## 1jpnea2024004

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---

### Executive summary — scope, purpose, and mission
- FSAP carried out a targeted evaluation of banking supervision and regulation in Japan, focusing on findings from the 2017 Basel Core Principles (BCP) Detailed Assessment Report (DAR) and the Financial Services Agency’s (FSA) transformation.
- Mission dates: FSAP mission to Japan from September 19 to October 6, 2023.
- Key framing:
  - 2017 DAR concluded the supervisory framework was generally sound but identified priority areas.
  - This note reviews progress and the FSA’s shift to a more risk-focused, principles-based supervisory approach.

### Financial sector structure and market concentration (key statistics)
- Total assets of the Japanese financial sector: approximately 6.6 times GDP at end-2022.
- Banking sector share of financial system: about 60 percent.
- Three Global Systemically Important Banks (G-SIBs) hold about half of the banking system assets and a third of the financial system assets.
- Japan’s insurance sector: about 12 percent of the financial system.
- Japanese securities market capitalization: 11 percent of GDP in 2022.
- Investment funds have grown and represent the third largest sector of nonbank financial intermediaries (NBFI).
- Japan has three domestic central counterparties (CCPs), including one of the top ten global CCPs.
- Banking market composition:
  - Three “mega banks” (G-SIBs): Mizuho Bank, MUFG Bank, Sumitomo Mitsui Banking Corporation.
  - Four D-SIBs designated in 2015: Sumitomo Mitsui Trust Holdings, Norinchukin Bank, Daiwa Securities Group, Nomura Holdings.
  - Japan Post Group: about 12 percent of the banking sector and 22 percent of the life insurance sector.
  - Nine “major” banks in total.
  - Regional banks: Regional Banks Association of Japan (Regional banks I) with 62 members; Second Association of Regional Banks (Regional banks II) with 37 members; one regional bank is a member of neither association.
  - 399 Shinkin banks and credit cooperatives, of which 247 Shinkin banks hold current accounts at the Bank of Japan.

### Transformation of supervisory approach — achievements and remaining work
- Reform trajectory:
  - FSA initiated a major transformation from checklist/compliance-based supervision to principles-based, forward-looking, risk-focused engagement (reforms from 2018).
  - New engagement structures, supervisory priorities, and expectations communicated and supported by industry.
- Ongoing work:
  - Continued development of supervisory guidelines.
  - Investment in joint data project with the Bank of Japan (BOJ).
  - Further development needed in supervisory methodology, Early Warning System (EWS), and data analytics.
- Cultural and operational notes:
  - Establishing supervisory judgement and psychological safety remains challenging; sustained training and guidance required.
  - Industry feedback indicates banks welcome engagement and dialogue; FSA seen as approachable though stringent.

### Mandate, legal framework, and recommended legal clarifications
- Historical FSA missions under Article 3 of the Act on the Establishment of the Financial Service Agency: (i) ensuring financial stability, (ii) promoting consumer protection (including depositor safety), and (iii) maintaining market integrity and transparency.
- 2018 reforms introduced growth-oriented objectives balancing “stability” and “effective financial intermediation.”
- Identified legal gap and recommendation:
  - Make explicit provision in law to ensure priority of financial safety and stability in the FSA mandate. (Timing: NT. Authorities: Gov.)

### Human resources, organization, and resourcing recommendations
- Institutional status and staffing:
  - FSA is an external agency of the Cabinet Office; budget part of national budget debated in the Diet.
  - Headcount context: a little over a quarter of the FSA’s staffing (around 450 out of 1,650 in FY 2024) is assigned to the Securities and Exchange Surveillance Commission and the Certified Public Accountants and Auditing Oversight Board.
  - Remaining 1,200 staff deployed across regulation and supervision—both prudential and conduct—for banking, insurance, and securities firms.
  - Banking supervision supplemented by around 340 staff in the BOJ’s Financial System and Bank Examination Department, and staff dedicated to banking supervision (circa 100) in the Local Finance Bureaus.
- Observations and recommendations:
  - Headcount has increased marginally but remains limited even for supervision of major banks and three G-SIBs.
  - Frequent rotation of staff and turnover at Commissioner level (FSA was on its fourth Commissioner since 2020) risks undermining skills and continuity.
  - Recommendation: Fund and staff the FSA commensurately with its elite technical role; consider fixed term for the Commissioner and longer staff rotations; review options to pay a “risk” premium for scarce skills (e.g., cyber resilience). (Selected timing: NT/I. Authorities: Gov/FSA)

### Supervisory methodology, Early Warning System (EWS), and data analytics
- EWS and metrics:
  - EWS composed of four metric sets: credit risk, stability (market risk and interest rate risk in the balance sheet), cash flow (liquidity), and profitability.
  - EWS data update frequencies: liquidity and market risk data monthly; credit risk data half-yearly; IRRBB data quarterly; profitability data annually.
  - Profitability EWS forecasts profits over a five-year horizon under current trends and alternative adverse scenarios.
  - Limitations: EWS uses simple balance sheet ratios (lagging indicators) and does not capture non-financial risks (e.g., governance, risk management).
  - Recommendation: Explore more forward-looking metrics (e.g., extent of higher-risk lending; loans in arrears but not yet non-performing; adequacy of provisioning coverage; sources of liquidity and potential future cash flows) and include non-financial metrics (e.g., customer complaints, operational outages). (Timing: I. Authorities: FSA)
- Supervisory risk methodology and baseline supervision:
  - FSA discontinued formal supervisory rating system; EWS acts as partial substitute but is narrower in scope than a supervisory rating.
  - Recommendation: Develop a revised, articulated, risk-based supervisory methodology to consolidate full risk profiles (governance, business, strategy), allocate supervisory resources, identify risk trends, and underpin supervisory consistency and quality control. Enhance baseline supervision activities (including on-site inspections) for all banks. (Timing: I. Authorities: FSA)
- Data analytics and stress testing:
  - FSA-BOJ joint annual stress test using a common economic scenario; results not published but BOJ’s Financial System Report provides analysis.
  - Banks apply common scenario to their models under ICAAP; large banks conduct annual stress tests; FSA reviews results.
  - FSA expanding access to granular datasets and developing a common data platform with BOJ to reduce redundant reporting and enable transaction-level corporate loan data.
  - Recommendation: Continue investment in data access and analytical capabilities, including budget for infrastructure and advanced analytical skills; foster a culture of data-driven supervision. (Timing: I. Authorities: FSA/BOJ)

