## INTRODUCTION AND METHODOLOGY — Detailed Assessment Report (cr17282), Japan ## Source details **Canonical URL:** [INTRODUCTION AND METHODOLOGY — Detailed Assessment Report (cr17282), Japan](https://www.imf.org/-/media/files/publications/cr/2017/cr17282.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17282.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17282.pdf.json) --- ### A. Overview and context - Assessment completed as part of the Financial Sector Assessment Program (FSAP) mission undertaken by the IMF during December of 2016. - Assessment reflects the regulatory and supervisory framework in place as of the date of completion of the assessment. - Japan requested assessment according to the Revised BCP Methodology issued by the BCBS in September 2012; assessment performed against both Essential Criteria (EC) and Additional Criteria (AC). - Grading categories used: compliant; largely compliant; materially noncompliant; and noncompliant. - Key institutional mandates: - JFSA mandates: promote stability of the financial system; protect depositors/policyholders/securities holders; facilitate finance. - BoJ role: ensure smooth settlement of funds and contribute to financial system stability; conducts onsite examinations under Article 44 contracts. ### B. Main priority areas (high-level) - Enhance JFSA’s ability to use capital requirements to promote more robust capital planning and risk management practices. - Further strengthen corporate governance and risk management practices at banks, including board independence and risk function independence. - Introduce a more rigorous risk assessment process and a risk tolerance framework to support a fully risk-based approach to supervision. ### C. High-level key findings - Low rates and slow domestic credit growth accompanied by growing offshore lending, especially by megabanks, increasing reliance on wholesale foreign currency funding. - Long-term sustainability of regional and Shinkin bank business models is under pressure. - JFSA would benefit from a residual power to set Pillar 2 capital requirements for individual banks based on specific risk profiles. - Dividends and capital distributions should be constrained before bank capital ratios fall below minimum requirements. - Boards need stronger oversight capabilities and internal audit/risk functions need clearer independence and reporting lines. - Risk rating methodology and calibrated risk tolerance framework require further development to guide supervisory intensity and resource allocation. - Related party exposures need a stronger principle-based approach, more specific periodic reporting and proactive supervisory investigations beyond internal audit signals. ### D. Recommended supervisory and policy actions (high-level) - Provide JFSA residual power to set Pillar 2 capital requirements tailored to individual banks’ risk profiles. - Recalibrate PCA triggers and early intervention thresholds so constraints on capital distributions activate well before capital ratios fall to 4 percent. - Strengthen board independence and oversight; promote separate and functional committee structures (including remuneration committees). - Strengthen independence and reporting lines of risk management and internal control functions (CRO reporting to board/BRC). - Develop and implement a comprehensive risk rating methodology across risk categories and a calibrated risk tolerance framework tied to systemic importance. - Improve supervision of related party exposures with specific periodic reporting requirements and proactive supervisory investigations. - Increase frequency and depth of onsite and offsite assessments of board and committee functioning across a broader range of banks. - Consider longer-run options for JFSA funding model to preserve operational independence if financial sector expands amid public sector fiscal restraint. - Strengthen willingness to use binding corrective powers and improve inter-agency crisis management coordination. ### E. Institutional and market structure — selected statistics and system-wide indicators - Combined assets of banking system: ¥1,826 trillion (about US$16 trillion). - System size: assets of 365 percent of Gross Domestic Product (GDP). - Regional banks collectively represent approximately 40 percent of banking system assets. - Cross-border lending scale: $3.53tn of foreign loans (end-Q1 2015). - Japanese banks purchased about 200 trillion yen of JGBs since 2000. - JGBs accounted for around 10 percent of the industry's balance sheet (as of July 2016), down from 20 percent as of March 2012. - Deposit protection: other deposits protected up to a maximum principal of ¥10 million including interest, per depositor, per financial institution. - Minimum initial capital for a bank at licensing: ¥2 billion. - DICJ guarantee lines provided by the annual State budget: ¥69 trillion. - DICJ capital injections since 2010: as of March 2010, injected capital in 13 banks totaling about ¥350 billion of public funds. - Significant historical loan threshold for supervisory provisioning review: more than ¥10 billion (roughly equivalent to $100 million). ### F. System-wide financial soundness and profitability — key indicators (exact values) - Return on equity: - 2013 8.29; 2014 7.8; 2015 8.82; 2016 8.5 - Return on assets: - 2013 0.37; 2014 0.33; 2015 0.37; 2016 0.25 - Pre-provision income/RWAs: - 2013 1.56; 2014 1.51; 2015 1.64; 2016 1.38 - Cost-to-income ratio: - 2013 54.13; 2014 52.44; 2015 51.26; 2016 54.32 - CET1 ratio /2: - 2013 11.15; 2014 11.42; 2015 11.37; 2016 11.75 - Leverage ratio /3: - 2013 5.25; 2014 5.31; 2015 5.72; 2016 5.48 - NPLs/gross loans: - 2013 1,98; 2014 1.64; 2015 1.37; 2016 1.17 - Texas Ratio /4: - 2013 17.7; 2014 15.05; 2015 11.56; 2016 10.15 - Domestic loans/domestic assets: - 2013 39.39; 2014 38.7; 2015 38.7; 2016 38.7 - System average nonperforming loan (NPL) ratio: 1.6 percent. - Domestic credit growth: about 2 percent (yoy). - Overseas loan growth (2015 yoy): - Major banks measured in U.S. dollars increased by approximately 10 percent in 2015 year-on-year (an annual increase of approximately US$80 billion). - Regional banks increased by approximately 20 percent in 2015 year-on-year (an annual increase of approximately US$4 billion). ### G. Capital, liquidity and funding — precise rules, thresholds and observations - Capital regime: - Minimum CET1 for internationally active banks: 8 percent. - Risk-weighted core capital ratio requirement for domestic banks: 4 percent (Core capital). - JFSA expanded minimum capital requirements for internationally active banks to include Basel III buffers (capital conservation buffer, countercyclical buffer, and GSIB/DSIB buffer requirements). - Shortcoming: lack of explicit Pillar 2 powers to impose bank‑specific additional capital add‑ons. - Prompt Corrective Action (PCA): - Constraints on dividends and capital disbursements would only start when bank capital ratios fall below 4 percent. - Recommendation: recalibrate PCA triggers so constraints start well before capital ratios fall to the 4 percent threshold. - Liquidity: - LCR implementation for internationally active banks: monthly compliance required since March 2015; quarterly disclosures from the end of June 2015. - Minimum LCR trajectory: "60 percent" in 2015, "70 percent" in 2016, rising in equal annual steps to reach "100 percent" in 2019. - JFSA introduced "Approximate LCR" daily calculation: if Approximate LCR falls below a level "higher than the LCR minimum level by 20 percent", bank must submit daily report to JFSA. - FX funding: - FX funding exposure is a significant risk for megabanks with expanded overseas lending; wholesale funding makes up a large share of FX funding. - Cross-border lending left Japan’s banks as the biggest cross-border lenders at end-Q1 2015 with $3.53tn of foreign loans. ### H. Supervisory framework, tools and practices — selected findings - Legal and supervisory architecture: - Four-level legal framework: Banking Act (Diet), Orders for Enforcement (Cabinet), Ordinances for Enforcement (JFSA), and JFSA supervisory guidelines/inspection manuals. - JFSA conducts safety-and-soundness oversight and conduct-of-business regulation; BoJ conducts onsite examinations and offsite monitoring of counterparties. - Supervisory responsibilities, powers and independence: - JFSA can require reports, conduct onsite inspections, issue improvement plans and business improvement orders, and recommend license revocation (final acts require PM endorsement in practice). - Statutory provisions governing removal of a JFSA Commissioner could be tightened; Commissioner lacks a fixed term in practice. - JFSA budget funded by central government; potential long-term funding risk under public fiscal restraint recommended for review. - Onsite/offsite supervision and risk-based framework: - Risk-proportional mix: megabanks receive more frequent and intensive supervision; regional and Shinkin banks receive less frequent onsite inspections (every two to three years for JFSA; three to five years for BoJ). - JFSA moved from single comprehensive onsite to targeted single-risk-area inspections since 2014 and has enhanced thematic inspections and risk profiles introduced in 2014. - Consolidated and cross-border supervision: - JFSA supervises on solo and consolidated bases; G-SIB/D-SIB frameworks established (three G-SIBs designated December 2015; additional capital requirements applied since March 2016). - Home-host cooperation: CMGs, supervisory colleges, EoLs and MoUs in place for major Japanese banks; JFSA participates in CMGs and shares recovery and resolution plans. ### I. Corporate governance, risk management, internal control and audit — key findings - Corporate governance (Principle 14): Assessment LC. - Corporate Governance Code and Supervisory Guideline in place; legacy board structures limit separation between oversight and executive management. - Independent reporting by internal audit to Board Audit Committee often insufficient; in some instances committee reports to executive management. - Remuneration committees often absent; recommend frequency/depth of onsite/offsite board assessments be increased beyond megabanks. - Risk management (Principle 15): Assessment LC. - Greater emphasis needed on independence of the risk function and CRO reporting line to the Board Risk Committee. - Stress testing and ICAAP practices developing; SREP needs more structure and wider rollout beyond megabanks. - Internal control and audit (Principle 26): Assessment C. - Oversight sound but internal audit reporting lines should be strengthened to boards. - External auditors: JFSA has limited powers to remove weak external auditors except in extreme situations; recommendation to require external auditors to report corrective-action items to the Commissioner of the JFSA. - Financial reporting and external audit (Principle 27): Assessment LC. - Mandatory auditor rotation: seven-year rotation with two-year cooling-off period per CPA Act; JICPA five-year rotation rule for larger audit corporations. - External auditors are not legally required to report directly to supervisors except under specified provisions; recommendation to enhance prompt reporting of material findings to supervisors. ### J. Credit risk, provisioning and concentrations — selected findings and policy considerations - Credit risk (Principle 17): Assessment C — sufficient focus by banks and supervisors; routine and targeted offsite/onsite file reviews performed. - Problem assets, provisions and reserves (Principle 18): Assessment C — migration to expected credit loss framework will require significant work; JFSA may consider greater reliance on external auditors where scope/prudential rigor permit. - Concentration risk and large exposures (Principle 19): Assessment LC. - Large exposure limit: 25 percent of bank’s capital for single counterparty (Order for Enforcement). - Operational large exposure definition: more than "10 percent of bank’s Tier 1 capital" used for quarterly reporting. - Recommendation: broaden group definitions beyond ownership and expand concentration monitoring beyond credit (e.g., market/trading exposures). - Related party exposures (Principle 20): Assessment MNC. - Arm’s-length rule exists (Article 13−2) but no specific statutory limits beyond LE regime; framework principles-based, lacking specific periodic reporting and proactive supervisory powers; recommendation to strengthen requirements and reporting. ### K. Market risk, IRRBB, liquidity and operational risk — supervisory focus - Market risk (Principle 22): Assessment C — supervisory guidelines and market-risk specialists concentrated on megabanks and trading banks. - Interest rate risk in the banking book (IRRBB) (Principle 23): Assessment C. - Outlier threshold: impact of interest rate shocks on bank capital exceeding "20 percent of the sum of Tier 1 and Tier 2 capital." - Prescribed shocks: parallel shift by "200 basis points" or tail event as described. - JFSA transitioning to new IRRBB guidelines aligned with BCBS by "2018." - Liquidity risk (Principle 24): Assessment C. - LCR monthly compliance for internationally active banks since March 2015; LCR-by-major-currency reporting required monthly. - JFSA requires unencumbered asset monitoring and contingency funding plans; foreign currency liquidity risk prioritized. - Operational risk (Principle 25): Assessment C — governance, BCP and outsourcing supervision enhanced; BoJ inspects outsourced providers with permission. ### L. AML/CFT (Principle 29) — findings and recommendations - Japan has strengthened AML/CFT capabilities; STR reporting increased from 18,768 in 2002 to 399,508 in 2015. - Shortcoming: reduction in focus on routine onsite AML/CFT inspections; reliance on STRs supports offsite monitoring but routine onsite verification of CDD and correspondent banking relationships recommended. - Policy recommendation: increase routine onsite inspections for AML/CFT to complement STR-based offsite monitoring. ### M. Licensing, ownership transfer and major acquisitions — findings and recommendations - Licensing criteria include minimum initial capital of ¥2 billion and expectation to return to profitability within three years from start of banking business. - Major shareholder thresholds: - Major shareholder definitions at 15 or 20 percent depending on influence; 50 percent considered controlling in practice. - Recommendation: introduce pre-approval for acquisition of majority (controlling) interests (i.e., prior to crossing the 50 percent threshold). - Major acquisitions and investments: - Pre-approval required for mergers and subsidiaries; investments leading to significant influence lack formal pre-approval in some cases — recommendation to tighten approvals for material investments and ancillary business acquisitions. ### N. Crisis management, resolution and inter-agency coordination - Financial Crisis Response Council (FCRC) chaired by Prime Minister; includes MoF, Minister for Financial Services, JFSA Commissioner, Governor of BoJ and Chief Cabinet Secretary. - DICJ resolution role: manages deposit insurance, can inject capital, make payouts and issue bonds with government guarantee; current ¥69 trillion guarantee lines to DICJ. - JFSA serves as resolution authority; CMGs established with foreign resolution authorities, DICJ and BoJ; CMGs and Co‑Ags used for G‑SIFIs. - Recommendation: strengthen inter-agency coordination for crisis management and preparedness; recalibrate PCA to allow earlier intervention. ### O. Selected legal and supervisory thresholds and metrics (preserved) - Major shareholder notification: shareholders with more than 5 percent must notify JFSA within 5 days of crossing that threshold; holdings changing by more than one percent must be notified (Article 52−2−21 and 52−3). - Penal sanctions: failure to report/false statements, refusal to answer or interference with inspections: imprisonment with required labor for not more than one year or a fine of not more than three million yen (Banking Act Article 63–2,3). - Fines for bank violations: not more than 200 million yen (Banking Act Article 64). - Single counterparty large exposure limit: "25 percent" of bank’s capital (Order for Enforcement). - Related stricter limit for major shareholders in Order for Enforcement: "15 percent" of capital. - Mandatory auditor rotation: seven years with two-year cooling-off period per CPA Act; JICPA five-year rotation rule for larger auditors. - LCR minima and trajectory: "60 percent" in 2015; "70 percent" in 2016; reach "100 percent" in 2019. - IRRBB prescribed shock: "200 basis points". - Outlier IRRBB threshold: "20 percent of the sum of Tier 1 and Tier 2 capital". - SME provisioning material gap trigger for Article 26 orders: "30 percent or more of aggregate provisions". - Deposit protection cap (non-payment-and-settlement deposits): ¥10 million including interest, per depositor, per financial institution. ### P. Authorities’ response — summarized position - Japanese authorities welcome the assessment, note significant improvements since the late 1990s, and support continued dialogue. - Authorities highlight post-2012 steps: introduced capital buffer framework, revised definition of Core Capital for domestic banks to be more conservative and broadly equivalent to CET1, stepped-up corporate governance initiatives and enhanced supervision of related-party transactions. - Authorities view Pillar 2 recommendation as encouragement for earlier and more effective supervisory dialogue on risks outside Pillar 1 rather than a question of existing enforcement powers. *IMF staff summary based on the provided chapter content (cr17282).* ### INTRODUCTION AND METHODOLOGY ______________________________________________________ 12 ### INTRODUCTION AND METHODOLOGY ### A. Introduction and overview - Banking regulations and supervisory processes have undergone significant improvements since the last Financial Sector Assessment Program (FSAP). - The Japan Financial Services Agency (JFSA) is reforming supervisory practices, shifting focus from compliance to a more sophisticated and forward-looking risk-based approach for banks and bank holding companies. - Prudential requirements have been updated to incorporate the Basel III reforms in accordance with internationally agreed timelines. - Corporate governance expectations have been strengthened with the implementation of Japan’s Stewardship Code and Corporate Governance Code. - Japanese agencies have deepened working relationships domestically and with foreign counterparts. ### B. Main priority areas (high-level) - Enhance JFSA’s ability to use capital requirements to promote more robust capital planning and risk management practices. - Further strengthen corporate governance and risk management practices at banks, including board independence and risk function independence. - Introduce a more rigorous risk assessment process and a risk tolerance framework to support a fully risk-based approach to supervision. ### Key findings (enumerated) - A confluence of low rates and slow credit growth has been accompanied by growing offshore lending, especially by the megabanks, increasing reliance on wholesale foreign currency funding. - Long-term sustainability of regional and Shinkin bank business models is under pressure. - The JFSA would benefit from a residual power to set Pillar 2 capital requirements for individual banks based on specific risk profiles to respond more dynamically to emerging issues. - JFSA should work with regional and Shinkin banks to ensure dividends and other capital distributions can be constrained before bank capital ratios fall below minimum requirements. - Greater attention is needed to help boards of directors effectively oversee management and ensure appropriate checks and balances. - Risk management functions need strengthened independence and clearer reporting lines to the board. - Risk rating methodology needs further development to delineate risk profiles across credit, market, operational risk and AML/CFT vulnerabilities, taking into account financial condition, governance and risk management capacity. - JFSA needs to flesh out risk tolerances for failure across different bank types and calibrate them to bank systemic importance to guide supervisory intensity and resource allocation. - Related party exposures require a stronger principle-based approach; more specific periodic reporting requirements and proactive investigations are recommended beyond reliance on internal audit signals. ### C. Detailed supervisory framework findings (by theme / selected CPs) - Responsibility, Objectives, Powers, Independence, Accountability (CPs 1−2) - Legal framework for banking supervision is well established with comprehensive laws, regulations, and guidance. - Three JFSA mandates—promote stability of the financial system, protect depositors/policyholders/securities holders, and facilitate finance—are complementary. - Mechanisms largely allow operational independence, but statutory provisions governing removal of a JFSA Commissioner could be tightened. - JFSA budget has been stable; risk exists that the funding model may become less robust if financial sector expands during public sector fiscal restraint—authorities may consider alternative longer-run funding