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Hiroshi Nakaso Financial Markets Department Bank of Japan

Banking Crisis Resolution (Japan's case and the role of central banks). Hiroshi Nakaso Financial Markets Department Bank of Japan. 1. Overview of Japan’s Crisis in Late 1990’s. Number of Failed Depository Institution. Number of Failed Depository Institutions. (FY 1992 - FY 2004).

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Hiroshi Nakaso Financial Markets Department Bank of Japan

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  1. Banking Crisis Resolution (Japan's case and the role of central banks) Hiroshi Nakaso Financial Markets Department Bank of Japan

  2. 1. Overview of Japan’s Crisis in Late 1990’s

  3. Number of Failed Depository Institution Number of Failed Depository Institutions (FY 1992 - FY 2004) Banks 20 Credit unions 27 Credit-cooperatives 134 TOTAL 181

  4. NPLs / Nominal GDP Magnitude of Non-Performing Loans

  5. NPL / GDP ASSET / GDP NPL / ASSET USA 2.9% 63.3% 4.5% (1991) Sweden 13.2% 130.1% 10.1% (1992) Japan 7.8% 217.4% 3.6% (1999) Notes: NPL / GDP= Asset / GDP × NPL / Asset NPL : For the US, past due loans, loans in non -accrual status , and restructured loans. For Sweden, gross problem loans. For Japan, risk management loans. A sset : For the US, assets held by commercial banks, saving banks, and S&Ls. For Sweden, assets held by large banks. For Japan, assets held by all deposit taking institutions. NPL Ratios

  6. Cost of Disposal • Notes: • Losses include those arising from debt-forgiveness and loan restructuring. • For FY92-94, figures are for City Banks, Long-term Credit Banks and Trust Banks. • Source: FSA, DIC.

  7. Use of Public Funds ( ) ratio to nominal GDP Notes: 1. Resolution Trust Corporation 2. Federal Savings and Loan Insurance Corporation 3. Resolution Financing Cooperation 4. Total expenditure until July 1994 5. Total expenditure until Dec. 1993 6. Total expenditure until Dec. 1995 7. Japan’s figures are for FY 2000 8. Assigned for loss coverage

  8. Crisis of Autumn 1997 • Oct. 14 Failure of Kyoto Kyoei Bank • Nov. 3 Sanyo Securities files application for corporate rehabilitation • Nov. 17 Failure of Hokkaido Takushoku Bank • Nov. 24 Yamaichi Securities announces suspension of operations • Nov. 26 Failure of Tokuyo City Bank

  9. Profile of Long-Term Credit Bank of Japan Crisis of Autumn 1998 • Failure announced October 1998 • Financial data (consolidated basis, as of March 1998, in \ billion) Total assets : 26,565 Capital : 390 Debentures : 12,268 Deposits : 5,955 Derivatives : 50,000 (notional principal basis) • Branches : 39 (24 domestic, 15 overseas) • Employees : 3,346

  10. Safety Net Framework (after April 2002) Purchase and Assumption (P&A) Assuming institution(s) Failed bank Capital injection Systemic Risk Exception Full loss coverage Temporary nationalisation

  11. Credit Premiums for Banks Spread of 5-year Bank Bonds Yield over 5-year JGB yield

  12. Banknotes in Circulation

  13. 2. “Lender of Last Resort” – Japan’s Case

  14. Types of Lender of Last Resort Function Emergency liquidity assistance to a failed deposit taking institution Type 1 : Provision of liquidity to interbank markets Type 2 : Emergency liquidity assistance to a failed non-bank financial institution Type 3 : Provision of risk capital to a financial institution Type 4 : Emergency liquidity assistance to a temporarily illiquid financial institution Type 5 :

  15. Outstanding of the LoLR Fund Provision

  16. Loss Experience from the LoLR Function Note*: Subsequently covered by MOF.

  17. 3. Questions Out of Japan’s Experience

  18. (1) Solvency or Liquidity?

  19. Solvency or Liquidity? • General principle: LoLR assists solvent but illiquid financial institutions • Differentiation of solvency from liquidity does not make much sense in a real crisis • Many banks went under in what might be called a vicious cycle to insolvency, triggered by funding difficulties

  20. Vicious Cycle to Insolvency • A troubled bank faces depositwithdrawal due to deterioration of credit standing (e.g. down grading). • In order to meet the imminent funding requirement, the bank sells sound assets. • The sales of sound assets results in deterioration of asset quality. • This leads to further loss of confidence in the bank, triggering another round ofdeposit outflow. • The bank runs out of sound assets and NPLs erodes capital leading to an eventual insolvency.

  21. (2) What Should be the Scope of the LoLR Function?

  22. Case of Large and Complex Financial Institution LoLR support Yamaichi Securities Bank of Japan flow of funds Bank in GB Bank in DE Bank in CH Bank in NL Ring fencing Creditors

  23. Case of Cross-Border Banking (eg. Asian Crisis) Home country’s Central Bank Bank A Branch Bank F Bank B Bank C Bank E Bank D Tokyo Interbank Market flow of funds Bank of Japan

  24. (3) Is “Constructive Ambiguity” Constructive?

  25. Four Principles in the Actual Provision of LoLR Assistance (a) There must be strong likelihood thatsystematic risk will materialize. (b) There must be no alternative to the provision of central bank funds. (c) All parties involved are required to take clear responsibility to avoid moral hazard. (d) The financial soundness of the Bank of Japan should not be impaired.

  26. (4) Will Private Sector Solutions Always Work?

  27. Will Private Sectors Solutions Always Work? • A scheme orchestrated by private firms based on commercial interests (without the use of public funds) • Supervisory agency or the central bank may be involved as honest broker (e.g. LTCM in 1998) • Prisoners’ dilemma for the related private sector participants

  28. Risks to a Private Sector Solution • Related parties are diverse and the exposure isunforeseeable but could potentially be large • Legal risks for the related parties • Legal or reputation risks for the public sector • Could only be successful when the case is anisolated event

  29. (5) Any Role for Monetary Policy to Address Financial Crises?

  30. Quantitative Monetary Easing Current account targeting

  31. Intended Policy Effects • Support economic recovery --- encourage bank lending and facilitate corporate financing • Maintain financial system stability --- ensure banks’ liquidity positions

  32. Sign of Economic Recovery Real GDP growth

  33. Underbidding

  34. Market Function -1

  35. Market Function -2 Outstanding of Uncollateralized Call Market

  36. Outright Purchase Scheme for Asset-Backed Securities < Outline of the Scheme > (1) Types of eligible assets 　　・Asset-backed securities (publicly-offered) 　　・Synthetic-type securities (publicly-offered credit-link notes) 　　・Asset-backed commercial paper (including dematerialized commercial paper) (2) Underlying assets 　　・50 % or more of the total value or the total number of individual assets in underlying assets shall be composed of assets related to small and medium-sized enterprises.

  37. ABS Purchased by BOJ

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