Financial Crises - Japanese experience & - Responding to the present crisis

1. Financial Crises- Japanese experience & - Responding to the present crisis 6 September, 2009 Yosuke KAWAKAMI, Executive Director Deposit Insurance Corporation of Japan (DICJ) (for “Asian Economic Panel” @ Keio University, Faculty of Economics)

2. Outline • Introduction 2. Japanese financial crisis: history & lessons 3. US financial turmoil & responses 4. Issues for discussion

3. 1. Introduction Resolution schemes & parameters (Normal mode) • Least-cost test • P&A or pay-out (Crisis mode: “systemic risk exception”) • Blanket guarantee • Capital injection • Temporary nationalization (public administration)

4. 2. Japanese financial crisis: history • Phase I (1990-96) - Slow process & early warnings - “Jusen” & political trauma of public funds • Phase II (1997-2005) - Failure of major institutions & systemic crisis - Full gov’t response, including nationalization - Structural reforms & debt workouts

5. 2. Japanese financial crisis: history (cont’d) • 4 cases of temporary “nationalization” - LTCB & NCB (1998) : “Special public administration” (Deposit Insurance Law amended in 2000) [ - Resona (2003): Maj. ownership via capital injection ] - Ashikaga (2003): “Special crisis administration”

6. 2. Japanese financial crisis: lessons & implications • Gov’t commitment & winning public support - Banking policy Measures needed for entire B/S: L, C, A • Structural reforms to enable debt workouts • Political dynamics Public opinion & parliamentary support • Implications for current crisis - Swift domestic actions & int’l cooperation

7. (for reference) Japanese bank resolutions: framework & history • Current resolution methods - P&A preferred - Name-based aggregation - Systemic risk exception • Bank resolution history: mostly P&A - Capital injection - Japanese “bad bank” & bridge bank

8. Bank Resolution- Current resolution methods- • DICJ is equipped with a full-fledged set of resolution methods. • Purchase & assumption is preferred to payout as the least costly method. The Prime Minister (PM) decides on the application of the systemic risk exception, after consulting with the Financial Crisis Management Council, chaired by the Prime Minister and consisting of the Chief Cabinet Secretary, the Minister of Finance, the Minister of Financial Services, the Commissioner of the Financial Services Agency, and the Governor of Bank of Japan.

9. Purchase & Assumption Scheme- Under the current limited guarantee - FSA Court Applying Civil Rehabilitation Procedures Management Order by the Commissioner Appointment for Financial Administrator Financial Administrator/ Financial Assistance Continuous Transactions; Deposits, Loans etc. Depositors Borrowers General Creditors Failed Bank DICJ Asset Evaluation* Temporary Business Transfer Financial Assistance Financial Assistance Sponsorship Assuming Financial Institution RCC Bridge Bank Sound Assets Bad Assets Business Transfer *Conducted by a financial administrator (DICJ) and subject to the approval by FSA

10. Insurance Determination • Name-based aggregation • DICJ receives magnetic tapes (MT) containing depositors’ information from • a failed bank within 24 hours after failure. • DICJ aggregates deposits based upon names & dates of birth by computer. • Pre-failure preparation • Requirement for insured banks: All insured banks are required to hold • depositors information in the manner specified by DICJ (MT format) & maintain • necessary computer system to store them. • On-site inspection: DICJ regularly conducts inspection to ensure that insured • banks hold depositors information & relevant computer system properly. • “Drill”: DICJ regularly receives MT & conducts name-based aggregation as a • “drill”. DICJ provides insured banks with technical assistance, if necessary.

11. Systemic Risk Exception

12. Bank Resolution in the Past • Most failed banks resolved by P&A under blanket guarantee • 3 banks temporarily nationalized; subsequently sold to private investors • Long-Term Credit Bank (1998, total assets: JPY 24 tril.) • Nippon Credit Bank (1998, total assets: JPY 12 tril.) • Ashikaga Bank (2003, total assets JPY 5 tril.) • No failures since Ashikaga Bank • Totalgrants for financial assistance: about JPY 19 tril. • (about JPY 10 tril. from the Gov’t)

13. Financial Assistance

14. Capital Injection • Injection of public funds to insured banks totaled • over JPY 12 trillion. • Resona Bank was recapitalized as a crisis management measure in 2003.

