Hiroshi NakasoFinancial Markets Department

Bank of Japan

Banking Crisis Resolution(Japan's case and the role of central banks)

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

Magnitude of Non-Performing Loans

2.9%

13.2%

2.5%

7.8%

0%

2%

4%

6%

8%

10%

12%

14%

USA (1991) Sweden(1992) Japan(1931) Japan(1999)

NPLs / Nominal GDP

5

NPL Ratios

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 / AssetNPL : For the US, past due loans, loans in non-accrual status, and restructured loans. For Sweden, gross problem

loans. For Japan, risk management loans.

Asset : 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.

6

Cost of Disposal

Notes:

1) Losses include those arising from debt-forgiveness and loan restructuring.

2) For FY92-94, figures are for City Banks, Long-term Credit Banks and Trust Banks.

Source: FSA, DIC.

All Japanese banks, billion yen

FY92-94 FY95 96 97 98 99 00 01 02 03 Total

Loss 10,744 13,369 7,763 13,258 13,631 6,944 6,108 9,722 6,658 5,374 93,572

Provision 3,493 7,087 3,447 8,403 8,118 2,531 2,732 5,196 3,101 1,616 45,724

Write-offs 5,322 5,980 4,316 3,993 4,709 3,865 3,072 3,975 3,520 3,734 42,484

DIC financial assistance - 473 117 81 1,936 4,006 4,431 1,041 241 0 12,326

DIC asset purchase - - - 208 2,412 1,097 478 226 154 0 4,576

Capital Injection - - - 1,816 7,459 575 387 184 0 1,960 12,381

Total 10,744 13,842 7,880 15,363 25,438 12,623 11,404 11,173 7,053 7,334 122,855

7

Use of Public Funds

USA Expenditure to RTC1

Expenditure to liquidate FSLIC2

Interest payment for bonds issued by REFCORP3

$$$

81.942.776.2

billionbillionbillion

Total $ 200.8 billion ( 3%)

Sweden Capital injection and loans4 SEK 65.0 billion ( 4%)

Norway Capital injection5 NOK 24.9 billion ( 3%)

Finland Capital injection6 FIM 82.7 billion (17%)

Japan7 GuaranteesCashable bonds8

¥¥

5713

trilliontrillion

Total ¥ 70 trillion (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

( ) ratio to nominal GDP

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

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

Crisis of Autumn 1998

10

Safety Net Framework (after April 2002)

Purchase and Assumption (P&A)

Failed bank

Systemic RiskException

Assuming institution(s)

Capital injection

Full loss coverage

Temporary nationalisation

11

Credit Premiums for Banks

Spread of 5-year Bank Bonds Yield over 5-year JGB yield

0

10

20

30

40

50

60

70

80

90

100

1998 1999 2000 2001 2002 2003 2004 2005

Mizuho Corp

Tokyo-Mitsubishi

Mitsui-Sumitomo

UFJ

CY

(bps)

12

Banknotes in Circulation

-4

-2

0

2

4

6

8

10

12

14

16

18

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05

(y/y, %)

CY

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

Emergency liquidity assistance to a failed non-bank financial institution

Provision of risk capital to a financial institution

Emergency liquidity assistance to a temporarily illiquid financial institution

Type 1 :

Type 2 :

Type 3 :

Type 4 :

Type 5 :

15

Outstanding of the LoLR Fund Provision

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

1997/1Q 2Q 3Q 4Q 1998/1Q 2Q 3Q 4Q 1999/1Q 2Q 3Q 4Q 2000/1Q

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Article 38 Loans(left scale)

(billion yen)

Ratio to totalBOJ asset

(right scale)

16

Loss Experience from the LoLR Function

Legal basis

(A)

Period of experience

(B)

Peak outstanding

(C)

Loss

(D)

Ratio

(D)/(C)

Type 1 Article 38

Bank of Japan Law Aug 1995

2,858 billion

(Feb 1998) (0%)

Type 2 Article 33

Bank of Japan Law Nov 1997 – Dec 1997

22 trillion

(Dec 1997) (0%)

Type 3 Article 38

Bank of Japan Law

Nov 1997

Liquidity support to

Yamaichi Securities

1,200 billion

(Nov 1997) 111.1 billion (9.3%)*

Establishment of Tokyo

Kyodo Bank

Jan 1995-Mar 1999

20 billion 16.4 billion (82%)

