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Financial Markets Department
Banking Crisis Resolution (Japan's case and the role of central banks) Hiroshi Nakaso Financial Markets Department Bank of Japan
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1. Overview of Japan’s Crisis in Late 1990’s
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Number of Failed Depository Institution
Number of Failed Depository Institutions (FY FY 2004) Banks Credit unions Credit-cooperatives TOTAL
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Magnitude of Non-Performing Loans
NPLs / Nominal GDP
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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.
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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.
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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
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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
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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
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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
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Credit Premiums for Banks
Spread of 5-year Bank Bonds Yield over 5-year JGB yield
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Banknotes in Circulation
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2. “Lender of Last Resort” – Japan’s Case
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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 :
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Outstanding of the LoLR Fund Provision
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Loss Experience from the LoLR Function
Note*: Subsequently covered by MOF.
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3. Questions Out of Japan’s Experience
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(1) Solvency or Liquidity?
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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
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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.
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(2) What Should be the Scope of the LoLR Function?
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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
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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
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(3) Is “Constructive Ambiguity” Constructive?
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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.
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(4) Will Private Sector Solutions Always Work?
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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
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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
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(5) Any Role for Monetary Policy to Address Financial Crises?
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Quantitative Monetary Easing
Current account targeting
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Intended Policy Effects
Support economic recovery --- encourage bank lending and facilitate corporate financing Maintain financial system stability --- ensure banks’ liquidity positions
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Sign of Economic Recovery
Real GDP growth
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Underbidding
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Market Function -1
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Outstanding of Uncollateralized Call Market
Market Function -2 Outstanding of Uncollateralized Call Market
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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.
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ABS Purchased by BOJ
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