Prompt Recapitalization Act

The Japanese Diet passed a series of financial revitalization bills on October 2, 1998 (Japan Times 1998c). Among these bills were the Financial Reconstruction Committee Establishment Law, the Revolving Credit Transfers Facilitation Act, the Financial Services Agency Establishment Act, an amendment to the Deposit Insurance Act, and measures regarding debt management collection businesses. The evening of the passage of this set of bills, the Liberal Democratic Party proposed a plan for bank recapitalization to be debated by the upper and lower houses of the Japanese diet (Japan Times 1998b). The bill was passed 14 days later on October 16, 1998 (Japan Times 1998e).

The legislation was part of a series of capital injections between 1998-2008, preceded by a capital injection in March 1998, and followed by a third injection legislation in June 2004 (Hoshi and Kashyap 2010).

The Japanese Diet first addressed the banking crisis in February 1998 with the Financial Function Stabilization Act. This act allocated ¥30 trillion of public funds for a set of measures, including ¥13 trillion for bank recapitalization (Hoshi and Kashyap 2010). However, just ¥1.8 trillion of funds were allocated in March 1998 (DICJ 2020a).

The plenary session of the 1998-99 Japanese Diet began with the Liberal Democratic Party announcing a forthcoming package of bills aimed at the unstable Japanese financial landscape. Beginning as two financial stabilization bills introduced to the Diet by the Prime Minister’s Office on August 5, 1998, the proposed stabilization program eventually evolved into the Financial Reconstruction Act—which provided the framework with which to nationalize the Long-Term Credit Bank of Japan—in addition to an act establishing the Financial Reconstruction Commission, both of which were passed through the lower house on October 2, 1998 (Iimura 1999; Japan Times 1998a; Japan Times 1998b). That evening, the Liberal Democratic Party proposed a bill for bank recapitalization (Iimura 1999). On October 13, 1998, the Japanese Diet passed the Prompt Recapitalization Act, the final form of the bank recapitalization bill (Japan Times 1998d).

Through the new bills, the government doubled available funds for financial revitalization from ¥30 trillion to ¥60 trillion. Of this ¥60 trillion, ¥25 trillion was available for capital injections (Nakaso 2001). These injections were done in installments as banks applied for funding (DICJ 2021a). In addition, ¥18 trillion was allocated to nationalize failed banks and ¥17 trillion was allocated for depositor protection (Hoshi and Kashyap 2010).

Within two months of the passage of the Prompt Recapitalization Act, the Financial Reconstruction Commission (FRC) began to work on determining the dividend policies for the preferred shares to be bought for capital injections (Japan Times 1998f). The FRC was an independent commission under the Prime Minister’s office. It had five members, including a cabinet member who served as the chairman, and oversaw the Financial Supervisory Agency. Through legislation, the Diet gave the FRC planning authority on matters concerning the resolution of financial institution failures and financial crisis management, as well as the authority to inspect and supervise financial institutions (Nakaso 1999).

By legislation, the FRC’s term only lasted for two years and officially ended in January 2001 (Spindle and Dvorak 2000). At that time, the FRC and the Financial Supervisory Agency were merged to create the Financial Services Agency (FSA), now Japan’s bank, insurance, and securities regulator. The FSA then took on the responsibilities of the FRC, and screened applications for the final three banks to apply for public injection through the Prompt Recapitalization Act.

The Resolution and Collection Corporation (RCC) 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 (RCC 2018; DICJ 2021b). The RCC was funded entirely by the DICJ (RCC 2018).

The RCC was a subsidiary of the DICJ (DICJ 2021b). The DICJ acts independently of the Bank of Japan or the Treasury, though in close cooperation. Financial assistance from the DICJ is funded through the issuance of government-backed DICJ bonds. In rare instances, the DICJ may borrow money directly from the Bank of Japan (FSB 2016).

The RCC used DICJ capital to purchase preferred shares and subordinated debt of banks that requested capital injections (DICJ 2005) . The RCC noted that it was able to exercise its rights as a shareholder and investor, although available information doesn’t clarify to what extent the RCC exercised those rights (RCC 2018). The preferred shares converted to common shares after a grace period; if the FRC (or FSA after the merger of the two organizations) was dissatisfied by progress in restructuring for a specific bank, it could convert the shares to common shares and use its position as largest shareholder to put pressure on management (Kanaya and Woo 2000). The FRC determined the terms of the capital on a case-by-case basis (Nakaso 2001).