### Prudential powers, Pillar 2, and capital framework
- Identified gaps:
  - The FSA lacks the “Pillar 2” power to set and adjust individual bank capital ratios above minimum requirements.
  - Cabinet Order ties capital-related Business Improvement Orders (BIOs) to quantitative triggers; the FSA cannot order a bank to raise capital until minimum regulatory requirements are breached.
- Capital triggers (excerpted thresholds presented in report):
  - Minimum Ratio:
    - CET1 Ratio ≥ 4.5 percent
    - Tier 1 Ratio≥ 6 percent
    - Total Equity Ratio≥ 8 percent
    - Core Capital Ratio ≥ 4 percent
  - BIO categories and actions:
    - Category 1: Total Capital Ratio of 4% to less than 8% — Order to submit and implement capital improvement plan.
    - Category 2: Total Capital Ratio of 2% to less than 4% — Range of measures including prohibition on dividends/bonuses and limits on asset growth.
    - Category 2-2: Total Capital Ratio of 0% to less than 2% — Order for drastic reduction in services; merger; discontinuation of banking services.
    - Category 3: Total Capital Ratio less than 0% — Order to suspend banking services in whole or in part.
- Implications and recommendations:
  - Effect: Supervisory ability to require banks to hold capital in excess of the minimum is constrained; Japan is an outlier versus peers.
  - Recommendation: Provide the FSA with the power to set and adjust individual bank capital ratios above minimum requirements (“Pillar 2” power). Consider phased introduction focused first on G-SIBs, then D-SIBs/internationally active banks, then others; amend Cabinet Order and update Supervisory Guidelines to explain decision framework. (Timing: NT/I. Authorities: Gov/FSA)
  - Other recommended measures: Recalibrate Prompt Corrective Action triggers in Cabinet Order related to Article 26(2) of the Banking Act; amend the Order to permit BIOs to raise capital in a wider range of circumstances (e.g., if a bank could fall within a category within a short period, e.g., 6 months). (Timing: NT. Authorities: Gov)

### Liquidity requirements and monitoring
- Standards applied:
  - Internationally active banks: LCR and NSFR standards applied; minimum LCR phased from initial 60 percent to 100 percent by 2019; NSFR implemented from September 2021; LCR and NSFR disclosed quarterly.
  - Domestic banks: no quantitative minimum liquidity requirement prescribed.
  - FSA collects monthly liquidity profile information and simplified LCR measures from domestic banks; uses EWS for intensified monitoring.
- Assessment and recommendation:
  - Absence of a minimum liquidity requirement for domestic banks is unusual and inconsistent with the Basel Core Principles.
  - Recommendation: Establish a minimum liquidity requirement for domestic banks. (Timing: NT. Authorities: FSA)

### BOJ alignment and inter-agency information sharing
- Current arrangements:
  - 2021 program “Initiatives for Further Strengthening Coordination between the Financial Services Agency and the Bank of Japan” established the Financial Monitoring Council (FMC).
  - High volume of information flows between FSA and BOJ; legal bases exist for some exchanges (e.g., Bank of Japan Act Clause 3 of Article 44 enables BOJ to submit on-site results to FSA on request).
  - Other exchanges commonly require bank consent, which in practice is often obtained.
- Identified weakness and recommendation:
  - Legal foundations for information sharing are incomplete; recommended legislative amendment to allow statutory information flow between FSA and BOJ without banks’ consent and consider an obligation for agencies to share material information with each other. (Timing: NT. Authorities: Gov)
  - BOJ should ensure its practices and approach remain broadly aligned with the FSA given the FSA’s role as primary regulator/supervisor. (Timing: NT. Authorities: BOJ)

### Licensing, change of control, and acquisitions
- Licensing practice and observation:
  - Since 2017, three successful applicants for banking licenses; extensive pre-application contact common; no systematic on-site testing of new entrants or systematic follow-up during first year.
  - Japanese licensing failsafe: a bank must achieve profitability within three years.
  - Recommendation: Ensure on-site inspection is part of licensing approvals and maintain close observation during follow-up monitoring. (Timing: NT. Authorities: FSA)
- Change-of-control and approval thresholds:
  - Notification triggered at 5 percent shareholding; approval required for major shareholder at 20 percent control of voting rights (15 percent under some circumstances); above 50 percent, notification or approval applies depending on circumstances.
  - FSA can apply a condition so any future increase above 50 percent requires approval; conditionality is not mandatory and not routinely applied.
  - Concern: a non-bank shareholder could obtain control with only retrospective notification in some cases.
  - Recommendation: Mandatory approval at the 50 percent controlling threshold for all classes of shareholders. Interim measure: impose pre-approval condition on new major shareholders (20–50 percent) to require pre-approval if they later seek >50 percent. (Timing: I/NT. Authorities: Gov/FSA)
- Major acquisitions:
  - Ex ante review required for acquisitions of banks as subsidiaries; investments in ancillary or banking-related businesses generally require notification, not pre-approval.
  - Trend: instances of change of control more than doubled since last FSAP; major acquisitions increased more than 15-fold over same time.
  - Recommendation: Implement stricter pre-approval for acquisitions (including ancillary and banking-related business) and expand scope for approval beyond subsidiary acquisitions. (Timing: I. Authorities: Gov)

### Related-party risks and governance
- Related-party framework:
  - Article 13-2 of the Banking Act prohibits non-arm’s length transactions; updated framework recognizes “economic interdependence.”
  - Gap: definition of related parties does not extend to natural persons other than major shareholders; spouses or children of directors not captured.
  - Recommendation: Broaden definition of related parties to include individuals connected to a bank; apply related party supervision and regular reporting to the FSA for all banks. (Timing: MT. Authorities: Gov/FSA)
- Corporate governance:
  - Companies Act and Corporate Governance Code (CGC) apply via comply-or-explain; Prime Market listing requires at least one third external independent directors.
  - Progress observable in major and larger regional banks; more than 60 percent of regional banks have audit and supervisory committees.
  - Recommendation: Carry out corporate governance and risk management review of regional and smaller banks to identify deficiencies and target awareness programs. (Timing: I. Authorities: FSA/LFB)

### Operational resilience, cyber, and third-party providers
- Operational resilience initiatives:
  - Specialist teams (e.g., IT Cyber Monitoring Team) located in Risk Analysis Division; industry exercises such as Delta Wall (voluntary cybersecurity exercise) have been running since 2016 and in 2022 covered 160 financial institutions.
  - Incident reporting: incidents must be reported immediately; aggregated data made public annually.
- Interconnection and third-party provider risks:
  - Concerns about banks’ ability to assess third-party service providers and to obtain provider information.
  - Recommendation: Strengthen analysis of operational interconnections through network analysis of common technologies and service providers to identify critical nodes; broaden mapping beyond cyber to operational resilience. Consider regulatory footing to secure banks’ access to third-party service providers and ensure cyber security and operational resilience. (Timing: NT/I. Authorities: FSA/Gov)
- Skills shortages:
  - Scarcity of cyber and IT skills across supervisors and industry.
  - Recommendation: Review options to pay a “risk” premium to scarce skills and invest in supervisory expertise and training. (Timing: I. Authorities: Gov/FSA)

### Audit oversight and external auditors
- Current state:
  - Certified Public Accountants and Auditing Oversight Board established in 2004 as an independent authority under the FSA.
  - FSA lacks preventive supervisory power to reject or rescind appointment of an external auditor prior to appointment.
- Recommendation:
  - Provide FSA with power to reject and rescind appointment of an external auditor who lacks expertise or independence, or who does not adhere to professional standards, as a “safety net” to ensure audit firms’ skills and resources are commensurate with appointing firms. (Timing: MT. Authorities: Gov)