models. - Ownership, Licensing, and Structure (CPs 4−7) - Requirements for licensing, ownership and major acquisitions are broadly well established. - Marginal enhancements could tighten licensing, allow JFSA pre-approval of majority voting interests beyond major shareholder threshold, and strengthen powers to review bank investments in other institutions. - Methods of Ongoing Supervision (CPs 8−10) - Supervision has been strengthened since the last FSAP, but risk rating methodology requires further development. - Onsite and offsite processes are relatively sound; a more comprehensive analytical risk framework is needed to assess banks and banking groups systematically. - Establishment of D-SIB and G-SIB frameworks is progress, but elements remain a work in progress and should be completed to support risk-based supervision. - Planning and coordination of supervisory tasks could be improved; integrated approach used for megabanks and major trading banks is planned to be rolled out to larger Regional and smaller banks. - The approach for Regional/Shinkin banks has moved away from annual onsite inspections; greater emphasis on planning is needed to allocate resources across banks and supervision activities. - Corrective and Sanctioning Powers of Supervisors (CP 11) - JFSA has necessary powers to take measures against banks, but greater willingness to exercise these powers is needed. - In practice, JFSA generally uses non-binding measures (e.g., suasion), which may delay remedial actions when consensus is not forthcoming. - Prompt Corrective Action (PCA) triggers should be recalibrated to grant JFSA sufficient flexibility to intervene promptly. - Authorities may wish to consider strengthening inter-agency coordination for crisis management and crisis preparedness. - Cooperation, Consolidated, and Cross-Border Banking Supervision (CPs 3−12−13) - Significant progress in oversight of banking groups on a consolidated basis and in deepening domestic and foreign supervisory relationships. - Legislative changes give supervisors more powers to review holding company activities and evaluate suitability of senior management and owners. - BoJ and JFSA have taken steps to enhance working relationships. - New MoUs and EoLs and Crisis Management Groups have been formed for three major Japanese banks designated as global systemically-important banks. - Corporate Governance (CP 14) - Initiatives to improve corporate governance standards have commenced, but higher standards are needed for banks given their global importance. - Further work needed to embed better practices and drive cultural change; disparities in governance practices remain even across major banks. - Legacy board structures cause lack of separation between board oversight role and executive management role. - Insufficient independent reporting by internal audit to Board Audit Committee; in some instances the committee reports to executive management (typically the President/CEO). - Committee structures often lack a separate remuneration committee, reducing oversight separation between those setting strategy/targets and those setting remuneration. - JFSA should increase frequency and depth of onsite and offsite activities to assess effective functioning of boards and committees and roll out engagement beyond megabanks and major trading banks. - Prudential Requirements, Regulatory Framework, Accounting and Disclosure (CPs 15–29) - Risk management (CP 15) - Greater emphasis on the independence of the risk function is needed, especially the reporting line of the Chief Risk Officer (CRO) to the Board Risk Committee (BRC). - JFSA and BoJ frameworks suffice to identify and evaluate bank risk management systems, but further work needed to strengthen independence of risk management with clear reporting line to the board. - Given flat yield curve and subdued demand for credit, banks’ search for yield requires more robust risk management systems to monitor and detect risks early. - Continued supervisory attention recommended to promote stronger risk governance arrangements including independent risk management and internal control functions with direct reporting to the board. - Capital adequacy (CP 16) - Capital requirements are closely aligned with Basel Pillar 1 for internationally-active banks, but a Pillar 2 capital framework to tailor capital requirements to individual bank risk profiles is lacking. - Lack of Pillar 2 makes it difficult for authorities to require banks to carry more capital beyond minimums to address specific bank risks such as concentration or IRRBB. - JFSA’s plans to be a more dynamic supervisor will require more influence to set capital and adjust risk management practices in anticipation of events; relying on minimum capital framework alone may be insufficient. - While most domestic banks are currently well capitalized, thresholds for early intervention measures are set too low. Constraints on dividends and capital disbursements would only start when bank capital ratios fall below 4 percent. - JFSA is encouraged to explore feasibility of introducing constraints for capital levels above official minimum requirements, through bank policies and recovery plans, so they start to kick-in well before capital ratios fall below the 4 percent threshold. - Credit risk (CP 17) - (Assessment introduction ends here; detailed CP 17 findings follow in the report.) ### Recommended supervisory and policy actions (high-level) - Provide JFSA with residual power to set Pillar 2 capital requirements tailored to individual banks’ risk profiles. - Recalibrate PCA triggers and early intervention thresholds so constraints on capital distributions activate well before capital ratios fall to 4 percent. - Strengthen board independence and oversight, promote separate and functional committee structures (including remuneration committees). - Strengthen independence and reporting lines of risk management and internal control functions (CRO reporting to board/BRC). - Develop and implement a comprehensive risk rating methodology across risk categories and a calibrated risk tolerance framework tied to systemic importance. - Improve supervision of related party exposures with specific periodic reporting requirements and proactive supervisory investigations. - Increase frequency and depth of onsite and offsite assessments of board and committee functioning across a broader range of banks. - Consider longer-run options for JFSA funding model to preserve operational independence if financial sector expands amid public sector fiscal restraint. - Strengthen willingness to use binding corrective powers and improve inter-agency crisis management coordination. *INTRODUCTION AND METHODOLOGY — Detailed Assessment Report (cr17282), Japan* ### 19. In general, there is a sufficient focus by banks as well as the JFSA and BoJ on credit ### cr17282 - 19. In general, there is a sufficient focus by banks as well as the JFSA and BoJ on credit ### Credit risk management - Findings: - There is a sufficient focus by banks as well as the JFSA and BoJ on credit risk management. - Banking industry discussions indicated sufficient senior-management attention to identified problem areas and willingness to further migrate credit risk management processes towards best practices. - Credit risk is a key focus in JFSA Strategic Directions and Priorities, which are made public. - Supervisory and inspection bureaus of the JFSA perform both routine and targeted ad-hoc work, including detailed monitoring and in-depth file-review analysis of credit risks and adequacy of risk management. ### Problem assets, provisions and reserves (CP 18) - Findings: - Policies and practices with respect to problem assets have improved considerably since the Japanese banking crisis. - Gaps in provisioning of SME and other special measure loans have shrunk in recent years, although some legacy issues remain. - Regular detailed reviews of loan classifications and provisioning practices by Japanese authorities contributed to improved performance. - Migration to the new expected credit loss framework (emerging as best practice in international accounting standards and Basel Committee provisioning guidance) will require significant work by banks and the JFSA. - Policy considerations: - The JFSA may consider placing more reliance on reviews carried out by external auditors, provided the scope and prudential rigor of those audits is adequate. ### Concentration risk (CP 19) - Findings: - JFSA has tightened regulations for large exposures, including reducing stricter limits for connected counterparties from 40 percent of capital to 25 percent. - JFSA will implement the new BCBS LE guidelines that take effect in 2019. - More attention is needed to expand risk management for risk concentrations other than large exposures, including concentrations from market risk and other risk types. - There is no requirement that all material concentrations be regularly reviewed and reported to banks’ supervisory boards. - Inclusion of these exposures in stress testing is limited. ### Related party exposures (CP 20) - Findings: - Exposures to related parties are required to be conducted at 'arms-length' terms. - Specific limits for related party exposures have not been set by either banks or the JFSA beyond existing large exposure rules. - JFSA considers related party exposures in periodic compliance inspections but supervision would benefit from more specific periodic reporting requirements and more proactive investigations less reliant on signals from internal audit. - Policy recommendations: - Introduce more specific periodic reporting requirements for related party exposures. - Adopt more proactive supervisory investigations independent of internal audit signals. ### Country and transfer risks (CP 21) - Findings: - JFSA monitors country and transfer risks closely with additional regular prudential returns focused on country exposures. - Faced with weak profitability, sluggish local loan demand, and a low interest rate environment, Japanese banks—particularly the mega banks—are expanding overseas, notably in the US and Asia. ### Market risk (CPs 22–24) - Findings: - Supervisory Guidelines obligations are generally sound and establish requirements for effective market risk frameworks. - Supervisors periodically review banks to assess consistency of market risk management with banks’ risk-bearing capacity. - City banks, including the three megabanks, are the more active trading participants; instruments traded typically include Japanese Government Bonds (JGBs), Interest rate swaps (IRS) and currencies. - JFSA market risk specialists conduct onsite inspections; risk limits for trading are usually low with real time monitoring and daily escalations. - Supervisory focus and expertise is concentrated on mega bank and trading bank market risk activities; market risk exposures of other banks are not material. - Interest rate risk in the banking book (IRRBB): - Findings: - IRRBB has been a key supervisory priority and has received significant supervisory attention in recent years. - Banks are required to measure, calculate and report IRRBB exposures on a quarterly basis. - Banks must conduct regular stress testing using both standardized and bespoke scenarios, especially those with complex business models and optionality. - IRRBB features in the SREP assessment and is a key topic in discussions with bank senior management. - JFSA has begun transition to new IRRBB guidelines to closely align with new BCBS requirements in 2018. - Liquidity and FX funding: - Findings: - FX funding exposure is a significant risk for megabanks with expanded overseas lending. - BoJ and JFSA carry out coordinated onsite examinations/inspections and offsite monitoring; BoJ inspections include detailed coverage of risk management. - For internationally active banks (non-consolidated and consolidated), JFSA requires compliance with the total Liquidity Coverage Ratio (LCR) minimum requirement on a monthly basis; this was implemented in March 2015 and includes quarterly disclosures from the end of June in 2015. - Banks report the LCR by significant currency to the JFSA on a monthly basis in accordance with the BCBS liquidity standard. - Transposition of the LCR into local rules closely aligns with the BCBS text and implementation timeline meets the Basel III requirements. - Offsite monitoring and onsite inspections by both the JFSA and BoJ appear rigorous. - Contingency funding plans and FX liquidity risk management have been a focus of the authorities. ### Internal control, financial reporting and audits (CPs 26 and 27) - Findings: - Oversight of bank internal control frameworks is sound. - Internal audit functions could be strengthened by introducing a more direct reporting relationship to bank boards of directors. - Stronger relationships with external auditors could enable the JFSA to exercise more influence over audit scope and be more promptly informed about financial reporting vulnerabilities. - JFSA has limited powers to remove weak external auditors except in extreme situations. - External auditors should be required to report to the Commissioner of the JFSA all items requiring corrective action, not only those unaddressed by the bank within two weeks of notification. - Policy recommendations: - Require external auditors to report all corrective-action items to the Commissioner of the JFSA. - Strengthen internal audit reporting lines to boards. ### Disclosure and transparency (CP 28) - Findings: - Domestic and internationally-active banks have strong disclosure practices. - Banks have implemented Basel III Pillar 3 disclosure requirements on both a consolidated and unconsolidated basis in accordance with internationally-agreed timelines. - Policy considerations: - As Pillar 3 requirements become more detailed following planned revisions to the Basel Pillar 3 Framework, the JFSA may wish to consider the regulatory burden on smaller banks and assess costs and benefits of imposing more detailed requirements on those institutions. ### Abuse of financial services (CP 29) - Findings: - Japan has taken a number of steps to strengthen AML/CFT capabilities; improvements include increased reporting of Suspicious Transaction Reports (STRs). - A reduction in focus on onsite inspections for AML/CFT is a shortcoming. - STR reporting supports offsite monitoring, but routine onsite inspections are needed to verify effectiveness of risk management and controls (e.g., customer due diligence (CDD) processes and correspondent banking relationships). - Policy recommendations: - Increase routine onsite inspections for AML/CFT to complement STR-based offsite monitoring. ### Introduction and methodology (assessment context) - Facts about the assessment: - Assessment completed as part of the Financial Sector Assessment Program (FSAP) mission undertaken by the IMF during December of 2016. - Assessment reflects the regulatory and supervisory framework in place as of the date of completion of the assessment. - Japan requested assessment according to the Revised BCP Methodology issued by the BCBS in September 2012. - The assessment was performed against both Essential Criteria (EC) and Additional Criteria (AC). - The number of principles increased from 25 to 29; the number of essential criteria expanded from 196 to 231 (including 35 new essential criteria); there are 16 additional criteria for jurisdictions choosing to be assessed against ACs. - Grading categories used: compliant; largely compliant; materially noncompliant; and noncompliant. - Process and sources: - Team reviewed laws, rules, guidance, and held extensive meetings with JFSA, BoJ, Ministry of Finance (MoF), Financial Intelligence Unit (FIU), audit firms, credit rating agencies, and banking sector participants. - Authorities provided a comprehensive self-assessment and detailed responses to questionnaires and facilitated access to supervisory documents, files, staff, and systems. ### Institutional and market structure — overview (selected statistics) - Findings and statistics: - The Japanese banking industry mainly consists of the three mega banks (classified as Global Systemically Important Banks — G-SIBs), Japan Post Bank, two trading banks, a large number of regional banks, and many cooperative banks (Shinkin banks) including Farmers Bank. - These institutions have combined assets of ¥1,826 trillion (about US$16 trillion). - The system is large (assets of 365 percent of Gross Domestic Product (GDP)) and is the second largest banking system in the world. - Regional banks, while individually small, collectively represent approximately 40 percent of banking system assets. *Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17282.pdf* ### 39. The banking system is characterized by low profitability, sound yen liquidity, low ### The banking system is characterized by low profitability, sound yen liquidity, low ### System-wide financial soundness and profitability - Low profitability: net interest margins (NIM) on a downward path; cost-to-income ratio flat; return on equity remained broadly static between 2015 and 2016; pre-provisioning income is falling because net interest income is the main source of revenue. - Sound yen liquidity and capitalization: banks invest excess liquidity largely in JGBs or hold deposits with the BoJ, supporting favorable LCR and Net Stable Funding Ratio in local currency. - Low NPLs: the average nonperforming loan (NPL) ratio for the system is 1.6 percent. - Domestic credit demand weak: prolonged low economic growth has depressed domestic credit demand with domestic loan growth slowing. ### Key financial indicators (as presented) - Return on equity: 2013 8.29; 2014 7.8; 2015 8.82; 2016 8.5 - Return on assets: 2013 0.37; 2014 0.33; 2015 0.37; 2016 0.25 - Pre-provision income/RWAs: 2013 1.56; 2014 1.51; 2015 1.64; 2016 1.38 - Cost-to-income ratio: 2013 54.13; 2014 52.44; 2015 51.26; 2016 54.32 - CET1 ratio /2: 2013 11.15; 2014 11.42; 2015 11.37; 2016 11.75 - Leverage ratio /3: 2013 5.25; 2014 5.31; 2015 5.72; 2016 5.48 - NPLs/gross loans: 2013 1,98; 2014 1.64; 2015 1.37; 2016 1.17 - Texas Ratio /4: 2013 17.7; 2014 15.05; 2015 11.56; 2016 10.15 - Domestic loans/domestic assets: 2013 39.39; 2014 38.7; 2015 38.7; 2016 38.7 - Source note: Source: JFSA, ERAs and IMF staff calculations. - Footnote: 1/ All figures as at 31 December, 2015 - Footnotes: 2/ CET1-ratio - transitional: 2010-2013 Core Tier1-ratio; 3/ Calculated as Shareholders equity/Total assets; 4/ Calculated as NPLs/Shareholders equity+ loss reserves ### Offshore expansion and associated risks - Japanese banks expanding abroad to capture lending opportunities due to challenging domestic operating conditions. - Examples of cross-border activity noted: - Mizuho Financial Group and two other banks received licenses to operate in Myanmar (last year as of the source). - Sumitomo Mitsui Banking bought a stake in Cambodia’s Acleda Bank in 2014. - Bank of Tokyo-Mitsubishi UFJ (MUFJ) acquired Thailand’s Bank of Ayudhya in 2013. - Overseas business contribution: at Mizuho, overseas business operations account for more than half of income from customers. - Benefits and risks: - Benefit: more diversified income base and geographic reach, expanded lending opportunities. - Risks: need for stronger risk management and potential foreign exchange funding risks. ### Deposit base, funding structure, and FX liquidity risk - Large, stable, and growing deposit base: more than half of domestic savings are held in bank deposits—a much higher proportion than most other developed markets. - Low market-based financing reliance: Japanese banks have one of the lowest ratios of market-based financing globally, with very little reliance on confidence-sensitive funding. - Low loan-to-deposit ratios: average of less than 70 percent; excess liquidity invested in JGBs or held with the BoJ. - FX liquidity risk: financing overseas (non-yen) loan growth outpacing deposits—wholesale funding makes up a large share of FX funding, leaving banks vulnerable to FX liquidity risk. - Cross-border lending scale (BIS data cited): Japan’s banks became the biggest cross-border lenders at end-Q1 2015 with $3.53tn of foreign loans. ### Credit risks: commercial real estate and cross-border exposures - Real estate lending growth: - Recent growth in real estate loans has surpassed that observed during the real estate boom preceding the Lehman shock. - Increase in loans by major banks mainly attributable to Japanese Real Estate Investment Trusts and demand from large real estate developers and private real estate funds (SPCs) sponsored mainly by foreign affiliated funds. - Macro indicator: real estate firms’ investment to GDP ratio was rated “red” on the BoJ’s April 2016 heat map (though noted later the rating turned “green” in October 2016, the ratio remains high). - Overseas loan growth: banks' overseas loans grew relatively quickly, particularly to advanced economies (such as North America). - Loans by major banks, measured in U.S. dollars, increased by approximately 10 percent in 2015 year-on-year (an annual increase of approximately US$80 billion). - Loans by regional banks increased by approximately 20 percent in 2015 year-on-year (an annual increase of approximately US$4 billion). - Domestic credit growth weak: about 2 