesses; 48 agricultural, forestry, and fisheries cooperatives;5

 and

48 other institutions.6

Since 1928, two institutions have monitored the safety and soundness of

the Japan’s banking industry—MOF and BOJ, Japan’s central bank. Although

MOF’s legal authority to supervise banks was first granted in 1872, BOJ

began examining banks in 1928 on the basis of its contractual agreements

with client banks, as recommended by the Financial System Research

Council—an advisory council to the Minister of Finance. In 1942, the Bank

of Japan Law gave BOJ the mission of maintaining and fostering a safe and

sound financial system, thus giving BOJ what it believes is a stronger

statutory basis to conduct on-site examinations of its client banks.7

In 1949, the Ministry of Finance Establishment Law gave MOF its current

broad responsibility for the government’s fiscal and related monetary

functions, including budget formulation,8

 tax assessment and collection, as

well as for the supervision and inspection of banks and securities firms.

Also in 1949, amendments to the Bank of Japan Law gave BOJ

responsibilities for formulating and implementing monetary policy.

With respect to banks, MOF’s regulatory and supervisory responsibilities

are set out in the Banking Law of 1981, which was prompted by economic

and financial changes in Japan following the early 1970s oil crisis.

Allowable activities for Japanese financial institutions were further

expanded in 1992 with the passage of the Financial System Reform Law.

The 1992 law, which eliminated many differences among financial

institutions, allowed banks to engage in securities and trust activities

through their subsidiaries. The law also provided MOF with the authority to

4

In addition to these seven traditional trust banks, there were seven trust bank subsidiaries and nine

foreign-owned trust banks as of Mar. 1995.

5

These cooperative-based credit federations represented a total of 4,080 local agricultural and fishery

cooperatives at the local, town, and village level of government.

6

Other institutions included the Shoko Chukin Bank (a special corporation for providing financial

assistance to unions of small- and medium-sized enterprises) and 47 labor banks.

7

In Japan, the term supervisor is used only to describe government agencies, according to MOF. Since

BOJ is not a government agency, it is not described as a supervisor in Japan, even though BOJ does

perform some of the supervisory functions described below.

8

The formulation, execution, and coordination of the national budget allows MOF to play a pivotal role

within the national government. This role currently includes approving BOJ’s budget.

Page 4 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Executive Summary

establish standards to safeguard the soundness of banks and controls over

transactions between banks and their subsidiaries.

The Deposit Insurance Corporation of Japan (DIC) was established as a

special corporation in 1971 to protect depositors and maintain the stability

of the financial system. The DIC serves these purposes by insuring

individual depositors for up to 10 million yen ($93,800) and by providing

financial assistance to facilitate the merger or acquisition of failing

financial institutions. The DIC is supervised by MOF.

Results in Brief In Japan, two entities are responsible for ensuring the safety and

soundness of the nation’s banking system—MOF and BOJ. MOF, as a

governmental agency, has the sole responsibility for licensing banking

institutions and for developing and enforcing banking regulations. In

addition to its power to order business suspensions and to rescind a

bank’s license, MOF can seek the imposition of fines, and, in some cases,

imprisonment as enforcement measures. Although MOF officials said there

have been no cases in which it has had to impose fines or seek

imprisonment, it has used its power to order business suspensions.

MOF supervises through on-site and off-site monitoring to assess

(1) compliance with laws and regulations and (2) soundness of financial

institutions. MOF also uses its frequent—almost daily—contact with bank

officials to gather information as well as to discuss supervisory concerns

and to provide guidance. BOJ is not a governmental entity and has no

regulatory authority. However, in order to fulfill its responsibility

stipulated in the Bank of Japan Law, BOJ has contractual arrangements

with 700 financial institutions, including all commercial banks, that allow

it to examine these institutions and provide advice. BOJ conducts

examinations to assess the safety and soundness of these financial

institutions and, ultimately, the safety of the financial system. It also

maintains oversight through frequent contacts with its client institutions.

Over the period 1990 to 1994, MOF and BOJ have examined approximately

500 banks annually. MOF and BOJ do not regularly share information

obtained during their separate on-site monitoring visits to the same banks,

but they do work together on a case-by-case basis to resolve crisis

situations.

In June 1996, several bills were enacted to help improve bank inspection

and supervision in response to a series of failures of credit cooperatives,

regional banks, and housing loan companies. The bills contained

Page 5 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Executive Summary

provisions designed to prevent the recurrence of problems with bad loans,

to improve disposal of failing or failed financial institutions, and to provide

additional funding for the Deposit Insurance Fund in anticipation of more

potential failures over the next 5 years. In addition, other reforms affecting

the banking system are under discussion.

Apart from their respective safety and soundness functions, MOF and BOJ

have other financial system responsibilities. In connection with its

responsibility to maintain the financial system’s stability, BOJ is the lender

of last resort. As the central bank, BOJ can provide funds to banks in

trouble or to the system as a whole if there is no alternative financial

provider of liquidity to prevent a systemic crisis, and such liquidity is

needed. Under the Bank of Japan Law, BOJ sets monetary policy and the

interest rate, known as the official discount rate, at which it loans or

discounts bills for its client banks. In other areas, MOF and BOJ share

responsibilities for such functions as failure resolution and representing

Japan’s interests in international forums.

Figure 1: Responsibility for Bank Regulatory and Related Functions in Japan

Responsible entity
 Developing laws


Developing

 regulations

Issuing regulations


Licensing banks

Bank information 

reporting and analysis

Bank inspections/

examinations

Developing

enforcement actions

Enforcement authority

Failure resolution

Liquidity provider

Crisis management

Payments clearance 

system

International forum

 representative

Deposit insurance

Lender of last resort

MOF


BOJ


DICa

Private bankers associations

aJapan’s deposit insurance system is administered by the Deposit Insurance Corporation.

Source: Japanese laws, bank regulation, and other materials obtained from Japanese sources.

Page 6 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Executive Summary

Principal Findings

MOF and BOJ Authorities

Differ Concerning the

Safety and Soundness of

Financial Institutions

Although both MOF and BOJ have responsibilities for the safety and

soundness of the financial system, the basis for their respective authority

is different. The Japanese parliamentary system and Japanese law gives

MOF wide-ranging and diverse responsibilities to supervise and inspect

financial institutions. In contrast, BOJ’s oversight authority is obtained

through its contractual agreements with client financial institutions. This

contractual relationship allows BOJ to conduct examinations of and

provide advice to its client financial institutions, which is necessary for it

to fulfill its responsibilities for the soundness of the financial system

stipulated in the 1942 BOJ law.

Although MOF and BOJ are responsible for the safety and soundness of the

financial system and the guidance of banks, they function largely

independently of each other. Moreover, only MOF has the legal authority to

take enforcement actions against financial institutions, which could lead

to fines, imprisonment, and licensing revocation resulting in closure of the

institution. Although, according to MOF officials, there have been no cases

in which MOF has had to impose fines or seek imprisonment, it has ordered

suspension of business. For the most part, MOF has taken supervisory

action through administrative notifications, such as issuing circulars,

although the guidance provided through such notifications is not legally

enforceable. Officials said that the use of administrative guidance has long

served as a major instrument in Japan’s approach to bank supervision.

According to banking officials, banks are expected to act on MOF’s

guidance and do so. The number of cases in which MOF gave major banks

what it calls “concrete” guidance, for the purpose of improving bank

performance, totaled 127 in 1994. In addition to these cases, MOF also

provides guidance through frequent contacts with banks.

BOJ has no legal authority to take enforcement actions against financial

institutions. However, it does provide advice to these institutions through

frequent contacts. According to officials from several banks GAO visited,

this advice is typically treated as binding by Japanese financial

institutions.

MOF Has Responsibility

Over Licensing and

Regulation

Under the 1981 Banking Law, MOF is responsible for regulating and

supervising Japan’s banking system. MOF licenses, regulates, and

Page 7 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Executive Summary

supervises banks that accept deposits or installment savings and lend

money, discount bills, or conduct exchange transactions.

Under the 1981 Banking Law, MOF’s role is to protect depositors and

maintain an orderly credit system. According to the law, applicants must

obtain a license from MOF before engaging in banking. MOF is responsible

for determining whether applicants meet licensing criteria, such as

whether they have adequate financial means to carry out banking

business. MOF also has the authority to suspend business operations or

revoke licenses for violations of any law, articles of incorporation, or MOF

measures designed to protect the public interest. In addition, MOF may

impose conditions on a banking license when it considers it in the public

interest.

MOF and BOJ Rely on

On-Site and Off-Site

Monitoring to Carry Out

Safety and Soundness

Responsibilities

MOF and BOJ obtain information needed to fulfill their safety and soundness

responsibilities primarily through on-site and off-site monitoring. As part

of their off-site monitoring, MOF and BOJ officials request various bank

reports and conduct their own independent analyses. Japanese authorities

also rely heavily on their day-to-day contacts with banks, which allow

them to keep abreast of the financial condition and operations of the

institutions they oversee. In addition, banks are required to submit reports

to MOF twice a year on their business and financial condition. These

reports are also submitted to BOJ. Banks submit more frequent periodic

reports to BOJ covering such matters as deposits with BOJ, commercial

paper, extensions of credit, and securities activities.

MOF has the authority to investigate banks at any time for the purpose of

ensuring sound and appropriate bank management. MOF conducts two

types of on-site inspections—comprehensive inspections and inspections

focusing on specific aspects of a bank’s operation, such as credit-risk or

market-risk management. MOF’s comprehensive inspections, which are

unannounced, concentrate on banks’ risk management, profitability, asset

quality, and compliance with regulations.

For the purpose of meeting its responsibility for the overall safety and

soundness of Japan’s financial system, BOJ conducts on-site examinations

that focus on the business operations of institutions, with special attention

paid to assessing overall risk management. BOJ’s examination authority is

based on contractual agreements BOJ reaches with institutions at the time

they open their accounts with the central bank. All major Japanese banks,

including ordinary banks, long-term credit institutions, and most shinkin

Page 8 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Executive Summary

banks,9 have current accounts with BOJ. BOJ typically provides banks with 2

months advance notice before an on-site examination. BOJ also requests

bank reports before such examinations. BOJ’s examinations review

management, credit, market, foreign exchange, liquidity, operations,

electronic data processing, and systemic risks.

To date, MOF and BOJ have not typically used independent external auditors

to provide information on the banks they monitor. Although banks are

subject to Commercial Code10 provisions requiring them to obtain

independent audits and do so, MOF and BOJ officials told GAO that they

depend on their own on-site and off-site monitoring processes to obtain

necessary information.

Increases in

Nonperforming Loans and

Financial Institution

Failures Caused Japan to

Review Role of Banking

Authorities

During 1995 and early 1996, Japanese banks and the banking system were

confronted with several events that prompted the authorities to enhance

the regulatory and supervisory system’s ability to deal with industry

problems. These events included mounting levels of nonperforming loans,

an inadequately funded deposit insurance fund; financial institution

failures, including seven housing loan companies; and improper trading by

an employee of a city bank with offices in New York.

Economic changes, including Japan’s stagnant economy and declining real

estate prices, have led in the past several years to sharp increases in

publicly reported nonperforming loans held by Japanese banks and other

deposit-taking institutions, estimated by MOF to total at least 34.8 trillion

yen ($326 billion) as of March 1996. Concerns have increased about the

adequacy of the deposit insurance fund as losses from nonperforming

loans have caused several financial institutions to fail. In the last 2 years,

outlays of financial assistance provided to assist in the resolution of failing

institutions have come close to depleting the deposit insurance fund,

according to Japanese government officials.

The Japanese government recently designed a plan aimed at rebuilding

public confidence and protecting depositors. In June 1996, the Diet passed

several bills intended to provide new and more effective enforcement and

resolution powers and to better protect depositors. Key features of the

bills were (1) a system of prompt corrective action based on capital

adequacy ratios, (2) a system under which supervisory authorities would

9

Shinkin banks are cooperatives serving the financial needs of small companies and local residents.

10The Japanese Commercial Code, administered by the Ministry of Justice, was promulgated in 1890 to

designate rules for conducting business.

Page 9 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Executive Summary

be able to initiate proceedings for a financial institution’s reorganization or

bankruptcy, and (3) creation of a special premium for deposit insurance

and governmental guarantees for borrowings by DIC for the disposal of

failed credit cooperatives.

In September 1995, a Japanese city bank with offices in New York

reported to the U.S. Federal Reserve that a securities trader in its New

York office had initiated improper trades over an 11-year period that had

gone undetected in inspections. Reported losses resulting from the

unauthorized trading activities amounted to over $1 billion. The following

month, U.S. banking authorities issued cease and desist orders against the

bank requiring a virtual cessation of trading activities in the United States.

In November 1995, MOF also took action intended to correct what were

viewed as inadequate management of overseas practices at the city bank.

MOF stated that it has committed itself to strengthening its supervision and

inspection of overseas branches and offices of Japanese banks. BOJ also

announced measures to improve and enhance examinations.

MOF and BOJ Have Other

Financial System

Responsibilities

MOF and BOJ have other financial system responsibilities, some of which

they share. BOJ has responsibility for setting monetary policy, thus

influencing the nation’s money supply and interest rates. It also acts as the

lender of last resort—a function unique to the central bank. Additionally,

BOJ has a key role in administering the payments clearance system in

Japan.

