Bank of Japan presents summaries of articles in the February edition of its
Quarterly Bulletin BANK OF JAPAN, COMMUNICATION, 27/2/98.
Response to the Disclosure Framework for Securities Settlement Systems: The-BOJ-NET JGB
Services
Introduction
This document provides answers to the "Disclosure Framework for Securities
Settlement Systems", a survey questionnaire drawn up by a joint working group of the Committee on
Payment and Settlement Systems (CPSS) of the Bank for International Settlements, and the
International Organisation of Securities Commissions (IOSCO).
The Securities Settlement System (SSS) here is the "Bank of Japan Financial
Network System (BOJ-NET) JGB Services", which is the Japanese government bonds (JGB)
settlement system in Japan. The answers as prepared by the operator of the system, the Bank of
Japan, are intended to help current and future participants in the settlement system to appropriately
understand and assess the risks associated with it.
The answers provide basic information about the BOJ-NET JGB Services as they
were in October 1997 (when the answers were prepared). The BOJ-NET funds transfer system is also
referred to where necessary.
Please note that the answers are intended to provide a general explanation, and the
information may not apply to every individual case.
Utilization of Financial Institutions' Self-Assessment in Enhancing Credit Risk Management
Summary
The government's Prompt Corrective Action (PCA) measures to be implemented
from April 1998 require financial institutions to conduct adequate assessment of their assets and to
calculate appropriate "loan-loss write-offs and provisions" based on their own internal rules and
referring to guidelines of the authorities. The Japanese "Big Bang" reform package is expected to be
conducted by the year 2001. Given these situations, large financial institutions in Japan are making
great efforts to enhance credit risk management. Medium and small-sized financial institutions are on
their way to establish basic credit risk management systems under the PCA measures. Since
information derived from self-assessment can be useful in a wide range of activities from
strengthening risk management systems to formulating business strategy large differentials in
business management are likely to arise among financial institutions depending on the utilization of
this valuable information.
The Bank of Japan introduced the Tracing Method of asset assessment and loan
losses in order to support financial institutions to maximize the use of their own assessments as a
management tool. The Tracing Method is used to observe changes in the condition of individual
assets in a time series and is one way to utilize financial institutions' self-assessment of assets. The
Bank conducted a follow-up analysis in the recent on-site examination to analyze how many of the
loans classified in the previous examination (1993-94) were later "written off and others" in relation
to financial losses ("others" are defined as specific loan-loss provisions, losses from support by
renunciation of claims, and losses from sales of nonperforming loans to the Cooperative Credit
Purchasing Company [CCPC]).
These empirical studies using the Tracing Method suggest the following four points
of importance for enhancing credit risk management.
(1) Importance of strengthening the early warning functions
It is vital to control loans classified as "substandard" (S) because the likelihood of loan losses in
terms of "write-offs and others" reaching a substantial size in the long term may vary
substantially depending on the adequacy of the long-term management of this classification of
loans.
(2) Importance of utilizing statistical methods which cover the life-span of loans
For example, for loans classified as (S), there is a tendency for the loan-loss ratio to rise after the
third year following the assessment.
(3) Importance of avoiding loan concentration
Financial institutions with highly concentrated loans in terms of industry had higher loan-loss
ratios, while institutions with diversified loan portfolios had relatively low ratios.
(4) Importance of gathering financial institutions' own default data for risk quantification
The estimated losses may be understated when only publicly disclosed bankruptcy data are used
since losses incurred through loans against "de facto bankrupt borrowers" and recipients of
financial support are not covered in such data. The latter type of losses accounts for a significant
share of outstanding losses. The Tracing Method covers all these data and enhances establishment
of financial institutions' own default data for credit risk quantification.
On our part, the Bank of Japan will continue to check and monitor the credit risk
management systems at financial institutions on the off-site basis and also during the on-site
examination in a more risk-focused, seamless and flexible manner, taking individual institutions'
circumstances into consideration. In addition, the Bank will continue to research methods of
quantifying credit risks as well as conducting follow-up analysis of the Tracing Method, in line with
the worldwide trend to further enhance credit risk management.
Revision of the Wholesale Price Indexes to 1995 Base
Introduction
The Wholesale Price Indexes (WPI) system is one of the three sets of price index
statistics presently compiled by the Bank of Japan, along with the Corporate Service Price Index
(CSPI) and the Input-Output Price Indexes of Manufacturing Industry by Sector (IOPI). Each has
different coverage and purposes. The WPI provides a measure of average changes in the prices of
goods in inter-enterprise transactions. It functions as (1) an economic indicator; (2) a barometer of the
purchasing power of the currency; and (3) a deflator.
A base-year revision of the WPI from the 1990 base to 1995 has been conducted to
incorporate changes in Japan's economic and trade structures.1 While the basic framework of the
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index system remains unchanged by the revision, the selected commodities (i.e., the smallest unit of
commodities for which indexes, calculated based on sample prices, are published) have been revised
and expanded in order to further increase the precision of the index. This paper outlines the details
involved in the revision of the WPI to the 1995 base, figures on the new base having been released in
December 1997.
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1 A base-year revision of the WPI, involving the updating of the base year for both indexes and weight calculation, is
conducted every five years based on a recommendation made by the Statistics Council in March 1981. In the revision
to the 1995 base, indexes were recalculated from the 1990 average = 100 base to the 1995 average = 100 base, and the
weights used in the calculation of indexes were updated based on 1995 data from such sources as the Census of
Manufactures" of the Ministry of International Trade and Industry and the Trade Statistics of the Ministry of Finance.
The framework of the index system is also reviewed as necessary at the time of the base-year revision.