percent (yoy) despite rapidly growing lending to real estate firms. ### Market and portfolio concentration risks - Cross-shareholdings and equity exposure: - Banks hold large JGB and equity portfolios—about ¼ of total assets. - Equity holdings primarily support long-term relationships and related business with large corporations, and account for more than half of city banks’ Tier 1 capital—well above the less than 10 percent typical among U.S. and European banks. - Nikkei performance: rallied by 57 percent in 2013, by 7.1 percent in 2014 and by almost 18 percent in 2015; Nikkei decline since August 2016 reduced that benefit. - Large exposures to JGBs: - Japanese banks purchased about 200 trillion yen of JGBs since 2000. - As of July 2016, JGBs accounted for around 10 percent of the industry's balance sheet (down from 20 percent as of March 2012). - Negative interest rate policy (NIRP) pushed yields on most low risk assets to near-zero or negative and flattened the yield curve, reducing profits from maturity transformation. - Yield curve appeared stabilized since the introduction of yield curve control at end-September 2016. ### Preconditions for effective banking supervision — institutional framework - Integrated supervisory framework: - Single universal regulator: JFSA conducts both safety-and-soundness oversight and conduct-of-business regulation for all financial services sectors. - BoJ conducts onsite examinations and offsite monitoring of its counterparty financial institutions. - MoF retains an important role. - DICJ implements reimbursement of insured deposits and financial assistance to reorganize failed banks. - Historical reform: integrated supervisory system established in the late 1990s in response to perceived weaknesses of the previous MoF-centric approach. ### Domestic coordination and crisis management - Strengthened coordination: - Council for Cooperation on Financial Stability launched in June 2014; includes senior officials from the BoJ and JFSA. - Monthly meetings on international financial and capital market issues among senior officials from the JFSA, BoJ and MoF since March 2016. - Financial Crisis Response Council (FCRC): - Activated by the PM when government intervention is necessary under “measures against crisis” or “orderly resolution” regimes. - Membership: Prime Minister (chair), Chief Cabinet Secretary, Minister for Financial Services, the MoF, Commissioner of Financial Services Agency, and the Governor of the BoJ. - Advises the PM; ultimate decisions formally taken by the PM. - Usage: convened only twice; general bank resolution measure of providing partial depositor protection used only once since the blanket guarantee was lifted. - Article 38 of the Bank of Japan Act: - PM and the MoF may request the BoJ to take actions when especially necessary for maintenance of financial stability; BoJ may undertake necessary actions, including provision of uncollateralized loans, judging propriety based on four principles. - PM may delegate power to request BoJ actions to the JFSA Commissioner under Article 61−2 of the Bank of Japan Act. ### System-wide risk analysis and advisory bodies - Bank of Japan Financial System Report (FSR): - BoJ analyzes and assesses risks in the entire financial system and releases findings semi-annually in the FSR. - FSR informs onsite examinations, offsite monitoring, seminars of BoJ's Center for Advanced Financial Technology, and international discussions. - Financial System Council (FSC) within JFSA: - Provides general advice on the financial system via sectional committees and subcommittees. - Conducts deliberations in response to requests from the PM, Commissioner of the JFSA, or the MoF and presents reports on medium- and long-term perspectives. ### Infrastructure supporting supervision - Accounting standards: - Banks subject to Japanese GAAP for regulatory reporting; convergence toward IFRS underway since March 2005. - Tokyo Agreement (August 2007) set timeline to eliminate major differences by end-2008 and remaining differences by June 2011. - Japanese GAAP allows certain assets/liabilities to be reported at historical cost; fair value accounting sometimes applies as lower of historical cost or fair value under certain circumstances. - External audit framework: - Legislation requires external auditors to be independent in fact and appearance. - CPAAOB within JFSA oversees quality review work performed by JIPCA. - CPA Act: mandatory rotation from audit engagements of listed companies within a maximum period of seven years from appointment with a two-year cooling-off period. - Larger audit corporations auditing 100 or more listed companies must follow a five-year rotation rule. - Payment and settlement infrastructure: - Real Time Gross Settlement (RTGS) for all large-value payments; liquidity saving features in RTGS; delivery-versus-payment (DVP) for securities. - Japan and the U.S. were the only jurisdictions to adopt legislation mandating central clearing of standardized OTC derivatives by end-2012. ### Market discipline and disclosure - Disclosure and transparency safeguards: - Banking Act requires banks to publicly disclose annual reports on solo and consolidated basis detailing business and financial condition. - Companies Act and Financial Instruments and Exchange Act specify disclosure requirements for shareholders and listed companies. - Listed companies must publicly disclose and submit annual financial statements to the JFSA (Article 435 of the Companies Act); statements audited by external auditors. - Securities Exchanges and JSDA require timely disclosure of performance information via TDnet. - JFSA’s Supervisory Guidelines and Inspection Manuals set corporate governance expectations; non-binding but administrative actions can follow non-compliance. ### Public safety nets and resolution - Deposit protection: - “Payment and Settlement deposits” (current deposits or non-interest bearing ordinary deposits meeting three conditions) are fully protected. - Other deposits (e.g., time deposits) are protected up to a maximum principal of ¥10 million including interest, per depositor, per financial institution. - Deposit Insurance Corporation of Japan (DICJ): - Manages deposit insurance system and resolves failed banks; may make payouts to insurable deposits, inject capital in solvent banks (funded by government guaranteed borrowings), and take resolution actions in coordination with the Resolution and Collection Corporation (RCC). - Since 2008, capital injections based on the Act on Special Measures for Strengthening Financial Functions. - As of March 2010, DICJ injected capital in 13 banks totaling about ¥350 billion of public funds. - Funding and backstops: - Deposit Guarantee Scheme funded ex ante by periodical flat-rate contributions from banks. - DICJ can make borrowings and issue bonds with JFSA and MoF approval; government may provide guarantee on DICJ’s financing. - Currently, ¥69 trillion of guarantee lines are provided to the DICJ by the annual State budget. - DICJ allowed to ask the BoJ for temporary liquidity support guaranteed by the government. - DICJ resolution role is contingent on appointment by the JFSA to execute specific resolution actions determined by the JFSA or PM. ### Legal framework and supervisory tools - Four-level legal framework for banking supervision: - First level: Banking Act approved by Cabinet and passed by Diet. - Second level: Orders for Enforcement of the Banking Act approved and issued by the Cabinet. - Third level: Ordinances for Enforcement of the Banking Act issued by the JFSA (JFSA substantially involved in drafting). - Fourth level: JFSA supervisory guidelines and inspection manuals published to implement and reinforce the legal framework. - Use of supervisory materials: - Supervisory Guidelines used for offsite assessment; Inspection Manuals guide onsite inspections. - Financial institutions are expected to establish internal control systems referencing Supervisory Guidelines and Inspection Manuals, which are public and frequently updated. *IMF staff summary based on the provided chapter content.* ### 58. Both the BoJ and the JFSA conduct day-to-day supervision of banks using both ### cr17282 - 58. Both the BoJ and the JFSA conduct day-to-day supervision of banks using both ### Supervisory framework and responsibilities - Both the Bank of Japan (BoJ) and the Japan Financial Services Authority (JFSA) conduct day-to-day supervision of banks using onsite inspections and offsite monitoring, and regular interactions with officials of supervised entities. - Legal bases and institutional roles: - JFSA established by the Act for Establishment of the Financial Services Agency; Article 3 sets the mission: “the mission of the Financial Services Agency is to ensure the stable functioning of the financial system of Japan and to protect depositors, policyholders, securities investors and other persons equivalent thereto, while facilitating finance.” - BoJ Act Article 1, paragraph 2: Bank’s objective is to “ensure a smooth settlement of funds among banks and other financial institutions, thereby contributing to the maintenance of financial system stability.” - Article 44 of the Bank of Japan Act: BoJ may enter into contracts with certain financial institutions and, based upon these contracts, undertake onsite examinations in the context of its lender-of-last-resort function. - Legal and regulatory hierarchy for banking supervision in Japan: - Four levels: (1) laws passed by the Diet (e.g., Banking Act); (2) Orders for enforcement approved by Cabinet; (3) Ordinances for enforcement issued by the JFSA; (4) supervisory guidelines and the JFSA inspection manual (publicly available). - Delegation and scope: - JFSA has delegated day-to-day supervision of most regional banks to Local Finance Bureaus of the MoF; JFSA maintains a special unit providing overall guidance. - Cooperative-type institutions (Shinkin banks, credit cooperatives, labor banks, agricultural cooperatives, fishery cooperatives) operate under special acts and are supervised with comparable regulations; about 700 agricultural cooperatives and about 110 fishery cooperatives exist. - Norinchukin (central agricultural and fishery cooperative bank) is co-supervised by JFSA and Ministry of Agriculture, Forestry and Fishery; JFSA has sole responsibility for setting soundness standards for Norinchukin. ### Supervisory powers, tools and enforcement - Powers and instruments: - JFSA powers derive from the Banking Act (e.g., Articles 14–2, 52–25, 24, 25, 26, 27, 52–11, 52–31, 52–32). JFSA can require reports, conduct onsite inspections, issue improvement plans and business improvement orders, and recommend license revocation (final acts such as license approval/revocation and suspension of banking operations require PM endorsement). - BoJ collects data and conducts onsite examinations under Article 44 contracts; BoJ has no administrative powers to impose corrective action but communicates findings and proposed follow-up to institutions and may publicly announce violations under the Onsite Examinations Agreement (Article 13). - Risk-based supervision: - Both JFSA and BoJ determine frequency, scope and number of examiners using a “risk-based” framework for onsite examinations/inspections. - BoJ announces onsite examination policy annually, including key issues and major findings. - G-SIBs and D-SIBs: - November 2015: JFSA revised public notice on capital adequacy ratios and Supervisory Guidelines to set up a framework to identify and designate G-SIBs and D-SIBs. - December 2015: three financial groups designated as G-SIBs and seven as D-SIBs. - Additional capital requirements applied through public notice since March 2016. - For D-SIBs, JFSA may require higher capital: “more than or equal to 0.5 percent of risk weighted assets—RWA rate needs to be added.” - Legal sanctions and penalties: - Failure to report/false statements, refusal to answer or interference with inspections: punishment by imprisonment with required labor for not more than one year or a fine of not more than three million yen (Banking Act Article 63–2,3). - Bank violating provisions may be subject to a fine of not more than 200 million yen (Banking Act Article 64). ### Coordination, information sharing and crisis arrangements - JFSA–BoJ coordination: - Regular exchanges to coordinate inspection/examination schedules and lists. - BoJ may submit onsite examination documents to the JFSA Commissioner or allow JFSA officials to inspect them (Article 44 of Bank of Japan Act). - Frequent/informal contacts at division chief/director levels (visits, calls, e-mails). - Staff exchanges and secondments take place regularly; JFSA hosts a person from the BoJ as the deputy Commissioner. - Inter-agency frameworks: - Council for Cooperation on Financial Stability (established 2014) includes senior officials (JFSA Commissioner and BoJ Deputy Governor) to discuss macroprudential policy; meets about once every half year. - Monthly meeting to exchange information on international financial and capital markets among JFSA, MoF, and BoJ since March 2016. - Crisis management and resolution: - JFSA serves as the resolution authority; works closely with BoJ and Deposit Insurance Corporation of Japan (DICJ). - Financial Crisis Response Council (chaired by PM) includes MoF, Minister for Financial Services, JFSA Commissioner, Governor of BoJ, Chief Cabinet Secretary and advises PM on systemic risks and resolution measures. - Single-point-of-entry resolution planning: DICJ serves as receiver for complex resolution cases and may be receiver of a failed holding company; DICJ bridge bank plans need JFSA confirmation. - JFSA has set up Crisis Management Group (CMG) with foreign resolution authorities, DICJ and BoJ; CMG meetings held once a year; Cooperation Agreement (Co-Ag) concluded among CMG participants. ### Independence, governance, accountability and resourcing - Institutional independence and accountability: - JFSA is an extra-ministerial bureau of the Cabinet Office; PM retains some powers under the Banking Act but “most” have been delegated to the JFSA Commissioner (Paragraph 1 of Article 59 of Banking Act; Article 17 of Order for Enforcement). - Decisions not delegated to Commissioner include approval/revocation of banking license, orders to suspend whole/part operations, and approval of establishment of bank holding companies (these require PM endorsement). - The JFSA reports to the Cabinet and to the Diet; subject to Administrative Procedure Law, Law concerning Access to Information, and Public Comment procedures (Articles 38–45 Administrative Procedure Act referenced). - JFSA publishes “Strategic Directions and Priorities” (September 2015) covering July 2015 to June 2016 and emphasizes PDCA cycle; JFSA regularly summarizes performance in public annual reports. - Governance and internal structure: - JFSA internal bureaus: Planning and Coordination Bureau, Inspection Bureau, Supervisory Bureau; Inspection and Supervisory Bureaus report independently to their directors to prevent supervisory capture. - Regional Financial Institution Planning Office established in 2015 to work with Local Finance Bureaus and develop risk profiles for regional banks, Shinkin banks and credit cooperatives. - Personnel, professionalism and protections: - JFSA staff are government officials; Commissioner appointed by PM (no fixed term in practice but tends to hold office for two to three years); personnel rules governed by National Public Service Act (Articles 75, 78), including protections against dismissal and conditions for disciplinary action. - Staff development actions: secondments to international organizations and foreign authorities; secondments to graduate schools; recruitment from private sector; extensive internal training program: 88 programs provided during the period of April 2015 to March 2016. - Professionalism and integrity measures include conflict of interest rules, prohibition on ownership stakes in regulated entities, confidentiality obligations. - Resourcing: - JFSA funded by central government budget approved by the Diet. Budget covers staff, training, IT, onsite inspections and travel; budgets and staffing have been stable in recent years despite public fiscal restraint. - Specialist hiring authority since 2000 allows recruitment at better salary conditions for experienced specialists, subject to conflict of interest and confidentiality provisions. - BoJ finances its budget mainly by interest on own assets (Japanese government securities, bills, loans and foreign currency assets); BoJ independence and budgetary financing described in Bank of Japan Act (Articles cited). ### Licensing, permissible activities and licensing criteria - Definition and name controls: - Article 2 Banking Act: defines a bank as a person who operates a banking business under PM license (Article 4). Banking business includes acceptance of deposits or savings and loans of funds or discounting of bills and notes, or conducting exchange transactions; Article 3 extends to acceptance of deposits or installment savings. - Article 6 Banking Act prohibits use of the term “bank” in corporate name by non-banks; police and Consumer Agency respond to illegal use. - Permissible activities: - Articles 10 and 11 Banking Act list activities a bank may undertake. 2016 Banking Act revision allows banks to have subsidiaries engaged in Fintech activities. - Licensing authority and process: - Formal licensing authority: PM (Article 4); JFSA manages the approval process and prepares recommendations, which in practice have been routinely endorsed by PM. - Licensing criteria (Article 4; Ordinance for Enforcement of the Banking Act, Article 1–8; Supervisory Guideline Chapter VII): - Financial basis to conduct business soundly and efficiently and good prospects for income and expenditure. - Knowledge and experience to carry out banking business appropriately, fairly and efficiently and sufficient social credibility (personnel and relevant structures). - Minimum initial capital: Article 3 of the Order for Enforcement of the Banking Act and Article 5 of Banking Act stipulate minimum capital required for a bank is ¥2 billion. - Applicant expected to return to profitability within three years from the start of banking business (Article 1−8 of Banking Act). - Major shareholder approval: - Persons intending to hold voting rights equal to or above major shareholder thresholds (15 or 20 percent depending on influence) must obtain pre-approval (Article 52–9); JFSA examines funds for acquisition, financial condition, status of income/expenditure, personnel structure (Article 52–10). - For shareholders with more than 50 percent of voting rights, JFSA assesses ability to provide additional financial support (VII–2–2–1 of Supervisory Guideline). - Fit and proper (F&P) criteria (Article 7–2 Banking Act; Supervisory Guideline): - Directors and operating officers must have knowledge and experience to carry out banking business appropriately, fairly and efficiently and have sufficient social credibility (no unsocial acts, no links to organized crime, no criminal record, no securities law/regulatory violations, no involvement in previous bank failures). - Outsourcing and operational controls: - Article 12–2 Banking Act and Article 13–6–8 Ordinance require banks to take necessary measures to ensure outsourced business is conducted appropriately; JFSA may require third parties to report and allows onsite inspections (Article 24 and Article 25). - Consistency with ongoing supervision: - Licensing criteria are applied and checked in ongoing supervision via offsite monitoring and onsite inspections; JFSA may issue business improvement orders (Article 26) or request license revocation endorsement from PM (Article 27) if criteria are not met or false information was provided. ### Assessments, findings and supervisory observations (from the source) - Assessments of compliance with Core Principles: - Principle 1 (Responsibilities, objectives and powers): Assessment C. Findings: legal framework comprehensive, clear roles and responsibilities, JFSA has substantial powers for remedial action. Noted that critical powers (license approval/revocation, suspension of operations) are retained by the PM but are prepared and managed by JFSA and endorsements have not been withheld in practice. - Principle 2 (Independence, accountability, resourcing and legal protection): Assessment LC. Findings: JFSA and BoJ have mechanisms for operational independence and legal protection; JFSA Commissioner lacks a fixed term (unlike BoJ Governor) which does not fully meet EC2; budget stability observed but potential long-term funding risk if public fiscal restraint persists; delegation of supervision of regional/cooperative banks to Local Finance Bureaus (MoF) noted and recent steps to strengthen JFSA coordination welcomed. - Principle 3 (Cooperation and collaboration): Assessment C. Findings: Significant progress in inter-agency cooperation domestically and with foreign supervisors; CMGs and Co-Ags aligned with FSB Key Attributes. - Principle 4 (Permissible activities): Assessment C. Findings: Definitions and permitted activities clearly defined; use of “bank” controlled. - Observations and comments from assessors (selected): - The three mandates of the JFSA (financial stability, depositor protection, facilitating finance) are treated as complementary; achieving them requires nimble and proactive supervision and closer coordination with BoJ and MoF to inform supervisory activities. - The JFSA has been strengthening risk-based supervision, integrating onsite and offsite monitoring (Financial Monitoring Policy 2013–2014; “Strategic Directions and Priorities” September 2015). - The JFSA has published supervisory tools (Comprehensive Guidelines for Supervision of Major Banks; Comprehensive Guidelines for Supervision of Small- and Medium-Sized and Regional Financial Institutions; Guideline for Financial Conglomerates Supervision; Inspection Manual for Deposit-Taking Institutions and for Financial Holding Companies) and uses “No action letters” and “Written Inquiry Procedures for General Legal Interpretation” to provide legal clarity to market participants. - Assessors encourage consideration of whether a different funding model for the JFSA might be appropriate in the longer run to ensure robustness if the financial sector expands and public fiscal restraint continues. *IMF detailed assessment material as provided in the source content.