Enforcement in defining the underwriting terms of the preferred shares and subordinated loans faced issues due to varying leadership styles over the year and a half of the execution of the law. While the first chair of the FRC, Hakuo Yanagisawa, attempted to enforce strict terms such as calling for major restructuring of banks in exchange for capital injections, he was removed from the position in less than a year to be followed by “less-resolute” chairmen due to attempts to balance coalitions built in the Diet by Prime Minister Obuchi. The changes in leadership to the FRC caused volatility in the Japanese market, with shareholders unsure of future underwriting terms. Under the new chair, Michio Ochi, the restructuring slowed. Where Yanagisawa inserted requirements that banks meet Basel capital standards, Ochi dropped such requirements; similarly, where Yanagisawa requested banks merge, Ochi was reluctant to force mergers (Spindle and Dvorak 2000). Following a scandal after recordings surfaced with Ochi inviting bankers to approach him for more lenient standards, Ochi was followed by three other Chairmen over the one and a half years of the FRC’s existence before the first chairman of the FRC, Hakuo Yanagisawa, was reappointed.

The bill, announced as part of a series of bills to address the jusen problem, was originally introduced as an idea by the Liberal Democratic Party in the plenary session of the Japanese Diet (Japan Times 1998a). After the passage of other financial revitalization bills, the Prompt Recapitalization Act faced much negotiation before its passage 14 days later (Japan Times 1998c). Components of the original proposal changed—for instance, the initial proposal contained a constraint that banks with a capital adequacy ratio of 8% or higher would only receive capital injections when there is an “imminent danger or deflationary spiral” (Japan Times 1998a).

Any domestic or foreign bank was eligible for a capital injection (Prompt Recapitalization Act 1998). However, no foreign banks participated (DICJ 2020b).

The law did not require participation of any banks (Prompt Recapitalization Act 1998). The law also permitted applications by three specific non-banks, all cooperatives: Norinchukin Bank, Agricultural Cooperative Association, and the Federation of Fisheries Cooperative Associations.

Banks considered “capitalized” were required to acquire or merge with a struggling bank in order to receive capital injections (Japan Times 1998d). The definition of under-capitalization varied depending on whether the bank was a domestic or foreign entity, as shown in Figures 2, 3, and 4 (Prompt Recapitalization Act 1998).

In addition to balance sheet information, banks were required to submit management improvement plans that explained structural changes they planned to make. These affected the underwriting terms for the preferred shares and subordinated bonds purchased in the capital injections. The FRC sought to encourage restructuring, cost reduction, and corporate reorganization, and including these factors in management improvement plans decreased the overall cost of government capital through reduced dividends and bond yields (Nakaso 2001). Capital was injected both through purchases of preferred shares and subordinated debt (Hoshi and Kashyap 2010). (A detailed table listing of the dividend terms for preferred shares for the first 15 banks to receive injections is available in the source note; a listing of underwriting terms for subordinated debt of the first 15 banks to receive injections is available in the source note as well.)

Preferred shares had mandatory conversion dates to common shares; however, many banks chose to purchase these preferred shares and reissue common shares before their respective mandatory conversion dates (DICJ 2020b).

In addition, banks were encouraged to close foreign branches and subsidiaries, and incorporated such stipulations into their restructuring plans. They were rewarded in underwriting requirements guided by a rubric shown below in Figure 8. The proposed restructuring plans also involved reductions of personnel (Fukao 2000). An example of these proposed reductions are in Figures 5, 6, and 7 below:

During the course of the capital injection, management positions were no longer allowed to take bonuses on their salary. In addition, the banks were no longer allowed to issue dividends to shareholders while using capital injection funding (Prompt Recapitalization Act 1998).

All banks receiving capital injections in the form of subordinated debt received step-up clauses that began after three years of receiving the injection. Mandatory conversion dates of preferred shares for each bank varied widely, from within three months of injection in the case of Daiwa Bank to after six years in the case of Sumitomo Bank (DICJ 2020b).

There were no explicit legislated or enforced exit strategies. However, all banks but one—Shinsei Bank, formerly the Long-Term Credit Bank of Japan—repurchased their shares by June 2015 (DICJ 2020b). The Shinsei Bank continues to list the Resolution and Collection Commission as a majority shareholder. As of March 31, 2020, the DICJ and RCC hold 18.1% of Shinsei bank’s common shares (Shinsei Bank 2021). These shares resulted from a negotiation between Ripplewood Holdings and the Japanese government, as a condition to buy the Long-Term Credit Bank in 1999. While Ripplewood could not immediately offload the bad loans, they were provided an injection through the capital injection scheme, in addition to a guarantee that the Japanese government double the Long-Term Credit Bank’s loan-loss reserves (Bremner 1999).