Japan’s Act on Strengthening Financial Functions (ASFF)

Subsequent amendments were sometimes packed with other economic or financial policies. For instance, the amendment in 2008 corresponded with economic policies at the Enterprise Turnaround Initiative Corporation of Japan and the SME Revitalization Support Councils (Hatanaka 2012; Endo 2013). Furthermore, the JFSA and media often emphasized the coordination of the COVID-19 related ASFF 2020 amendment and the Special Act under the Anti-Trust Law (FSA 2020). Lastly, the most recent amendment in June 2021 was paired with revisions in other laws; one banking law revision eased restrictions on the scope of bank's business and equity investments, and another investment law was intended to promote overseas investors’ participation in Japanese financial markets (Jiji Press 2021).

In January 2004, in response to the burgeoning nonperforming loan issue at regional banks, the Prime Minister’s Cabinet submitted the Act on Strengthening Financial Functions to the Japanese Diet, earmarking ¥2 trillion for public capital injections into regional banks. On June 14, 2004, the Japanese Diet finally passed the bill, two days before the end of the 159th Diet Session (House of Representatives, Japan 2004). Each subsequent amendment passed through the Diet successfully as well.

The Prime Minister’s office publicly announced each recapitalization bill and the subsequent amendments. The Diet debated each bill and amendment publicly before officially passing them. Occasionally, the Minister of State for Financial Service also released official statements.

Multiple stakeholders are involved in the ASFF capital injection scheme, including ministers from relevant ministries, prime minister, the Financial Function Enhancement Examination Committee (Committee), and the DICJ.

The Japanese Financial Services Agency (JFSA), under the Ministry of Finance, was tasked to form the Committee^FThis committee has also been referred to as the “Banking Function Reinforcement Study Council” and the “Examination Committee for Strengthening Financial Functions”, referred as 金融機能強化審査会 (Kinyuukinoukyoukashinsakai) in Japanese. to assess applications and oversee the implementation of the plans for the recapitalization (House of Representatives, Japan 2004, 48). The Committee consisted of part-time members appointed by the prime minister serving three-year terms (House of Representatives, Japan 2004, 49,51). The maximum number of members is 6 people (The House of Representatives, Japan 2021).  The JFSA website hosts the Committee’s meeting minutes soon after the meeting and transcripts are publicly disclosed three years after meetings (Financial Function Enhancement Examination Committee 2004, 5). As of June 2021, according to the JFSA website, the Committee has met 25 times over the span of the ongoing recapitalization (Financial Service Agency, n.d.).

The Committee evaluates the management enhancement plan submitted by the applicant financial institutions. The involved ministers—including the Commissioner of JFSA or the Minister of Agriculture, Forestry and Fisheries, depending on the type of the financial institution, the Minister of Finance, and prime minister—receive reports. The ministers also have the right to approve or request exercise rights, including conversions. Voting rights are only exercised if the banks with preferred shares do not pay their dividends (see Key Design Decision #11 for further detail) (Sakaguchi 2020).^FSo far, Howa Bank (received capital in December 2006) has been the only bank that borrowed capital in preferred shares with voting rights to appoint or dismiss directors (DICJ 2020b).

The DICJ entrusts the operation of capital participation, management, and disposal to the RCC, a subsidiary of the DICJ. The RCC^FFor more information regarding the RCC and its operations, please refer to the “Resolution and Collection Corporation” YPFS case study (Dreyer 2021). was created as a merger between the Housing Loan Administration Corporation and the Resolution and Collection Bank on April 1, 1999, under the Financial Revitalization Act. The RCC is funded entirely by the DICJ (DICJ 2020a). The DICJ acts independently of the Bank of Japan or the Treasury, though in close cooperation (Financial Stability Board 2016).

The RCC has been responsible for managing capital and making purchases as determined by the Committee. Funded by the DICJ, the RCC purchased either preferred stocks, subordinated bonds and debt, preferred investments, or trust beneficiary rights from the financial institutions that applied for capital injections under the ASFF (Hoshi and Kashyap 2010).

The actual capital injection operations vary based on the characteristics of the financial institutions applying for the injection. For instance, the support for financial institutions undergoing restructuring is different than that of institutions that are not undergoing restructuring. Also, non-banks (e.g., cooperative structured central financial institutions) and banks that are affected by earthquakes or COVID-19 receive a different treatment in application, screening, and funding (DICJ 2020a).

When the ASFF was passed in June 2004, the DICJ's Financial Functions Strengthening Account had a budget of ¥2 trillion. As the Act was amended over the years, the size expanded to ¥15 trillion. So far, as of the end of September 2020, the Japanese government had utilized ¥684.04 billion in capital, only 4.5% of the full capacity (DICJ 2020b).

Unlike the Prompt Recapitalization Act or other past capital injection frameworks, each financial institution received their capital on their own application timeframe, and there was no coordinated schedule across the various financial institutions. Each financial institution received capital once its application (including the management plan) had been screened by the Financial Function Enhancement Examination Committee and accepted by the Japanese government.

