Japan Provision of Subordinated Loans

The provision of subordinated loans for banks by the BOJ was designed to fill the gap of financing tools for banks. The BOJ expected that the new framework would contribute to strengthening the banks’ capital base in combination with capital raising in the market by the banks themselves and from the Deposit Insurance Corporation of Japan (DICJ) under the Act on Special Measures for Strengthening Financial Functions, which was amended in December 2008 to encourage broader use (Deposit Insurance Corporation of Japan 2009).

To reduce the risks associated with banks’ stockholdings, the BOJ also decided to resume purchases of stocks held by financial institutions in February 2009 so that they could handle the risk associated with stockholdings (Bank of Japan 2009b). The BOJ continued these purchases until the end of April 2010 (Bank of Japan 2010). The BOJ had first introduced the stock purchasing program in 2002, in response to the Japanese financial crisis, but it expired at the end of 2004 (Reuters Staff 2009).

Although the BOJ recognized that the provision of subordinated loans to banks by a central bank was an extremely extraordinary measure, no additional legislation was required to establish the new framework (Bank of Japan 2009b). Under Article 33 of the Bank of Japan Act, the BOJ, as the lender of last resort, could provide financial institutions with loans against collateral in the form of negotiable instruments, government securities, and other securities. However, the BOJ could not extend loans without collateral under Article 33 of the Act. Instead, the new framework for the provision of subordinated loans was introduced as “Other Business” that was authorized by the Minister of Finance and the Prime Minister. Article 43 of the Act stipulates that the BOJ may not conduct any business other than that specified by the Act as the business of the Bank; however, the BOJ can conduct other business that is necessary to achieve the Bank’s purpose specified by the Act by obtaining authorization from the Minister of Finance and the Prime Minister. The BOJ requested authorization from the Minister of Finance and Prime Minister to introduce the framework to provide subordinated loans to maintain the stability of the financial system (Bank of Japan 1997). This exception was also applied to the stock purchasing program by the BOJ that started in 2002 and resumed in 2009.

The total amount of loans available through the program was set at ¥1 trillion (Bank of Japan 2009b).

In addition to the limit on total amount of loans, there was a limit on the amount of loans per bank at ¥350 billion (Bank of Japan 2009b).

Only the banks that were subject to international capital standards were eligible (Bank of Japan 2009c). As a result, most regional banks and all cooperative banks and credit associations were not eligible for the loans (Whipp and Dickie 2009). The BOJ created the framework to support large banks that were expected to suffer significant losses directly from sharp declines in stock prices, to raise Tier-II capital as a complementary measure for capital raising through the market (Reuters Staff 2009; Shirakawa 2009). Banks that were not eligible for the provision of subordinated loans, including regional banks and cooperative banks, could raise Tier-I capital under the Act on Special Measures for Strengthening Financial Functions, which provided public funds in exchange for priority stocks (Bank of Japan 2009a, 10; Shirakawa 2009).

By setting a relatively limited target, the BOJ was able to reduce the risk of default. To receive loans under the framework, banks were required to be deemed creditworthy, but the BOJ did not conduct any additional investigation when it conducted the loan (Bank of Japan 2009c).

This program focused on providing a channel to strengthen the balance sheet of major banks through providing Tier-II capital (Bank of Japan 2009d, 64; 2009b). Since the government had already enacted the Act on Special Measures for Strengthening Financial Functions in December 2008, financial institutions had a tool to raise Tier-I capital outside the market. The provision of subordinated loans by the BOJ can be seen as a supplemental measure to provide capital (Shirakawa 2009).

Recipients of each loan had the right to repay the loan beginning three years after disbursement (Bank of Japan 2009c).

The term of the loan provided under this framework was either 10-year or perpetual in order to meet the requirement for Tier-II capital under Basel II. Auctions were held separately for 10-year and perpetual loans (Bank of Japan 2009c).

The amount 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. Targeted banks were not required to take part in the auction. The potential drawback of using auction was that banks might avoid participating in the auctions for fear of suffering stigma. The BOJ determined minimum spread at each auction for 10-year loans and perpetual loans respectively, in light of market conditions so as not to interfere with capital raising by financial institutions through markets (Bank of Japan 2009c). Banks were incentivized to raise capital through markets and repay the loan as soon as possible.

The interest rate would increase by 1.5% after five years of loan disbursement (Bank of Japan 2009c). This increase may have reflected the intention of the BOJ that the provision of subordinated loans under the framework should be used only as a temporary measure.

The BOJ decided that it would not release the names of banks that participated in the auctions until the end of May 2010. Only the total amount of loans and the average spread in each auction were released after each auction (Bank of Japan 2009b). The anonymity could have been intended for banks to avoid the stigma associated with accessing capital from the BOJ. However, the name of the participant was reported on media just after the auction as shown in Figure 3 below.

Figure 3: Snapshot of Articles Reporting Participation in First Auction

Source: Koenig 2009; Bloomberg 2009.

The framework was established as a temporary measure which would end at the end of March 2010. Reflecting the recovery of the financial market, the framework was not extended. The last auction was held in February 2010 and closed new loan disbursement as initially scheduled (Bank of Japan, n.d.; 2009c).