* ### Chapter III of the Supervisory Guideline explains how and what supervisors in charge of ### Chapter III of the Supervisory Guideline explains how and what supervisors in charge of offsite activities should examine with respect to internal controls for risk management and financial reporting, and approaches to tackle with organized crimes ### Licensing and new entrants (EC9–EC11; Principle 5) - Legal framework and application requirements: - Article 4 of the Banking Act: licensing criteria include: - "Financial basis to conduct the business of a Bank soundly and efficiently and good prospects for income and expenditure pertaining to the business"; and - "Knowledge and experience to be able to carry out the business of a bank appropriately, fairly and efficiently and sufficient social credibility in light of personnel and relevant structures." - Ordinance for Enforcement of the Banking Act (Article 1–8) and attachment to the Supervisory Guideline require a pro forma financial condition covering balances and adequacy of bank capital for three business years after commencement. - The JFSA examines whether an applicant’s stated capital amount is more than ¥2 billion, and whether the amount is sufficient for conducting banking businesses soundly and effectively (Article 1−8 of the Ordinance for Enforcement of the Banking Act). - The JFSA examines financial condition and balances of every major shareholder (see EC5). - Foreign entrants: - For foreign banks seeking to establish a branch or subsidiary, JFSA assesses whether the home country supervisor practices consolidated supervision (Article 4 of the Banking Act; Article 9 of the Order for Enforcement of the Banking Act). - If home-country approval is required, the foreign bank must submit documentation showing approval by the home supervisor (Article 28 of the Ordinance for Enforcement of the Banking Act). - In accordance with the Basel Concordat, JFSA would only recommend granting a license for a foreign branch or subsidiary if it receives a no objection letter from the foreign supervisor in advance. - Monitoring post-licensing: - JFSA issues reporting orders under Article 24 and conducts onsite inspections under Article 25 of the Banking Act to monitor newly licensed banks. - Supervisory focus areas include: business expansion beyond the licensed model, capital adequacy, implementation of licensed risk management, profitability vs licensing plan, and IT security (VII of the Supervisory Guideline). - Follow-up hearings are conducted where operations and earnings deviate from the original business model. - Assessment and recommendation: - Assessment of Principle 5: LC. - Comment: JFSA should consider more intensive probing of ownership structures during licensing to better identify ultimate beneficial owners and their capacity to provide capital in stress; not pressing short-term but recommended over the medium term. *Italic: Source — Chapter III, cr17282* ### Transfer of significant ownership (Principle 6; EC1–EC6) - Definitions and thresholds: - "Major Shareholder of a Bank" defined in Banking Act; major shareholder threshold is 20 percent of all voting rights. - In cases where "there is a fact that would have an important influence on the financial conditions and management policies of a bank," threshold is set at 15 percent (Article 8 of the Rule on Financial Statements gives examples). - In practice, JFSA considers a shareholder with more than 50 percent of shares or voting rights to be a controlling shareholder. - Approval and notification regimes: - Prior approval required if a person wishes to hold shares no less than the major shareholder threshold prescribed in Article 2 of the Banking Act (Article 52–9). - Article 52–10: JFSA confirms purpose of holding; will assess adequacy if applicant intends to hold more than 50 percent in future. - Shareholders with more than 5 percent of voting rights must notify the JFSA within 5 days of crossing that threshold. - Both major shareholders and those holding more than 5 percent must notify the JFSA when their holding percentage changes by more than one percent (Article 52−2−21 and 52−3). - Reporting and approval obligations extend to indirect owners and ultimate beneficial owners (Article 3–2; Article 2). - Supervisory powers and sanctions: - JFSA Commissioner may order a Major Shareholder to take necessary measures or rescind approval where violations occur (Article 52; Article 52–14 enables requesting improvement plans, ordering changes, issuing orders). - If approval as Major Shareholder was granted based on false information, JFSA may request reports and issue orders; may rescind approval for substantial violations or public interest damage. - Non-reporting "Major Holder of a Bank" may be punished with a non-criminal fine no more than 1 million yen. - Article 52-9 empowers JFSA to order measures to cease holding voting rights at or above the major shareholder threshold. - Gaps identified: - No explicit approval threshold at 50 percent prevents ex ante assessment of majority acquirers’ capacity to support banks under stress. - No requirement for banks to notify supervisor as soon as they become aware of material information negatively affecting suitability of a major shareholder (no such requirement currently in Japan). - Assessment and recommendation: - Assessment of Principle 6: LC. - Comment: Assessors recommend introducing pre-approval for acquisition of majority (controlling) interests—e.g., impose condition at time of major shareholder approval that future majority holdings be subject to pre-approval prior to crossing the 50 percent threshold. *Italic: Source — Chapter III, cr17282* ### Major acquisitions and investments (Principle 7; EC1–AC1) - Approvals required (statutory regime): - Mergers: pre-approval required for a bank merging with another bank (Article 30 of the Banking Act). - Subsidiaries: a bank intending to hold a subsidiary domestically or abroad must be pre-approved (Article 16-2). - Exception: No approval required where the subsidiary operates mainly ancillary businesses or conducts businesses related to banking; JFSA defines ancillary if it earns more than 1 yen in profits and 90 percent of revenue is from the bank (considering reduction to 50−60 percent). - Establishing a foreign branch requires approval from the Commissioner (Article 8 of the Banking Act; criteria in Article 9 of the Ordinance for Enforcement). - Investments: - Banks may only conduct businesses listed in Articles 10 and 11; Article 12 prohibits other businesses. - Article 16–3 limits bank holdings of shares of domestic companies to "5 percent of all voting rights of all shareholders." The 5 percent limit can be exceeded for one year if the position arose from collateral from a defaulting borrower. - Spring 2016: 5 percent limit removed for companies engaged in Fintech activities. - In computing the 5 percent threshold, aggregate voting rights of bank and its subsidiaries are included. - Securities transactions: banks may acquire up to 5 percent of voting rights of a company permitted to be a bank subsidiary without Commissioner approval. - Banking group equity holding limit: a banking group may hold equities up to the amount of its consolidated Tier 1 capital (Act on Limitation on Shareholding by Banks and Other Financial Institutions). - Large exposure regime: investments and loans to a single party or group of connected parties must not exceed 25 percent of the bank’s capital (Article 13; Articles 4 and 14 of the Ordinance for Enforcement). - Reporting obligation when acquiring/holding more than 5 percent of voting rights in companies included in Article 35 of the Ordinance (delegated by Article 53). - Assessment criteria and supervisory practice: - Criteria for mergers: Article 31 of the Banking Act. - Criteria for holding subsidiaries or changing subsidiaries’ businesses: Article 17–5 of the Ordinance for Enforcement. - Article 9 of the Ordinance sets criteria for foreign branch setup. - No formal criteria in place for assessing investment proposals (EC2). - JFSA criteria for approving holding a subsidiary include: appropriate capital adequacy post-approval; net income remains sufficiently positive; applicant can ensure subsidiary conducts business soundly and appropriately. - JFSA may reject applications if host-country confidentiality rules prevent appropriate control/supervision. - For acquisitions, JFSA examines whether subsidiary can appropriately and fairly conduct business and whether bank will ensure the subsidiary conducts its businesses appropriately and fairly. - Supervisory tools and group-wide oversight: - JFSA supervises group-wide risks including non-banking activities (Supervisory Guideline check points). - Offsite and onsite integrated monitoring used to assess undue risks from major acquisitions/investments. - Supervisory measures include reporting orders (Article 24, 52–31, 52–11), onsite inspections (Article 25, 52–32, 52–12), and business improvement orders (Article 26, 52–33, 52–14). - Guideline for Financial Conglomerates Supervision provides checkpoints for groups conducting non-banking financial services. - JFSA performs integrated monitoring and macroprudential analysis via the Macroprudential Policy Office (established July 2015). - BoJ conducts onsite examinations and offsite monitoring, including risk-based onsite examination framework. - Assessment and recommendation: - Assessment of Principle 7: LC. - Comment: Investments by a bank in another bank or related banking business (other than acquisition of a subsidiary) do not need prior approval though prior notification is required; assessors recommend stricter pre-approval for material investments that lead to significant influence, and reconsider scope for approval to include ancillary and banking-related business acquisitions. *Italic: Source — Chapter III, cr17282* ### Supervisory approach, risk assessment and resolution (Principle 8; EC1–EC8) - Risk profiling and supervisory intensity: - JFSA introduced risk profiles for regional and mega banks to allocate supervisory resources, capturing offsite surveillance and onsite inspection results; risk profiles are performed at least annually and inform supervisory action plans. - Methodology: expert judgment mixed with thresholds—approximately five categories based on total assets; calibration of size/impact still under development. - Mega banks: greater focus on international events; three major banks identified as G-SIBs; four banks designated as D-SIBs with resource allocation accordingly. - Risk profile covers business focus, group structure, risk profile, internal control environment, resolvability, and permits comparisons between banks; check points in Supervisory Guidelines include governance, capital adequacy, profitability, comprehensive risk management, credit risk, market risk, liquidity risk, remuneration, compliance, disclosure, consumer protection, operational risk, system risk, business control of foreign operations, business continuity management. - Offsite data, Early Warning System (EWS), and macroprudential coordination: - Under Article 24, JFSA collects data on profitability, amount of bad loans, credit risk concentration, market risk (including interest rate risk in banking book), liquidity, etc. - JFSA’s EWS identifies red-flag banks based on prescribed ratios and thresholds; red flags prompt intensive hearings and possible reporting orders (Article 24) and, if unresolved, further orders including business improvement plans (Article 26). - Macroprudential monitoring: Macroprudential Policy Office analyzes global market/macro economy daily and monitors potential system stability threats; BoJ contributes systemic analysis via the FSR and risk-based onsite examination policy. - System-wide monitoring and concentrations: - JFSA monitors build-up of risks using aggregate data; examples: NPL status and foreign currency funding costs (foreign exchange swap rates), regional banks’ commercial real estate exposures, energy sector exposures of major banks. - JFSA and BoJ coordinate and share system-wide risk analysis; JFSA holds timely discussions with mega banks on credit and liquidity management for identified sector risks. - Resolvability and crisis measures: - JFSA preparing resolution plans for G-SIBs and other SIBs in line with Key Attributes; discussions ongoing on resolution strategies and impediments via CMG meetings and RAP. - Deposit Insurance Act powers: - PM may confirm the necessity of measures where maintenance of an orderly credit system is extremely seriously hindered (Article 102–1), including: - Subscription for shares, etc. of said financial institution; - Financial assistance exceeding expected insurance payout costs; - Purchase of shares by the DICJ. - In severe market disruption, PM may confirm necessity of measures (Article 126–2–1), including: - Provision of loans to financial institutions; and - Financial assistance to financial institutions. - Prompt Corrective Action System: administrative actions tied to capital adequacy ratios prescribed in paragraph 2 of Article 26 of the Banking Act, including orders such as: - Prohibition or restraint from paying remuneration for directors, company auditors and/or executive officers; - Orders to implement optional measures (raising capital, closing significant business parts, merger, exit from banking business); - Order suspension of whole or part of business. - Where necessary for orderly resolution of assets and liabilities, JFSA may order financial institutions to take measures within a specified time (Deposit Insurance Act Article 137–4). - Perimeter and regulatory arbitrage: - JFSA conducts regular surveillance with other government organizations to identify bank-like activities outside the regulatory perimeter and addresses restructuring to avoid the perimeter. - Assessment and recommendation: - Assessment of Principle 8: LC. - Comment: JFSA’s approach is predominantly bottom-up with a top-down component driven by annual Strategic Directions and Priorities. The risk-profile methodology introduced in 2014 is still being refined (notably calibration to size, scale, complexity, systemic importance). Full implementation of a comprehensive analytical risk framework is needed to better integrate offsite and onsite processes and calibrate supervisory intensity, especially for megabanks. *Italic: Source — Chapter III, cr17282* ### introduction of the GSIB framework, which has helped to direct attention to the ### cr17282 - introduction of the GSIB framework, which has helped to direct attention to the ### Principle 9 — Supervisory techniques and tools: findings and practice - Scope: Supervisor employs a mix of onsite and offsite supervision to evaluate condition, risk profile, internal control environment and corrective measures (EC1–EC12). - Organization and responsibilities: - JFSA’s supervisory bureau: offsite monitoring; inspection bureau: onsite inspections. - BoJ focuses on systemic issues and preparedness for emergency liquidity assistance. - Onsite/offsite mix and frequency: - Onsite inspections for major banks: generally annually (JFSA) and bi-annually (BoJ). - Regional financial institutions: generally every two to three years (JFSA) and three to five years (BoJ); those needing frequent monitoring, every two to three years (BoJ). - Since 2014 JFSA moved from single comprehensive onsite to targeted single-risk-area inspections. - In the last year, greater attention dedicated to onsite activities. - Key tools and processes: - “Bank Ledger” compiles inspection findings and other information; separate risk identification program for major banks with semiannual peer comparisons. - Financial Inspection Rating System assigns grades A to D across ten categories (governance framework (basic points); legal compliance; customer protection framework; comprehensive risk management framework; equity capital management framework; credit risk management framework; asset assessment management framework; market risk management framework; liquidity risk management framework; operational risk management framework). - JFSA publishes “Criteria for Administrative Actions” and a quarterly collection of administrative cases; publishes “Financial Inspection Results Casebook” as appropriate. - JFSA/BoJ coordinate schedules, share contact lists, hold regular/ad-hoc meetings and conference calls. - Internal audit and reliance: - Quality and effectiveness of internal audit assessed at least annually; internal audit results are inputs to supervisory framework (EC6). - IT and data systems: - Since 2014 JFSA commenced use of new IT infrastructure; “Offsite Monitoring Data System” stores data submitted under Article 24 of Banking Act and supports the Early Warning System. - Assessment: C - Comments (preserved text): - The JFSA has enhanced the supervisory toolkit: implementation of risk profiles (see CP8); a more targeted approach to onsite inspections; use of thematic style inspections; and a greater emphasis on onsite inspections. - The introduction of the D-SIB and G-SIB framework has also helped to direct attention to the megabanks, so that the megabanks are receiving considerably more frequent and intensive supervision. ### Principle 10 — Supervisory reporting: scope, gaps, and assessment - Legal reporting powers and frequency: - Article 19 Banking Act: interim business report (1 April through to 30 Sep) and year end (audited). - Article 24 Banking Act: regular quarterly offsite monitoring data covering a full range of data points; reporting at both solo and consolidated levels. - JFSA requests data on Pillar 1 risks with various frequencies (annually, semi-annually, quarterly, or monthly depending on case). - Coverage and analysis: - Offsite monitoring teams regularly analyse financials and prudential returns; semiannual peer analysis for major banks on capital policy, growth strategy, profit structure, lending volume, lending to SMEs and domestic lending strategy. - Dedicated teams: “Supervisory Planning Office” set up in 2010; reorganized to “Macroprudential Policy Office” in 2015. - Governance and valuation gaps: - Reporting standards do not explicitly set out expectations for governance structures and control procedures for regulatory reporting or valuation frameworks (EC3). - Valuation framework and control procedures validated by Internal Audit and external auditors, but frequency and scope not prescribed. - Limited evidence that JFSA has taken action in relation to valuations that were not sufficiently prudent despite power to require adjustments to Pillar 1 risk-weighted assets. - Use of external experts: - JFSA does not use independent third parties for supervision; may ask banks to hire consultants but cannot compel directly (EC11). - Auditors do not have legal duty to report findings directly to banking supervisors in Japan; EA reports are submitted; audit firms have notification duties under Financial Instruments and Exchange Act in certain circumstances. - Data comparability and verification: - Regulatory data compiled by specialist unit for peer comparisons; JFSA reviews and verifies accuracy during onsite inspections (EC5, EC9). - Early Warning System: “red flags” trigger additional reporting and potential Article 26 business improvement orders. - Assessment: LC - Comments (preserved text): - Two main areas to be addressed: 1. Governance requirements for valuations—reporting standards lack explicit expectations; limited evidence of corrective action on imprudent valuations. 