### Selected consolidated recommendations (extracted highlights with timing)
- Make explicit provision in law to ensure priority of financial safety and stability in the FSA mandate. Timing: NT. Authorities: Gov.
- Provide the FSA with power to set and adjust individual bank capital ratios above minimum requirements. Timing: NT. Authorities: Gov.
- Provide a fixed term for the FSA Commissioner and allow organization of staff for an agreed period; ensure longer staff rotations. Timing: NT. Authorities: Gov.
- Review options to pay a “risk” premium to scarce skills (e.g., cyber resilience). Timing: I. Authorities: Gov/FSA.
- Provide a legal gateway for confidential supervisory information exchange between BOJ and FSA without firms’ approval. Timing: NT. Authorities: Gov.
- Ensure on-site visit is part of licensing approvals and follow-up monitoring. Timing: NT. Authorities: FSA.
- Strengthen pre-approval when a major shareholder obtains controlling (>50 percent) interest. Timing: I. Authorities: Gov.
- Implement stricter pre-approval for acquisitions (including ancillary and banking-related business). Timing: I. Authorities: Gov.
- Enhance baseline supervision requirements for all banks, including on-site inspections over a prescribed period. Timing: I. Authorities: FSA.
- Continue to develop the EWS, especially for credit and liquidity risk, and use non-financial information. Timing: I. Authorities: FSA.
- Establish periodic cycle to review and update Supervisory Guidelines (e.g., every five years). Timing: MT. Authorities: FSA.
- Continue to invest and prioritize data analytical capabilities. Timing: I. Authorities: FSA/BOJ.
- Develop a revised supervisory risk methodology to consolidate overall risk assessment for each bank. Timing: I. Authorities: FSA.
- Maintain alignment of BOJ supervisory practices with the FSA. Timing: NT. Authorities: BOJ.
- Recalibrate Prompt Corrective Action regime trigger points in the Order related to Article 26(2) of the Banking Act. Timing: NT. Authorities: Gov.
- Amend the Order to permit FSA to issue a business improvement order to raise capital in a wider range of circumstances (e.g., if a bank could fall within a category within a short period, e.g., 6 months). Timing: NT. Authorities: Gov.
- Broaden definition of related parties and apply related party supervision with regular reporting to FSA. Timing: MT. Authorities: Gov/FSA.
- Establish a minimum liquidity requirement for domestic banks. Timing: NT. Authorities: FSA.
- Strengthen banks’ access to third-party service providers and consider regulatory footing to ensure cyber security and operational resilience. Timing: NT. Authorities: Gov.
- Strengthen operational interconnection analysis through network analysis to identify critical nodes, addressing operational risk and resilience. Timing: I. Authorities: FSA.
- Carry out corporate governance and risk management review of regional and smaller banks. Timing: I. Authorities: FSA/LFB.
- Give FSA power to reject/rescind appointment of external auditors lacking expertise/independence. Timing: MT. Authorities: Gov.

*Source: EXECUTIVE SUMMARY and relevant sections, 1jpnea2024004*

### EXECUTIVE SUMMARY __________________________________________________________________________ 4

### EXECUTIVE SUMMARY

### Scope and purpose
- The FSAP carried out a targeted evaluation of issues relating to the effectiveness of banking supervision and regulation in Japan, focusing on key findings from the 2017 Basel Core Principles (BCP) Detailed Assessment Report (DAR) and the transformation of the supervisory approach by the Financial Services Agency (FSA).
- The 2017 DAR concluded the supervisory framework was generally sound but identified key priority areas to be addressed. This note reviews progress and the shift to a more risk-focused, principles-based supervisory approach.

### Transformation of supervisory approach
- The FSA has initiated a major transformation from checklists to a principles-based, risk-focused engagement.
- The new structure of engagements, supervisory priorities, and expectations have been communicated to and are supported by the industry.
- The change is work in progress; continued development of supervisory guidelines and investment in the joint data project with the Bank of Japan (BOJ) are notable ongoing initiatives.

### Mandate, priorities, and legal framework
- The FSA redefined policy goals, shifting from a narrow focus on “stability” alone to balancing “stability” and “effective financial intermediation,” but the legal mandate needs to confirm the priority of financial safety and stability.
- Recommendation: The primary objective of the FSA should be the promotion of safety and soundness; broader responsibilities should be subordinate and reflected in legal frameworks.

### Human resources and organization
- The FSA needs a cadre of staff sufficient in numbers and range of skills; headcount has increased marginally but remains limited even for major banks.
- Japan supervises three G-SIBs, increasing international expectations on staffing and skills.
- Frequent rotation of staff at senior and junior levels risks undermining skills, experience, and continuity.
- Recommendation: The FSA should be funded and staffed commensurately with its elite technical role; consider fixed term for the Commissioner and longer staff rotations; review options to pay a “risk” premium for scarce skills (e.g., cyber resilience).

### Supervisory methodology, EWS, and data analytics
- The FSA has moved toward a modern, risk-based approach but needs further development:
  - Explore more forward-looking metrics in the Early Warning System (EWS), especially for credit and liquidity risk.
  - Enhance baseline supervision activities to improve minimum understanding of each bank’s risk profile, noting regional/smaller banks may pose detection risks.
  - Develop a revised, more articulated and risk-based supervisory methodology to draw together full risk profiles (including governance, business, strategy), allocate supervisory resources, identify risk trends, and underpin supervisory consistency and quality control.
- Enhanced data analytics are core to the new supervision approach; stress testing, scenario analysis, and ICAAP review are benefiting from increased data focus.
- Recommendation: Continue investment in data access and analytical capabilities, including the joint initiative with the BOJ; the FSA should request necessary datasets and obtain investment to build robust analytical capacity.

### Prudential powers and capital framework
- Two related gaps persist in powers on capital adequacy:
  - The “Pillar 2” power to calibrate capital requirements to a bank’s risk profile and risk management capability is missing.
  - The FSA cannot order a bank to raise capital until it has breached minimum regulatory requirements, constraining proactive intervention.
- Consequence: Supervisory ability to require banks to hold capital in excess of the minimum is limited; this is an outlier compared with peers.
- Recommendation: Provide the FSA with the power to set and adjust individual bank capital ratios above minimum requirements and options to require more capital on a legal basis.

### Liquidity requirements
- Internationally active banks are subject to LCR and NSFR standards; domestic banks have no quantitative minimum liquidity requirement.
- The FSA collects monthly liquidity information on domestic banks using simplified LCR measures and uses EWS for intensified monitoring where needed.
- Risk: Lack of explicit minimum quantitative or qualitative liquidity standards for domestic banks creates potential prudential vulnerability.
- Recommendation: Establish a minimum liquidity requirement for domestic banks.

### BOJ alignment and coordination
- The BOJ examines banks that hold central bank accounts; cooperation with the FSA is evident and enhanced.
- Recommendation: The BOJ should update practices and approaches to remain broadly aligned with the FSA given the FSA’s primary regulator/supervisor role.

### Change of control and acquisitions
- Legislative easing may facilitate domestic consolidation and overseas expansion; this introduces new risk management challenges.
- Recommendation: The FSA must protect the change of control gateway; mandatory approval at the 50 percent controlling threshold (as opposed to notification) is warranted for all classes of shareholders. Strengthen pre-approval process for major shareholders and acquisitions (including ancillary and banking-related businesses).

### Related-party risks and governance
- Introduction of “economic interdependence” improved regime for related party risks.
- Recommendation: Broaden definition of related parties to include individuals connected to a bank; related party supervision and regular reporting to the FSA should apply to all banks.
- Recommendation: Carry out a corporate governance and risk management review of regional and smaller banks to identify deficiencies and target awareness programs.