BOJ and MOF share responsibilities for the deposit insurance system. MOF

supervises DIC and plays an active role in approving key appointments and

financial assistance decisions. If requested by DIC, BOJ staff handle

administrative functions of DIC on an as-needed basis with the approval of

MOF. The Minister of Finance appoints the Governor, and MOF approves the

executive directors and committee member appointments to DIC. In

addition, MOF must initially approve all applications for financial assistance

to financial institutions.

Page 10 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Executive Summary

MOF and BOJ both represent Japan in a number of international forums,

including the Group of Seven,11 the Group of Ten,12 the Basle Committee,13

 and the International Monetary Fund. In addition, both participate in the

Organization for Economic Cooperation and Development.

MOF and BOJ also work together in crisis management situations involving

financial institutions. As the lender of last resort, BOJ can provide liquidity

to troubled financial institutions or the financial system to prevent a

systemic crisis. According to BOJ officials, in rare cases, BOJ has provided

liquidity without eligible collateral.14 They added that the following four

conditions should be met before BOJ provides liquidity:

• There must be a strong likelihood that systemic risk will materialize;

• Central bank financial support must be indispensable to maintain the

stability of the financial system;

• All parties responsible for the institution’s problems must be penalized so

as to avoid the emergence of moral hazard; and

• The financial soundness of the central bank must be maintained.

Recommendations This report contains no recommendations.

Agency Comments Senior officials from MOF, BOJ, DIC, the Federation of Bankers Associations

of Japan, the Japanese Institute of Certified Public Accountants, and the

three city banks GAO visited provided comments on a draft of this report.

These comments were incorporated in the report where appropriate.

11The Group of Seven is a group of seven major industrial countries whose finance ministers and

central bank governors meet occasionally. The seven countries include the United States, the United

Kingdom, Germany, Japan, Canada, France, and Italy.

12The Group of Ten is a group of 11 major countries whose representatives meet to discuss issues of

mutual concern. The participating countries include Germany, Belgium, Canada, the United States,

France, the United Kingdom, Italy, Japan, the Netherlands, Sweden, and Switzerland.

13The primary purpose of the Basle Committee, which operates under the auspices of the Bank for

International Settlements, is to address bank supervision-related issues. It is made up of the banking

supervisors and central banks of the Group of Ten countries.

14The Bank of Japan Law allows the bank to make loans against collateral in the form of bills or notes,

government bonds and obligations, and other negotiable securities, gold and silver bullion, or

merchandise. These are considered “eligible” collateral.

Page 11 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Contents

Executive Summary 2

Chapter 1 

Introduction

14

Overview of Japanese Financial Institutions 14

History of Bank Regulation and Supervision in Japan 18

Overview of Participants in Bank Licensing, Regulation, and

Supervision

24

Objectives, Scope, and Methodology 29

Chapter 2 

Licensing, Regulation,

and Supervision of

Banks

32

MOF Licenses Banks 32

Regulatory Responsibility Belongs to MOF 33

BOJ as the Bankers’ Bank 35

Ensuring Safety and Soundness of Banks 35

MOF and BOJ Rely on Guidance and Advice 37

Increases in Nonperforming Loans and Financial Institution

Failures Caused Japan to Review Role of Banking Authorities

38

Chapter 3 

Safety and Soundness

Information Is

Obtained Through

On-Site and Off-Site

Monitoring

40

On-Site Monitoring Conducted Independently 40

MOF Inspections 40

BOJ Examinations 42

Results Are Provided Orally and in Writing by MOF and BOJ 44

Off-Site Monitoring by MOF and BOJ 44

MOF and BOJ Share Monitoring Information When Necessary 45

Limited Use of Independent Auditors 46

Chapter 4 

BOJ and MOF Have

Other Financial

System

Responsibilities; DIC

Administers Deposit

Protection

48

Liquidity Provider 48

Lender of Last Resort 48

Payments Clearance 49

Participation in International Organizations 49

Crisis Management and Resolution of Troubled Institutions 50

Deposit Insurance Is Administered by DIC 50

Appendixes Appendix I: Principal Japanese Financial Institutions 54

Appendix II: Major Contributors to This Report 61

Page 12 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Contents

Tables Table 1.1: Assets Held by Various Types of Japanese Financial

Institutions (as of March 31, 1995)

17

Table 1.2: Financial Institutions Examined by The Bank of Japan

(as of March 31, 1996)

27

Table 2.1: Number of Banks Inspected or Examined By Both MOF

and BOJ, (fiscal years 1992 to 1995)

36

Figures Figure 1: Responsibility for Bank Regulatory and Related

Functions in Japan

6

Figure I.1: Principal Japanese Financial Institutions, (as of

April 1996)

55

Abbreviations

BOJ Bank of Japan

CPA Certified Public Accountant

DIC Deposit Insurance Corporation

FSRC Financial System Research Council

JICPA Japanese Institute of Certified Public Accountants

MOF Ministry of Finance

SESC Securities and Exchange Surveillance Committee

Page 13 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Chapter 1 

Introduction

Japan’s highly segmented banking industry is made up of separate groups

of institutions engaged in short-term or long-term finance; trust activities;

foreign exchange, and trade financing; small business finance; and

regional and agricultural finance. The segmentation of the banking

industry reflects the extensive restructuring the Japanese economy

underwent in the aftermath of World War II. At that time, as a key part of

Japan’s efforts to promote rapid industrial recovery, the government

instituted legal reforms that created pronounced specialization in banking

that persists to some degree to the present day. Although the Japanese

banking industry remains segmented and specialized, deregulation and

liberalization since the 1970s have eliminated many functional distinctions

among the different types of banks and the separate, specialized markets

they formerly served. Bank regulation and supervision are the

responsibility of the central government, although some financial

institutions are under the jurisdiction of local governments.

Overview of Japanese

Financial Institutions

The current Japanese banking system had its inception during the late 19th

century with the emergence of a commercial banking system that was

dominated by a small number of banks associated with major industrial

conglomerates. After World War II, the Japanese government’s efforts to

rebuild the economy led to the dismantling of these prewar conglomerates

and to restrictions on universal banking powers1

 that were formerly

allowed to banks. As part of the nation’s postwar economic and industrial

recovery reforms, the Japanese government restricted banks from

engaging in activities outside of banking, such as securities activities, and

it limited their ownership of shares in other Japanese companies,

particularly industrial companies. The result was a segmented banking

structure, which even today retains some of its highly specialized

character.

Japanese banks currently may accept deposits or installment savings, lend

money, conduct exchange transactions, and certain ancillary activities.

Allowable ancillary activities include purchasing, lending, and selling

securities; underwriting government bonds; and the safekeeping of

securities and precious metals. In addition, through associated companies,

banks can provide venture capital, consulting services, leasing, housing

finance, and loans. Industry deregulation initiated in the early 1980s that

culminated with the 1992 Financial System Reform Law also now allows

banks to compete in securities underwriting activities through

1

Universal banking powers allow commercial banks to make loans, underwrite corporate debt, and

take equity positions in corporate securities.

Page 14 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Chapter 1 

Introduction

subsidiaries, albeit with certain restrictions on those activities. In addition,

there is to be a clear separation of banking and securities activities. Banks,

however, are currently prohibited from participating in insurance activities

and from setting up holding companies.2

The structure of the Japanese banking system is made up of five types of

specialized financial institutions: commercial banks, which are referred to

as ordinary banks; long-term financial institutions; financial institutions

for small business; financial institutions for agriculture, forestry, and

fisheries; and public financial institutions, which include a postal savings

system that is a major source of funds for the Japanese government. (See

app. I.)

Ordinary Banks Ordinary banks in Japan include city banks, regional banks, and branches

of foreign-owned banks. They offer a variety of products and services

including deposit-taking, fund transfers, and short- to long-term loans,

both domestically and abroad. Ordinary banks may also engage in certain

government securities activities, including some securities underwriting,

and the sale of corporate commercial paper (short-term unsecured funds)

to institutional investors and financial institutions. Collectively, city banks

are the largest private banks in Japan, whether measured by industry

assets, loans, or deposits. They are also among the largest banks in the

world. In December 1995, the six largest banks in the world, ranked by

assets, were Japanese city banks.

Long-Term Financial

Institutions

Long-term financial institutions in Japan include long-term credit banks3

and trust banks.4 Historically, the Japanese government has established

long-term financial institutions to provide long-term funds for agriculture

and other industries. Until recently, they have been the only institutions

permitted to raise long-term funds. Long-term credit banks may issue bank

debentures with up to 5-year maturities, and trust banks may handle 5-year

trust accounts. Since deregulation of the banking industry, however,

ordinary banks are also making longer-term loans, and the historic

differences between ordinary and long-term financial institutions have

become less pronounced.

2

Holding companies consist of a parent company and subsidiaries. In the United States, the dominant

form of banking structure is the holding company.

3

Japan has three long-term credit banks whose main business is long-term lending.

4

Trust banks are long-term, specialized financial institutions that supply major corporations with funds

that they mainly obtain from trusts.

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Financial Institutions for

Small Business

The group of cooperative-based institutions known as financial

institutions for small businesses serves the financial needs of their

members, which include small- and medium-sized businesses and labor

unions. Also included in this group are three central bodies serving the

financial needs of their member cooperatives through such services as

deposits and member loans, and a special corporation providing financial

assistance for cooperative institutions.

Financial Institutions for

Agriculture, Forestry, and

Fisheries

Institutions known as financial institutions for agriculture, forestry, and

fisheries are made up of entities operating at three levels that serve local

cooperatives. On the first level are cooperatives operating at the individual

village, town, and city levels of government. These cooperatives in turn are

members of a second level of prefectural-level credit federations serving

clients within their prefectures.5

 At the third level is the Norinchukin

Bank, which in several respects works as the central bank for agriculture,

forestry, and fisheries.

Public Financial

Institutions

Japan has 11 wholly owned government financial institutions, of which 2

are banks and 9 are public corporations. These lending institutions, which

are designed to supplement private-sector financing, are prohibited from

competing with private banks. The institutions’ funds come from loans

from the government’s Trust Fund Bureau, which in turn is largely

financed by the government’s Postal Savings System.

Although the Postal Savings System is not categorized as a bank, the

magnitude of its financial resources gives it important financial

significance in Japan. As of June 1995, the system held in excess of 200

trillion yen ($1.88 trillion) in deposits,6

 making it the largest financial

institution in the world. The extensive system operates out of 24,000

Japanese post offices throughout the country.

As of early 1995, the 1,130 financial institutions conducting banking

operations in Japan had approximately 1,148 trillion yen ($10.8 trillion) in

industry assets, as shown in table 1.1. Ordinary banks alone accounted for

over half, or 53 percent, of this total. Ten long-term financial institutions

held the next largest share of banking assets, or 28 percent of the total.

The most sizable share of banking assets controlled by cooperative-based

5

Prefectures are Japan’s political subdivisions. Each prefecture includes cities, townships, and villages.

6

The U.S. dollar equivalent used in this report is based on the exchange rate of 106.61 yen per U.S.

dollar published in the Apr. 25, 1996, Wall Street Journal.

Page 16 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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institutions was held by financial institutions servicing primarily local

communities, which had about 12 percent of total industry assets. As of

February 1996, there were 90 foreign-owned bank branches in Japan, of

which 16 were owned by U.S. firms, according to Japanese government

officials. Appendix I provides greater detail on financial institutions in

Japan.

Table 1.1: Assets Held by Various

Types of Japanese Financial

Institutions (as of March 31, 1995)

Yen in trillions

U.S. dollars in trillions

Type of financial

institution Number

Percentage of

industry

deposits

Percentage of

industry loans

Percentage of

industry assets

Ordinary banks

City banksa 11 1.1% 38.2% 28.5%

Regional banks 129 25.8 26.2 23.0

Foreignowned bank

branches

90 0.4b 1.1 2.0a

Subtotal 230 57.3% 65.5% 53.5%

Long-term financial institutions

Long-term

credit banks

3 7.5 7.4 6.4

Traditional

trust banksc

7 12.1 8.7 21.9

Subtotal 10 19.6% 16.1% 28.3%

Other financial institutions

Financial

institutions for

small business

794 13.0 12.4 11.9

Financial

institutions for

Agriculture,

Forestry, and

Fisheryd

48 8.8 3.6 3.8

Subtotal 842 21.8% 16.0% 15.7%

Other

Institutionse

48 1.3 2.4 2.6

Total 1,130 100.0% 100.0% 100.0%f

Total yen

(Total U.S.

dollars)

908.0

($8.5)

701.6

($6.6)

1,148.0

($10.8)

(Table notes on next page)

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aAs of Apr. 1, 1996, the Mitsubishi Bank and the Bank of Tokyo merged, thereby reducing the

number of city banks to 10.

bData provided by Ministry of Finance on Feb. 22, 1996.

cThere are 7 traditional trust banks in Japan and 16 others owned either by securities companies,

financial institutions, or by foreign-owned banks.

dThese institutions at the prefectural level provide deposit and lending services to about 4,000

local cooperatives.

eIncludes the Shoko Chukin Bank (a special corporation for providing financial assistance to

unions of small- and medium-sized enterprises) and 47 labor banks (banks promoting the welfare

activities of organizations, such as labor unions, consumer cooperatives, and other labor bodies).