2. Supervisor does not require that external experts bring to its attention all material shortcomings identified during their work (e.g., auditors’ issues rectified within 14 days are not currently disclosed to JFSA). To enhance integrity, JFSA should require external auditors to opine whether filings have been accurately made. ### Principle 11 — Corrective and sanctioning powers: tools, usage, and concerns - Early engagement and follow-up: - “Red flags” from offsite early warning system trigger follow-up interviews and remedial plans. - Issues identified in onsite inspections require formal responses within one month; follow-up via offsite monitoring and further inspections as needed. - Range of supervisory measures (Articles cited preserved): - Article 24, 25, 26, 26–2, 27, 28 of the Banking Act provide powers including: orders for submission/change of improvement plans; temporal suspension of whole/part of business; orders for deposit property; orders prohibiting or restraining payment of remuneration; orders to raise capital/merge/exit business; dismiss directors/executive officers/company auditors; revoke licenses. - Prompt Corrective Action (PCA): capital distributions can be constrained corresponding to capital adequacy ratios (Article 26–2); capital conservation buffer requirements introduced December 2015. - Deposit Insurance Act Article 74 procedures for appointment of administrator/financial reorganization administrator and Deposit Insurance Corporation role. - Practical issues and constraints: - PCA regime does not provide sufficient flexibility for JFSA to require banks to raise capital unless prudential minimum capital ratios are breached. - Prudential minimums: 8 percent Common Equity Tier 1 (CET1) capital for internationally active banks and 4 percent Core capital for domestic banks (preserved text). - Historical adherence: not all banks adhered to orders in the past (e.g., 2000 to 2005). - Crisis coordination: - Coordination via Council for Cooperation on Financial Stability and Financial Crisis Response Council (FCRC); assessors recommend strengthening inter-agency coordination for crisis management and preparedness (preserved text listing enhancements). - Assessment: LC - Comments (preserved text): - Concerns regarding (i) willingness of JFSA to exercise powers at an early stage and (ii) PCA triggers set too low and lacking flexibility. - Recommend review of PCA and consideration of earlier trigger points. - Intervention could be enhanced through greater use of direct supervisory tools (impose prudential limits/thresholds), which were seldom or never used. ### Principle 12 — Consolidated supervision: scope and practices - Legal basis and coverage: - JFSA supervises banks and banking groups on solo and consolidated basis; Articles 52–31 and 52–32 require reporting on solvency, earnings, risk management and outsourcing. - Capital adequacy standards and other prudential standards applied on solo and consolidated basis (Article 14–2, 52–25). - Understanding group structure and group-wide risks: - JFSA collects information at licensing stage and ongoing supervision; documents risk profiles of individual banks and revises them every year at the end of June and when significant issues arise. - Supervisory focus on group-wide arrangements, e.g., impact of low interest rates on relationships between banks and securities/trust affiliates. - Cross-border supervision and interaction with host supervisors: - JFSA deploys examiners to jurisdictions where Japanese banks operate (U.S., United Kingdom, Hong Kong, Singapore); frequency determined by risk profile and systemic importance. - JFSA requests inspection reports from foreign supervisors and cooperates with host supervisors; approval required for foreign subsidiaries/branches (Article 16–2 and Article 8). - BoJ examines effectiveness of group-wide business management and is enhancing onsite examinations of overseas branches (Onsite Examination Policy for Fiscal 2016). - Powers over parent/affiliates and activity limits: - JFSA reviews activities of parent companies and affiliates; major shareholder thresholds (15 or 20 percent depending on influence) require pre-approval (Article 52–9, 52–10). - Banking Act stipulates permissible activities and empowers JFSA to limit activities/locations, order downsizing or sale of subsidiaries, or require suspension of parts of business (Article 10, 11, 12, 16–2, 52–21, 52–23, Article 26). - Supervisory approach: - Both consolidated and standalone supervision of individual banks; capital adequacy and large exposure limits monitored on both bases. - Assessment: (findings described in text; EC-by-EC descriptions preserved) *Source: cr17282 - introduction of the GSIB framework, which has helped to direct attention to the* ### Section V of the Guideline. ### Section V of the Guideline ### Home‑host relationships and supervision of cross‑border banking groups (Principle 13) - Assessment: C - Key arrangements and practices: - JFSA has ongoing contacts with foreign supervisors where Japanese banks have material operations; colleges and Crisis Management Groups (CMGs) established since 2008 for major Japanese banks designated as G-SIFIs. - BoJ participates in supervisory colleges and CMGs and actively shares business condition information with host authorities. - Identification of relevant supervisors occurs when approving banks’ applications to establish overseas branches or subsidiaries; arrangements for information sharing are generally established then. - Information sharing: - Mainly via informal peer‑to‑peer contacts; JFSA has also signed EoL when requested. - EoLs generally agree to cooperate on supervision, allow sharing of examination information subject to domestic law, and treat exchanged information as confidential for supervisory purposes. - JFSA holds annual supervisory colleges and CMGs for major banks; topics include supervisory issues, results of onsite inspections, crisis management plans, business strategies, and challenges. - JFSA has institution‑specific formal arrangements in the resolution area for Japanese G‑SIFI banks. - Coordination and collaborative work: - JFSA consults foreign college members ahead of meetings to develop agendas (e.g., cyber security). - Colleges have led to some collaborative work, e.g., coordinating data collection between home and host authorities. - Communication strategy: - Largely through informal conversations, onsite visits and supervisory colleges; scope reflects size and complexity of cross‑border operations. - EoLs include articles specifying coordination on public messaging. - JFSA shares supervisory reports and exit findings with home/host supervisors; provides three major banks with supervisory college summaries. - Crisis cooperation and group resolution: - CMGs established with DICJ and BoJ; JFSA shares recovery and resolution plans at CMG meetings. - JFSA concluded Co‑Ag among CMG members to support orderly resolution of Japanese G‑SIFIs. - Host country treatment: - Foreign bank subsidiaries incorporated and licensed in Japan are subject to same prudential requirements as domestic banks. - Branches in Japan are subject to same reporting and inspection requirements (section 7, paragraph 2 of Article 47, and Article 48 of the Banking Act). - Onsite access and cooperation: - JFSA does not prohibit home supervisor onsite inspections of local offices and subsidiaries, but requires advance notification; access to client accounts is not restricted. - JFSA has power under Article 25 of the Banking Act to conduct onsite inspections of Japanese banks’ foreign branches and subsidiaries; it notifies host supervisors in advance and may brief them on exit findings. - Booking offices and shell banks: - Licensing required under Article 47 of Banking Act; establishment of shell bank is prohibited; no booking offices operating in Japan. - Supervisory action consultation: - When taking consequential action based on another supervisor’s information, JFSA will attempt to exchange information/opinions with the other supervisor to the extent it will not interfere with immediate action. - Comments: - Foreign banks in Japan are held to same prudential standards as domestic banks. - More MoUs and EoLs have been negotiated since the last FSAP; G‑SIFI designations have led to CMGs and constructive engagement on recovery and resolution planning. *JFSA and BoJ descriptions and practices as provided in the Supervisory Guidelines, Onsite Examination Policy for Fiscal 2016, and related CMG/college arrangements.* --- ### Supervision of owners and senior management of banking groups (Additional Criterion AC1 / Principle 12) - Assessment of Principle 12: C - Legal powers and findings: - JFSA empowered under Articles 52–33 and 52–34 to review holding company and affiliated entity activities and evaluate suitability of owners and senior management. - Approval from the JFSA required for establishment of bank holding companies; JFSA can assess parent company suitability during approval. - In assessing eligibility of an applicant as a major shareholder, Paragraph 1, Article 52–10 of the Banking Act requires checks on funds for acquisition, financial condition, status of income and expenditure, and personnel structures (including sufficient understanding of public nature of banking and social credibility). - Supervisory Guideline VII–2–2–1 provides detailed checklists for major shareholder applications from nonfinancial business companies. - JFSA can issue reporting orders and conduct onsite inspections against major shareholders (Article 52–11 and Article 52–12); may order measures under Article 52–13 if major shareholder no longer satisfies Article 52–10 items. - Comments: - Framework enables consolidated and solo supervision and oversight of foreign activities; recent Banking Act changes extending JFSA powers to review holding companies and affiliates are welcomed. - A legal clause allows bank subsidiaries and outsourced companies to refuse JFSA investigations if there are "justifiable reasons"; authorities confirm this is a legal safeguard and has not impeded prudential oversight in practice. --- ### Corporate governance (Principle 14) - Assessment: LC - Framework and standards: - Companies Act and Corporate Governance Code apply; Supervisory Guidelines stipulate JFSA expectations and Inspection Manual details onsite verification. - Corporate Governance Code (General Principle 4 and Supplementary Principles) sets board roles: strategy, risk management, oversight, internal controls, and disclosure of appointment/nominations procedures. - Three permitted company/governance structures under Banking Act Article 4–2: - “Company with auditors” (most banks, including one major bank and most regional and Shinkin banks); - “Company with nominating committee, etc.” (two major banks and a few regional banks); - “Company with audit and supervisory committee” (approximately 20 percent of regional banks). - JFSA Supervisory Guideline provides expectations specific to each board structure (III‑1‑2‑1 and III‑1‑2‑2). - JFSA encourages G‑SIBs to apply “Company with nominating committee” structure; two of three megabanks adopted it, third scheduled to adopt in June 2017. - Supervisory assessment practices: - Frequency/intensity proportional to size, complexity, systemic importance and risk profile. - For megabanks and trading banks: close continuous supervision—monthly or quarterly board reporting, MIS review, interviews with senior management, thematic reviews. - For regional and Shinkin banks: mix of regulatory reporting and annual questionnaire; at least annual meetings with senior management. - JFSA reviews effectiveness of external directors; noted increased influence of external directors over past 3−4 years. - Board composition and committees: - Corporate Governance Code: banks subject to Code (listed) should appoint at least two independent directors. - JFSA does not prescribe board structure; in practice boards do not always include separate audit, risk and remuneration committees; representation of non‑executives varies by structure. - Nominating committees often dominated by executive directors for banks not subject to the Code. - Fitness & Propriety (F&P): - Supervisory Guideline III–1‑2‑1(2)13 requires consideration of Article 7–2 of Banking Act (knowledge, experience, social credibility) in appointments. - F&P application differs by board structure; for Company with Auditors and Company with Audit and Supervisory Committee, F&P applied to board but not necessarily to senior management layer below board. - Remuneration: - JFSA updated Supervisory Guidelines following FSB recommendations; principles‑based approach covering balance fixed/variable pay, clawbacks, and identification of material risk takers. - Supervisory Guideline III–2‑3‑5‑2 requires review of group executive remuneration frameworks and monitoring arrangements (remuneration committees where applicable). - Supervisory powers: - Article 27 of Banking Act: JFSA Commissioner may order dismissal of a Director for violations harming public interest; Article 24 and Article 26 provide reporting and business improvement order powers. - Additional criterion AC1 (notification of material adverse F&P information): - Article 35 Item 1 (xxv): banks must submit notification to JFSA Commissioner within the 30 days after Director’s criminal conduct (fraud, embezzlement, misappropriation) is brought to light. - Comments and supervisory deficiencies: - Progress with Corporate Governance Code and JFSA guideline revisions noted, with stepped‑up engagement for largest banks. - Key shortcomings identified: - Legacy board structures: limited separation between oversight and executive management; independent non‑executive directors’ challenge function remains uneven. - F&P processes need strengthening, particularly to assess collective board expertise and to extend F&P to senior management in some board structures; expand F&P coverage to heads of divisions and material risk takers. - Supervision of compensation systems could be enhanced across the industry to ensure incentives align with prudent risk taking. - Supervisory processes to validate boards’ oversight of strategy, risk appetite and strategy implementation should be enhanced (more direct interviews with independent directors encouraged). --- ### Risk management process (Principle 15) - Assessment: LC - Supervisory expectations and practices: - JFSA provides basic checkpoints in III–2‑3 of Comprehensive Supervisory Guideline covering board‑approved risk management policy, existence of a risk management division, internal check functions, and allocation of risk capital limits to business units. - JFSA assesses via board minutes review, interviews, MIS and onsite verification; megabanks receive more intensive scrutiny (monthly/quarterly). - JFSA Strategic Directions and Priorities: will check if banks establish concrete implementable action plans based on stress tests and if banks adjust capital/distribution policy when necessary. - BoJ onsite examinations also focus on board involvement, senior management execution per risk policy, reporting adequacy, and effectiveness of group‑wide business management including overseas branches and subsidiaries. - Risk management coverage: - JFSA requires comprehensive bank‑wide policies and processes; assessment is proportional to size/complexity. - Stress testing required; JFSA plans reviews and common scenarios for systemically important institutions. - JFSA does not currently have a single composite rating integrating nonbank subsidiary risks; subsidiaries captured in separate risk ratings. - Models and validation: - Examiners assess model assumptions, limitations and independent internal audit of models; IRB and AMA requirements include model verification and regular validation; approvals can be withdrawn per Capital Adequacy Notice (Articles 145, 279, and 317). - Non‑executive directors have not commonly been engaged in detailed discussions on models and outputs. - Information systems, contingency and recovery planning: - JFSA checks adequacy of information systems for credit, market, liquidity and operational risks (reporting, limit monitoring), including LCR monitoring for internationally active banks. - Banks required to submit recovery plans annually in principle; JFSA assesses and expects improvements. - Comments and supervisory deficiencies: - JFSA and BoJ have sufficient frameworks but guidelines are somewhat generic, placing burden on supervisory practice to determine implementation adequacy. - ICAAP and RAS implementation developing (most advanced at megabanks); SREP not fully structured. - Governance arrangements at banks need strengthening: more independent risk management/internal control functions and stronger independence of audit committees/Boards of Auditors in substance as well as form. - JFSA engagement with non‑executive directors has increased but depth on technical topics (models, stress testing) should be enhanced. --- ### Capital adequacy (Principle 16) - Assessment: MNC - Framework and legal powers: - Commissioner of JFSA has authority under Article 14–2 of the Banking Act to set capital adequacy ratios and publish detailed calculation standards in Capital Requirements Notice; applies on solo and consolidated bases and to bank holding companies on consolidated basis. - Articles 26 and 52–33 permit ordering business improvement or business suspension (latter subject to Prime Minister endorsement) when capital ratios fall below public minimum requirements. - Alignment with Basel: - For internationally active banks (defined as operating a branch or subsidiary in a foreign jurisdiction), JFSA applies the Basel III Framework in all respects. - November 2015: JFSA expanded minimum capital requirements for internationally active banks to include Basel III buffers (capital conservation buffer, countercyclical buffer, and GSIB/DSIB buffer requirements). - Leverage ratio disclosure requirements implemented in March 2015; G‑SIB/D‑SIB framework established and 3 G‑SIBs and 7 D‑SIBs designated effective March 2016. - JFSA introduced disclosure requirements on 12 G‑SIB assessment indicators at end of March 2014. - RCAP follow‑up: Compliant rating for Basel III loss absorbency; Largely Compliant for capital buffer standards with four minor deviations (two to be corrected in forthcoming publications). - Domestic banks vs internationally active banks: - Domestic banks: differences include exclusion of unrealized gains/losses on Available for Sale securities and revaluation reserve for land from capital, and no Tier 2 capital requirement; focus on Core capital that closely resembles CET1. - Risk‑weighted core capital ratio requirement for domestic banks: 4 percent (compared to 8 percent CET1 for internationally‑active banks). - Countercyclical capital buffer implemented March 2016 and currently set at zero. - Supervisory powers (Pillar 1 vs Pillar 2): - JFSA can amend Pillar 1 public capital requirements and apply more stringent public requirements to subsets (e.g., D‑SIBs). - JFSA lacks explicit power to impose Pillar 2 individual capital add‑ons; instead relies on dialogue and moral suasion to encourage voluntary additional capital. - Monitoring and early intervention: - Early Warning System and offsite monitoring track profitability, credit, market and liquidity indicators; selection thresholds (e.g., 20 percent of own capitals for IRRBB) used to identify banks for close monitoring. - If capital concerns arise, JFSA may request capital plan revisions, risk reductions, improvements to risk management, and may issue business improvement orders under Article 26. - Comments and supervisory deficiencies: - Capital framework closely aligned with Basel Pillar 1 for internationally‑active banks. - Shortcoming: lack of explicit Pillar 2 powers to require bank‑specific additional capital to address risks not captured in Pillar 1 (e.g., IRRBB, risk concentrations, reliance on foreign currency wholesale funding). - Thresholds for early intervention for domestic banks arguably low (binding at 4 percent), which may reduce supervisory leverage before severe capital erosion; consider exploring private mechanisms to trigger constraints above official minimums via bank policies and recovery plans. --- ### Credit risk (Principle 17) - Assessment: C - Supervisory expectations and practices: - Detailed guidance and inspection checklists on credit risk: organization for credit administration and review, separation of business promotion and credit review, auditing divisions’ oversight, staff capabilities to assess borrowers. - JFSA examines bank‑wide business policies, medium/long‑term planning, and credit risk management policy in accordance with III–2‑3‑2‑1‑2 of Supervisory Guidance. - For megabanks, JFSA routinely receives board reporting packs and meets senior management regularly; JFSA reviews credit policies at least annually. - BoJ onsite examinations focus on appropriate credit screening and monitoring, large exposure/concentration management, and overseas credit exposure management. - Credit decisioning and arm’s length rule: - Article 13–2 Banking Act implements “arm’s length rule” prohibiting transactions with group entities or customers on terms harmful to bank safety and soundness; JFSA checks compliance during inspections. - Monitoring and stress testing: - Banks required to include credit exposures in stress testing programs; JFSA expects banks, especially internationally active institutions, to evaluate transmission mechanisms and scenario impacts on markets and macroeconomy and to ensure capital and liquidity adequacy. - Comments: - Sufficient focus by banks, JFSA and BoJ on credit risk management; routine and targeted supervisory activities include file reviews and in‑depth analysis. - No explicit regulatory requirement for board or senior management approval of major credit exposures beyond JFSA expectations that such exposures be reported to the board. --- ### Problem assets, provisions and reserves (Principle 18) - Assessment: C - Legal and supervisory framework: - Article 6 of the Financial Reconstruction Act: banks required to assess asset quality and classify assets every accounting period. - Ordinance for Enforcement of the Act provides criteria for loan classification based on borrower financial condition and business performance. - Supervisory Guidelines and Inspection Manual: JFSA reviews bank self‑assessments of NPLs, write‑offs and provisions; examines consistency of internal ratings with borrower results and market signals. - Boards required to set standards for self‑assessment and establish organizational structures for accurate self‑assessment and provisioning. - Supervisory practice: - JFSA conducts regular reviews and onsite verification of loan portfolios using both individual and portfolio approaches; assesses adequacy and timeliness of credit file reviews. - BoJ conducts offsite monitoring and onsite examinations to assess credit quality and accuracy of financial institution self‑assessments. - Supervisory guidance supports prudent evaluation of problem assets, provisioning and write‑offs. - Comments: - Guidelines and inspection manual provide a sufficient basis for evaluating policies and processes for identifying and managing problem assets; supervisory file review and bank visits confirmed frequent loan portfolio reviews and appropriate use of individual and portfolio approaches. *Section V content as provided in "Section V of the Guideline."