Japanese Financial Institutions' Efforts to Address Their Management Tasks *1
- *1This is a translation of the summary of the report in Japanese released on April 8, 2002. The English version of the full report, which will be published in the August 2002 issue of the Bank of Japan Quarterly Bulletin.
April 8, 2002
Bank of Japan
Bank Examination and Surveillance Department
Click on ron0204a.pdf (254KB) to download the full text (released on June 3, 2002.)
The environment surrounding the business of Japanese financial institutions remains severe due mainly to the prolonged weakness in the economy and the continuous downtrend in land prices. In addition, developments in stock prices including those of banks remain unstable.
The Bank Examination and Surveillance Department of the Bank of Japan is making various efforts through on-site examinations and off-site monitoring to gain a thorough understanding of the business operations and management strategy of financial institutions that have current accounts at the Bank. Based on the information gathered, it has analyzed the developments in profits and losses of banks and the nonperforming-loan (NPL) problem, and produced a list of management tasks that the banking sector faces in a report titled Developments in Profits and Balance Sheets of Japanese Banks in Fiscal 2000 and Banks' Management Tasks released in summer 2001. In addition, it has published its view on financial institutions' risk management systems in other reports from time to time.
This report outlines the current state of financial institutions' business and how financial institutions that have current accounts at the Bank including shinkin banks have addressed their management tasks.
A. The Current State of Japanese Financial Institutions' Business
- Addressing the NPL problem and thereby improving their profitability continue to be the urgent management tasks for Japanese financial institutions. In addition, high priority should be given to the task of controlling risks involved in holding stocks, mainly in the case of major banks.
- Regarding all banks' profits and losses at the interim book closings at end-September 2001, NPL disposal continued to exceed operating profits from core business. Net income showed a loss due to (1) stock-related losses reflecting the fall in stock prices and (2) NPL disposal. Overall financial strength, which works as a buffer against losses, was weakening due not only to losses in net income but also to the deterioration in unrealized capital gains/losses on securities.
- For shinkin banks, NPL disposal did not exceed operating profits from core business in fiscal 2000. Developments up to the end of fiscal 2000 showed their financial strength to be on an uptrend due mainly to an increase in capital subscription. However, some developments suggesting an increase in the cost of NPL disposal have been observed since the turn of fiscal 2001, and the outlook is somewhat uncertain.
B. Financial Institutions' Efforts to Address Management Tasks
- Regarding credit risk management, including the NPL problem, the quality of assets has not improved significantly, as the deterioration in loan assets has not come to a halt yet. Establishment of the framework regarding credit risk management including an internal credit rating system has progressed, and the framework for self-assessment of asset quality has steadily improved. Nevertheless, there still seems to be room for improvement. It is important to utilize credit ratings when formulating a policy for overall loan asset management. Also, it is essential that financial institutions fully grasp the state of business of each debtor, refine their financial analysis, and ensure that these results are reflected in internal credit ratings in a timely manner. On this basis, it is important when necessary that financial institutions swiftly consider the following: (1) guidance on business recovery to debtor firms; (2) improving the adequacy of collateral, guarantees, or the like; and (3) sale of loan assets. In this process, an appropriate assessment of collateral real estate is indispensable. As a result of these processes, it is hoped that loan asset management will be conducted in a manner that is not vulnerable to changes in the surrounding environment.
- The market risk management system has been improved in major banks, and they are expeditiously reducing the risk involved in cross-shareholdings for the purpose of long-term investment. Regional financial institutions are making efforts to gauge risks by using indicators and establish risk monitoring systems. It is, however, important for them to further strengthen such aspects of their risk management systems as risk analysis and internal checking functions, since there are cases where investment risks are not adequately assessed against the background of the current severe environment for profitability.
- With various changes in the environment surrounding financial institutions' business, it is becoming more important for financial institutions to manage risks appropriately. They are attaching greater importance than before to securing the safety and soundness of their business operations computer systems in line with (1) consolidation among major banks and (2) heavier dependence on IT and the expansion of networks in financial business operations. There are, however, some tasks that remain to be tackled by them in relation to strengthening their risk management systems so that they function appropriately in line with the progress in outsourcing of systems sections and joint management of systems or administrative centers by financial institutions. With regard to payment and settlement risks, financial institutions have a deeper understanding of (1) the new points for business operations to be kept in mind since the introduction of real-time gross settlement (RTGS) and (2) the necessity to establish systems that would allow them to continue their operations even if their offices were damaged in a disaster.
- Against the background of the diversification and increasing complexity of risks to be managed as described above, banks, in particular major banks, are addressing risk factors in line with integrated risk management to (1) secure their soundness by controlling risks in a way that reflects their financial strength and (2) aim at managing business on a risk-adjusted return basis. Banks whose risk profiles are complex due to consolidation and diversification of their business are being encouraged to establish integrated risk management systems.
- In order to overcome the NPL problem, and thereby improve their profitability, financial institutions should give the highest priority to improvement and effective operation of their credit risk management systems. It is essential that financial institutions make efforts to improve their credit risk management and that in line with this firms also make efforts to reconstruct their business. The effectiveness of NPL disposal will be strengthened when corporate reconstruction progresses in parallel with financial institutions' efforts to achieve an appropriate balance between risks and returns. Furthermore, strengthening financial institutions' competitiveness by, for example, improving their cost efficiency and providing improved financial services which meet firms' needs, will (1) improve financial institutions' profitability and soundness of management; and (2) improve their risk intermediary function of indirect financing.