Does not include special housing finance companies, known as jusen, nor does it include public

financial institutions, such as the Postal Savings System.

f

Amount does not add to 100 due to rounding.

Sources: Ministry of Finance, U.S. Department of the Treasury, and GAO analysis.

History of Bank

Regulation and

Supervision in Japan

Historically, Japanese laws for bank regulation and supervision have been

simple and limited in scope. The current Japanese bank regulatory and

supervisory7

 structure is based on the 1981 Banking Law, which revised

earlier banking laws. The 1981 Banking Law designated the Ministry of

Finance (MOF) as solely responsible for authorizing and regulating the

banking industry in Japan, and it maintained MOF’s legal supervisory

authority over banks. While the Bank of Japan (BOJ) lacks the regulatory

authority of MOF, it carries out its safety and soundness responsibilities

based on the authority granted by the 1942 Bank of Japan Law that BOJ

maintain a safe and sound financial system.

Changes in the bank regulatory structure have resulted from essentially

two stages of evolution in the Japanese banking industry, according to

historical literature. The first stage spans the 1860s up to the early 1970s

and includes the origin of the banking system as well as regulatory

changes following World War II. The second stage, which dates from the

mid-1970s to the present, was triggered by the first oil crisis in 1973.

7

In our earlier reports on bank oversight in the Federal Republic of Germany, the United Kingdom,

France, and Canada, we referred to supervision as (1) the conduct of examinations and off-site

monitoring of financial institutions and (2) the taking of enforcement actions. According to MOF in

Japan, the term supervisor is used only to describe government agencies. Since BOJ is not considered

a government agency, it is not described as a supervisor in Japan, even though BOJ does perform some

of the supervisory functions described above.

Page 18 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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Origin of the Banking

System: 1860s to Early

1940s

The origins of the Japanese banking system can be traced to the Meiji

restoration period in 1869, when money-transfer companies with many of

the functions of modern banks were established in major cities. Soon

after, Japan’s first bank legislation (the National Bank Act) was enacted in

1872. This act created national banks, which were private banks issuing

bank notes.

The central bank of Japan, BOJ, was founded in 1882, although it was later

reorganized under the Bank of Japan Law of 1942. The original 1882 law

gave BOJ the sole right to issue bank notes, taking away this responsibility

from national banks, most of which disappeared soon after. The Banking

Act of 1890 converted the remaining national banks and other private

banks into ordinary banks.

In the same year, the Savings Bank Act of 1890 established savings banks,

whose number then climbed steeply over the next decade to a peak of

about 720 banks at the turn of the century. The 1915 amendment to the

Savings Bank Act prohibited ordinary banks from engaging in similar

savings activities until World War II, when the expansion of savings

became a national policy goal. At that point, ordinary banks were allowed

to conduct the same business activities as savings banks and, as a result,

savings banks began to disappear.

The 1927 Banking Law In response to a nationwide financial panic in 1927, which heightened

concerns about the stability of the Japanese banking industry, the

government enacted the Banking Law of 1927. This law, which defined the

structure and organization of Japan’s banking system for the following 54

years, established a banking system focused on short-term lending.

The 1942 Bank of Japan

Law

Fundamental changes to BOJ’s governance structure enacted in the 1942

Bank of Japan Law also made BOJ a means for conducting monetary policy.

Prior to 1942, BOJ was a stock corporation that was directly accountable to

its stockholders. However in light of wartime conditions, the 1942 law

gave the government influence over the bank’s operations. The

government became the majority stockholder of the bank, while voting

rights were denied to all stockholders.

The 1942 law, according to BOJ officials, provided BOJ a legal basis to foster

and maintain a sound financial system. In particular, BOJ believes that the

law provided a stronger statutory basis for conducting its safety and

Page 19 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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soundness examinations of client banks, which began in 1928. In addition

to on-site examinations, BOJ relies on frequent contacts to ensure that

financial institutions follow sound practices. BOJ carries out such

examinations under the terms of contractual agreements made with all

banks that have current accounts with BOJ. The roles and responsibilities

of BOJ are currently under review by an ad hoc advisory committee to the

Prime Minister with the aim of possibly making changes to recognize the

changing economic and financial environment.

Financial Specialization for

Industrialization:

Mid-1940s to Mid-1970s

Industrialization policies adopted in the mid-1940s to support the

reconstruction of the postwar economy led Japan to develop a financial

system characterized by a high degree of specialization. Pursuit of such

broad goals as financial order and stable institutional earnings led the

country to enact restrictions aimed at compartmentalizing banking

activities. The national goal of protecting and strengthening Japanese

securities companies, for example, led to the adoption of restrictions

similar to those provided for in the Glass-Steagall Act, which separates the

U.S. banking and securities industries.8

During the period from post-World War II to the 1970s, the “main bank

system” (defined as a unique business relationship between banks and

companies) played a key financial role in Japan’s economic expansion.

Under the main bank system, banks and companies were closely tied to

each other through practices such as cross shareholdings and exchanging

senior management personnel (usually from main banks to companies). As

a result, companies enjoyed stable funding regardless of their health, while

main banks maintained solid market share by supplying loans to

companies. However, in subsequent years, factors such as an increase in

the funding needs of companies due to economic expansion, the

diversification of company funding sources due to financial liberalization,

and the development of risk management based on portfolio

diversification have diluted the relationship between banks and companies

under the main bank system.

Deregulation and

Liberalization: Mid-1970s

to Early 1980s

Japan was shaken from a period of stable economic growth by the first

global oil crisis in 1973. The crisis, which initially disrupted the banking

industry along with Japan’s other economic sectors, eventually prompted

the evolution of a more flexible, open, and international system. In turn,

8

After the stock market crash of 1929, the U.S. Congress enacted the Banking Act of 1933, known as

the Glass-Steagall Act, which forced the separation of the banking and securities businesses.

Page 20 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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these changes have helped Japan emerge as a major global financial

presence in the years since.

The shock to Japan’s economic growth brought about by skyrocketing oil

prices led, within a relatively brief period, to a doubling of Japan’s public

sector debt. To fund the public debt, the government issued an

increasingly large volume of government bonds. In 1979, 6 years after the

1973 oil crisis, the government issued bonds worth a record total of 15.3

trillion yen ($70.5 billion).9

 However, as the deficit increased, financial

institutions became less willing to help the government absorb the debt at

above-market prices. Businesses also became less dependent on bank

credit and services, such as bank loans. As a result of these developments,

banks began to seek out new markets outside the traditional financial

marketplace. To expand their market share and increase their

competitiveness, banks and securities companies became advocates of

financial liberalization, and banks began to diversify their loans and

funding.

The resulting liberalization, which began in the late 1970s, has continued

over the course of succeeding decades and has primarily affected three

areas: interest rates, scope of business, and foreign exchange controls. The

relaxation of restrictions on interest rates began in 1979, with the

introduction of negotiable certificates-of-deposit, followed soon after by

the emergence of money market certificates of deposit paying interest

rates linked to money market accounts. By October 1994, interest rates

had been liberalized on all time deposits except for checking accounts.

Over the same period, the relaxation of lending regulations had enabled

banks to increasingly set their short-term prime rates relative to the

official discount rate.

The enactment of the 1980 Foreign Exchange Law eased the regulation of

banks’ foreign exchange activities, except during times of crisis. The 1986

opening of the Tokyo offshore market further liberalized Japanese banks’

foreign exchange activities.

The 1981 Banking Law The primary law governing bank licensing, regulation, and supervision in

Japan today is the 1981 Banking Law. The complete revision of the past

law—the 1927 Banking Law—was prompted by the economic and

financial changes that took place in Japan after the first oil crisis. The 1981

law was designed to maintain financial order and promote economic

9

Exchange rate of 217 yen per U.S. dollar as of 1979.

Page 21 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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development by ensuring sound and appropriate bank management,

depositor protection, and facilitation of financial transactions. The law

designated MOF as the governmental body responsible for authorizing and

regulating banks.

The Banking Law of 1981, which totally revised Japanese banking law,

provided banks with greater guidance in the conduct of banking business.

The law reorganized the basic supervisory framework for Japanese banks

without making major changes to MOF authority or responsibilities. In

particular, the law provided more guidance on the conduct of banking

business than was provided in the 1927 banking law, which up until that

time had delineated the basic requirements for Japanese banks. Specific

areas covered by the 1981 law include

• general requirements, such as banking licenses and capital requirements;

• permissible banking business;

• required reports;

• MOF supervision;

• MOF enforcement and penalty provisions;

• merger and transfer or acquisition of business;

• termination of business; and

• licenses for foreign bank branches.

The 1992 Financial System

Reform Law

The 1992 Financial System Reform Law was meant to be a comprehensive

reform of Japan’s financial and securities transaction systems

corresponding to domestic and international developments. The law,

which was enacted to expand the scope of permissible business activities,

eliminated many differences among financial institutions, allowing them to

compete in one another’s sectors through subsidiaries, albeit with

restrictions and firewalls. In particular, it allowed Japanese banks to

conduct securities business through subsidiaries in which they have at

least a 50-percent share. The law also provided MOF with the authority to

establish standards to safeguard the soundness of banks and controls over

transactions between banks and their subsidiaries.

Proposed Changes to Bank

Supervision: 1995 to

Present

During 1995 and early 1996, Japanese banks and the banking system were

confronted with several events that encouraged authorities to enhance the

ability of the regulatory and supervisory process to deal with industry

problems. These events included (1) a high number of nonperforming

loans, (2) near depletion of the deposit insurance fund, and (3) large losses

Page 22 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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suffered by a major Japanese bank—the Daiwa Bank—due to improper

trading by an employee.

The nonperforming loan problem originated in the economic boom of the

late 1980s, when Japanese banks substantially increased their

real-estate-related lending. After years of rapid appreciation, banks

experienced rapid depreciation of asset prices. The value of

nonperforming loans held by Japanese financial institutions as of

March 1996, according to MOF, was 34.8 trillion yen ($326 billion), a

condition considered unacceptable by the Japanese government.

Nonperforming loans, which have caused several credit cooperatives and

regional banks to fail, have also called into question the financial

soundness of other financial institutions. As a result, Japanese officials

recently undertook an analysis of the nonperforming loan problem, which

has led to changes in the supervisory process.

The Japanese government’s attention has also been directed toward

devising supervisory responses to the problems of one particular type of

institution, housing loan companies—called jusen—which have

experienced heavy losses. Japan’s eight jusen, which were established in

the 1970s by Japanese banks and other financial institutions such as

insurance companies and securities firms, have been especially hard hit in

recent years with the steep decline of the Japanese real estate market.

Although their original intended function was to supplement home

mortgage lending, jusen became heavily involved in commercial real estate

and housing development lending, which contributed to their losses when

the Japanese real estate market declined sharply in early 1992.

As of March 1996, nonrecoverable problem loans of jusen were estimated

at 6.3 trillion yen ($59 billion). In Japan, there was widespread concern

that the failure of one or more jusen could spark public panic and lead to a

chain reaction of withdrawals from other financial institutions, since many

financial institutions had provided financing to jusen companies. To avert

such a crisis, the Japanese government designed a plan aimed at

rebuilding public confidence and protecting depositors, including

establishing a jusen account in the Deposit Insurance Corporation (DIC)

with a governmental contribution of 680 billion yen ($6.4 billion).

In the summer of 1995, Daiwa reported that a securities trader in its New

York office had initiated improper trades over an 11-year period that had

gone undetected. Reported losses totaled more than $1 billion. In

October 1995, BOJ conducted a special on-site examination of Daiwa

Page 23 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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Bank’s—a major city bank—New York Branch to ascertain the facts at its

New York Branch, as well as to evaluate Daiwa’s overall risk management

system. Also in October, banking regulators in the United States issued

cease and desist orders against Daiwa requiring a virtual cessation of

trading activities in the United States. In November 1995, MOF identified

and took action intended to correct inappropriate management practices

at Daiwa Bank. MOF also ordered Daiwa Bank to reduce its international

operations, including the amount of loans outstanding, the amount of

securities holdings, and market-related activities. MOF and BOJ also

committed themselves to strengthening their oversight of overseas

branches and offices of Japanese banks.

In the last 2 years alone, DIC has provided financial assistance totaling

643.3 billion yen ($6 billion) to assist in the resolution of troubled credit

cooperatives and regional banks, which has come close to depleting the

deposit insurance fund. At the time of our visit in September 1995, a DIC

senior official told us that the insurance fund could be depleted if current

resolution plans were implemented to handle the remaining failing

financial institutions. In June 1996, the Diet—the Japanese

Parliament—passed three financial bills to facilitate the resolution of

failed or failing institutions and to increase deposit insurance premiums.

Overview of

Participants in Bank

Licensing, Regulation,

and Supervision

Bank licensing and regulation is the responsibility of MOF. However, both

MOF and BOJ have responsibilities for ensuring the safety and soundness of

the banking system. The two agencies’ responsibilities do not typically

extend to credit cooperatives, which are generally supervised at the local

government level.