* ### 1. Appropriate Credit Screening and Monitoring, and Establishment of a Framework ### 1. Appropriate Credit Screening and Monitoring, and Establishment of a Framework Compatible with Lending Strategies. ### Appropriate Credit Screening and Monitoring, and Establishment of a Framework Compatible with Lending Strategies. - Appropriate Credit Screening and Monitoring, and Establishment of a Framework Compatible with Lending Strategies. ### Strengthening the Management of Large Exposures/Concentration Risk. - Strengthening the Management of Large Exposures/Concentration Risk. *Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17282.pdf* ### 3. Strengthening the Management of Credit Exposure with Respect to Overseas ### 3. Strengthening the Management of Credit Exposure with Respect to Overseas Businesses ### Asset classification, provisioning, and NPL management (EC2–EC12) - JFSA directly assesses the accuracy and appropriateness of banks’ self-assessments, write-offs and provisions during onsite inspections; it does not rely on external experts for these assessments. - Onsite review practices: - Review bank self-assessments against bank policies and sample loans for correct classification and adequate provisioning. - Instruct banks to increase provisions if material gaps are uncovered; material gaps defined as "30 percent or more of aggregate provisions" trigger business improvement orders under Article 26 of the Banking Act if not promptly corrected. - Verify collateral valuations, including fair values of marketable securities and annual (preferably semi-annual for weaker credits) updates of real estate appraisals; JFSA employs some qualified real estate appraisers on staff. - Off-balance sheet exposures: - Banks are required to include off-balance sheet items in self-assessments, classification and provisioning; supervisory files and bank visits confirmed these exposures are taken into account. - Treatment of SME loans: - Issues with provisioning of some SME loans have diminished but "continue to linger." - Expected credit loss transition: - Banks and JFSA face significant challenges implementing the new expected-credit-loss framework emerging in international accounting standards and BCBS guidance. - Early identification and oversight of deteriorating assets: - Supervisory Guideline III-2−3−2−3 requires timely identification of NPLs and NPL management systems; loans with principal/interest unpaid for three months or more categorized as "loans with special attention." - JFSA does not actively monitor or require reporting for loans in arrears fewer than ninety days. - Documentation and access to data: - Article 24 of the Banking Act requires semi-annual offsite submission of NPL classifications and provisions; detailed large exposure credit risk documents (including classification and provisions) are required at least quarterly in dialogues on financial results. - At inspection, JFSA accesses all necessary information per Article 25 of the Banking Act and asks banks to preserve documentation supporting loan-classification and provision decisions. - Supervisor powers and remedial actions: - JFSA can require reclassification, increases in provisioning, reserves or capital, and other remedial measures; inspection report followed by an Article 24 order requires reporting analysis and improvement measures within one month. - Article 26 of the Banking Act permits orders to submit improvement plans or suspend business where significant gaps persist. - Significant exposure measurement and thresholds: - For largest borrowers, temporary threshold: "more than ¥10 billion (roughly equivalent to $100 million)" — banks requested to calculate provisions using the Discounted Cash Flow Method for "loans with special attention." - Sectoral/system-wide monitoring: - JFSA conducts semi-annual NPL surveys publishing items including transitions of loans reported under the Financial Reconstruction Act, transitions of evaluation value of real estate collaterals, transition of losses from disposing NPLs, and obligor classification transitions; data available for the last 15 years informs sector provisioning adequacy. - Assessment summary: - Assessment of Principle 18: LC. Comment encourages JFSA to eliminate remaining SME legacy issues, consider additional guidance on collateral valuations stressing prudence, and consider greater reliance on external auditors where scope and prudential rigor are satisfactory. *Source: cr17282 - 3. Strengthening the Management of Credit Exposure with Respect to Overseas Businesses.* ### Concentration risk and large exposures (Principle 19, EC1–EC7, AC1) - Legal and reporting framework: - Article 13 of the Banking Act sets large exposure limits to a single counterparty. - Article 4−8 of Order for Enforcement of the Banking Act: single counterparty limit = "25 percent of bank’s capital"; consolidated application via Article 13−2. - Large exposure defined operationally as more than "10 percent of bank’s Tier 1 capital" (Supervisor guidance III−2−3−2−6). - Scope and measurement: - Definition of credit includes on-balance sheet assets and off-balance sheet items; derivative transactions added to the definition in 2014 amendments. - Positions are calculated on a gross basis after possible collateral and guarantees are taken into account. - Quarterly JFSA collection: data on borrowers with exposures > "10 percent of bank’s Tier1 capital" or the top 100 largest borrowers. - Group of connected counterparties: - Article 4−1 (Order for Enforcement): group concept based on ownership (quantitative: owner of "50 percent or more of the voting rights"; qualitative: one counterparty substantially controls or economically depends on others). - JFSA does not have discretionary power to redefine groups on a case-by-case basis; current ownership-based definition may narrow LE regime coverage. - Information systems and aggregation: - Banks must submit large exposure data quarterly and are required to have information systems to identify and aggregate exposures by counterparty, currency, credit grade, geography and industry; systems less capable in capturing complex connected-counterparty groups beyond direct ownership. - Supervisory review and limits governance: - JFSA inspects whether boards set thresholds, credit limits and periodically report material concentrations to the board. - Supervisory plans to implement BCBS revised LE guidelines effective from 2019 (aligned with BCBS timeline). - Stress testing: - No explicit legal requirement to include concentration risk in stress-testing programs for all banks, though megabanks use bottom-up approaches; 2016 JFSA priorities include checking implementation of concentration management and stress scenario setting. - Assessment of Principle 19: LC. Comments highlight need to broaden group definitions beyond ownership, adapt large exposure limits to different bank capital contexts (noting same LE limits applied to banks with minimum capital adequacy ratios of 8 percent and 4 percent), and strengthen attention to concentrations beyond credit (e.g., market, traded portfolios). *Source: cr17282 - 3. Strengthening the Management of Credit Exposure with Respect to Overseas Businesses.* ### Transactions with related parties (Principle 20, EC1–EC7) - Definitions and scope: - Article 13−2 of the Banking Act and Article 4−2 of Order for Enforcement define "specified related person" (subsidiaries, major shareholders, holding companies, agents, other persons with special relationship) but do not explicitly capture close family members or corresponding persons in affiliated companies. - Paragraph 2, Article 14−7 of the Ordinance grants JFSA discretion to consider real influence (e.g., director dispatch) but JFSA has not exercised this discretion to date. - Arm’s-length rule and prohibitions: - Article 13−2 prohibits transactions with specified related persons on preferential terms causing "unreasonable losses" compared with ordinary terms; Article 14−1 similarly prohibits preferential terms to directors/senior management. - Companies Act Article 369 restricts directors with interests from participating in decisions; Banking Act requires at least two-thirds of board members for granting credits to "specified related person." - Board approval, write-offs, limits and reporting: - No specific statutory requirement for prior board approval of related-party exposures or for write-offs of exposures to "specified related person." - Related party exposures are effectively captured via large exposure reporting when they meet LE thresholds (> "10 percent of bank’s Tier 1 capital" or top 100 exposures); no dedicated aggregate related-party reporting framework exists. - Paragraph 6, Article 4 of Order for Enforcement: stricter limit for major shareholders = "15 percent" of capital. - No authority to deduct related-party exposures from capital for Pillar 2 purposes; JFSA does not require collateralization/deduction specifically for related-party exposures beyond LE regime. - Controls and conflicts of interest: - Legal provisions (e.g., Act Regulating the Receipt of Contributions, Receipt of Deposits and Interest Rates) prohibit officers/employees from lending using their position for personal/third-party benefit; banks required to report breaches; JFSA conducts surprise visits and whistleblower follow-ups. - Supervisory Guideline V-5 requires banks to identify conflict-of-interest transactions and take measures to avoid them; Inspection Manual includes checks on business management systems protecting customer interests. - Assessment of Principle 20: MNC. Comments emphasize shortcomings: framework is principles-based and lacks specific periodic reporting and proactive supervisory criteria; JFSA has limited powers for capital deduction and has not fully exercised discretion to expand related-party definitions. *Source: cr17282 - 3. Strengthening the Management of Credit Exposure with Respect to Overseas Businesses.* ### Country and transfer risk (Principle 21, EC1–EC6) - Supervisory expectations: - Supervisory guidelines (III−2−3−2−4−2) require banks to establish processes to identify, monitor and manage country and transfer risk; BoJ onsite exams also focus on overseas credit exposure management. - Onsite inspection checkpoints include board understanding of country risk, monitoring systems, and processes for quick/flexible responses to changing international circumstances. - Reporting and analysis: - Banks required to report exposures by country and by currency; internationally active banks submit credit risk policies and risk appetite statements for JFSA evaluation. - Quarterly JFSA submissions: country credit exposures; JFSA may request more granular data (gross/net, provisions). - Post-crisis practices: monthly reporting required for exposures to European countries with breakdowns by sovereign/financial/non-financial and maturities for granular analysis. - Supervisory review of provisioning and classification: - Inspection Manual requires examination of "Provisions for Loans to Specific Countries" and of country classifications, loan classifications and measurement of expected losses. - JFSA does not set explicit provisioning percentages or limits per country but assesses adequacy and can impose Article 24 reporting orders or Article 26 business improvement orders where necessary. - Stress-testing and scenarios: - JFSA requires banks to include country- and transfer-risk scenarios (e.g., sovereign downgrades such as Saudi Arabia) in stress tests and to maintain sufficient capital and liquidity. - Assessment of Principle 21: C. Comment notes intensified monitoring as megabanks expand overseas, with additional prudential returns on country exposures. *Source: cr17282 - 3. Strengthening the Management of Credit Exposure with Respect to Overseas Businesses.* ### Market risk (Principle 22, EC1–EC6) - Supervisory framework: - Supervisory Guidelines require banks to have market risk management systems commensurate with risk appetite, risk profile and capital strength; boards responsible for market risk policies. - JFSA maintains more than 30 onsite market-risk specialists and conducts inspections, especially for mega/trading banks. - Trading activity and RWAs: - Trading book activity generally limited; for top five banks market risk RWAs approximately "3–5 percent" and for other banks generally less than "3 percent"; Nomura and Daiwa: market risk consumes approximately "30 percent" and "25 percent" respectively. - Controls and governance: - Expectations include clear segregation of front/middle/back offices, independent valuation and model validation, real-time or daily position monitoring, and daily reporting of profit and loss, limit excesses and positions. - JFSA replicates VaR models and conducts its own stress tests; inspectors compare bank and JFSA stress-test results and assess management responses. - Valuation and marked-to-market: - Banks required to revalue positions real-time or at least daily; valuation adjustments required for illiquidity or model uncertainty; strict prohibition on asset transfers between trading and banking books per Article 13–6–8. - Stress testing: - Banks must conduct regular stress tests reflecting market stresses and liquidity deterioration; contingency plans expected and assessed. - Assessment of Principle 22: C. Comment notes focused expertise and generally compliant practices, with priority on mega banks and trading banks. *Source: cr17282 - 3. Strengthening the Management of Credit Exposure with Respect to Overseas Businesses.* ### Interest rate risk in the banking book (IRRBB) (Principle 23, EC1–EC4, AC1, AC2) - Regulatory expectations and monitoring: - IRRBB covered within market risk management framework; JFSA requires banks to submit monthly IRRBB-related data to offsite monitoring; outliers identified for intensive dialogue. - "Outliers" definition: banks whose impact of interest rate shocks on bank capital exceeds "20 percent of the sum of Tier 1 and Tier 2 capital." - Prescribed shocks: (i) parallel yield curve shift by "200 basis points"; or (ii) "one or 99 percent tile event happening to one-year holding assets measured during the observation period of at least five years." - Supervisory activities: - Onsite inspections validate internal models, review stress-testing processes and governance, and check board oversight; JFSA transitioning to new IRRBB guidelines aligned with BCBS, implementation timeline "2018." - Internal capital and ICAAP: - Banks required to include IRRBB in ICAAP; JFSA validates adequacy during onsite inspections, including review of core deposit definitions and back testing. - Assessment of Principle 23: C. Comment: high JGB holdings increase IRRBB; tools and supervision are in place and JFSA moving to align with BCBS revisions. *Source: cr17282 - 3. Strengthening the Management of Credit Exposure with Respect to Overseas Businesses.* ### Liquidity risk (Principle 24, EC1–EC8, AC1) - Liquidity coverage and monitoring: - For internationally active banks (solo and consolidated), JFSA requires monthly compliance with LCR; implementation began March 2015 with disclosures from end-June 2015. - Minimum LCR trajectory: "60 percent" in 2015, "70 percent" in 2016, rising in equal annual steps to reach "100 percent" in 2019. - JFSA introduced "Approximate LCR" daily calculation: banks must calculate within two business days; if Approximate LCR falls below a level "higher than the LCR minimum level by 20 percent", bank must submit daily report to JFSA. - Additional liquidity reporting: - Monthly reporting required on (i) contractual maturity mismatches; (ii) concentration of funding; (iii) unencumbered liquidity assets; and (iv) LCR by major currency. - BoJ monitors liquidity daily and engages in daily dialogues with banks where necessary; BoJ and JFSA collaborate closely on liquidity concerns. - Liquidity risk management framework: - Supervisory Guideline and Inspection Manual require bank boards to set liquidity strategy, contingency funding plans, stress testing and ALCO oversight; JFSA evaluates governance and conducts targeted onsite inspections with checklists and grading. - For systemically important institutions, "Key Matters in Examining Liquidity Risk Management at Large Complex Financial Groups" provides further guidance. - Foreign currency liquidity: - JFSA prioritizes assessment of foreign currency liquidity management given banks’ overseas expansion; reporting includes LCR by currency and liquidity mismatches to assess FX funding risk and transferability across legal entities. - Contingency planning and stress testing: - Banks must maintain contingency funding plans, conduct crisis simulations and include short-term and protracted bank-specific and market-wide scenarios; JFSA assesses feasibility and may require remedial measures through Article 24 or Article 26. - Encumbrance: - Supervisory Guideline III–2–3–4–4–1 emphasizes holding sufficient HQLA; JFSA monitors unencumbered assets as part of LCR supervision. - Assessment of Principle 24: C. Comments highlight rigorous offsite and onsite monitoring; ongoing focus necessary on foreign currency funding risks as banks expand overseas. *Source: cr17282 - 3. Strengthening the Management of Credit Exposure with Respect to Overseas Businesses.* ### Operational risk (Principle 25, EC1–EC8, AC1) - Operational risk governance: - Supervisory Guidelines require bank boards to establish operational risk management systems commensurate with size and risk profile; offsite monitoring and onsite inspections validate implementation. - BoJ examines operational risk with emphasis on changing business environments, IT systems, fraud, errors, and system failures. - Business continuity and disaster recovery: - Banks required to maintain disaster recovery and business continuity plans (BCP); JFSA conducted a 2015 horizontal BCP review post-Great East Japan Earthquake. - BoJ inspects BCP and business continuity for payment and settlement participants; BoJ can inspect outsourced service providers with permission. - IT and outsourcing: - Supervisory Guidelines require board awareness and mitigation of IT risks; banks must report IT system troubles immediately (Inspection Manual and Article 24). - Article 12 of the Banking Act mandates appropriate outsourcing management; JFSA can require third-party reporters and conduct onsite inspections of major outsourced providers (e.g., NTT Data, Hitachi, IBM). - Operational risk data and reporting: - Offsite reporting provides internal loss data broken down by event type and top loss events; AMA banks face heightened reporting (BEICFs, internal/external loss data, scenario analysis). - Common points of exposure: - JFSA identifies common operational vulnerabilities, including shared IT services among regional banks, and has conducted inspections to assess DR and BCP. - Assessment of Principle 25: C. Comment: comprehensive offsite reporting and intensified supervision of IT/outsourcing risks; ongoing focus on integrated risk management for expanding overseas operations. *Source: cr17282 - 3. Strengthening the Management of Credit Exposure with Respect to Overseas Businesses.