15. International Comparison- Systemic crisis management -

16. International Comparison- Bank Resolution in the Past -

17. Resolution and Collection Corporation (RCC) - Brief History and Function - • RCC is a 100% subsidiary of DICJ. • RCC disposes of bad assets acquired from failed institutions • thru a variety of methods including collection, bulk sales & • revitalization of debtor firms. • As a temporary measure, RCC purchased assets from non-failed banks during • the previous crisis. • Brief History of RCC

18. Resolution and Collection Corporation (RCC)- Performance - • RCC has posted profits from disposing assets acquired from • insured banks. • Meanwhile, RCC has registered losses from disposing assets acquired from • mortgage lenders (Jusen).

19. Bridge Bank (BB) • Under the blanket guarantee regime • 1st BB established March 2002 to process resolution of • two regional banks. • Under the limited guarantee regime • 2nd BB established in March 2004. • (Presumption) DICJ cannot find assuming bank immediately after failure. • Capital: 100% subsidiary of DICJ • Terms of operation: The BB would be operational for 2 years with • possible extension of 1 year in face of bank failure. • Function: The BB shall assume sound assets and insured deposits. • In principle, the BB shall not conduct new business to keep its • assets in a sound condition.

20. 3. US financial turmoil & responses (Major US resolutions in 2008 -09) • IndyMac: - Payout for uninsured deposits - Conservatorship → Sale to investor consortium • WaMu: - Marketing & acquisition (by JPMC) w/ premium • Wachovia(initial), Citigroup, BoA： - Systemic risk exemption - Loss-sharing (cf.) IceSave(Icelandic internet bank in UK)： - Temporary & partial subrogation by HMTreasury

21. 4. Issues for Discussion (Regular issues) • Coordination w/ other safety-net players • Availability/capacity of assuming banks - bridge bank? - franchise premium? • Treatment of payment/settlement liabilities • Cross-border cooperation 

22. 4. Issues for discussion (cont.) Containing & resolving systemic crisis = “Confidence crisis” ⇒　Utilize all possible measures & avenues swiftly, substantially, & strictly to reverse downward spiral of despair thru overwhelming & (int’lly) concerted actions: “Shock & Awe”

23. Resolving “confidence crisis” 1) Financial policies to stem & contain crisis • Increased (blanket) deposit guarantee • Strict assessment of systemic soundness • B/S improvements - Capital injection: type of shares & conditions - Removal of bad assets: “ring-fencing”, “bad bank”?

24. Resolving “confidence crisis” (cont’d) • Bank governance: monitoring & control (if “push comes to shove”) • Temporary nationalization - least desirable option, but “necessary evil”? - “creeping” vs. “outright” nationalization

25. Resolving “confidence crisis” (cont’d) • Macro- & structural measures to reverse “fallacy of composition” & deflationary spiral • Fiscal & monetary policy - conventional, unconvent’l ＆unconvent’l² • Structural measures - to enable debt workouts & resolve real-sector bottlenecks

26. Resolving “confidence crisis” (end) 3) Winning public confidence & parliament support - Reform of financial regulation & supervision - Pursuing legal & moral responsibility “- G7 is committed to working with partners in international fora to accelerate reforms of the regulatory framework including limiting procyclicality, the scope of regulation, compensation practices, market integrity and risk management. - G7 ministers asked deputies to prepare progress report on developing agreed set of common principles and standards on propriety, integrity and transparency of international economic and financial activity. ” (G7 Finance Ministers’ Statement, February 2009) • ( 4) “Exit policy” - e.g. Transition from blanket to limited DI Re-privatization of “nationalized” banks (end) ((