### Third-party providers, cyber, and operational resilience
- Greater attention needed on risks from third-party service providers amid growing cyber threats.
- Industry access to third-party service provider information may need regulatory or legislative underpinning.
- Recommendation: Strengthen analysis of operational interconnections (network analysis of common technologies and service providers) to identify critical nodes; address operational risk and resilience beyond cyber alone.
- Recommendation: Consider regulatory footing to secure banks’ access to third-party service providers and ensure cyber security and operational resilience.

### Audit oversight
- Recommendation: Provide the FSA with power to reject and rescind appointment of an external auditor lacking expertise or independence or not adhering to professional standards, as a “safety net” to ensure audit firms’ skills and resources are commensurate with appointing firms.

### Summary of selected recommendations (from Table 1)
- Make explicit provision in law to ensure priority of financial safety and stability in the FSA mandate. Timing: NT. Authorities: Gov.
- Provide the FSA with power to set and adjust individual bank capital ratios above minimum requirements. Timing: NT. Authorities: Gov.
- Provide a fixed term for the FSA Commissioner and allow organization of staff for an agreed period; ensure longer staff rotations. Timing: NT. Authorities: Gov.
- Review options to pay a “risk” premium to scarce skills (e.g., cyber resilience). Timing: I. Authorities: Gov/FSA.
- Provide a legal gateway for confidential supervisory information exchange between BOJ and FSA without firms’ approval. Timing: NT. Authorities: Gov.
- Ensure on-site visit is part of licensing approvals and follow-up monitoring. Timing: NT. Authorities: FSA.
- Strengthen pre-approval when a major shareholder obtains controlling (>50 percent) interest. Timing: I. Authorities: Gov.
- Implement stricter pre-approval for acquisitions (including ancillary and banking-related business). Timing: I. Authorities: Gov.
- Enhance baseline supervision requirements for all banks, including on-site inspections over a prescribed period. Timing: I. Authorities: FSA.
- Continue to develop the EWS, especially for credit and liquidity risk, and use non-financial information. Timing: I. Authorities: FSA.
- Establish periodic cycle to review and update Supervisory Guidelines (e.g., every five years). Timing: MT. Authorities: FSA.
- Continue to invest and prioritize data analytical capabilities. Timing: I. Authorities: FSA/BOJ.
- Develop a revised supervisory risk methodology to consolidate overall risk assessment for each bank. Timing: I. Authorities: FSA.
- Maintain alignment of BOJ supervisory practices with the FSA. Timing: NT. Authorities: BOJ.
- Recalibrate Prompt Corrective Action regime trigger points in the Order related to Article 26(2) of the Banking Act. Timing: NT. Authorities: Gov.
- Amend the Order to permit FSA to issue a business improvement order to raise capital in a wider range of circumstances (e.g., if a bank could fall within a category within a short period, e.g., 6 months). Timing: NT. Authorities: Gov.
- FSA to supplement/amend Supervisory Guidelines clarifying principles to move directly to issuing a BIO under Article 26 to avoid undue delay. Timing: NT. Authorities: FSA.
- Broaden definition of related parties and apply related party supervision with regular reporting to FSA. Timing: MT. Authorities: Gov/FSA.
- Establish a minimum liquidity requirement for domestic banks. Timing: NT. Authorities: FSA.
- Strengthen banks’ access to third-party service providers and consider regulatory footing to ensure cyber security and operational resilience. Timing: NT. Authorities: Gov.
- Strengthen operational interconnection analysis through network analysis to identify critical nodes, addressing operational risk and resilience. Timing: I. Authorities: FSA.
- Carry out corporate governance and risk management review of regional and smaller banks. Timing: I. Authorities: FSA/LFB.
- Give FSA power to reject/rescind appointment of external auditors lacking expertise/independence. Timing: MT. Authorities: Gov.

- Timing key: I Immediate (within 1 year); NT Near Term (within 1-2 years); MT Medium Term (within 3−5 years).

*Source: EXECUTIVE SUMMARY, 1jpnea2024004*

### INTRODUCTION

### INTRODUCTION

### Scope and Approach
- The note was prepared in the context of the FSAP mission to Japan from September 19 to October 6, 2023.
- Purpose:
  - Presents FSAP findings and recommendations focused on banking supervision and regulation.
  - Topics selected primarily according to the findings of the full assessment of the 2017 Basel Core Principles (BCP) assessment, the IMF’s policy on the matter, and the Japanese authorities’ views.
  - Considers supervisory reforms undertaken by the FSA from 2018 to establish a more risk-based, forward-looking approach.
- Coverage and limitations:
  - This note is not a detailed assessment report and does not give grades on compliance or revise the grades given in the 2017 BCP assessment.
  - A review of the progress achieved in addressing the main recommendations from the 2017 assessment is included (see Appendix I).
  - Focuses on the prudential supervision of deposit-takers that are supervised by the FSA for prudential matters.
- Basis of analysis:
  - Based on the regulatory framework in place and the supervisory practices employed as of October 2023.
  - Draws on review of regulations and supervisory guidance, meetings with Japanese financial regulators, Bank of Japan, and review of their joint responses to questionnaires.
  - FSAP team also met with representatives from banks, external auditors, consultants, and industry associations.
- Acknowledgement:
  - The FSAP team appreciated cooperation from the authorities, in particular the FSA, which was the main counterpart.

### Financial Sector Structure
- Key statistics and structure:
  - Total assets of the Japanese financial sector stood at approximately 6.6 times GDP at end-2022.
  - The banking sector accounts for about 60 percent of the financial system.
  - Three Global Systemically Important Banks (G-SIBs) hold about half of the banking system assets and a third of the financial system assets.
  - Japan’s insurance sector is the third largest in the world, accounting for about 12 percent of the financial system.
  - The Japanese securities market had a capitalization of 11 percent of GDP in 2022.
  - Investment funds have grown since the last FSAP and represent the third largest sector of nonbank financial intermediaries (NBFI).
  - Japan has three domestic central counterparties (CCPs), including one of the top ten global CCPs.
- Banking market composition and players:
  - Three “mega banks” with extensive international operations: Mizuho Bank, MUFG Bank, Sumitomo Mitsui Banking Corporation (classified as G-SIBs).
  - Four domestically systemically important banks (D-SIBs) designated in 2015: Sumitomo Mitsui Trust Holdings, Norinchukin Bank, Daiwa Securities Group, and Nomura Holdings.
  - Norinchukin Bank is supervised by the FSA together with the Ministry of Agriculture, Forestry, and Fishery under the Norinchukin Bank Act; the FSA retains sole responsibility for setting soundness standards and conducting on-site inspections related to credit extended to individuals.
  - Japan Post Group accounts for about 12 percent of the banking sector and 22 percent of the life insurance sector.
  - Nine “major” banks in total, including the three G-SIBs.
  - Regional banks are grouped into two associations:
    - Regional Banks Association of Japan (Regional banks I): 62 member banks.
    - Second Association of Regional Banks (Regional banks II): 37 members.
    - One regional bank is a member of neither association.
  - There are 399 Shinkin banks and credit cooperatives, of which 247 Shinkin banks hold current accounts at the Bank of Japan.
- Market concentration observation:
  - While the mega banks are dominant, the domestic Japanese banking market is not as concentrated as in several other jurisdictions with G-SIBs; regional banks, Shinkin banks, and credit cooperatives are important sub-sectors.