* ### Internal control and audit (Principle 26, EC1) - Legal and supervisory requirements: - Article 13 of the Banking Act requires banks and bank holding companies to establish appropriate internal control frameworks; details delegated to boards. - Supervisory Guidelines and Inspection Manual set detailed checklists covering organizational structure, accounting policies, four-eyes principle, and safeguarding assets. - Supervisory practice: - JFSA conducts monthly offsite reviews for major banks and annual or biennial reviews for smaller institutions; targeted onsite reviews investigate incidents and probe root causes. - Horizontal peer reviews and client surveys used to obtain forward-looking insights into control effectiveness and decision-making in foreign operations. - BoJ conducts offsite and onsite reviews of counterparties’ internal control frameworks. - Inspector assessment and follow-up: - Findings from inspections are graded and followed by Article 24 reporting requests requiring coordinated remedial reports within one month; JFSA monitors implementation via offsite surveillance. - Assessment of Principle 26: C. Comment: JFSA is diligent in monitoring internal control systems and seeks to enhance forward-looking assessment techniques, including peer comparisons and client feedback. *Source: cr17282 - 3. Strengthening the Management of Credit Exposure with Respect to Overseas Businesses.* ### 1. Ensuring the Effectiveness of Internal Control. ### 1. Ensuring the Effectiveness of Internal Control ### Role of internal control frameworks - To ensure the effectiveness of risk management, internal control frameworks at financial institutions need to function effectively. ### Onsite examinations by the BoJ - In onsite examinations, the BoJ examines the following: - (1) whether the board of directors has provided risk management frameworks and oversees the implementation appropriately; - (2) whether senior management executes operations in accordance with the risk-taking policy determined by the board of directors and manages risks; and - (3) whether senior management provides reports appropriately so that the board of directors can oversee the risk management practice. - In doing so, the BoJ will also examine (4) the effectiveness of the group-wide business management of financial institutions, including overseas branches and subsidiaries, which offer a wide range of financial services on a group basis. ### Proactive improvement via internal audits - Internal audits provide a basis for ensuring the proper conduct of business operations and play an important role in promoting the proactive improvement of risk management. - The board of directors needs to be aware of the importance of internal audits and ensure their effectiveness. - Internal auditors need to evaluate the effectiveness of risk management and other control functions and report to the board of directors as appropriate from an independent and objective standpoint. *Source: cr17282 - 1. Ensuring the Effectiveness of Internal Control.* ### 3. In onsite examinations, the BoJ examines the following: (1) whether the board of ### cr17282 - 3. In onsite examinations, the BoJ examines the following: (1) whether the board of ### Onsite examinations — BoJ focus - The BoJ examines: - (1) whether the board of directors appropriately decides the scope of internal audits and allocates audit resources based on the risk assessment; - (2) whether the internal auditors adequately audit businesses, including those of overseas entities and subsidiaries; and - (3) whether the board of directors makes the most of auditors' recommendations regarding their business management. - For major financial institutions, the BoJ examines: - (1) whether they have appropriately set up mechanisms to gather the necessary information, including management information system (MIS) infrastructure; - (2) whether the reliability and timeliness of information are ensured; and - (3) the routes by which risk spreads as well as potential effects through fund transactions and credit provision relationships with other major domestic and overseas financial institutions. ### Development of Management Information Systems (MIS) - Importance: - Appropriate mechanisms to gather information are critical to manage business operations and risks, especially for institutions expanding international businesses and offering group-wide financial services. - BoJ onsite checks (mainly for major financial institutions) assess: - MIS and information infrastructure set-up; - reliability and timeliness of gathered information; - contagion routes and potential effects via fund transactions and credit provision relationships with major domestic and overseas financial institutions. ### Governance, internal audit and control — JFSA findings (EC2–EC5) - EC2 (Back office, control functions vs. origination units): - Supervisor determines appropriate balance of skills/resources and adequate expertise and authority for back office/control functions; access to board where appropriate. - JFSA monitors integrated risk management, inspects management systems per Inspection Manual, and confirms independence of internal audit control function. - Findings: - Some internal audit functions still report via president/CEO to board or board of auditors rather than directly. - JFSA reviews experience/qualifications of internal control staff and monitors rotation and career profiles of internal audit staff. - EC3 (Compliance function): - Supervisor requires adequately staffed, permanent, independent compliance function with suitable training, experience and authority; board oversight required. - JFSA onsite/offsite monitoring ensures banks assign well-trained and experienced staff to legal compliance teams. - JFSA conducted a horizontal review of the three major banks in 2014 and compared them with a major U.S. bank to identify training needs. - EC4 (Internal audit function mandate): - Supervisor requires independent, permanent, effective internal audit function charged with assessing policies/processes/internal controls and ensuring compliance. - JFSA Inspection Manual requires policies, internal rules and management systems for internal audit; periodic evaluation of internal audit system effectiveness. - Findings: - Boards have internal audit units commensurate with bank size/risk profile; attention to independence. - Major banks have used hub-spoke internal audit arrangements; JFSA works with banks to address potential consistency weaknesses. - EC5 (Internal audit resourcing, independence, access and methodology): - Requirements include sufficient resources, independence with reporting to board/audit committee, timely information on material changes, full access to staff/records, risk-based methodology, audit plan, and authority to assess outsourced functions. - JFSA Supervisory Guidelines (added March 2014) and Inspection Manual require: - internal audit units have appropriate staffing, knowledge, experience and specialist capability; - independence from other units and protection from influence; - full access to records, materials, staff and directors; - inspection of critical service providers and review of how banks audit those providers. - Assessment of Principle 26: C - Comment: Oversight of bank internal control frameworks is sound; internal audit profile improved. Assessors recommend strengthening direct reporting relationships to bank boards or boards of auditors, although not currently a material gap. ### Financial reporting and external audit — JFSA findings (Principle 27, EC1–EC9, AC1) - EC1 (Responsibility for financial statements and recordkeeping): - Banks required to prepare and publicly disclose non-consolidated and consolidated financial statements (Article 20 of the Banking Act) and annual/interim reports (Article 21). - Banks may use Japanese GAAP or IFRS; Japanese GAAP assessed as equivalent to IFRS by EU in December 2008. - Listed companies required from March 2009 to obtain audit certification for internal control reports. - JFSA Supervisory Guideline III–3–2–2 requires proper internal control systems and regular testing. - EC2 (External audit requirement and standards): - Under Article 4–2 of the Banking Act and Articles 435 and 396 of the Companies Act, banks must engage external auditors and provide audited opinions. - Regulators inspect financial statements; JFSA increasingly relies on external auditors' work and communicates with them. - EC3 (Valuation practices and fair value estimation): - Banks submit regulatory data in accordance with Japanese GAAP; no significant differences between financial reporting and regulatory valuations. - Tradable securities required to be carried at fair value. - Since 2002/2006, banks required to report equity portfolios at market prices and subject to limits on equity holdings as a share of bank capital. - EC4–EC5 (Scope and content of external audits): - Companies Act (Article 396) defines audit scope; Japanese auditing standards aligned with ISA. - Audits cover loan portfolios, loan loss provisions, non-performing assets, asset valuations, securities, derivatives, securitizations, off-balance sheet vehicles and internal controls over financial reporting. - EC6 (Power to reject/rescind external auditor): - Possible under Article 27 of the Banking Act in severe cases; JFSA may take disciplinary actions under the Certified Public Accountants Act (Articles 30, 31, 34–21–2, etc.). - In practice, rescission/rejection would require extreme circumstances; no recent examples since 1998 Daiwa case. - EC7 (Rotation of external auditors): - Supervisory Guidelines require banks to appropriately determine CPA tenure. - Mandatory rotation: auditors of listed and certain large companies every seven years with a cooling off period of two years under the CPA Act. - JICPA requires larger audit firms to follow a five-year rotation rule with a five-year cooling off period for lead engagement partners and quality review partners. - EC8 (Periodic meetings with external audit firms): - JFSA meets with external auditors and reviews issues; BoJ holds trilateral meetings with the financial institution and its auditor when necessary. - JICPA published “Guidelines for Cooperation between Financial Inspection and Accounting Audit” on July 27, 2000. - EC9 (External auditors reporting to supervisor): - External auditors are not legally required to report directly to supervisors, but under Article 397 of the Companies Act they must report misconducts to company auditors, who report to directors; JFSA may require banks to report facts auditors found. - Under Article 193–3 of the Financial Instruments and Exchange Act, auditors must report to the Commissioner of the JFSA if the audited company does not correct identified facts within two weeks. - AC1 (Access to external auditors’ working papers): - JFSA has indirect authority by ordering banks to submit materials under Article 24 of the Banking Act. - Assessment of Principle 27: LC - Comments: Legislative powers over external auditors are limited to breaches of the CPA Act or negligence. JFSA would not be able to reject/rescind auditors except in extreme situations. Assessors suggest broader supervisory powers to take timely actions against external auditors, and consideration of introducing a more prompt reporting regime for external auditors to notify supervisors of significant findings beyond material misstatements or law violations. ### Disclosure and transparency — JFSA findings (Principle 28, EC1–EC5, AC1) - EC1 (Periodic public disclosures): - Article 20 and Article 21 of the Banking Act require public disclosure of audited consolidated and non-consolidated financial statements and annual/interim reports. - JFSA Disclosure Notice sets out detailed instructions and templates for Basel Pillar 3 public disclosure obligations applied to both internationally-active and domestic banks. - Forthcoming Pillar 3 enhancements under Basel III to be implemented per internationally-agreed timelines. - EC2 (Qualitative and quantitative disclosures): - Disclosures include financial performance, position, risk management, exposures, related-party transactions, accounting policies, governance and remuneration; commensurate with risk profile and systemic importance. - EC3 (Group structure disclosures): - Banks and bank-holding companies subject to the Financial Instruments and Exchange Act must disclose important entities in group structures. - EC4 (Review/enforcement of disclosure standards): - JFSA reviews disclosures via offsite monitoring and onsite inspections; business improvement orders are available for failures or incorrect disclosures. - EC5 (Publication of aggregate banking system information): - JFSA and BoJ publish aggregate banking industry data (capital adequacy ratios, net income breakdowns, nonperforming loan ratios); BoJ publishes research/Financial System Report with macroprudential perspective. - Japanese Bankers Association publishes industry financial results and bank financial statements. - AC1 (Disclosure of period-average exposures): - JFSA Disclosure Notice requires banks to disclose average balances when period-ending exposures materially differ from average balances and to disclose methodology if average daily balances are not used. - Three major Japanese banks have implemented many Financial Stability Board Enhanced Disclosure Task Force recommendations; 2015 EDTF report notes Asian-Pacific banks implemented almost two-thirds of recommendations at end-2014. Mitsubishi UFJ FG was singled out as best practice for troubled debt restructurings disclosures. - Assessment of Principle 28: C - Comments: Strong disclosure standards; Pillar 3 requirements applied to domestic and internationally-active banks. JFSA should consider regulatory burden on smaller banks when applying future detailed Pillar 3 enhancements. ### Abuse of financial services / AML-CFT — JFSA findings (Principle 29, EC1–EC13) - EC1 (Legal framework and supervisory duties): - JFSA is the supervisory agency for AML/CFT; Act on Prevention of Transfer of Criminal Proceeds (APTC) is the main law (Articles 15–18 empower JFSA to supervise compliance). - JFSA conducts inspections, access to information, orders reports and business improvement orders; banks required to develop internal controls to ensure APTC compliance. - EC2 (Banks’ policies/processes to prevent criminal activity): - Article 8 APTC requires submission of Suspicious Transactions Reports (STRs). - Article 11 APTC requires banks to develop training programs and necessary systems. - JFSA inspects banks per Supervisory Guideline sections (e.g., III–3−1–3–1–2). - Follow-up amendments to APTC in 2011 and 2014 addressed FATF 2008 Mutual Evaluation deficiencies (beneficial owner, purpose of business relationship, ongoing due diligence, record keeping, enhanced due diligence). - EC3 (Banks report to supervisor when suspicious activities material to safety/soundness/reputation): - Legal basis: paragraph 1, Article 53 of the Banking Act and related Ordinance items. - STRs reporting increased from 18,768 in 2002 to 399,508 in 2015. - JFSA assesses STR processes during onsite inspections. - EC4 (Supervisor shares suspicious transaction information with FIU and other authorities): - Paragraph 5, Article 8 APTC requires JFSA to promptly forward all STRs to FIU; Article 13 requires FIU to provide STR information to law enforcement. - Article 14 APTC allows JFSA to share STR information with foreign counterparts via their FIUs; JFSA exchanges information via BCBS, FATF and Asia Pacific Group. - EC5 (CDD policies and program elements): - APTC requires CDD when opening accounts and other specified transactions; recordkeeping for seven years after business relationship end; operational procedures and internal controls; approval requirements for higher-risk transactions. - Supervisory Guideline II–3–1–3–1–2 requires integrated management systems for CDD, including customer acceptance policy, beneficial ownership, risk assessment documents, operational manuals, monitoring policies and enhanced due diligence for high-risk accounts and PEPs. - Inspection Manual examines clarity/appropriateness of CDD/STR rules and internal control systems to oust anti-social rogues. - EC6 (Correspondent banking controls): - APTC Article 9 requires gathering sufficient information on respondent banks, operational procedures for assessment, and identification that respondent bank is not a shell bank; supervisory guidelines and Inspection Manual support correspondent bank risk management. - EC7 (Controls to prevent/identify/report abuses including ML/TF): - APTC requires CDDs and seven-year record retention; JFSA onsite inspections evaluate compliance; Article 30 of APTC punishes legal persons for non-compliance. - Supervisory Guideline requires annual “hearing on internal audit” including AML/CFT topics. - EC8 (Powers to take action against non-compliant banks): - JFSA can order reporting, issue business improvement orders (Articles 24–26 Banking Act), suspend part or whole business (Articles 26–27), and APTC also grants corrective powers and penalties; fines and imprisonment decided by courts. - EC9 (Independent evaluation, compliance officers, screening and training): - APTC requires training, assignment of general compliance managers, recruitment of capable staff. - Supervisory Guideline III–1–2–1 requires Representative Director and President to develop independent internal audit and company auditor systems; JFSA may access internal audit reports under Articles 24 and 25 of the Banking Act. - Supervisory Guideline III–3–1–3–1–2 and III–3–3–4–2 require ongoing staff training and due diligence on outsourcing providers. - EC10 (Staff reporting systems and MIS for AML/CFT): - Supervisory Guideline requires reporting systems for staff to flag abuse; JFSA evaluates whether banks have management frameworks and assign compliance officers at management level. - Inspection Manual checks for compliance helplines/hotlines and integration of compliance information. - EC11 (Legal protection for good-faith reporters): - Item 1, paragraph 1, Article 23 of Act concerning Protection of Personal Information permits provision of personal data in accordance with laws (e.g., STRs under APTC). - Article 709 of Civil Code and Supreme Court case law protect acts done in accordance with laws/regulations; Article 35 Penal Code exempts lawful acts from punishment. - Conclusion: legislations effectively protect bank staff who report STRs from criminal, civil or personal information liabilities. - EC12 (Domestic and foreign cooperation/sharing related to suspicious activity): - APTC requires joint-supervised institutions to submit STRs to JFSA and other relevant ministries; Article 14 allows STR sharing with foreign FIUs; JFSA exchanges information via AMLEG, BCBS, FATF and Asia Pacific Group. - EC13 (In-house specialist expertise and risk communication): - JFSA has staff with criminal expertise transferred from law enforcement; collaborates with National Police Agency and Public Prosecutors Office; National Public Safety Commission publicizes National Risk Assessment annually. - Assessment of Principle 29: LC - Comments: Japan strengthened AML/CFT capabilities and saw large increases in STRs. A noted shortcoming is a reduction in focus of onsite inspections for AML/CFT; assessors recommend routine onsite inspections to verify effectiveness of CDD, correspondent banking and controls rather than relying mainly on offsite monitoring and STR reporting. ### Key numeric and timeline items (exact as in source) - Inspection and supervisory guidance references and years: - March 2014: Supervisory expectations requiring banks to appoint qualified internal auditors added to Supervisory Guidelines (III–1–2–1 (5)). - 2014: Horizontal review of the three major banks’ compliance functions. - March 2009: listed company required to obtain audit certification for internal control reports. - 2002: banks required to report equity portfolios at market prices for regulatory purposes since 2002. - 2006: banks subject to limits on equity holdings as a share of bank capital since 2006. - 2008: EU assessed Japanese GAAP equivalent to IFRS in December 2008. - 2011 and 2014: amendments to APTC following FATF 2008 evaluation. - 2015: 399,508 STRs reported in 2015. - 2002: 18,768 STRs reported in 2002. - Auditor rotation rules: - Mandatory rotation for auditors of listed and certain large companies every seven years with a cooling off period of two years under the CPA Act. - JICPA requires larger audit firms to follow a five-year rotation rule with a five-year cooling off period for lead engagement partners and quality review partners. - Record retention: - APTC requires banks to keep records of CDDs for seven years after the business relationships end and to keep records for specified transactions for seven years. - EC5 (principle text) states records have at least a five-year retention period. *Italic: IMF staff report content (cr17282) as provided in the supplied source.