MOF Responsibilities MOF, the government’s central agency with jurisdiction over the banking

industry, is responsible for bank licensing, regulatory compliance,

guidance, and supervision. Originally created in 1869, its legal authority to

supervise banks was first granted in 1890, and again defined in the 1949

Ministry of Finance Establishment Law, which was enacted during a major

government reorganization after World War II. The statute used by MOF to

carry out its current responsibilities is the 1981 Banking Law.

Bank supervision is just one of MOF’s broad responsibilities. Among other

things, MOF is also responsible for overall administration of the

government’s fiscal and related monetary functions, including budget

formulation and execution, and tax assessment and collection. The

Page 24 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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Introduction

formulation, execution, and coordination of the national budget allows

MOF to play a pivotal role within the national government. This currently

includes approving BOJ’s budget.

Organization of MOF MOF is headed by the Minister of Finance, a cabinet member appointed by

the Prime Minister. The ministry is 1 of 12 ministries reporting to the

Prime Minister. MOF’s organizational structure consists of one secretariat

and seven bureaus.10 The Banking Bureau is the main bureau responsible

for regulatory guidance and supervision of banks, but it shares these

responsibilities with MOF’s Secretariat and the International Finance

Bureau. Generally speaking, domestic banking issues are under the

auspices of the Banking Bureau, and international banking issues are

under the International Finance Bureau.

The Banking Bureau consists of five divisions and one department. Three

divisions—the Commercial Banks Division, the Special Banks Division,

and the Small Banks Division—share responsibilities for providing

supervision and regulatory guidance to banks. As of September 1995,

according to MOF, the Banking Bureau had a staff of 130.

The Banking Bureau also works with MOF Securities Bureau in supervising

bank securities activities. The Securities Bureau provides guidance and

supervision to a broad range of participants in the securities market,

including financial institutions engaged in securities business. As of

September 1995, according to MOF, the Securities Bureau had a staff of 90.

The International Finance Bureau oversees the foreign activities of

Japanese financial institutions. It also handles international

finance-related affairs, including those involving the international currency

system, the yen’s internationalization, balance of payments, and foreign

exchange control; and it coordinates activities with its foreign

counterparts. As of September 1995, according to MOF, the International

Finance Bureau had a staff of 114.

Prior to 1992, bank inspections were conducted separately by the

individual bureaus. Since then, the MOF Secretariat’s Financial Inspection

Department has been responsible for conducting all inspections. As of

September 1995, according to MOF, the Financial Inspection Department

had a staff of 112, of which 80 to 90 were assigned to inspection teams. An

additional 307 inspectors work in local branch offices, primarily inspecting

10The seven bureaus are: Budget, Tax, Customs and Tariff, Financial, Securities, Banking, and

International Finance.

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shinkin banks.11 However, when needed, they conduct joint inspections of

regional banks with inspectors of the Financial Inspection Department. In

fiscal year12 1996, there is to be an increase of 20 inspectors in the

Financial Inspection Department and an increase of 46 inspectors in local

branch offices, according to MOF officials.

To strengthen oversight of the securities market, MOF established the

Securities and Exchange Surveillance Commission (SESC) as a separate

agency in July 1992. SESC is authorized to inspect securities companies,

conduct surveillance of market transactions, investigate suspected

criminal offenses, and propose policy changes to MOF. If illegal activities

are discovered, SESC may recommend disciplinary actions to MOF.

SESC has the authority to obtain a court warrant, and it can bring charges

against a suspect through the Public Prosecutor’s Office if it believes a

crime has been committed. SESC has a chairman and two commissioners

that MOF appoints with consent of the Diet—the Japanese Parliament. They

have equal power and serve 3-year terms. SESC has an Executive Bureau

consisting of 2 divisions and 11 regional offices, with a staff of 206

employees as of February 1996.

BOJ Responsibilities BOJ first started examining banks in 1928, following financial crises caused

by the recession after World War I and the Kanto Earthquake of 1923. All

institutions having current accounts with BOJ are subject to its

examinations in accordance with contractual agreements with BOJ. They

include city banks, regional banks, trust banks, long-term credit banks,

most shinkin banks, overseas branches and affiliates, branches of

foreign-owned banks, and some securities companies.

BOJ has two principal missions: (1) stabilizing the value of money and

(2) fostering a safe and sound credit and finance system. To keep the

currency stable, BOJ:

• influences the money supply and money markets;

• implements monetary policy and controls credit by setting the official

discount rate,13 directly selling and buying securities and bills in the

financial markets, and imposing the reserve deposit requirement; and

11Shinkin banks are cooperatives serving the financial needs of small companies and local residents.

12The Banking Law of 1981 required banks to adopt an annual business year which runs from April 1 to

March 31.

13The interest rate charged by BOJ when extending loans to banks.

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• intervenes—as the agent of the Finance Minister—in the foreign exchange

market to stabilize the yen’s value against foreign currencies.

To foster a safe and sound financial system, BOJ:

• facilitates payments and settlements by issuing bank notes and providing

funds transfer services among bank accounts;

• monitors financial institutions and markets through regular contacts,

on-site examinations, and the provision of advice; and

• acts as lender of last resort.

Legally, BOJ is a special corporation in a unique category. While BOJ’s

budget is currently approved by MOF, BOJ is considered to be neither a

government entity, nor a private institution within the structure of the

Japanese financial system. Although it coordinates some activities with

MOF, BOJ functions as an independent organization separate from MOF,

according to MOF officials. In March 1996, BOJ, whose assets totaled 57.7

trillion yen ($541 billion), had responsibilities for 700 financial institutions,

as shown in table 1.2.

Table 1.2: Financial Institutions

Examined by the Bank of Japan (as of

March 31, 1996)

Assets

Japanese yen in billions

U.S. dollars in billions

Type of financial

institution Number Yen U.S. dollars

Banks

City banks,

long-term credit

banks, and trust

banks

43 477,975 $4,484

Regional banks 129 267,775 2,512

Shinkin banks 358 106,679 1,000

Total banks 530 852,429 $7,997

Other financial

institutionsa

170 N/A N/A

Total 700 1,704,858 $15,993

N/A: Data was not provided by BOJ.

aIncludes branches of foreign-owned banks and foreign securities companies.

Source: BOJ.

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Organization of BOJ BOJ is headed by its Governor. The Governor is appointed by the Cabinet

for a term of 5-years and may be reappointed. Historically, BOJ governors

have alternated between individuals with MOF or BOJ backgrounds.

The Governor is the link between the bank’s executive board and BOJ’s

Policy Board. The Policy Board, which is BOJ’s highest decisionmaking

body, is the sole decisionmaking body for monetary policy, including

decisions on the official discount rate. The Policy Board was established

in 1949 by amendments to the 1942 Bank of Japan Law. The amendments

were in response to a desire to modernize the Japanese monetary and

economic system and to enhance BOJ’s independence.

Board members include BOJ’s Governor and representatives from MOF, the

Economic Planning Agency, and four individuals with experience in and

knowledge of banking, commerce, manufacturing, or agriculture.

Government representatives from MOF and the Economic Planning Agency

are nonvoting members. The four “knowledgeable and experienced”

members, who are appointed by the cabinet with approval from the Diet,

serve renewable 4-year terms without restrictions.

BOJ has 13 departments,14 a Secretariat of the Policy Board, the Governor’s

office, and an Institute for Monetary and Economic Studies. In addition to

its 33 branches and 12 local offices in Japan, BOJ has overseas offices in

New York; Washington, D.C.; London; Paris; Frankfurt; and Hong Kong.

Bank monitoring is handled by the Bank Supervision, Financial and

Payment System, and Credit and Market Management departments,

according to BOJ.

Within BOJ, the Bank Supervision Department15 is primarily responsible for

monitoring financial institutions. Headed by a director, it is divided into

two divisions: the Bank Supervision Division and the Data Analysis

Division. The former division manages on-site examinations of banks and

securities companies through four examination groups. The latter division

compiles and analyzes various statistics regarding financial institutions. As

14Individual BOJ departments are: policy planning, financial and payment system, credit and market

management, bank supervision, international, operations, issue, budget and management, personnel,

administration, information system services, research and statistics, and public relations.

15In Japanese, this department is known as “kosa.” We were told that the English interpretation may be

either examinations or supervision. BOJ interprets kosa in its broad sense and thus believes the

English translation is supervision. However, MOF interprets kosa strictly, as only examinations, and

believes the department should be known, in English, as the Examinations Department, because

on-site monitoring on a statutory basis is called “kensa” (Inspection) and on-site monitoring not based

on law is called “kosa.”

Page 28 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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of October 1995, according to BOJ, the Bank Supervision Department had

an examination staff of between 100 and 120.

BOJ’s Financial and Payment System Department’s role is to maintain and

foster a safe and sound credit system. It sets out the basic

macro-prudential policies including working out the disposition of failed

banks. BOJ’s Credit and Market Management Department oversees the

activities of domestic and overseas financial institutions. It also monitors

money and capital markets, administers BOJ’s money operations, and

conducts off-site monitoring of financial institutions’ activities in such

broad areas as day-to-day cash positions and long-term management

strategy.

Prefectural or Local

Governments

Each of the 47 prefectural governments authorizes and supervises credit

cooperatives in its own prefecture. However, credit cooperatives must

obtain MOF’s authorization if their activities go beyond the prefecture’s

geographical boundaries. Although MOF and BOJ do not have responsibility

for supervising credit cooperatives, such institutions are required to be

insured by the deposit insurance system.

If a request is received from the prefectural governor, MOF may inspect a

credit cooperative. The recent failure of several credit cooperatives has

prompted the government to consider adopting measures to ensure close

cooperation between national and local supervisory authorities. Measures

under consideration are intended to provide local authorities with timely

guidance, clarify conditions warranting MOF inspections, establish regular

meetings, and provide for joint inspections by MOF staff and local

authorities.

As of April 1995, according to MOF, Japan’s prefectural governments had a

supervisory and inspection staff of 338, of which 264 were inspectors.

According to Japanese banking industry representatives, prefectural

inspections are conducted by an insufficient number of inspectors, who

must also carry out various other noninspection duties.

Objectives, Scope,

and Methodology

At the request of Congressman Charles E. Schumer, we examined various

aspects of the bank regulatory and supervisory structure of a number of

countries. Specifically, our objectives were to describe how (1) Japanese

bank regulation and supervision is organized; (2) Japan’s banking

oversight structure functions, particularly with respect to bank licensing,

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Introduction

regulation, and supervision; (3) banks are monitored by their supervisors;

and (4) participants handle other financial system responsibilities.16 This

report focuses more attention on describing the legal structure within

which Japanese banking oversight has been conducted and less attention

on the methods used to carry out that oversight.

To address these objectives, we interviewed senior officials from MOF and

BOJ, both in Japan and in the United States. They provided us with

documents and information, including annual reports, tables of statistics,

translations and analysis of selected banking legislation, organizational

summaries and charts, reports on the Japanese banking structure, lists of

reports banks must submit, and other documents to illustrate the current

regulatory and supervisory environment.

In addition to those interviews, we met with senior representatives of

Japan’s DIC; the Federation of Bankers Associations of Japan (Zenginkyo);

the Japanese Institute of Certified Public Accountants (JICPA); senior

executives at six Japanese banks representing a cross-section of Japan’s

specialized financial structure; senior executives from a public accounting

firm; experts on the Japanese banking structure; and U.S. agencies with

regulatory responsibilities over foreign banks: Department of the Treasury,

the Federal Reserve, and the Office of the Comptroller of the Currency.

Finally, we relied on translations of the 1981 Banking Law, the law that

relates most directly to bank regulation and supervision in Japan, and the

1942 Bank of Japan Law, which gave Japan’s central bank its oversight

authority. We also relied on translated summaries of three bills passed in

June 1996 by the Diet, which significantly changed Japan’s regulatory

process and the disposition of failed and failing institutions.17 This report

does not include an evaluation of the efficiency or effectiveness of the

Japanese bank regulatory structure.

16We completed similar studies on the bank regulatory and supervisory structures in the Federal

Republic of Germany, the United Kingdom, France, and Canada. For information on these reports, see

Bank Regulatory Structure: The United Kingdom (GAO/GGD-95-38, Dec. 29, 1994); Bank Regulatory

Structure: The Federal Republic of Germany (GAO/GGD-94-134BR, May 9, 1994); Bank Regulatory

Structure: France (GAO/GGD-95-152, Aug. 31, 1995); and Bank Regulatory Structure: Canada

(GAO/GGD-95-223, Sept. 28, 1995). We also issued a capping report drawing lessons for the U.S.

regulatory system from the foreign countries, Bank Oversight Structure: U.S. and Foreign Experience

May Offer Lessons for Modernizing U.S. Structure, (GAO/GGD-97-23).

17The three acts are (1) Act Ensuring Sound Management of Financial Institutions, (2) Act to Improve

Reorganization and Bankruptcy Procedures for Financial Institutions, and (3) Amendment to the

Deposit Insurance Act.

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We conducted our review, which included one visit to Japan, from

June 1995 through July 1996 in accordance with generally accepted

government auditing standards.

We gave senior officials and executives of MOF, BOJ, DIC, JICPA, the

Federation of Bankers Associations of Japan, and the three city banks we

visited a draft of this report for their comments. They provided comments

that were incorporated in the report where appropriate.