### Institutional Setting — Mandate, Supervisory Objectives, Organization and Powers
- FSA mandate and objectives:
  - Historically sought to achieve three missions under Article 3 of the Act on the Establishment of the Financial Service Agency: (i) ensuring financial stability, (ii) promoting consumer protection (including safety for bank depositors), and (iii) maintaining market integrity and transparency.
  - In 2018, FSA announced reforms to incorporate more growth-oriented objectives, balancing financial stability and depositor protection with goals of effective intermediation, better services, and market vigor.
  - The 2018 reform aimed to underpin a more forward-looking, proactive, and risk-based supervisory approach.
- Recommendation on legal clarity:
  - The FSA’s revised objectives are not explicitly stated in law. It is recommended that the FSA be strengthened by making explicit provision in law to confirm the priority of financial safety and stability.
- Organizational changes:
  - Internal reorganization into three bureaus: Strategy Development and Management Bureau, Policy and Markets Bureau, and the Supervision Bureau.
  - Restructure set out in the Cabinet Order for the Organization of the Financial Services Agency (No. 392 of 1998, as most recently amended in 2019).
  - Internal delegated decision-making system retained.
- Powers and limitations:
  - Powers and authorities substantively unchanged following reforms; FSA broadly well equipped with a suite of graduated powers necessary for supervision.
  - Gaps persist in the area surrounding capital adequacy:
    - The FSA cannot issue a direct order to increase capital until a bank has breached a minimum threshold.
    - The “Pillar 2” power to calibrate a capital requirement to a bank’s risk profile and risk management capacity is missing.
    - Given these gaps, Japan is an outlier relative to its peers.
  - Under the Banking Act, the Prime Minister grants powers; delegation to the Commissioner of the FSA is set out under Article 59(1) of the Banking Act, with exclusions confirmed in the Order for Enforcement of the Banking Act (Cabinet Order No. 40 of 1982, Article 17).
  - Six items are iterated in the Cabinet Order covering licensing and revocation of a bank and a bank holding company, publication in the official gazette related to revocation, and formal notification requirements to the Minister of State for Financial Services regarding revocations and authorizations of bank holding companies.
  - Cabinet Orders relating to the FSA are drafted by the FSA.
- Decision-making practice:
  - Banking Act powers not delegated to the FSA Commissioner are exercised by the Minister for Financial Services, though preparation of authorization and revocation decisions is undertaken by the FSA.
  - In practice, the FSA has a de facto veto over new entrants via informal gatekeeping and close dialogue with applicants.

### Independence and Resources
- Institutional status and budget:
  - The FSA is an external agency of the Cabinet Office; staff are government officials and its budget allocation comes from the national budget.
  - FSA funding is part of the national budget debated in the Diet, not subject to separate parliamentary scrutiny.
- Staffing and resourcing:
  - There has been a modest increase in headcount since 2017, with uplift directed towards divisions focusing on major banks.
  - FSA can travel to overseas locations of major banks, attend international meetings, and has embarked on a data integration and upgrade program.
  - Investment in training resources available online and on-demand for staff.
- Numerical staffing details:
  - A little over a quarter of the FSA’s staffing (around 450 out of 1,650 in FY 2024) is assigned to the Securities and Exchange Surveillance Commission and the Certified Public Accountants and Auditing Oversight Board.
  - The remaining 1,200 staff are deployed across regulation and supervision—both prudential and conduct—for banking, insurance, and securities firms, with banking assigned the lion’s share.
  - Banking supervision resources are supplemented by around 340 staff in the BOJ’s Financial System and Bank Examination Department, and staff dedicated to banking supervision (circa 100) in the Local Finance Bureaus.
- Resourcing challenges and recommendations:
  - The FSA’s complement of staff, even for major banks, is not generous; the risk-based approach rightly prioritizes the G-SIBs and major banks, but regional banks warrant more resources than the FSA can reasonably devote.
  - The FSA has attracted risk experts despite government pay scales, but employees are generally expected to return to industry, creating confidentiality sensitivities and limiting long-term transfer of skills.
  - The FSA does not deploy external parties to assist supervisory activities due to confidentiality constraints; authorities should find options to manage confidentiality that allow fuller use of resources.
  - Need to accrue a cadre of staff sufficient in numbers and range of skills; may need options for providing “risk premiums” for scarce skills such as cyber resilience and better operational modes to utilize staff who may return to private sector practice.
- Personnel management constraints:
  - The FSA Commissioner has authority over personnel management of staff whose position is equivalent to or lower than Director (Article 55-1, National Public Service Act).
  - Rotation of staff is widespread; frequent rotation can impede build-up of in-depth experience and institutional memory.
  - At the time of the FSAP, the FSA was on its fourth Commissioner since 2020; frequent turnover at the head may impede cohesion and development of the organization and its international standing.

### Interagency Cooperation
- Coordination and preparedness:
  - The FSA has coordination, collaboration, and information sharing arrangements at domestic and international levels.
  - Supervisory Colleges and Crisis Management Groups are in place for the three G-SIBs and for one D-SIB.
  - In 2020, the FSA established the "Recovery and Resolution Planning Office" in the Supervision Bureau to help coordinate and centralize interagency information for crisis readiness efforts.

*Technical Note prepared by Katharine Seal (IMF) and Wayne Byres (IMF Expert and former Chair of the Australian Prudential Regulation Authority).*

### 21.      Information sharing between the FSA and BOJ on supervisory matters appears to be

### 21.      Information sharing between the FSA and BOJ on supervisory matters appears to be effective but could be made stronger.

### Information sharing: current state and mechanisms
- Considerable effort undertaken by both organizations in recent years to better coordinate and share information.
- Program of work under the ‘Initiatives for Further Strengthening Coordination between the Financial Services Agency and the Bank of Japan,’ released in March 2021, established the Financial Monitoring Council (FMC).
- FMC objective: achieve more efficient and effective monitoring by sharing information and coordinating monitoring themes and on-site inspection targets.
- Feedback from staff in both the FSA and BOJ indicated a high volume of information flows between the two organizations at multiple levels about supervised banks, attesting to the fluency of the relationship.
- Supervisory planning arrangements are discussed in more detail below (see supervision planning under Section III Supervisory Approach).

### Legal foundations and practical arrangements
- Bank of Japan Act (Clause 3 of Article 44) permits the BOJ, if requested by the Commissioner of the FSA, to submit documents describing results of on-site examinations and related materials to the Commissioner or have FSA officials inspect them.
- Other exchanges of confidential information about individual banks (e.g., BOJ requesting information from the FSA, or either agency proactively providing information) usually require the consent of banks.
- Both organizations indicated bank consent was not difficult to obtain (example: in the case of the BOJ, it is a standard consent in the agreement under which they undertake on-site examination), so in practice consent requirements did not present a major barrier to effective information exchange.

