Masaaki Shirakawa: Provision of subordinated loans
Excerpt from an address by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a
Meeting with Banks' Top Management, Tokyo, 24 March 2009.
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At the Policy Board meeting held on March 17, the Bank of Japan decided to explore a new
framework for providing subordinated loans to banks. We have invited today representatives
of banks which are subject to international capital standards to explain the background and
the Bank of Japan's view on the decision.
The funding conditions for firms have deteriorated rapidly since last autumn due to the
increased strains in global financial markets after the collapse of Lehman Brothers. While
financial institutions have retained the financial intermediation function accordingly by
increasing lending, the environment surrounding financial institutions has become
increasingly severe due to the stock price plunge and the domestic economic downturn.
Fund raising in financial markets for funds over the fiscal year-end has mostly been
completed, but the firms continue to face difficult funding conditions. While the CP market
has started to restore its function, funding in the capital market has been limited to the firms
with high ratings. Looking ahead, while demand for funds to secure liquidity for the year-end
and the fiscal year-end and demand for working capital due to the rise in raw material prices
until last summer will decline, demand for funds to continue and to restructure business are
expected to gain momentum.
There might be a case in which the financial intermediation function will not be carried out
smoothly from a macro perspective, if the strains in global financial markets increase and
financial institutions become more conscious of possible capital constraints in the future. If
financial institutions become more conscious of taking credit risk and all financial institutions
take the same action simultaneously, the adverse feedback loop between the finance and
the economy may intensify through financial institutions' restraining from accumulating their
assets, leading to the fallacy of composition, although the action is judged as rational for
each individual institution. As a result, that might weaken the capital strength of each
financial institution.
From that point of view, concern is for the influence of a possible decline in stock prices.
While the amount of stocks currently held by financial institutions is significantly reduced
compared with the early 2000s, it remains unchanged that they hold substantial market risk
associated with stockholdings. Although stock prices have recently somewhat rebounded,
the financial systems in the U.S. and Europe have remained unstable. It should be avoided
that each financial institution's consciousness about a possible decline in stock prices
triggers the aforementioned fallacy of composition.
Against such a backdrop, the Bank has decided to begin exploring specifically the provision
of subordinated loans to the banks that are subject to international capital standards. This
measure aims at ensuring the smooth functioning of financial intermediation and the stability
of Japan's financial system, by enabling Japan's banks to maintain sufficient capital bases
even in severe financial and economic environments.
By the measure taken by the Bank, financial institutions are provided with three channels to
raise capital; (1) capital raising by financial institutions through markets, (2) capital raising
based on the Act on Special Measures for Strengthening Financial Functions, (3) borrowing
subordinated loans from the Bank. Subordinated loans by the Bank will work effectively in
conjunction with the other two measures to raise capital. In addition, providing such a
safetynet measure would enhance the robustness of Japan's financial system and the functioning
of financial intermediation even under the stressed conditions.
For a central bank, this kind of direct provision of quasi-capital funds is an extremely
extraordinary measure. However, considering the future stress scenario of the financial
system, the Bank has judged that, from the standpoint of a central bank, it is necessary to do
its best to maintain the smooth functioning of financial intermediation and ensure the stability
of the financial system even by conducting this extraordinary measure.
The Bank expects financial institutions to grasp the thinking behind the measure and to strive
to maintain the smooth functioning of financial intermediation with further efforts of boosting
capital bases. Needless to say, risk management is extremely important for financial
institutions, which cannot be emphasized too much. However, under the current
circumstances, as I mentioned above, the surfacing of the risk stemming from the fallacy of
composition should be avoided. To that end, it is important for the management of financial
institutions, while conducting sound business operations, to boost capital bases with
envisioning the consequences for Japan's economy.
The Bank also expects financial institutions to pay due concern for the smooth
communication with their client companies to convey business policies and lending stances.
It is the basic premise that the stability of the financial system should be ensured in order to
return to a sustainable economic growth path under price stability. From the standpoint of a
central bank, the Bank is determined to make its best effort to secure the stability of the
financial system. We would appreciate your continued support and cooperation. Thank you.