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MOF, as supervisor and regulator, licenses banks, regulates most aspects of

Japan’s banking operations, and monitors any developments in bank

operations that may adversely affect the banking system, in accordance

with the 1981 Banking Law. In its role as Japan’s central bank, BOJ is to

ensure the safety and soundness of the financial system through its

oversight of financial institutions. Changes to oversight are being

proposed due to the mounting levels of nonperforming loans. These

changes are intended to make the supervisory system more transparent

and increase the accountability of individual banks.

MOF Licenses Banks The 1981 Banking Law requires each bank to obtain a license from MOF.

The law defines “banking” as a business that accepts deposits and makes

loans or conducts exchange transactions. However, a license is also

required of institutions that accept deposits or installment savings

regardless of whether they lend money or discount bills at the same time.

In reaching licensing decisions, according to the 1981 law, MOF is to

consider the applicant’s:

• financial capability to conduct banking soundly, and efficiently, and the

potential income and expenses of its planned business operations;

• competence and experience to conduct banking appropriately, fairly and

efficiently; and its credibility; and

• reasons for entering the banking business and anticipated effects on the

existing financial system (e.g., supply and demand of funds, the operations

of existing banks and other financial institutions, and the local economy).

After applying the above criteria, MOF may impose conditions on a license

to the extent it believes the public interest could be affected. Banks must

obtain permission from MOF to establish a head office, branch, or

subbranch and to relocate, change the status of, or close any such offices.

However, Japanese banks are free of geographical restrictions on where

their branches can be located.

Foreign-owned banks wishing to establish a branch or agency in Japan are

required to obtain a license from MOF. Separate licenses are required for

each branch. Concurrently, according to BOJ officials, BOJ determines

whether to allow the bank to open an account with BOJ. For the fiscal year

ending March 31, 1995, MOF reviewed four license applications for

foreign-owned bank branches and approved all four. These banks also

established accounts with BOJ.

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In addition to complying with Japanese laws, branches of foreign-owned

banks in Japan must conduct their banking business in accordance with

the banking laws of their home country. They are to be supervised on a

consolidated basis by the home country’s authorities who have primary

responsibility for the operation of the parent bank, according to MOF. Both

BOJ and MOF examine or inspect branches of foreign-owned banks in Japan.

Licensed Banks Must Meet

Capitalization

Requirements

A licensed bank is also required to be incorporated and properly

capitalized. The 1981 Banking Law established a minimum capitalization

level for banks established in Japan of at least 1 billion yen ($9.4 million).

This threshold has since been raised to 2 billion yen ($18.8 million).

According to MOF officials, banks are subject to two target capital ratio

standards. Domestic banks with no overseas establishments are subject to

a minimum 4-percent capital adequacy ratio. Banks maintaining overseas

branches or subsidiaries are subject to an international minimum

risk-based capital standard of 8 percent agreed to by the Basle Committee.1

MOF does not apply these standards to Japanese branches of

foreign-owned banks in Japan because they are to be supervised on a

consolidated basis by their home countries.

Regulatory

Responsibility

Belongs to MOF

MOF has broad responsibilities for formulating and carrying out policies

relating to banks. Banking, securities, and other laws establish MOF as the

primary, if not sole, authority with responsibility for financial regulation in

Japan. Under these laws, the agency has responsibility for regulating most

aspects of Japan’s banking operations, including sources and uses of

funds, terms on which banks can borrow and lend, activities in which they

may engage, branching and merger activities, and investment decisions

regarding other companies’ stockholdings.

In Japan, legislative proposals are generally drafted by individual

government ministries and are submitted through the cabinet to the Diet.

Japanese laws typically give government ministries considerable latitude

in their interpretation and implementation. Laws are supplemented by two

types of governmental ordinances: cabinet and ministerial. Unlike laws,

1

The Basle Committee, whose primary purpose under the auspices of the Bank for International

Settlements is addressing bank supervision-related issues, is made up of the banking supervisors and

central banks of the Group of Ten countries and Luxembourg: Germany, Belgium, Canada, the United

States, France, the United Kingdom, Italy, Japan, the Netherlands, Sweden, and Switzerland. For

further information on the Basle Committee, see International Banking: Strengthening the Framework

for Supervising International Banks (GAO/GGD-94-68, Mar. 21, 1994). For additional information on

risk-based capital adequacy standards, see International Banking: Implementation of Risk-Based

Capital Adequacy Standards (GAO/NSIAD-91-80, Jan. 25, 1991).

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ordinances do not need to be passed by the Diet, so they are used for

adjustments required in response to social changes. For example, a bank’s

minimum capitalization requirement is set by cabinet ordinance and its

business hours are set by ministerial ordinance. Bank activities are also

subject to circulars and administrative notices issued by MOF. Circulars are

used to explain laws and ordinances and to give guidance on their

practical application. For example, MOF circulars established standards for

judging institutional soundness, such as liquidity ratios. Similar circulars

established uniform standards for bank accounting and reports.

MOF typically sets policy by consensus—a process that involves the input

of many parties, such as other governmental agencies, industry groups,

academic groups, and BOJ. In Japan, offices, ministries, and government

agencies may establish councils, or government advisory bodies, for the

purpose of studying and discussing important issues or to provide

administrative reviews. These councils are often responsible for initial

discussions of major regulatory issues which eventually result in

ministerial ordinances or legislation. The Financial System Research

Council (FSRC), a senior-level consultive body to the Minister of Finance, is

one such advisory body. The current FSRC, which is mandated by law, was

originally created in 1956 to study the monetary system and make

recommendations to the Minister. It now has 17 members2

 who are chosen

from a broad range of experiences and expertise, including the financial,

industrial, and academic community to provide a broad-based forum on

policy issues and to conduct studies of the Japanese financial system. The

Banking Bureau serves as FSRC’s Secretariat, and it provides FSRC with both

information and resources, according to MOF officials.

Over the years, FSRC has served as a forum for discussing and analyzing

proposed changes in Japan’s banking legislation. Its findings provided a

basis for the 1981 Banking Law. In 1992, changes it recommended for

Japan’s compartmentalized financial system similarly became the basis for

the Financial System Reform Law. More recently, in a report issued to the

Minister of Finance in December 1995, FSRC proposed ways to restore

Japan’s nearly depleted deposit insurance fund, promptly dispose of

nonperforming loans, ensure sound management of financial institutions,

and dispose of failing financial institutions.

2

According to Japanese officials, by law FSRC may have up to 20 members.

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Banks Influence Changes

in Policy Through Various

Means

In addition to working with FSRC, banks also influence changes in policy

through their bankers’ associations. Japanese banks nationwide are

organized into regional associations whose primary function is to operate

a clearinghouse to clear checks and bills for participating institutions. For

example, the Tokyo Bankers Association operates the Zengin data

telecommunication system, which is a domestic funds transfer system

operated on a national scale. The associations also play an important role

in communicating the industry’s views to governmental agencies.

Another group with a key role in communicating the banking industry’s

views to the government is the Federation of Bankers Associations of

Japan, or Zenginkyo. The Zenginkyo is a consortium of regional bankers

associations that acts as a representative for banks throughout Japan.

Because the Zenginkyo represents a broad constituency, it attempts to

reflect the views of its broad membership, not the particular interests of

individual subgroups. This broad constituency has led such subgroups as

city banks to turn to other types of affiliations to further their specific

interests.

BOJ as the Bankers’

Bank

In its role as Japan’s bankers’ bank, BOJ maintains current accounts for its

client institutions. Funds held in current accounts are used to clear

accounts, make remittances among districts, and settle other transactions

among financial institutions.

BOJ also discounts bills, a form of credit provision. In addition, it buys from

or sells to current account holders various bills and bonds, including

long-term government bonds, and government short-term bills.

Ensuring Safety and

Soundness of Banks

In ensuring the safety and soundness of the financial system, both MOF and

BOJ monitor banks through on-site monitoring, reviewing financial reports,

and frequent contacts. When corrective action is necessary, MOF and BOJ

typically rely on guidance or advice, a form of moral suasion, as their main

means of enforcement. MOF provides supervisory direction and guidance

by issuing administrative guidelines and notifications, which function as

important components of Japan’s banking regulatory system.

On-Site Monitoring MOF designates its on-site monitoring of banks as inspections based on its

statutory authority, while BOJ calls its on-site monitoring examinations and

conducts them under its contractual agreements with client banks. Despite

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the different terminology, actual on-site monitoring activities are

somewhat similar, although their monitoring objectives are different.

In conducting its supervisory responsibilities, MOF is required to

• ensure that each bank subject to MOF’s supervision operates within limits

set by both Japanese banking legislation and the bank’s own internal

policies, and

• monitor any developments in bank operations that may have an adverse

effect on the integrity of the bank involved or the banking system as a

whole.

BOJ also requires banks to undergo periodic on-site examinations and to

submit necessary information upon request, which allow BOJ to obtain an

understanding of the bank’s operations to fulfill its responsibility to

maintain and foster the safety and soundness of the financial system. BOJ

carries out its bank oversight primarily through its Bank Supervision

Department.

Both MOF and BOJ may inspect or examine banks at any time and with any

frequency, although each typically examines the average bank once every

2 to 3 years. Officials from the agencies told us that they coordinate their

on-site monitoring with each other so that banks are generally examined

annually by either MOF or BOJ. For the fiscal year ending March 31, 1995,

according to MOF, a total of 485 Japanese banks were inspected or

examined by either MOF or BOJ, as shown in table 2.1.

Table 2.1: Number of Banks Inspected or Examined by Both MOF and BOJ, (Fiscal Years 1992 to 1995)

1992 1993 1994 1995

Type of banks

Total

number of

banksa MOF BOJ MOF BOJ MOF BOJ MOF BOJ

City banks, trust banks,

long-term credit banks

21b 4 9 4 4 9 5 9 7

Regional banks 129 41 51 45 47 46 47 54 4 1

Shinkin banks 421 190 150 198 155 213 157 212 162

aAs of Mar. 31, 1995.

bAs of Apr. 1, 1996, the Mitsubishi Bank and the Bank of Tokyo merged thereby reducing to 20

the number of city banks, long-term credit banks, and trust banks.

Source: MOF and BOJ.

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MOF and BOJ Rely on

Guidance and Advice

Actions that MOF and BOJ take against banks subject to their jurisdiction

are typically through guidance or advice. MOF relies on administrative

guidance to influence actions taken by banks it supervises. BOJ lacks such

authority because it is not a regulatory authority. Instead, BOJ provides

advice, which according to government and bank officials banks generally

follow.

MOF’s Legal Enforcement

Authority

Under the 1981 Banking Law, MOF can suspend a bank’s business activities

or revoke its license if the bank violates a law, its article of incorporation,

MOF’s enforcement actions, or if its activities undermine the public

interest. The Banking Law also provides penalties for law violations,

including fines and imprisonment. For example, individuals can be liable

for imprisonment or fines of up to 3 million yen ($28,140) if they conduct

banking activities without obtaining a license from MOF. Individuals are

also liable for fines of up to 500,000 yen ($4,690) if they do not meet

reporting requirements, or if they refuse, obstruct, or circumvent an

examination. However according to MOF officials, there have been no cases

in which MOF has used fines or imprisonment.

According to bank officials, MOF has the authority to correct the operations

of a troubled financial institution. MOF can also remove bank managers

from their positions and order the restructuring of a bank’s management

or suspension of its business if violations of laws and regulations are

found. Although MOF has such legal enforcement authority, until recently it

has not been used. Instead, banking industry representatives said, MOF

prefers to rely on administrative guidance as its primary means of

enforcement. MOF also provides supervisory direction and guidance

through the frequent contacts it has with banks.

MOF’s Administrative

Guidance

MOF’s administrative guidance basically involves the agency interpreting

existing laws and regulations and providing these interpretations to banks.

This guidance can take the form of oral guidance or written circulars or

notices. MOF sees this flexibility as one advantage of administrative

guidance. MOF officials also described such forms of guidance as

preferable to initiating legal proceedings in the Japanese court system,

which can be a lengthy process.

Although administrative guidance is not legally enforceable, government

officials and bankers said that banks are expected to act on it and they

typically do. According to MOF, banks are allowed to interpret

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administrative guidelines within reason. When conflicts arise, differences

are resolved through discussions with bank officials and MOF. Circulars or

notices may also be used to clarify or explain terms and concepts.

The Japanese government recently adopted new legislation to ensure that

governmental administrative actions are more transparent. In

October 1994, the Administrative Procedures Law was passed to establish

standards for fairness and openness in the administrative process. The

law, among other things, requires a clear explanation of administrative

decisions, and it requires that guidelines for regulated institutions, which

include banks, be standardized. It also confirms that compliance with

administrative guidance is strictly voluntary. Under new provisions of this

law, MOF is to issue administrative guidance in writing, if required by the

affected party. According to MOF, the number of cases in which it gave,

what it termed concrete guidance on business-improvement measures to

major banks totaled 178 in 1992, 129 in 1993, and 127 in 1994.