### Identified weaknesses and suggested legal reinforcement
- The legal foundations for information sharing are incomplete.
- Recommendation (policy option): legislative amendment to provide a statutory foundation for information to flow between the FSA and BOJ without first needing the consent of banks.
- Suggested enhancement to the framework: make it an obligation for each agency to share information with the other if the agency in receipt of information had reasonable grounds for considering that it would be of material interest to the other agency.
- Rationale: would place the FSA and BOJ on par with international peers and ensure no doubt about ability to pool information and coordinate effectively in the event concerns arise.

### Licensing and change of control—key findings
- Since 2017, three successful applicants approached the FSA (plus cases where banks with an existing license changed their business model from traditional to non-traditional), representing emerging, innovative, and online business models.
- Extensive contact between applicant and FSA prior to formal application often yields submission packs that essentially already meet approval criteria.
- Observations: FSA placed significant emphasis on systems of new entrants, but had not undertaken independent testing such as an on-site examination; no systematic process of close observation over the first year of operation.
- Japanese licensing failsafe: a bank must achieve profitability within three years.
- Recommendation: at minimum, FSA should conduct an on-site visit prior to granting authorization and maintain close observation through follow-up to confirm documentary submissions are substantiated and the new entrant is sound and orderly.

### Measures supporting regional bank consolidation
- Act on special measures for the anti-monopoly act for regional banks: 10-year window for merger or integration between regional banks, exempting merger from anti-monopoly act if new merged bank judged to better serve local communities.
- Temporary grant scheme for regional banks merging or integrating to strengthen business foundations: running for 5 years from 2021, subsidizes some initial merger costs.
- BOJ measure introduced in 2021: Special Deposit Facility to Enhance the Resilience of the Regional Financial System—additional (“extra”) interest rate paid on BOJ deposits by regional and Shinkin banks undertaking initiatives to strengthen business foundations (e.g., by reducing overhead ratio).
- BOJ discloses the regional banks that have received the extra interest but does not publicly disclose the number of regional banks that meet the requirements.

### Change-of-control and acquisition framework—rules and vulnerabilities
- Notification of shareholding in a bank triggered by a 5 percent threshold, as well as any subsequent changes (Banking Act Articles 52-2-11 and 52-3).
- Approval required to become a major shareholder (Article 52-9). Threshold set at 20 percent control of voting rights but is 15 percent under some circumstances.
- Above 50 percent, notification or approval processes apply depending on whether change of control/acquisition is triggered by a bank (or bank holding company (BHC), or company seeking to become a BHC). Example: a bank seeking to obtain control of another bank (raising its holding from 20 percent to over 50 percent) requires approval (Banking Act Article 16-2 (4)).
- A post-facto notification requirement applies to all other major shareholders (defined as holding more than 20 percent, who increase their holding to greater than 50 percent; see Banking Act Article 53(2)(ii)).
- The FSA can apply a condition to a major shareholder so that any increase above the 50 percent threshold will require approval; conditionality is not mandatory, not routinely applied, and must be in place before the shareholding crosses the 50 percent threshold.
- Assessment: current system’s strength depends on rigorous operation of approvals at the 20 percent threshold. Potential lapse of time between passing the 20 percent mark and seeking 50 percent could render prior assessments obsolete.
- Concern: if the shareholder is not a bank (or BHC/company seeking to become a BHC), controlling interest could be obtained with no approval and only retrospective notification.
- Recommendation: mandatory approval at the 50 percent threshold warranted for all classes of shareholders.
- Interim recommendation until legislation changes: make all new major shareholders (between 20 and 50 percent) subject to the condition of pre-approval in the future event they wish to pass the 50 percent threshold; if possible, attach same pre-approval condition to all current major shareholders.

### Major acquisitions—scope of review
- Unless a bank intends to acquire a bank as a subsidiary, requirements are largely notification.
- FSA has power to ex ante review major acquisitions by a bank, except acquisitions in ancillary business or banking related business for which pre-approval is not necessary.
- Investments by a bank in another bank, in ancillary business, or related banking business other than acquisition of a subsidiary, domestically or abroad, require prior notification, not prior approval.
- Based on prior notification, the FSA can require a bank to take measures if concerned about potential impact.

### Trends and regulatory changes affecting prudential oversight
- Instances of change of control have more than doubled since the last FSAP, compared with the previous period.
- Major acquisitions increased more than 15-fold over the same time.
- 2021 amendment to the Banking Act permitted foreign bank subsidiaries of Japanese banks to directly acquire consumer lending and leasing companies with “out-of  -scope business lines.”
- Amendment also permits more flexible authorization of banks’ subsidiaries and affiliated companies, facilitating sale of internally developed IT applications and systems, financial technology-related businesses, data analysis, marketing and advertising.
- Regulatory caution: diversification into such activities may boost income and growth but risks need careful monitoring domestically and overseas as banks expand beyond traditional competencies.

### Recommendations (Section E)
- Make explicit provision in the law to ensure the priority of financial safety and stability in the mandate of the FSA, in keeping with current policy and practice.
- Provide the FSA with the power (“Pillar 2” power) to set and adjust individual bank capital ratios (above the minimum requirements) in response to either a bank’s heightened risk profile or deteriorating financial position.
- Raise the thresholds set out in the Prompt Corrective Action regime. That is, recalibrate the trigger points for action in Cabinet Order in relation to Article 26(2) of the Banking Act.
- Amend the Order to Define the Categories Prescribed in Article 26 Paragraph (2) of the Banking Act to permit the FSA to issue a business improvement order to raise capital in a wider range of circumstances than currently prescribed, e.g., if it has reasonable grounds for believing a bank could fall within one of the categories within a short period of time (e.g., 6 months).
- Provide a fixed term for the appointment of the FSA Commissioner. Give the Commissioner the right to organize his staff for an agreed period (e.g., 5 years with option to stay on if individual agrees). Ensure longer staff rotations at senior and junior levels in recognition of the specialist nature of the agency and the need for the FSA to retain international standing. Also ensure that handover of responsibilities are managed effectively to maintain continuity.
- Review options to pay a “risk” premium to scarce skills that are key for the FSA (e.g., cyber resilience).
- Provide a legal gateway to ensure exchange of confidential supervisory information between the BOJ and FSA (and vice versa) for the purposes of executing the institutions’ supervisory and stability mandates, and without the requirement for banks’ approval.
- Ensure on-site inspection forms part of licensing approvals as well as close observation in the follow-up monitoring process.
- Strengthen the pre-approval process when a major shareholder obtains a controlling (over 50 percent) interest to ensure an up-to-date understanding.
- Implement a stricter pre-approval for an acquisition as already provided for in the case of subsidiaries. Expand the scope for approval of acquisitions to include acquisition of ancillary business and banking related business.

### Supervisory approach—transformation and remaining gaps
- 2018 FSA reforms: shift from backward-looking, compliance-based checklists to a modern supervisory approach based on substantive, forward-looking, and holistic analysis and judgment; align regulation, supervision, and enforcement with goal of contributing to national welfare.
- Previous approach: comprehensive checklists, prescriptive requirements, heavy loan-by-loan review and compliance checks, limited supervisory discretion—legacy of 1990s banking crisis.
- Transformation required changes to supervisory policies, procedures, data collection, forms of engagement with banks, quality assurance mechanisms, and staff skills/culture.
- FSA view: five years on, the new approach is fully implanted, though specific tools and techniques continue to evolve.