Subordinated loans to Midori

Bank

Jan 1996 – Jan 2006

110 billion (0%)

Capital injection to NCB

July 1997 – Dec 1998 80 billion 80 billion (100%)

Type 4 Article 38

Bank of Japan Law

Total 210 billion 96.4 billion (45.9%)

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

Sound assets Deposits

Asset sales Deposit withdrawal

NPLs

Capital

Sound assets Deposits

NPLsCapital

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

Yamaichi Securities

Creditors

Bank of Japan

flow of funds

LoLR support

Bank in GB

Bank in CH

Bank in DE

Bank in NL Ring fencing

23

Bank A

Case of Cross-Border Banking (eg. Asian Crisis)

Home country’s Central Bank

Bank B

Branch

Bank C

Bank D

Bank E

Bank F

Tokyo Interbank Market

Bank of Japan

flow of funds

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

-0.05

0.00

0.05

0.10

0.15

0.20

01/3 01/7 01/10 02/1 02/5 02/8 02/12 03/3 03/6 03/10 04/1 04/5 04/8 04/12 05/3

(％)

0

5

10

15

20

25

30

35

40CA target5 trillion

yen

above 6trillion yen

10-15 trillionyen

15-20trillion yen

6 trillionyen

Uncollateralized O/Ncall rate (Left Scale)

Current accounttarget (Right scale)

17-22trillion

yen

27-30trillion yen

22-27trillion

yen

27-32 trillionyen

30-35 trillionyen

(trillion yen)8/14 12/19 4/110/309/18 4/30 5/20 10/10 1/20

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

-4

-2

0

2

4

6

8

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04CY

(year on year, %)Real GDP growth

33

Underbidding

0

5

10

15

20

25

30

35

40

45

50

01/1

/4

01/3

/1

01/4

/25

01/6

/21

01/8

/15

01/1

0/10

01/1

2/4

02/2

/4

02/4

/1

02/5

/28

02/7

/19

02/9

/11

02/1

1/8

03/1

/8

03/3

/5

03/4

/30

03/6

/24

03/8

/18

03/1

0/14

03/1

2/9

2004

/2/6

2004

/4/1

2004

/5/3

1

2004

/7/2

3

2004

/9/1

5

2004

/11/

12

05/1

/12

05/3

/8

05/5

/6

-0.05

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35Number of Under-Bidding (left scale, times/month)

Current Account Outstanding(left scale, tril. Yen)

Required Reserve (left scale, tril. Yen)QuantitativeEasing Policy

Uncollateralized Overnight Call Rate (right scale, %)

34

Market Function -1

0.000

0.005

0.010

0.015

0.020

0.025

0.030

0.035

45 47 49 51 53 55 57 59 61 63 65 67

TB1Y rate, %

Total Outstanding Balances of Short-term Fund-supplying Operationstrillion yen

Data: From January 2004 to May 2005.

35

Market Function -2

Outstanding of Uncollateralized Call Market

0

5

10

15

20

25

30

35

40

95 96 97 98 99 00 01 02 03 04 05

(trillion yen)

ZIRP : Zero Interest Rate PolicyQEP: Quantitative Easing Policy

ZIRP QEP

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.

Bank of Japan

loansloan sales

sale proceeds

Investors(markets)

SPC(Pools of SME risk)

Banks, etc.(originators)

sale proceeds

sale of receivable

SMEs

Senior security(low risk portion)

Senior security(low risk portion)

Mezzanine security(middle risk portion)

Mezzanine security(middle risk portion)

Equity(first-loss portion)

Equity(first-loss portion)

Bank of Japan

loansloan sales

sale proceeds

Investors(markets)

SPC(Pools of SME risk)

Banks, etc.(originators)

sale proceeds

sale of receivable

SMEs

Senior security(low risk portion)

Senior security(low risk portion)

Mezzanine security(middle risk portion)

Mezzanine security(middle risk portion)

Equity(first-loss portion)

Equity(first-loss portion)

37

ABS Purchased by BOJ

0

0.5

1

1.5

2

2.5

3

8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5

(tril. Yen, as of end of month, accumulated amount)

Revision of the eligibility standard

2003 2004 2005