BOJ’s Safety and

Soundness Advice

In order to fulfill its mission of maintaining price stability and fostering a

safe and sound financial system, BOJ said it extends safety and soundness

advice to solve the prudential problems of each examined bank, if

necessary. In this regard, BOJ’s advice is different from law-based action

taken by governmental agencies, such as MOF. BOJ’s authority comes from

its contractual agreements with client banks. Advice to banks may cover

such areas as operational safety and soundness and risk concentration.

Increases in

Nonperforming Loans

and Financial

Institution Failures

Caused Japan to

Review Role of

Banking Authorities

The high number of nonperforming loans and the near depletion of the

deposit insurance fund in 1995 led Japanese officials to conclude that

changes were needed in the supervisory process. A committee of FSRC, in

September 1995, after almost 3 months of deliberation, proposed a number

of supervisory changes.

Interim and final reports by FSRC3

 observed that supervisory authorities

should have responded to the loan problem by constructing a financial

system in which market mechanisms and the principle of

self-responsibility of both banks and depositors would come fully into

play. Specifically, the reports proposed strengthening supervisory

oversight and suggested that supervisory authorities:

3

Interim Report by the Financial System Stabilization Committee of the FSRC, Sept. 27, 1995 and The

Summary of the Final Report of the Financial System Stabilization Committee of the FSRC, Dec. 22,

1995.

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• take action in a timely manner,

• inspect financial institutions more frequently,

• increase the number and quality of inspection and monitoring staff,

• introduce tools to promote the prompt correction of financial institutions’

mismanagement,

• promote more disclosure of nonperforming loans, and

• implement a prompt disposal procedure for failing or failed financial

institutions.

In addition, in late December 1995, MOF announced plans intended to

reform Japan’s bank supervisory system.4 MOF was to (1) issue new

guidance for banks regarding internal controls and risk management,

(2) increase its staff of bank inspectors from 420 to 490, (3) make use of

external audits and encourage external audits in overseas branches, and

(4) promote a closer exchange of information with other supervisory

authorities abroad. Under the new supervisory system, banks will be

encouraged to

• improve their own internal control and risk management systems in

accordance with new MOF guidelines,

• make greater use of certified public accountants (CPA) to conduct external

audits,

• provide timely notification of wrongdoing, and

• ensure their business operations comply with requirements through check

and balance functions.

Collectively, these measures are intended to make the supervisory system

more transparent and increase the accountability of individual banks.

Some supervisory reform measures are already under way, including the

passage of three reform bills in June 1996. In addition to increasing the

frequency and scope of inspections of overseas branches and subsidiaries

in Asia, MOF has issued an inspection checklist on overseas offices. BOJ has

initiated special examinations of the New York branches of some major

Japanese banks. In addition, BOJ is expanding the scope of its

examinations of overseas branches to (1) enhance examinations,

(2) upgrade examination skills, and (3) increase cooperation with other

central banks.

4

Measures to Improve Banking Inspection and Supervision by the Ministry of Finance, Dec. 26, 1995.

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Safety and Soundness Information Is

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Monitoring

MOF and BOJ obtain information needed to fulfill their safety and soundness

responsibilities primarily through on-site and off-site monitoring. MOF and

BOJ also rely on required and ad hoc reports from banks, frequent meetings

with banks, and their own research and analysis. The two agencies

cooperate with each other, as necessary, in order to achieve their distinct

missions. Neither agency has typically used audit information developed

by external, statutory,1

 or internal auditors.

On-Site Monitoring

Conducted

Independently

Although the scope of MOF’s and BOJ’s on-site bank monitoring, which MOF

calls inspections and BOJ calls examinations, is similar, the two agencies’

actual on-site monitoring is carried out largely independently of one

another. Recently, due to financial liberalization, both MOF and BOJ have

placed greater emphasis on their on-site monitoring of risk management.

Although there is no legal requirement governing the frequency of bank

examinations, MOF and BOJ coordinate their monitoring efforts to ensure

that most banks are monitored annually. This coordination allows MOF and

BOJ to alternate their on-site monitoring of the approximately 700 banks2

subject to their inspections or examinations.

MOF Inspections MOF conducts an on-site inspection of the banks it supervises about once

every 2 to 3 years. The average duration of inspections and the size of

inspection teams varies due to several factors, including the size of the

bank and its operational record. Inspections of city banks take about 6

weeks and involve about 10 inspectors. For regional banks, inspections

last 4 to 5 weeks and typically require five inspectors. Inspections of

shinkin banks, which are conducted by one of MOF’s regional bureaus, take

about 2 weeks and involve four to five inspectors. Inspection teams are led

by a chief inspector, and team members are responsible for different

components of the inspection.

MOF conducts two types of on-site inspections—comprehensive

inspections and inspections focusing on specific aspects of a bank’s

operation, such as credit-risk or market-risk management. Comprehensive

inspections, which are the most common type of inspection, are

1

The Japanese Commercial Code was promulgated in 1890 to designate rules for conducting business.

It requires banks with paid-in-capital of at least 500 million yen ($4.7 million) or total liabilities of 20

billion yen ($18 million) or more to have their financial statements audited by independent auditors

and to appoint at least two auditors, known as statutory auditors.

2

This number includes 93 foreign-owned bank branches. MOF also inspects other financial institutions,

such as insurance companies, in addition to banks. In all, MOF has inspection authority for more than

3,000 financial institutions.

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Monitoring

unannounced. Nonetheless, banking officials said the timing of past visits

tends to indicate when they are likely to receive their next inspection.

Comprehensive inspections assess all major elements of a bank’s

activities, including regulatory compliance, assets and liabilities, profits

and losses, general business operations, and such physical items as cash

on hand.

As part of the inspection process, MOF inspectors check a bank’s overall

risk management policies and procedures. They also check the bank’s

compliance with regulations related to financial soundness, such as those

dealing with its minimum capital ratio requirements and large loan

exposures to a single party. MOF inspectors also review the bank’s

compliance with other regulations, for instance, those specific to the risk

management of a particular business activity or product.

Prior to conducting a comprehensive inspection, MOF inspectors review

bank documents to help focus their on-site efforts. Following this review,

they initiate the inspection, beginning with physical items, at one branch

or simultaneously at several branches. Comprehensive inspections, which

usually involve verification of records, typically involve inspectors

inspecting cash, securities, notes, legal documents, deposits, and loans. At

any time during the inspection, MOF inspectors can request additional

information.

Inspectors classify assets according to their likelihood of repayment. Such

classifications, combined with an analysis of the bank’s capital, indicate

how deposited money is used and the extent of credit risk present,

according to MOF. Assets are classified into four categories:

(1) unmarked—when the loan is considered sound,

(2) substandard—when the loan carries above average risk,

(3) doubtful—when full payment is considered doubtful and some loss is

expected, and

(4) loss—when the loan is considered unrecoverable.

During on-site inspections, inspectors select loans to ensure a coverage

ratio of at least 50 percent of a bank’s entire loan portfolio, according to

MOF. Standards call for the selection of loans with large exposures over a

certain amount, loans overdue beyond a certain period, and loans to

companies having financial problems at the time of inspection. MOF

inspectors also conduct financial analyses and interview bank

management and key personnel to better understand bank policies and

other matters.

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Since 1987, MOF has used a rating system similar to the U.S. CAMEL rating

system, which bases ratings on five factors: capital, assets, management,

earnings, and liquidity. In June 1996, MOF issued guidelines for banks’ risk

management of market-related risks, which are based on guidelines

established by the Basle Committee.

BOJ Examinations BOJ examiners conduct on-site examinations of banks subject to the

agency’s examinations about every 2 to 3 years, although the frequency of

examinations can vary depending on bank size, business conditions, and

MOF’s inspection schedule. BOJ examiners provide approximately 2 months

advance notice of an on-site examination and typically request documents

and other information in advance of their visit. Requested information

commonly includes, for example, loan and deposit balances for each

branch, data on client bankruptcies, and internal investment policies. BOJ

examiners request additional information from banks with international

operations on such matters as the condition of foreign real estate loans

and earnings from their international banking activities.

Since BOJ obtains bank information in advance of visits, its on-site

examinations generally require less time than do MOF inspections,

according to bank officials. Examinations of city banks typically take 3 to

4 weeks for one or two senior examiners, which BOJ calls chief

supervisors, and ten examiners. In comparison, regional bank

examinations take 2 to 3 weeks for one or two chief supervisors and four

or five examiners. For shinkin banks, comparable examinations take 1 to 2

weeks for a chief supervisor and three examiners.

As part of the examination process, BOJ examiners place their main

emphasis on checking a bank’s overall risk management, including

policies and procedures. Examiners use a check list for risk management

developed in 1987 and later completely revised in 1996 to reflect the

changing financial environment. They also check the bank’s compliance

with MOF regulations related to financial soundness, such as those dealing

with its minimum capital ratio requirements and large loan exposures to a

single party. As for other regulations, such as those on business area or

product, BOJ reviews them from a risk management viewpoint rather than

from a compliance perspective.

BOJ’s examination process has two key components: (1) a preexamination

analysis and (2) fieldwork. The initial preexamination analysis is used to

identify a bank’s primary activities and to focus on potential problem

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areas. As part of this analysis, examiners look at bank operations from a

risk management perspective, including lending, funding, internal controls,

and international activities. During the fieldwork component, which

consists of the actual on-site examination, examiners meet with the bank’s

senior executives to review policies and discuss problems. They assess

asset quality by (1) evaluating individual loans, (2) holding discussions

with loan officers, and (3) reviewing the credit files of borrowers and

other related documents. BOJ officials told us that examiners typically

evaluate about one-half of a bank’s total loans.

BOJ selects bank loans for review by categorizing them into one of three

categories: (1) insider loans, (2) marked loans, and (3) large loans.3

 During

the examination, loans are classified as to their quality using procedures

similar to those used for MOF’s classification.

As part of their fieldwork at a typical bank’s head office and selected

branches, BOJ examiners review the bank’s daily operations for reliability.

They review cash on hand, accounting books, and other financial

documents. In addition, they assess the bank’s management of risk related

to credit, interest rates, and foreign exchange. At the completion of this

process, BOJ chief supervisors give an overall evaluation to the bank

management regarding the bank’s condition, as well as provide

recommendations to improve risk management.

In addition to regular full-scope examinations, BOJ periodically conducts

special examinations of particular aspects of bank operations. A recent

example is the special examination of Daiwa Bank, which primarily

involved investigating the case and ascertaining risk-management

deficiencies in the bank’s New York branch trading operations. Another

recent BOJ special examination focused on the use of operational controls

and the management of market risk by the New York branches of leading

Japanese banks.

BOJ also conducts on-site examinations of securities firms that have

current accounts with it. During these examinations, examiners check

such indicators of overall financial conditions as the firm’s

risk-management policies and procedures, asset quality, and earnings.

Such examinations, which take 2 or 3 weeks, are usually conducted every

2 to 3 years by 1 or 2 chief examiners and 4 to 6 examiners. Securities

3

BOJ categorizes direct loans to directors and loans guaranteed by directors as insider loans. Loans

with problem purposes and terms and loans to borrowers in bankruptcy are categorized as marked

loans. Consolidated loans higher than designated amounts are categorized as large loans.

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Safety and Soundness Information Is

Obtained Through On-Site and Off-Site

Monitoring

subsidiaries of banks are often examined at the same time the parent bank

is examined.

Results Are Provided

Orally and in Writing

by MOF and BOJ

When MOF and BOJ complete their inspection or examination, they meet

with senior bank officials to discuss their findings and recommendations

for improvement. Both agencies regard these individual discussions with

bank management at the completion of their work as an essential method

for communicating inspection or examination concerns.

Typically, MOF’s chief inspector meets with the bank’s management to

discuss findings at the conclusion of an inspection. This meeting is an

opportunity both for the chief inspector to express his opinions informally

and for the bank’s management to provide comments. Following this, an

official inspection report is prepared and reviewed by senior MOF officials.

MOF then issues an official conclusion in the form of a letter or an

administrative order, which is given to the bank along with a copy of the

inspection report. The conclusion, when appropriate, identifies areas

needing improvement and provides guidance for the bank. MOF sometimes

requests an improvement plan and periodic reports if the situation

warrants such follow-up actions.

At BOJ, periodic, interim, and closing meetings are attended by both

examiners and senior bank management. According to BOJ officials,

interim meetings are held to minimize later misunderstandings. At the

closing meeting, BOJ examiners discuss examination results to highlight

identified problems and to provide recommendations and supervisory

guidance. A written report is subsequently shared with the bank’s senior

management.

Off-Site Monitoring by

MOF and BOJ

MOF and BOJ independently conduct their own off-site monitoring, which

typically involves analyses of information about banks under their

jurisdictions. Information is obtained through periodic reports submitted

by banks and frequent contacts with bank personnel and management.

Minimum Reporting

Requirements

Reports submitted by Japanese banks play a key part in MOF’s and BOJ’s

bank monitoring. Under the 1981 Banking Law, each bank in Japan is

required to submit an interim banking report and an annual banking report

to MOF describing its business activities and financial position. Interim and

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Safety and Soundness Information Is

Obtained Through On-Site and Off-Site

Monitoring

annual reports are also submitted to BOJ. Both MOF and BOJ may also

require additional information as needed.