### Cultural and operational challenges
- Establishing the right supervision mindset (shifting to greater exercise of judgment) was possibly the hardest component; extensive training and guidance provided, but continued investment required to make culture change permanent.
- Need for psychological safety: banks must be confident FSA will respond in a balanced manner when problems are revealed.
- FSA routinely seeks feedback (including anonymous third-party surveys); published survey results indicate a high degree of support from the banking sector for the new approach.

### New supervisory approach—features and further strengthening
- Shift to a more modern, risk-based approach: forward-looking, risk-focused, differentiated supervision by bank size.
- Active supervisory judgement encouraged; horizontal reviews used more actively; investment in data analytics to support changes.
- Industry feedback: engagement and dialogue welcomed; FSA seen as approachable and communicative though still “stringent” in expectations. Bank management acknowledges accountability for prudent, sustainable operation.
- Areas for continued strengthening: increase intensity of supervision for regional banks; improve data analytics; enhance EWS; develop a revised supervisory risk methodology.
- Some improvements (e.g., EWS, revised supervisory risk methodology) could be implemented without additional staff, while others (e.g., data analytics, higher intensity for regional banks) will be challenging without more resources.

*JAPAN — INTERNATIONAL MONETARY FUND*

### 39.      The BOJ should also ensure that its practices and approach remain broadly aligned

### 39.      The BOJ should also ensure that its practices and approach remain broadly aligned with the FSA given the latter’s role as the primary regulator and supervisor of the banking sector.

### Alignment between BOJ and FSA
- The BOJ is not formally a regulator and conducts supervision activities with different objectives, but there is considerable overlap between the interests of the two organizations.
- When the FSA substantially overhauled its supervisory approaches in 2018, there were no similar reforms to the BOJ’s supervisory activities, although the BOJ’s existing risk-based structure and long history of cooperation position it well.
- Supervision of banks will be both more effective and more efficient if supervisory practices are aligned to the maximum extent possible.
- Recommendation: The BOJ should ensure that it continually updates and tailors its own approaches to remain broadly aligned with the evolution of practices at the FSA.

### Organizational Structure
- Organizational changes in the FSA since the previous FSAP produced more integrated oversight of banks.
- Previous structure: strong delineation between on-site inspections (Inspection Bureau) and interviews/dialogue with banks (Supervision Bureau).
- New structure: supervision activities split between the Supervision Bureau and the Strategy Development and Management Bureau with much greater cooperation and collaboration.
- The Risk Analysis Division (RAD) of the Strategy Development and Management Bureau plays a central role: active partner in supervision of the largest banks and provider of data analytics and risk expertise to the Supervision Bureau.

### Supervision Planning
- Both FSA and BOJ publish supervision priorities annually; BOJ fiscal year begins April; FSA supervisory year begins July.
- High degree of coordination via joint FSA-BOJ committees (biannual Financial Monitoring Council; quarterly Coordination Meeting for on-site inspections and examinations).
- BOJ average examination cycles (adjustable):
  - Mega banks: every three years (i.e., one mega bank per year)
  - Other major banks, regional banks and foreign banks: every five years
  - Shinkin banks: every seven years
- Cycles can be shortened or scope adjusted based on bank’s risk profile, capital adequacy, profitability, and systemic impact.
- FSA tailoring by bank size/risk:
  - Four peer groups with different supervisory methodology.
  - Nine major banks: most highly structured and intensive supervision.
  - Around 100 regional banks.
  - 399 Shinkin and other small banks.
  - 56 foreign banks.
  - Respective shares of banking sector assets: about 50 percent, 30 percent, 15 percent, and 5 percent.
- Largest nine banks: structured annual supervision cycle (July to June).
  - August: each major bank provided with a supervision plan.
  - June (following year): bank receives a formal feedback letter (typically 20-30 pages long), personally delivered at meeting between a Director-General of the FSA and the CEO.
- Supervision plans are adjusted as needed mid-year (e.g., response to the failure of SVB and Credit Suisse in March 2023).
- Regional banks: less rigid approach; no individual supervision plan or end-of-cycle feedback letter; supervisors determine activities guided by FSA priorities, Early Warning System (EWS), and horizontal reviews.
- Shinkin and other small banks: day-to-day supervision primarily by Local Finance Bureaus (LFBs) under delegated authority; 10 LFBs perform bulk of inspection and liaison functions.
- Foreign banks: lightest supervision; most operate as branches; supervision largely off-site; on-site inspections averaged 1-2 per annum since 2014-15 after a horizontal review program in 2014-15.

### Supervision Intensity and the Early Warning System (EWS)
- Largest banks: close and continuous supervision; dedicated supervisors in regular (usually daily) contact; RAD heavily involved in day-to-day supervision.
- EWS purpose: identify banks with financial metrics that could indicate potential problems, allowing early allocation of supervisory resources.
- EWS composition: four sets of metrics covering credit risk, stability (market risk and interest rate risk in the balance sheet), cash flow (liquidity), and profitability.
- EWS data update frequencies:
  - Liquidity and market risk data: monthly
  - Credit risk data: half-yearly
  - IRRBB data: quarterly
  - Profitability data: annually
- Profitability EWS involves forecasting profits over a five-year time horizon under current trends and alternative scenarios if trends are adverse.
- Supervisors use EWS outputs (type and number of flags) to guide supervisory response; a hearing is always conducted when a bank triggers the EWS.
- Limitations noted:
  - Credit and liquidity EWS use simple balance sheet ratios (lagging indicators).
  - No metrics within the EWS attempt to capture non-financial risks (e.g., poor governance, risk management, internal controls), although such information is assessed elsewhere.
- Recommendation: FSA should explore development of more forward-looking metrics, especially for credit and liquidity risk. Suggested metrics include:
  - Extent of higher-risk lending
  - Loans in arrears but not yet non-performing
  - Adequacy of provisioning coverage
  - Greater focus on sources of liquidity and potential future cash flows
  - Consideration of non-financial metrics such as customer complaints and operational outages
- Recommendation: FSA could examine early warning systems used by peer authorities to draw from best practice.

### Supervisory Tools and Activities
- FSA’s supervisory toolkit is largely aligned with modern risk-based approaches used in peer countries: mix of on-site and off-site supervision.
- FSA seeks close and continuous supervision, particularly for the largest banks, with routine communication and collection/analysis of financial and business information; on-site inspections directed where more intensive examination required.
- Supervisory Guidelines (SGs): extensive and outcomes-focused; old inspection manuals abolished and replaced with SGs that guide questions supervisors will consider without prescribing how banks should run their businesses.
- Supplementary materials (discussion papers, other publications) supplement SGs but risk growing in volume and obscuring total expectations.
  - Recommendation: commit to a periodic update of the SGs (e.g., every five years) to incorporate and/or repeal supplementary material.
- Increased use of horizontal (thematic) reviews to support consistent supervisory assessments; recent examples include credit risk management of domestic leveraged buy outs (LBOs), internal ratings and provisioning practices, risk-taking investment policy, model risk management, overseas project finance, and foreign currency liquidity management.
- Offshore monitoring: FSA and BOJ monitor offshore operations of largest banks; FSA restarting offshore visits paused during COVID-19; FSA collects data specific to overseas offices; BOJ’s examinations also cover major overseas offices.
- FSA does not outsource supervisory work to external parties; when additional technical expertise is needed, FSA seeks to hire such expertise directly on short-term contract as effectively FSA employees during assignment.
  - Note: this approach can be difficult given resourcing constraints.