The DICJ holds the Financial Functions Strengthening Account, which is specifically dedicated for the ASFF. Under Article 29, paragraph (1) of the ASFF Act, the DICJ’s Financial Functions Strengthening Account is funded through the issuance of government-backed DICJ bonds and borrowings from financial institutions, other investors, and in rare instances, directly from the Bank of Japan (Financial Stability Board 2016; DICJ 2020a). Under Article 45 of the ASFF, the government guarantees the account (Financial Stability Board 2016; DICJ 2020a).^FDICJ bond issuances and borrowings are subject to ceilings set out in the Deposit Insurance Act and are complemented by annual budgetary appropriations (as approved by the Diet) for the amount guaranteed by the government. (Financial Stability Board 2016). The government guarantee ceiling was ¥12 trillion in the budget for fiscal year 2020 and ¥15 trillion for the second supplementary budget for fiscal year 2020 (DICJ 2020a). The extent to which DICJ funded the ASFF recapitalization from either source is shown in Figure 6 below.

Note: Years in Japanese fiscal year (April – March next year).

Source: DICJ 2020a.

Meanwhile, the funding source for financial institutions that undergo mergers and management integration under the ASFF capital injection scheme introduced in May 2021 is slightly different. The revised ASFF now provides approximately a third of the initial cost of system integration and branch consolidation, accounting for about ¥3 billion (Nikkei 2021; Jiji Press 2021).

Unlike some of the previous recapitalizations, the ASFF did not require financial institutions to be of systemic importance to receive capital injections using public funds. The Committee accepts applications from financial institutions that fail to fulfill the capital adequacy requirements (but are not bankrupt or insolvent) or financial institutions that meet the capital adequacy requirements but intend to undertake a fundamental organizational restructuring (Ikenaga and Watanabe 2008).

Any domestic or foreign bank was eligible for capital injection; however, no foreign banks participated (Deposit Insurance Corporation of Japan 2020b).

The law did not require the participation of any banks, and the application was voluntarily. It did allow the participation of specific non-banks, listed explicitly: Norinchukin Bank, the Long-Term Credit Bank, the Federation of Agricultural Cooperatives, Fisheries Cooperative Association, and the Federation of Fisheries Processing Cooperatives. The law also allowed the participation of shinkin banks, labor unions, credit cooperatives (shinkumi), and bank holding companies (House of Representatives, Japan 2004).^FThe amendment of 2008 newly created an injection scheme for the Central Organization of Cooperative Structured Financial Institution, enabling easier access to capital support to each non-banks as well as reinforcing the financial soundness of the for the Central Organization of Cooperative Structured Financial Institution (Ikenaga and Watanabe 2008).

Furthermore, after the amendment in 2008, the focus on SMEs in the regional economy intensified (Ikenaga and Watanabe 2008). After the collapse of the Lehman Brothers on September 15, 2008, the Japanese government proposed the Comprehensive Immediate Policy Package to Ease Public Anxiety, with fears over how global economic events might lead to a credit crunch for SMEs (Aso 2008; Yamori et al. 2013). In the new iteration of the program, the facilitation of credit to SMEs became a special focus in management plans submitted. The amendment extended the period for application from March 31, 2008 to March 31, 2012.

Following the Great East Japan Earthquake, the Diet passed an amendment to the existing recapitalization legislation with special clauses for regional institutions supporting the revitalization of areas affected by the earthquake (FSA 2011a).  In this amendment, the Japanese government extended the application period for capital injections, in addition to creating special treatment for those institutions impacted by the Great East Japan Earthquake. Similarly, the June 2020 amendment established special treatment for financial institutions that were affected by COVID-19.

The affected institution can apply for a capital injection without being screened for the feasibility of the targets in the management plan or feasibility of repayment within 15 years  (Rhee and Unnava 2020). Affected institutions are those whose “financial statements have gotten considerably worse due to the coronavirus or measures to prevent coronavirus, or if the financial institution needs to lend to companies that are affected by coronavirus or measures to prevent coronavirus” (Rhee and Unnava 2020). Sakaguchi (2020) assumes that eventually all financial institutions should fall under these criteria.

Lastly, the 2021 amendment related to COVID-19 covers approximately one-third of initial costs related to business integration, including system and branch consolidations for those financial institutions undergoing mergers and organizational restructuring (Jiji Press 2021). While the promotion of mergers and reorganization is similar the Organizational Restructuring Act (a capital injection scheme that was established in December 2002), financial institutions can apply for the capital injection even when their capital adequacy ratios are above the requirement. According to the revised Act, financial institutions that wish to receive capital for system and branch consolidations will submit an “implementation plan,” indicating their outlook for the reorganization and contribution to the regional economy (The House of Representatives, Japan 2021).