Annual reports provide the most extensive information. They are to

include certain detailed schedules on securities, loans, fixed assets,

commitments and underlying capital, total amount of domestic and foreign

drafts remitted and received, and total amount of foreign currency bought

and sold. Interim reports, which are submitted on a semiannual basis,

provide less extensive information on a bank’s activities and financial

position.

In addition, banks must report certain information to MOF on a more

frequent basis that ranges from daily to quarterly. Information on a bank’s

trading activities, for example, is typically provided to MOF monthly and

quarterly, according to MOF officials. BOJ also requires each institution to

file periodic financial reports. For the most part, MOF and BOJ do not

require banks to file reports electronically. However, BOJ does gather

computer-generated data from banks on a monthly basis. Currently, none

of the information gathered from routine reports or daily monitoring is

accumulated in an early warning system to identify banks that may be in

trouble. However, MOF officials said MOF is developing a computerized

system that is to accumulate information from banks, which would serve

as an early warning system.

Meetings Provide Critical

Information

MOF and BOJ officials told us they rely a great deal on frequent contacts

with bank personnel and management during which useful information is

exchanged. During informal meetings, which are held as needed, MOF and

BOJ officials are able to provide guidance or advice while staying abreast of

developments at individual banks. Meeting topics can include, but are not

limited to, bank liquidity, overall business activities, new product

development, and corrective actions.

MOF and BOJ Share

Monitoring

Information When

Necessary

Although MOF and BOJ at times share information informally on a

case-by-case basis, there is no legal or formal requirement for MOF or BOJ to

share supervisory information with each other. In fact, MOF’s staff is bound

by law to maintain confidentiality with respect to information gained in

the course of their duties or by virtue of their position in the government.

On the other hand, BOJ’s staff are not bound by law to maintain

confidentiality with respect to information gained in the course of their

duties. While MOF’s staff are restricted from sharing information regularly

Page 45 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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Safety and Soundness Information Is

Obtained Through On-Site and Off-Site

Monitoring

with BOJ’s staff, MOF may disclose information in those cases in which

circumstances warrant such actions.

As a result, on-site monitoring results ordinarily are not shared, unless

problems arise requiring joint action by MOF and BOJ. BOJ officials explained

that its examination results are considered proprietary, and that MOF

respects this proviso.

For serious problems requiring supervisory coordination, MOF typically

assumes responsibility for coordination and exchanges of information,

according to MOF and BOJ officials. In addition, MOF and BOJ officials told us

they also communicate through daily telephone calls and informal

meetings.

Limited Use of

Independent Auditors

Independent bank audits by CPAs have not historically played a major role

in the supervision of Japanese banks, according to MOF and BOJ officials.

MOF and BOJ have not typically used internal audits by statutory auditors.

However, use of independent external audits by MOF appears likely to

increase with the introduction of new legislation to improve oversight of

the banking system.

Banks Are Audited Under

Corporate Law but MOF

and BOJ Do Not Rely on

These Independent Audits

Japanese banks with capital stock totaling at least 500 million yen

($4.7 million), or with total liabilities of 20 billion yen ($188 million) or

more, are required by Japan’s Commercial Code to undergo annual audits

by an independent certified public accountant. Such audits must be

undertaken prior to the bank’s annual shareholders’ meeting, which is

typically held within 3 months of the end of the company’s financial year.

Prior to World War II, independent or external audits were not required.

However, corporations offering securities to the public became subject to

mandatory annual audits by CPAs with passage of the Securities and

Exchange Law in 1948. The new requirement grew out of the postwar

demand for business reforms and corporate disclosures and in response to

the introduction of foreign capital for postwar economic development.

Subsequent amendments to the Commercial Code in 1974 and 1981

extended the auditing requirement to other types of corporations.

Independent auditors are required to certify in their reports that

Page 46 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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Safety and Soundness Information Is

Obtained Through On-Site and Off-Site

Monitoring

• the balance sheet and profit and loss statement fairly present the bank’s

financial position and the results of its operations;

• proposed uses of retained earnings and accounting matters in the business

report are presented in conformance with applicable laws and articles of

incorporation; and

• accounting supplementary schedules present correct data and are in

accordance with provisions of the Commercial Code.

In addition to significantly enhancing the CPA’s role in the Japanese

corporate system, the revised Commercial Code also required every bank

to appoint statutory auditors. Statutory auditors are responsible for

(1) auditing the bank’s accounting records and (2) monitoring the

activities of its directors. Japanese Institute of Certified Public

Accountants (JICPA) officials told us that statutory auditors rely on the

results of the audits performed by CPAs on a bank’s accounting records.

These audits and monitoring activities must be completed prior to the

annual general meeting of the shareholders.

Under the revised code, statutory auditors are considered “members” of

the bank, but they cannot be employees or directors of the bank or its

subsidiaries. According to accounting officials, statutory auditors, who

receive salaries from the banks they audit, are often retired bank

employees or former bank managers. The revised code does not require

statutory auditors to have specific qualifications, and few are CPAs. Several

independent auditors said the independence of statutory auditors is often

compromised by their prior relationship with the bank being audited and

their lack of auditing expertise.

MOF and BOJ officials told us they do not rely on reports prepared by

independent or statutory auditors. They said they depend instead on their

own contacts with banks and their own monitoring activities. Our

discussions with the Japanese Institute of Certified Public Accountants

confirmed that CPAs have little contact with MOF or BOJ.

As mentioned in chapter 2, legislative measures have been enacted that are

designed to strengthen the supervisory oversight of banks. One provision

requires increased use of external audits to ensure sound management of

certain segments of the banking industry.

Page 47 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Chapter 4 

BOJ and MOF Have Other Financial System

Responsibilities; DIC Administers Deposit

Protection

BOJ and MOF have other financial system responsibilities in addition to their

regulatory and/or safety and soundness responsibilities. BOJ is responsible

for maintaining liquidity, serving as the lender of last resort, and providing

funds transfer service. Both BOJ and MOF share responsibility for managing

financial crises and for participating in international forums. A special

corporation—the Deposit Insurance Corporation—administers the

insurance system that protects deposits in Japanese banks.

Liquidity Provider BOJ’s statutory responsibilities for monetary policy are based on the 1942

Bank of Japan Law. As the nation’s central bank, BOJ influences the

nation’s money supply and interest rates to maintain adequate market

liquidity, to help provide a basis for sustained economic growth. It also

sets commercial bank reserve requirements and participates directly in

financial markets by buying and selling securities and bills at market

prices to influence the money supply and money markets and to ensure

the smooth functioning of the financial system.

Lender of Last Resort As lender of last resort, BOJ can provide liquidity when an institution has

severe difficulties in obtaining sufficient funds from the market, and such

liquidity is needed. However, BOJ is expected to exercise discretion in

deciding whether to extend loans to failing financial institutions. In an

October 1994 statement, the Governor of BOJ stated that the central bank

should only serve as lender of last resort for those cases in which an

institution’s liquidity shortage could threaten the stability of the entire

financial system. According to BOJ officials, in certain rare cases and with

special approval, BOJ has provided liquidity without eligible collateral.1

According to BOJ officials, BOJ’s function as lender of last resort basically

involves its providing liquidity to troubled financial institutions or to the

financial system, to prevent a systemic crisis. They explained that the

following four conditions should be met before it can carry out this

function:

• There is a strong likelihood that systemic risk will materialize;

• Central bank financial support must be indispensable for the successful

disposal of a failed financial institution;

1

The Bank of Japan Law allows the BOJ to make loans against collateral in the form of bills or notes,

government bonds and obligations, and other negotiable securities, gold and silver bullion, or

merchandise. These are considered “eligible” collateral.

Page 48 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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BOJ and MOF Have Other Financial System

Responsibilities; DIC Administers Deposit

Protection

• All parties responsible for the institution’s problems must be penalized so

as to avoid the emergence of moral hazard; and

• The financial soundness of the central bank must be maintained.

Payments Clearance BOJ also plays a key role in clearing payments. The main payment system

in Japan is the bill and check clearing and domestic funds transfer system,

which is operated by private institutions. Local bankers associations

operate the check clearinghouses and the Zengin data telecommunication

system, which form the core of the domestic funds transfer system. BOJ

cooperates with these institutions and plays a key role in the payments

and settlements process by issuing bank notes and transferring funds

among account holders. Banks can draw checks on BOJ or issue transfer

instructions to it.

In late 1988, BOJ launched a network for on-line settlements of payments

called the Bank of Japan financial network system. The network, which

links BOJ with hundreds of private financial institutions, provides an

electronic infrastructure for operations, including funds transfer and

government securities transfers. As of March 1996, BOJ data show 420

institutions had used the network for funds transfer, 266 had used it for

yen settlements of foreign exchange transactions, and 432 had used it to

transfer Japanese government securities.

Participation in

International

Organizations

BOJ and MOF participate in the activities of numerous international

organizations, including those of the Group of Seven,2

 whose meetings

they regularly attend. In addition, both attend Group of Ten3

 meetings,

such as the group’s governor’s meetings, which primarily focus on

macroeconomic and monetary policy issues. BOJ also participates in such

international organizations as the Bank for International Settlements and

the International Monetary Fund. As a shareholder member, BOJ sits on all

Bank for International Settlements institutional committees, according to

a BOJ official. As Japan’s central bank, BOJ also cooperates and coordinates

closely with other central banks on such issues as intervention in foreign

exchange markets with the aim of achieving currency stability.

2

The Group of Seven is a group of major industrial countries whose finance ministers and central bank

governors meet occasionally. The seven countries are the United States, the United Kingdom,

Germany, Japan, Canada, France, and Italy.

3

The Group of Ten is a group of major industrial countries whose representatives meet to discuss

issues of mutual concern. Participating countries include Germany, Belgium, Canada, the United

States, France, the United Kingdom, Italy, Japan, the Netherlands, Sweden, and Switzerland.

Page 49 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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BOJ and MOF Have Other Financial System

Responsibilities; DIC Administers Deposit

Protection

MOF and BOJ also participate in activities of the Basle Committee on

Banking Supervision, as well as those of the International Monetary Fund

and the Organization for Economic Cooperation and Development. In

addition, MOF’s securities supervisors attend meetings of the International

Organization of Securities Commissions.

Crisis Management

and Resolution of

Troubled Institutions

MOF and BOJ work closely together to assist troubled institutions to

establish policies and provide a plan for resolving crises. They told us that

once the two agree on an overall resolution plan, BOJ typically manages

cash transactions and provides liquidity when necessary.

According to the Bank of Japan Law, BOJ may, with approval from MOF,

conduct such activities other than its normal business as are necessary for

the maintenance and fostering of the credit system. According to MOF

officials, this should also include BOJ making loans to troubled institutions

without eligible collateral. Close cooperation and coordination between

the two agencies has resulted in MOF supporting all of BOJ’s past decisions,

according to MOF officials.

Although prefectural governments supervise credit cooperatives, MOF and

BOJ can step in to resolve crises affecting troubled credit cooperatives.

According to a MOF official, MOF and BOJ recently formulated a resolution

plan to prevent a financial crisis involving the Cosmo and Kizu credit

cooperatives. BOJ also provided needed liquidity to the two institutions.

Deposit Insurance Is

Administered by DIC

The Deposit Insurance Corporation of Japan (DIC) was established as a

special corporation in 1971 to protect depositors and maintain the stability

of the financial system. DIC serves these purposes by insuring individual

depositors for up to 10 million yen ($93,800) and by providing financial

assistance to facilitate the merger or acquisition of failing financial

institutions. DIC is supervised by MOF.

Institutions required to be insured include banks (city banks, regional

banks, trust banks, long-term credit banks, foreign exchange banks),

shinkin banks, credit cooperatives, and labor banks. Agricultural

cooperatives, fishery cooperatives, and fishery production cooperatives,

due to their special characteristics, are not required to be insured by DIC.

Depositors at these institutions are instead protected under a separate

Page 50 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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BOJ and MOF Have Other Financial System

Responsibilities; DIC Administers Deposit

Protection

system administered by the Savings Insurance Corporation,4 established in

September 1973.

The principal functions of DIC include the collection of insurance

premiums, payment of insurance claims and advance payments, execution

of financial assistance, purchase of assets from failing or failed financial

institutions, and management of funds. DIC is headed by a management

committee consisting of up to eight members and the corporation’s

governor and three executive directors. By law, the governor is appointed

by the Finance Minister. The governor appoints the executive directors

and committee members, after obtaining approval from MOF.

DIC’s administration is handled by its secretariat and the Special

Operations Department. The latter was established by the June 1996

amendment to DIC law. In September 1995, DIC secretariat had a staff of 15

employees, but recent legislation substantially increased its staff. As

needed, some administrative functions can be delegated to BOJ or to

private financial institutions with MOF’s approval. In emergencies, for

example, these institutions may be asked to provide staff and other

assistance for the processing of claims.

DIC insures member institutions5 through premiums levied on their insured

deposits. The premium rate, which is determined by the management

committee, requires MOF approval. Before April 1996, member premiums

were set at 0.012 percent of insured deposits. In order to build up the

deposit insurance fund in preparation for potential future insolvencies, the

premium was raised four-fold to 0.048 percent. Furthermore, based on

revision in the Deposit Insurance Act, a special premium of 0.036 percent,

which is to be paid into the Special Account6

 of DIC, will be assessed for 5

years. Member institutions are required to make half of the annual

insurance payments within 3 months and the rest within 9 months of the

beginning of the business year.

