Japan Provision of Subordinated Loans

Although Japan’s financial system remained relatively stable, on the whole, during the Global Financial Crisis, the strains in global financial markets and worsening economic conditions at home and abroad negatively affected the financial intermediation function and robustness of the system in Japan. Reflecting the declining function of commercial paper and corporate bond markets, financial conditions for firms’ funding in capital market deteriorated beginning in the autumn of 2008. Japan’s financial institutions, which had shown robustness to a certain degree amid the turbulence of the global financial system, retained financial intermediation function and supported firms through the increase of lending as shown in Figure 1 below. As Japanese banks had been fortifying their financial bases since Japan’s own banking crisis in the 1990s and had limited exposure to overseas structured credit products, their business was relatively sound compared to foreign counterparts. However, market risk associated with stockholdings increased, especially for major banks, and credit risk that had previously been in decline also turned upward as shown in Figures 1 and 2 below. A substantial amount of both realized and unrealized losses on stockholdings had been reported amid a leveling off in the outstanding value of banks’ stockholdings. Given the increased volatility of stock prices, the management of market risk associated with stockholdings remained an important challenge for banks. The Financial System Report (FSR) in March 2009 pointed out that even under the assumption of future economic downturns with different degrees of severity, the banking sector’s expected losses were not so large that banks’ Tier-I capital ratios would substantially deteriorate. However, the FSR warned that if banks became more conscious of capital constraints in the future, the decline of stock prices could have a negative impact on financial intermediation from a macro perspective (Bank of Japan 2009a).

Recognizing the risks of a potential adverse feedback loop between the financial system and the economy, the Bank of Japan (BOJ) announced a new framework to provide subordinated loans to banks after the regular meeting of the Policy Board on March 17, 2009. This measure aimed to ensure the smooth functioning of financial intermediation and the stability of Japan’s financial system “by enabling Japan’s banks to maintain sufficient capital bases even in severe financial and economic environments” (Bank of Japan 2009b).

On April 10, 2009, the BOJ decided to set “Principal Terms and Conditions for Provision of Subordinated Loans” at a regular meeting of the Policy Board and released the outline of the framework on the same day. The program was created as a temporary measure and planned to close new loan disbursement by the end of March 2010 (Bank of Japan 2009c).

Under the new framework, the BOJ offered 10-year subordinated loans and perpetual subordinated loans, which could be counted as Tier-II capital under Basel II, to the banks that were subject to international capital standards up to ¥350 billion^FNIn April 2009, the monthly average exchange rate was $1 = ¥99 (International Monetary Fund Exchange Rates Database). for each bank and ¥1 trillion in total (Bank of Japan 2009c; Whipp and Dickie 2009). The loan did not require collateral. Recipients of each loan had the right to redeem the loan beginning three years later after disbursement. To incentivize financial institutions to repay the borrowed funds as soon as possible, the interest rate would increase by 1.5% after five years of loan disbursement (Bank of Japan 2009c).

The size of each loan and interest rates for the first five years on the 10-year and perpetual loans were determined at auctions using a premium over the six-month yen LIBOR (Bank of Japan 2009c).

A multiple-price competitive auction was conducted for each loan in which banks bid “yield spreads,” which were calculated by subtracting the “minimum spreads” determined by the Bank of Japan from the spread which banks desired to add on the base rate (six-month yen LIBOR) (Bank of Japan 2009c).

The minimum spread was set by the BOJ at each auction for 10-year loans and perpetual loans, in light of market conditions, so as not to interfere with capital raising by financial institutions through markets. The minimum spread for each auction was released about ten days before each auction (Bank of Japan 2009c).

The auction schedule was published on May 8; the auctions were held on May 29, August 27, November 26, and February 24, 2010 (Bank of Japan, n.d.). The total amount of loans and the average spread in each auction were released after each auction. The names of recipients of the loans were not published after each auction but were released around the end of May 2010 (Bank of Japan 2009c).

The new scheme was designed to complement the two other channels for financial institutions to raise capital: (1) capital raising by financial institutions themselves in the market, and (2) capital raising based on the Act on Special Measures for Strengthening Financial Functions, which was amended on December 16, 2008,^FNThe Act on Special Measures for Strengthening Financial Functions, which enabled the Japanese government to inject capital into financial institutions, was first introduced in 2004 but expired in March 2008. In December 2008, the law was amended to extend the scheme to the end of March 2012 and to lower the bar for banks to apply for the scheme. and provided public funds as Tier-I capital (Shirakawa 2009). The provision of subordinated loans aimed to provide another channel for major banks, which were directly affected by the potential decline of stock prices, to raise Tier-II capital (Shirakawa 2009; Whipp and Dickie 2009). For banks that were not eligible for the provision of subordinated loans, including regional banks and cooperative banks, capital injection of public funds based on the Act on Special Measures for Strengthening Financial Functions was the measure intended to help them to strengthen their balance sheets (Deposit Insurance Corporation of Japan 2009).

At a press conference on March 18, where the BOJ released the idea of providing subordinated loans, BOJ Governor Masaaki Shirakawa said that the new scheme was created as a safeguard and market funding was preferred (Reuters Staff 2009). He indicated that the value of the scheme could not be assessed simply by the amount of loans under the scheme as the scheme was designed as a safeguard (Whipp and Dickie 2009).

The auctions were held on May 29, 2009; August 27, 2009; November 26, 2009; and February 24, 2010 (Bank of Japan, n.d.). At the first auction on May 29, only Sumitomo Trust & Banking Co., the eighth largest bank in Japan at the end of March 2009, made a successful bid for a ¥20 billion perpetual subordinated loan at the minimum spread (210bp) (Bank of Japan, n.d.; Koenig 2009). There was no bid for 10-year subordinated loans at the auction, and no banks took part in the remaining three auctions (Bank of Japan, n.d.).

Although the BOJ did not publish the name of banks that bid for loans, Nikkei reported on May 29 that six banks did not take part in the auction, and Sumitomo Trust & Banking Co. would receive a loan (Bloomberg 2009).

As planned in the “Principal Terms and Conditions for Provision of Subordinated Loans,” the period of new loan disbursement came to an end in March 2010 (Bank of Japan 2009c; n.d.). On June 11, 2012, just three years after the disbursement, Sumitomo Trust & Banking Co. fully redeemed the loan, and the scheme was complete (Bank of Japan 2012; 2013).