* ### 1. Responsibilities, objectives and powers C ### 1. Responsibilities, objectives and powers C ### Overview - The legal framework and supporting regulations and guidance are comprehensive with clear roles and responsibilities assigned to the different agencies plus a suite of powers that enables supervisors to effectively oversee the banking system. - The three mandates assigned to the JFSA are complementary: depositor protection, financial stability, and ensuring banks have capital and risk management practices commensurate with the risks they undertake and the environment in which they operate. ### 2. Independence, accountability, resourcing and legal protection for supervisors — LC - Most mechanisms are in place to allow banking supervision to be conducted with requisite operational independence. - Statutory provisions governing the removal of a JFSA Commissioner from office could be tightened. - The funding model for the JFSA may become less robust over time if the financial sector continues to expand in a period of public sector fiscal restraint; consider whether a different funding model might make sense over the longer run. ### 3. Cooperation and collaboration — C - Significant progress in strengthening links between domestic agencies involved in banking supervision. - Deepened relationships with foreign supervisory agencies via more MoUs, EoLs and introduction of CMGs for major Japanese banks designated as global systemically important. ### 4. Permissible activities — C - The definition of a bank and the range of activities that banks and bank holding companies are permitted to engage in is clearly defined. ### 5. Licensing criteria — LC - As banking groups become more complex, the JFSA should consider more intensive probing of ownership structures to ensure understanding of ultimate beneficial owners and their capacity to provide capital in times of stress. ### 6. Transfer of significant ownership — LC - Major changes in shareholding above the 20 percent threshold do not necessarily need supervisory approval ahead of time. - In practice, intentions are clarified when a shareholder becomes a “major shareholder” and extra conditions could be set on future increases. - Assessors believe authorities are generally better placed to exercise influence before a transaction takes place; when a major shareholder obtains a majority shareholding (controlling interest) this should, in the assessors’ view, be subject to a pre-approval process. ### 7. Major acquisitions — LC - Material investments that would lead to significant influence could majorly affect the business model and risk profile of the investee; a stricter pre-approval is recommended as provided in the case of subsidiaries, rather than a system based upon prior notification combined with onsite and offsite supervisory action. - Consider expanding the scope for approval of acquisitions to include acquisition of ancillary business and banking related business. ### 8. Supervisory approach — LC - A risk rating methodology (“risk profiles”) was introduced in 2014; rollout is ongoing and aspects are being refined (e.g., balancing risk against size, scale, complexity and systemic importance). - Full implementation of an analytical risk framework is needed to assess bank and banking group risk profiles more comprehensively and systematically and to better integrate offsite and onsite processes. - The GSIB framework has augmented attention to megabanks, which are receiving considerably more frequent and intensive supervision; full roll out will enhance planning and resource allocation. ### 9. Supervisory techniques and tools — C - JFSA enhanced the supervisory toolkit: implementation of risk profiles, more targeted onsite inspections, thematic inspections, greater emphasis on onsite inspections, and greater engagement with banks’ senior management and boards. - Mix of onsite and offsite activities is commensurate with bank’s risk profiles, size, scale, complexity and systemic importance. - Introduction of the D-SIB and G-SIB framework helps direct attention to the megabanks. ### 10. Supervisory reporting — LC - JFSA can collect, review and analyze prudential returns on both solo and consolidated basis. - Potential for collecting too much information which may obscure supervisory focus. - More emphasis could be placed on internal risk management practices to confirm prudent valuation of assets as part of regulatory reporting; currently valuations are determined by accounting standards which may not fully capture governance and risk management requirements for valuations. - Reporting standards do not explicitly set out expectations for governance structures and control procedures for regulatory reporting nor explicit reference to the valuation framework or control procedures for regulatory reporting. ### 11. Corrective and sanctioning powers of supervisors — LC - Concerns about (i) willingness of the JFSA to exercise its powers at an early stage and (ii) PCA triggers set too low and not granting sufficient flexibility to intervene early. - Administrative actions under Articles 24 and 26 could potentially result in delays in remedial actions. - Recommend considering strengthening inter-agency cooperation for crisis management and preparedness. ### 12. Consolidated supervision — C - Framework enables supervision on both a consolidated and a solo basis and gives powers to oversee foreign activities of Japanese banks and to supervise shareholders and senior management of parent and affiliated companies including outsourcing companies from a prudential perspective. - Legal clause allows bank subsidiaries and bank outsourced companies to refuse JFSA investigations if there are “justifiable reasons” as a safeguard against demands beyond prudential responsibilities. ### 13. Home-host relationships — C - Foreign banks operating in Japan are held to the same prudential standards as domestic counterparts. - Significant progress in deepening home-host relations with foreign supervisors in recent years. ### 14. Corporate governance — LC - Corporate Governance Code introduced recently; implementation will take time. - Need for greater oversight of management (e.g., President/CEO) by board non-executive directors, especially among regional banks; disparities in governance practices remain even across major banks. - Fit & Proper (F&P) processes to assess collective experience and expertise of the board should be strengthened and applied at senior management level for bank structures where it is a Company with Auditor. - JFSA should increase frequency and depth of onsite and offsite activities to assess effective functioning of the board and its committee structure across a broader range of banks. ### 15. Risk management process — LC - JFSA and BoJ have sufficient frameworks for identifying and evaluating banks' risk management systems and requiring remedial actions. - Independence of the risk management function needs greater attention, especially reporting line of the CRO to the board risk committee. - JFSA engagement with non-executive directors for megabanks has stepped up but needs sector-wide rollout. ### 16. Capital adequacy — MNC - Capital requirements closely aligned with Basel Pillar 1 for internationally-active banks. - Important shortcoming: lack of a Pillar 2 capital framework to tailor capital to individual bank risk profiles, limiting authorities’ ability to require banks to carry more capital beyond minimums. - JFSA’s plans to be a more dynamic supervisor will likely require more proactive influence on bank capital planning and risk management. - Thresholds for early intervention measures (e.g., constraints on dividends and other capital disbursements) are set too low, only starting to kick in when capital ratios fall below 4 percent. - Feasibility of introducing constraints that kick in above official minimums through bank policies and recovery plans should be explored. ### 17. Credit risk — C - Sufficient focus by banks, JFSA and BoJ on credit risk management. - Credit risk is a key focus in JFSA’s strategic plans; supervisory and inspection bureaus conduct detailed monitoring and in-depth analysis (through file reviews). - Trend toward more risk-based lending and new product lines (e.g., consumer finance) requiring JFSA vigilance on adequacy of bank risk management. ### 18. Problem assets, provisions, and reserves — LC - Policies and practices regarding problem assets have improved considerably since the Japanese banking crisis. - Gaps in provisioning of SME and other special measure loans have become less important after termination of relevant government programs; lingering issues should be resolved to increase confidence in provisioning practices. - More guidance on collateral valuations stressing prudence would be helpful; provisioning practices must evolve as the expected credit loss framework is implemented in accordance with international accounting standards. - JFSA may consider more reliance on reviews by external auditors if scope and prudential rigor of those audits provide sufficient satisfaction. ### 19. Concentration risk and large exposure limits — LC - JFSA strengthened large exposure regime, imposing stricter limits for connected counterparties reduced from 40 percent of capital to 25 percent. - JFSA will implement LE guidelines revised by the BCBS which will take effect from 2019 (aligned with the BCBS timeline). - More attention needed to expand risk management for concentrations beyond large exposures (e.g., market risk); no requirement that all material concentrations be regularly reviewed and reported to the bank’s supervisory board; inclusion in stress testing is limited. ### 20. Transactions with related parties — MNC - JFSA has a principles-based approach to related party exposures relying on the credit risk framework to set expectations. - Framework falls short in several areas compared to this principle: no requirement for bespoke policies and processes covering granting and managing related party transactions; no dedicated limits. - Related party exposures are inherently higher risk and require enhanced due diligence and governance supported by supervisory expectations. ### 21. Country and transfer risks — C - With weak profitability, sluggish domestic loan demand and low interest rates, Japanese banks, particularly megabanks, have expanded overseas (particularly Asia); JFSA monitors country exposures closely with additional regular prudential returns on country exposures. ### 22. Market risk — C - Supervisory Guideline obligations are generally sound and establish requirements for effective market risk management frameworks. - Supervisors periodically review banks’ market risk management; most focus and expertise is directed toward megabanks’ market risk management with general compliance observed. ### 23. Interest rate risk in the banking book — C - IRRBB is a key supervisory priority; banks must measure, calculate and report exposure to IRRBB on a quarterly basis. - Banks required to conduct regular stress testing using standardized and bespoke scenarios, especially those with complex business models and optionality. - JFSA beginning transition to new IRRBB guidelines closely aligned with BCBS revisions; timeline for implementation is 2018. ### 24. Liquidity risk — C - BoJ and JFSA carry out onsite examinations/inspections and offsite monitoring in close coordination; inspections include detailed coverage of risk management. - For internationally active banks, JFSA requires compliance with minimum LCR (monthly) implemented in March 2015 and disclosures (quarterly) from the end of June in 2015; transposition of LCR into local rules closely aligns with BCBS Basel III text and timeline. - Offsite monitoring and onsite inspections by both JFSA and BoJ appear rigorous. - Extent of FX funding is a significant risk for megabanks with expanded overseas lending; contingency funding plans and FX liquidity risk management have been a focus. ### 25. Operational risk — C - Operational risk area enhanced since last FSAP, notably strengthening dedicated IT risk specialists. - Sound approaches for business continuity and disaster recovery and ongoing monitoring of operational risk events. ### 26. Internal control and audit — C - Supervisory oversight of internal control functions is sound and internal audit roles within banks strengthened following corporate governance enhancements. - Authorities should consider giving internal audit groups more direct links to boards in line with emerging best practice. ### 27. Financial reporting and external audit — LC - Stronger relationships could be developed between bank supervisors and external auditors to allow JFSA greater influence over audit scope and more prompt information on financial reporting vulnerabilities. - JFSA has limited powers to remove weak external auditors except in extreme situations. - External auditors should be required to report to bank supervisors all findings that could significantly impact the bank, including issues subsequently rectified by the bank, as even minor rectified issues can signal underlying weaknesses. *Source: cr17282 - 1. Responsibilities, objectives and powers C* ### 28. Disclosure and transparency C ### 28. Disclosure and transparency C ### Key findings - Domestic and internationally-active banks have implemented Basel III Pillar 3 disclosure requirements on both a consolidated and unconsolidated basis in accordance with internationally-agreed timelines. - As these requirements become more detailed in the future in the wake of planned revisions to the Basel Pillar 3 Framework, the JFSA may wish to consider the regulatory burden imposed on small banks and assess the costs and benefits of imposing the more detailed requirements on those institutions. ### Related observation (Abuse of financial services LC) - Japan has taken a number of steps to strengthen its AML/CFT capabilities. - Remaining gaps exist in parts of the frameworks to align further with this Principle. - Improvements have been noted, most notably in the reporting of STRs. - A significant reduction in supervisory attention through onsite inspections is identified as a shortcoming. - Recommendation: remain vigilant through rigorous offsite monitoring complemented with regular verification of the effectiveness of policies and processes to control abuse of financial services. ### Recommended actions (summary by Reference Principle) - Principle 2 - The statutory provisions governing the removal of a JFSA Commissioner from office should be strengthened. - Consider whether a different funding model might make sense over the longer run. - Principle 5 - The JFSA should introduce more intensive probing of ownership structures of banking groups to ascertain the ultimate beneficial owners and their capacity to provide capital to the bank in times of stress. - Principle 6 - Strengthen the pre-approval process when a major shareholder obtains a majority shareholding (controlling interest) to ensure the JFSA is able to proactively assess the capacity of a majority shareholder to provide financial support to the bank in times of stress. - Principle 7 - Implement a stricter pre-approval for an acquisition as provided for in the case of subsidiaries. - The scope for approval of acquisitions should be expanded to include the acquisition of ancillary business and banking related business. - Principle 8 - Complete finalization of the risk rating methodology as a way to support the transition to a more forward-looking and risk-based supervisory approach. - Ensure the methodology has due regard to the bank’s risk, size, scale and systemic importance in calibrating the rating. - Principle 10 - Establish clear requirements for governance and risk management arrangements of prudent valuations for data submitted as part of regulatory reporting. - Principle 11 - Recalibrate PCA triggers to allow the JFSA to intervene earlier. - Consider strengthening inter-agency cooperation for crisis management and preparedness. - Principle 14 - Further encourage involvement of non-executive directors in performing a check and balance of executive directors, especially their role on committees (e.g., remuneration, audit, nomination and risk). - For those banks expanding overseas into new markets, greater attention by the JFSA to the effectiveness of corporate governance is needed, such as through onsite and thematic reviews. - Establish the requirements for Internal Audit to report directly to the Board Audit Committee and follow up with necessary supervisory activities to verify new standards have been adopted. - F&P processes should be applied to include all key staff appointments. - Principle 15 - Strengthen bank risk management requirements for the risk function that has a reporting line into the Board Risk Committee, via the CRO. - Principle 16 - Establish a Pillar 2 capital framework to give the JFSA more influence in both bank capital planning exercises and discussions about bank risk management practices more generally. - Principle 18 - Issue more guidance on collateral valuations stressing the need for prudence and provisioning practices to continue to evolve as the expected credit loss framework is implemented in accordance with international accounting standards. - Principle 19 - Encourage appropriate risk management for risk concentrations that encompass both credit exposures in the banking book as well as large counterparty credit risk exposures emanating from trading activities (e.g., counterparty exposures) and other types of risks. - Principle 20 - Strengthen the risk management requirements for related party exposures in terms of bank’s policies and processes for assessing, granting and managing these types of exposures. - Enhance reporting requirements to explicitly include related party exposures reported on routine basis. - Principle 27 - Strengthen relationships between bank supervisors and external auditors so that the JFSA can exercise more influence over the scope of external audits and be more promptly informed about any financial reporting vulnerabilities. - Principle 29 - Increase the frequency and intensity of supervisory activities to verify the effective implementation of bank risk management to control abuse of financial crime. ### Authorities’ response (summary) - The Japanese authorities express sincere gratitude to the IMF mission led by Dr. Gaston R. Gelos for completing the assessment of compliance with the “Basel Core Principles for Effective Banking Supervision” (the BCP). They appreciated that the assessment was conducted in a fair, thorough and professional manner. - The Basel Committee published the revised BCP in September 2012, after the previous Japan FSAP mission in August 2012. Since the last FSAP, the JFSA has taken initiatives to improve the quality of banking supervision and regulations, and the BoJ has taken measures to ensure financial system stability while considering international developments and structural changes. - The full assessment against 29 principles of the revised 2012 BCP provided an opportunity to review effectiveness of initiatives comprehensively and objectively. - The Japanese authorities welcome the overall conclusion confirming a high level of compliance with the BCP and noting significant improvements in banking regulations and supervisory process. - Historical context: From the late 1990’s to early 2000’s the JFSA used rigorous onsite inspections and rigid administrative actions to rebuild public confidence and address NPL problems; reliance solely on ex-post supervision is no longer desirable. The JFSA will continue to develop regulatory and supervisory frameworks supporting banks’ continuous improvement. - The BoJ continues efforts to reinforce measures to ensure financial system stability through analysis and assessment in the Financial System Report (FSR); onsite examinations and offsite monitoring; and incorporating findings back into the FSR. - The BCP assessment will assist ongoing developments and highlight remaining issues to address. - Specific responses to findings: - On Principle 16 (capital adequacy framework): authorities view the recommendation as encouraging greater JFSA influence on banks’ capital planning and risk management at an earlier stage rather than questioning JFSA’s power to enforce Pillar 1 minimum capital requirements. Authorities are reviewing their supervisory approach considering “risks outside Pillar 1,” “appropriate balance of risks, return and capital”, and “sustainability of a bank’s business model” to enable more effective dialogues with banks. - Authorities note post-2012 developments: introduced the capital buffer framework above the minimum level of capital in line with the Basel standard for internationally active banks; revised the definition of capital (Core Capital) for domestic banks to be more conservative and broadly equivalent to Common Equity Tier 1 (CET1). - On Principle 20 (related party transactions): the JFSA aims to strengthen onsite and offsite monitoring in a more integrated manner. - On Principle 14 (corporate governance): authorities appreciate the BCP assessment based on substance; corporate governance initiatives include the Corporate Governance Code, enhanced use of independent non-executive directors, and adoption of corporate structures with a nominating committee by large banks. Authorities are committed to further efforts, including reviewing board oversight at small- and medium-sized banks under the “Company with auditor” structure and how independent directors contribute at banks adopting “Company with nominating committee, etc.” - The Japanese authorities fully support the role of the FSAP in enhancing global financial soundness and supervisory practices and expect to continue constructive dialogues with the IMF and other supervisory authorities. *Source: cr17282 - 28. Disclosure and transparency C* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17282.pdf_