In 1995, the insurance premiums and other revenues that accumulated in

the deposit insurance fund represented a small proportion of insured

4

Government-related financial institutions and Japanese branches of foreign banks are not covered by

either DIC or the Savings Insurance Corporation.

5

As of Mar. 31, 1995, according to DIC, 1,009 financial institutions, including 167 banks, were insured

by DIC.

6

As a temporary measure for the next 5 years, a Special Account was established within DIC. With this

account, the corporation is authorized to accord financial assistance up to the full amount of loss

incurred by a failed institution; the amount of financial assistance has thus far been limited to the

equivalent of pay-off cost.

Page 51 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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BOJ and MOF Have Other Financial System

Responsibilities; DIC Administers Deposit

Protection

deposits in Japanese banks. As of March 31, 1995, according to DIC, the

fund totaled 876 billion yen ($8.23 billion). The value of insured deposits

on that date totaled 555.7 trillion yen ($5.2 trillion), which represented

78.2 percent of total deposits in Japanese financial institutions. At

March 1995 funding levels, the deposit insurance fund reserves constituted

less than 0.16 percent of insured deposits.

Financial assistance to a failing institution, which must be approved by

MOF, may be provided through grants, loans, deposits, purchase of assets,

guarantee of liabilities, or acceptance of liabilities. As of March 1996, the

total cost of disposal during the past 4 years amounted to between 2

trillion yen ($19 billion) to $2.5 trillion yen ($24 billion). The deposit

insurance fund totaled about 387 billion yen ($3.63 billion) as of March 31,

1996. However, the premium increases required by the June 1996

legislation are expected to raise approximately 2.3 trillion yen ($22 billion)

over the next 5 years, according to Japanese officials.

Page 52 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Page 53 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Appendix I 

Principal Japanese Financial Institutions

The highly segmented Japanese banking structure consists of private

sector institutions, government institutions, and a central bank. Banks

specialize in different areas, such as short-term finance, long-term finance,

finance for small- to medium-sized companies, trust activities, and foreign

exchange. The nation’s financial sector also includes other types of

depository and nondepository institutions, such as insurance companies,

as shown in table I.1.

Page 54 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Appendix I 

Principal Japanese Financial Institutions

Figure I.1: Principal Japanese Financial Institutions, (as of April 1996)

Central

bank 

Private

financial 

institutions 

Type Group Category Number

1

129

93

3

8

10

11

1

The Bank of Japan

Ordinary banks

Long-term financial

institutions 

Financial institutions

for small- and

medium-sized

businesses 

Other private

financial institutions 

Financial institutions

for agriculture,

forestry, and

fishery 

Public

financial

institutions 

Banks and

public finance

corporations 

Postal savings

1

416

1

369

1

1

48

City banks

Regional banks

Foreign-owned banks

Long-term credit banks

Traditional trust banks

Zenshinren Bank

National Federation

of Credit Cooperatives 

Shoko Chukin Bank

Rokinren Bank

Norinchukin Bank

47

35

1

29

58

283

Insurance

companies 

Securities

companies 

Shinkin banks

Credit cooperatives

Life insurance

companies 

Nonlife insurance

companies 

Labor banks

Credit federations of

agricultural

cooperatives a

Credit federations 

of fishery cooperatives b

Subcategory

Page 55 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Appendix I 

Principal Japanese Financial Institutions

aThese cooperatives at the prefectural level provide deposit and lending services to about 2,500

local agricultural cooperatives.

bThese cooperatives at the prefectural level provide deposit and lending services to about 1,500

local fishery cooperatives.

Source: MOF and Zenginkyo.

Ordinary Banks Ordinary banks, which are established in accordance with the 1981

Banking Law, are licensed by MOF. There are three types of ordinary

domestic banks—city banks, regional banks, and regional banks II.

Branches of foreign-owned banks are also classified as ordinary banks.

Ordinary banks focus on short-term finance with an emphasis on deposits,

lending, and funds transfer. They also handle medium- and long-term

financial transactions with corporations and individual, as well as

domestic and international finance.

In addition to conducting primary banking business, ordinary banks may

engage in certain securities activities with restrictions, such as commercial

paper underwriting, foreign exchange and trade financing, and

international securities activities. Additional activities ordinary banks may

engage in through their affiliates include leasing, consumer finance, and

investment advisory services. While banks are permitted to maintain

equity investments in affiliates, they are prohibited from jointly managing

such businesses.

City Banks Japan’s 10 city banks1

 maintain their main offices in major cities, and their

branches are located throughout the country. Although these banks

emphasize wholesale business, their branches have also made them

competitive at the retail level. They are active in the securities business

and international operations. All city banks are licensed as foreign

exchange banks and may conduct transactions in foreign exchange

markets.

One-half of Japanese city banks’ deposits are from large corporate

accounts. Loans to large corporations, which make up one-third of city

bank assets, usually are short-term loans. The remaining loans are to

small- and medium-sized enterprises and individuals.

1

The 10 city banks are Asahi Bank, Bank of Tokyo, Dai-Ichi Kangyo Bank, Daiwa Bank, Fuji Bank,

Hokkaido Takushoku Bank, Mitsubishi Bank, Sakura Bank, Sanwa Bank, Sumitomo Bank, Tokai Bank.

and the merged Mitsubishi Bank and the Bank of Tokyo.

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Principal Japanese Financial Institutions

Regional Banks Regional banks in Japan are categorized as regional banks and regional

banks II. As of March 1995, there were 64 regional banks and 65 regional

banks II. Both types of banks conduct most of their operations within their

own prefectures.

Regional banks are located in the main cities of prefectures, where they

maintain strong local ties to the community. They lend primarily to smalland medium-sized businesses, and more than half of their deposits come

from individual account holders. Regional banks II also serve smaller

companies and individual account holders in their regions, but they

generally have a smaller asset base than that of regional banks.

Foreign-Owned Bank

Branches

There were 93 foreign-owned bank branches operating in Japan as of

March 31, 1996, of which 16 were owned by U.S. concerns. These

branches, which account for about 2 percent of industry assets, emphasize

off-balance-sheet trading, particularly in the derivatives market.

Foreign-owned bank branches conducting banking business in Japan

legally qualify as banks subject to Japan’s Banking Law. They may

establish bank subsidiaries, bank branches, and representative offices in

Japan. Representative offices, which cannot conduct regular banking

business, primarily serve as liaisons with their home offices.

Foreign-owned bank branches and subsidiaries are licensed by MOF, and

they function like those of city and regional banks.

Long-Term Financial

Institutions

Historically, the Japanese government established long-term financial

institutions to provide long-term funding for agriculture and other

industries. Until recently, they were the only financial institutions

permitted to raise long-term funds. However, under banking industry

deregulation, ordinary banks have captured a share of the long-term

lending market, and the historic differences between ordinary and

long-term financial institutions have become less pronounced.

Long-Term Credit Banks Long-term credit banks were established by the 1952 Long-Term Credit

Bank Law to facilitate rapid industrial recovery in Japan. Japan’s three

long-term credit banks share exclusive rights to issue bank debentures

with up to 5-year maturities. Since October 1993, however, ordinary banks

have been able to issue medium-term time deposits with up to 4-year

maturities. Long-term credit banks concentrate on providing long-term

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Appendix I 

Principal Japanese Financial Institutions

loans to industrial clients for plant and equipment, and long-term working

capital.

Trust Banks Trust banks, which are long-term specialized banks licensed to conduct

both banking and trust activities, are granted additional operational

latitude under the 1943 Concurrent Trust Business Law. They receive a

majority of their funds from trusts, and they supply funds to major

corporations. Trust banks receive and manage funds on behalf of their

clients. Their funding sources include pooled individual and corporate

deposits in money trusts, pension trusts, loan trusts, and securities

investment trusts.

Financial Institutions

for Small Business

Financial institutions for small business are basically cooperatives that

serve the financial needs of small- and medium-sized businesses, labor

unions, consumer cooperatives, and other labor bodies. Also included in

this group are three central bodies that take deposits, provide loans, and

meet other financial needs of their cooperative members. One such

institution, the Zenshinren Bank, serves shinkin banks. The Shinkin

Federation Bank similarly serves credit cooperatives, and a third

institution, the Rokinren Bank, serves labor banks.

Shinkin Banks Shinkin banks are nonprofit cooperatives with strong local community ties

that operate in accordance with the 1951 Shinkin Bank Law and its 1981

revision. Their target customers are small- and medium-sized enterprises

and the general public. They accept deposits and installment savings from

members and nonmembers, advance loans to members, discount bills for

members, transfer funds, and conduct foreign exchange operations. They

may also conduct some ancillary operations, such as the placement of

securities and trust services involving land and charities. Each shinkin

bank is a member of the Zenshinren Bank, the national federation of

shinkin banks. The Zenshinren Bank, which exists primarily to serve as a

central bank for shinkin banks, engages in deposit-taking, lending, and

funds transfer for its members, but it conducts ancillary business including

securities-related activities and also acts as an agent for public financial

institutions.

Credit Cooperatives Credit cooperatives provide their small- and medium-sized member

enterprises and their employees with such services as deposit accounts,

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Principal Japanese Financial Institutions

installment savings, and loans. Such cooperatives, which are subject to

ceilings on the credit they provide to any single member, may also lend to

local government bodies. Their authorization is granted by the local

governor if their activities remain within prefectural boundaries. If their

activities extend beyond these boundaries, they must obtain MOF

permission to operate. Supervisory responsibility for credit cooperatives

resides at the local government level rather than directly with MOF or BOJ.

The central bank for credit cooperatives is the Shinkin Federation Bank,

whose primary business is deposit accounts for members, national and

local government bodies, and nonprofit organizations. In addition, the

federation lends to its members and nonmembers.

Financial Institutions

for Agriculture,

Forestry, and

Fisheries

Serving local agriculture, forestry, and fisheries enterprises are private,

cooperative-based, financial institutions that operate on three levels. At

the lowest level are cooperatives operating at the village, town, and city

levels of government. At the middle level, these cooperatives in turn are

members of 47 prefectural-level associations called credit federations that

serve clients within their own prefectures. At the top level is the

Norinchukin Bank, which serves in several respects as the central bank for

agriculture, forestry, and fisheries enterprises. Supervisory responsibility

for the lowest level institutions is handled by local governments, while the

Norinchukin and the prefectural level associations are supervised by the

Ministry of Agriculture, Forestry, and Fishery and the Ministry of Finance.

Public Financial

Institutions

Loans by public institutions are primarily designed to supplement

private-sector financing. Public institutions, which are prohibited from

competing with private banks, borrow funds for permitted loans from the

government’s Trust Fund Bureau. Public corporations serve the financial

needs of specific sectors of the Japanese economy. For example, public

corporations may finance special sectors of the Japanese economy, such

as housing, agriculture, fisheries, small business, and environmental

sanitation.

Japan’s two government banks are the Japan Development Bank and the

Export-Import Bank of Japan. The purpose of the Japan Development

Bank is to supplement and encourage the credit operations of private

financial institutions. The Export-Import Bank of Japan serves to

supplement and encourage financing of exports, imports, and overseas

investments provided by other financial institutions.

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Appendix I 

Principal Japanese Financial Institutions

Postal Savings System Another government financial institution is the Japanese postal savings

system. Although the system is not a bank, the magnitude of its financial

resources gives it important financial significance in Japan. As of

May 1995, the system held more than 200 trillion yen ($1.88 trillion),2

making it the world’s largest financial institution. The postal savings

system was originally created to promote small-volume personal savings

to the general public. It offers such services as ordinary deposits, time

deposits, installment deposits, and deposit-based loans. The system, which

operates out of 24,000 Japanese post offices throughout the country,

accepts deposits from individuals of up to 10 million yen ($93,800).

Over the years, the postal savings system has gradually expanded its

services beyond demand deposits. For example, the system now offers

automatic payment of bills for public utilities and similar services. The

system’s expanded services have led to heightened competition with

private financial institutions. As a result, some Japanese banking industry

officials increasingly believe that the postal savings system has outgrown

its original purpose, and that a thorough review of its operations is

needed.

The system’s deposits are a major source of funds for the government’s

fiscal investment and loan activities, which are administered by the Trust

Fund Bureau through the Fiscal Investment and Loan Program. This

program is a trust fund for special accounts, government-affiliated

financial institutions, public corporations, local governments, and special

companies.

2

Exchange rate of 106.61 yen per U.S. dollar, as of Apr. 25, 1996.

Page 60 GAO/GGD-97-5 Japanese Bank Regulatory Structure
Appendix II 

Major Contributors to This Report

General Government

Division, Washington,

D.C.

Thomas J. McCool, Associate Director

Hazel J. Bailey, Writer-Editor

San Francisco-Seattle

Field Office

RoJeanne W. Liu, Evaluator-in-Charge

Gerhard C. Brostrom, Communications Analyst

Linda Chu, Evaluator

(233475) Page 61 GAO/GGD-97-5 Japanese Bank Regulatory Structure
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