No explicit statement limiting individual participation was found in the legal documents. As of September 2020, the largest capital injected was ¥100 billion (North Pacific Bank in March 2009), and the mean and median of the capital received were ¥18.5 billion and ¥15 billion, respectively (DICJ 2020b).

The capital characteristics and terms were decided on a case-by-case basis (DICJ 2020b). Ultimately, the Committee utilized a combination of preferred shares, subordinated debt, priority investment, and trust beneficiary rights for capital injections over the multiple injection windows.

So far, 18 banks received capital in the form of convertible preferred shares, 13 non-banks in trust beneficial rights, five non-banks in preferred investments, and one bank in the form of a subordinated loan (DICJ 2020b). No financial institution has received in capital support in the form of common shares, though it is an option if the financial institution’s capital ratio is below the regulatory requirement (Aso 2008; House of Representatives, Japan 2004; FSA 2008; House of Representatives, Japan 2011; 2016; Deposit Insurance Corporation of Japan 2020a). A detailed table listing of the characteristics and the terms for capital is available in the Appendix.

Applicant institutions proposed terms via their management plans, which were then considered by the Committee (Financial Service Agency, n.d.; House of Representatives, Japan 2004). A detailed table listing of the characteristics and the terms for capital is available in the Appendix.

It appears that financial institutions proposed granular terms in their plans—including repayment dates, dividend rates, and instruments to be used for injection—which were then reviewed by the Committee. These terms were presented to members in the Committee meetings and then approved or rejected. There appear to have been no rejections of financial institution applications at any point, including the revisions to management plans after the plan periods ended.

Management plans were evaluated along several criteria, listed in Figure 7 below.

No further detail has been found for this Key Design Decision.

There appear to have been no rejections of financial institution applications at any point, including revisions to management plans after plan periods ended.

Each financial institution reports the ongoing status of the management plan, and the JFSA publishes those reports annually on its website. Furthermore, if the management plan were to be revised, they are rescreened and reexamined by the Financial Function Enhancement Examination Committee (Financial Function Enhancement Examination Committee 2004).

The application also required banks to submit their capitalization status, as well as balance sheet information, for evaluation. While the Financial Function Enhancement Examination Committee did not explicitly require increased SME lending as part of the original application for capital injection, the Committee evaluated organizations along this criterion before the amendment to the legislation in 2008 (Financial Service Agency, n.d.; House of Representatives, Japan 2004). However, these requirements in the management plan and capitalization status were radically eased after several amendments (Figure 1). For instance, management responsibility no longer strictly pursued after the 2008 amendment. Furthermore, in 2011 amendment, the government introduced multiple exemptions of requirements for financial institutions that were affected by the Great East Earthquake amendment. Such exemptions included the requirement to set numerical targets and establish a responsible management system. After the 2020 amendment, these exemptions of the requirements eventually expanded to COVID-19 affected financial institutions (which are assumed to be all financial institutions, according to Sakaguchi 2020).

In the original, stricter version of management plans, the government required the highest levels of management to resign upon receipt of capital injection. In addition, external board members were required to be appointed if they were not already part of the board. Later, the government could request members of the board or management to resign only if the financial institution’s capital ratio was below 4% when the institution applied for capital injection.

Of the banks that participated in the capital injection program, five have repaid or repurchased shares either partially or in full. Both Howa Bank and Kiyo Bank repurchased their preferred shares within ten years of the capital injection. Under the extension made during the Lehman Brothers bankruptcy, two of the remaining 28 banks, North Pacific Bank and Kirayaka Bank, repurchased their preferred shares. Only one bank in the subsequent extensions, 77 Bank, has repaid the amount injected. (See the Appendix). As of the end of September 2020, the Japanese government had ¥684.04 billion capital injected, and ¥200.5 billion has been repaid so far, leaving ¥483.54 billions the remaining balance.

In October 2005, the DICJ published “Immediate Guideline for Disposal of Preferred Stocks, etc. Acquired through Capital Injection with Public Funds” and clarified the criteria for repayment and disposal (DICJ 2005). According to this guideline, the DICJ will dispose the preferred stocks and other capital under the following three situations:

1. If the recapitalized financial institution requests the selling of Preferred Stocks to third parties (including sale in the capital market)
2. If the recapitalized financial institutions request for repaying the public funds injected
3. If disposing is strongly preferable under the given market conditions.

Banks were expected to reacquire their shares within 15 years of purchase. In practice, the mandatory acquisition date for financial institutions varied, with some institutions facing mandatory acquisition dates within ten years and some firms facing mandatory acquisition dates 25 years after injection. Additional variation occurred in trust periods, with some firms receiving ten-year periods and some firms receiving 25-year periods, though all were extendable (DICJ 2020b). For those with ten-year periods, the allocation required they receive an additional approval for management plans. Injection through preferred investments have no explicit exit date, as each preferred investment is a preferred perpetual investment injection.