1. Financial Markets Department
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 FY 2004)
Banks
Credit unions
Credit-cooperatives
TOTAL

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

5. NPL Ratios USA Sweden Japan 2.9% 63.3% 4.5% 13.2% 130.1% 10.1% 7.8%
NPL / GDP
ASSET / GDP
NPL / ASSET
USA
(1991)
2.9%
63.3%
4.5%
Sweden
(1992)
13.2%
130.1%
10.1%
Japan
(1999)
7.8%
217.4%
3.6%
Notes:
NPL
/ GDP= Asset / GDP × NPL / Asset :
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
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.

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 USA Sweden Norway Finland Japan7
( ) ratio to nominal GDP
USA
Expenditure to RTC1
Expenditure to liquidate FSLIC2
Interest payment for bonds issued by REFCORP3 $
81.9
42.7
76.2
billion
Total
200.8
( 3%)
Sweden
Capital injection and loans4
SEK
65.0
( 4%)
Norway
Capital injection5
NOK
24.9
Finland
Capital injection6
FIM
82.7
(17%)
Japan7
Guarantees
Cashable bonds8 57 13
trillion 70
(14%)
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 Sanyo Securities files application for corporate rehabilitation
Nov Failure of Hokkaido Takushoku Bank
Nov Yamaichi Securities announces suspension of operations
Nov Failure of Tokuyo City Bank

9. Profile of Long-Term Credit Bank of Japan
Crisis of Autumn 1998
Profile of Long-Term Credit Bank of Japan
Failure announced October 1998
Financial data (consolidated basis, as of March 1998, in \ billion) Total assets : 26, Capital : Debentures : 12, Deposits : 5, Derivatives : 50,000 (notional principal basis)
Branches : (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
Provision of liquidity to interbank markets
Type 2 :
Emergency liquidity assistance to a failed non-bank financial institution
Type 3 :
Type 4 :
Provision of risk capital to a financial institution
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 deposit withdrawal 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 of deposit 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 B
Bank F
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 that　　 systematic 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 is 　unforeseeable 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 an 　 isolated 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. Outstanding of Uncollateralized Call Market
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