### Data-Driven Planning and Analysis
- FSA has established the Macro-financial Stability and Data Strategy Office within RAD to increase value from supervisory data and analysis.
- Comprehensive stress testing program components:
  - Joint annual stress test with BOJ applying a common economic scenario across a select group of major banks. The fact the stress test is conducted is public but results are not published; the BOJ’s Financial System Report provides analysis of its macro stress tests.
  - Banks asked to apply the FSA-BOJ common scenario to their own stress testing models for comparison and assessment of banks’ stress testing capabilities and assumptions.
  - Under ICAAPs, large banks conduct annual stress tests; FSA reviews and analyzes results.
  - For regional banks, FSA reviews internal stress tests and encourages improvements where EWS indicates potential problems.
  - FSA developing additional scenario analysis capabilities to test specific risk categories (e.g., deterioration in credit risk, market risk shock).
- Data access and platform initiatives:
  - FSA expanding access to more granular datasets from banks and greater use of third-party datasets.
  - FSA and BOJ developing a common data platform to allow banks to submit datasets once to both agencies and reduce redundant reporting while enabling access to more granular, transaction-level data on corporate loans.
- Recommendation: FSA must continue to invest in data analytical capabilities, including:
  - Expanded access to data
  - Sufficient budget for up-to-date infrastructure (databases and analytical tools)
  - Advanced data analysis skills among staff
  - Foster a culture of data-driven supervision across the supervisory cadre
- Note: FSA maintains a long-standing public commitment (contained in its SGs) to limit the supervisory burden of information collection.

*Source: 1jpnea2024004 - 39.      The BOJ should also ensure that its practices and approach remain broadly aligned*

### 69.      Unusual amongst risk-based supervisors, the FSA does not utilize a supervisory rating

### 1jpnea2024004 - 69.      Unusual amongst risk-based supervisors, the FSA does not utilize a supervisory rating

### Supervisory ratings, Early Warning System (EWS), and scope of assessment
- Finding: The FSA does not utilize a supervisory rating system to capture its overall supervisory risk assessment for each bank; it discontinued its former risk ratings system when it reformed its supervisory approach.
- Observation: The EWS is used as a partial substitute for a rating system but differs in scope:
  - The EWS is a series of metrics used as an input to a risk assessment and covers only financial metrics.
  - A supervisory rating is typically the output of a broader assessment and would capture qualitative items such as the inherent risk of the bank’s strategy, the strength of governance and management, robustness of risk management, and adequacy of internal controls.
  - The EWS is not a major input into the supervisory strategies of the major banks.
- Historical note: The 2017 FSAP offered recommendations on development of the former system, but the FSA prefers to move forward with new methodologies rather than reinstate the prior ratings.

### BOJ supervisory practice
- Finding: The BOJ employs a supervisory rating system.
- Process: Following an on-site examination, banks are rated with grades assigned to components: financial soundness, profitability, credit risk, market risk, liquidity risk and operational risk.
- Enforcement linkage: If material management issues are identified through BOJ examinations, banks are required to report progress of improvement to the BOJ.
- Coordination: Where necessary, the BOJ would coordinate with the FSA to ensure corrective action.

### Business Improvement Orders (BIOs) and enforcement powers
- Finding: The FSA generally achieves supervisory objectives through persuasion, routine dialogues and hearings; where this fails, it may mandate a Business Improvement Order (BIO) under Article 26 of the Banking Act.
- Delegation and notification:
  - Although the Act states BIOs are to be issued by the Prime Minister, the power is delegated to the FSA (Article 59(1)), which may further delegate to Directors-General of Local Finance Bureaus (Article 59(2)).
  - Issuance of a BIO must be notified to the Minister of Finance (Article 57-6); consultation may be required if maintenance of an orderly credit system could be materially affected (Article 57-5).
- Publication: BIOs may be published if deemed to serve the public interest; most BIOs made under Article 26 have been made public.
- Legal recourse: Banks may make submissions or hearings under the Administrative Procedure Law and may seek examination under the Administrative Complaint Review Act or file a lawsuit under the Administrative Case Litigation Act; the FSA advised there have been no recent examples of such appeals.
- BOJ: The BOJ has no formal enforcement powers; its capacity to enforce derives from access to BOJ current account services.

### Cabinet Order, capital-related BIOs, and corrective-action triggers (Table 2)
- Finding: The FSA’s ability to proactively require capital increases is constrained by a Cabinet Order (Order to Define the Categories Prescribed in Article 26, Paragraph (2) of the Banking Act) that ties capital-related BIOs to quantitative triggers.
- Key elements from Table 2 (Capital Ratio Action):
  - Category 1
    - Total Capital Ratio of 4% to less than 8%
    - Action: Order to submit a capital improvement plan that is acceptable to the FSA, and an order to implement the plan.
  - Category 2
    - Total Capital Ratio of 2% to less than 4%
    - Action: Order to pursue some or all of the following measures: (i) submission of acceptable capital enhancement plan; (ii) prohibition on dividends or bonuses, or restraint on amount thereof; (iii) reduction in assets, or limits on asset growth; (iv) prohibition or restriction on acceptance of deposits; (v) reduction in services at some business offices; (vi) elimination of some business offices; (vii) reduction of services incidental to core banking; (viii) reduction in services of subsidiary company, and/or sale of shares in subsidiary company; and/or (ix) other measures deemed necessary by the FSA Commissioner.
  - Category 2-2
    - Total Capital Ratio of 0% to less than 2%
    - Action: Order for drastic reduction in services; merger; discontinuation of banking services.
  - Category 3
    - Total Capital Ratio less than 0%
    - Action: Order to suspend banking services in whole or in part.
- Additional notes:
  - Capital triggers exist both on a consolidated and non-consolidated basis and include scaled triggers for Tier 1, CET1, and leverage ratios.
  - For domestic (non-internationally active) banks, a separate scale is applied based on a “core capital” ratio (broadly, CET1).
  - Effect: For banks with international business, BIO capital triggers are set at the level of Basel minimum requirements (and broadly equivalent levels for smaller banks). A BIO cannot require capital raising unless various triggers are hit (i.e., the bank falls below the minimum requirements).

### Implications of the Cabinet Order and corrective approach limitations
- Finding: The Cabinet Order delays formal direct action on capital enhancement until minimum capital ratios are breached.
- Comparison:
  - This delay contrasts with the Basel capital conservation framework and Prompt Corrective Action regimes used by many other supervisors, which aim to act before minimum requirements are breached.
- FSA compensatory measures and limitations:
  - The FSA relies on indirect means (increased reporting under Article 24, restrictions on business under Article 26) and its persuasive authority to generate corrective action prior to breaches.
  - If responses are slow or inadequate and triggers have not been breached, the FSA can impose operational constraints (e.g., reduce risk limits, restrict higher risk loan portfolios) that affect the denominator of the capital ratio rather than directly increasing capital.
  - Intense monitoring and intervention under Article 26(1) may not be well suited to rapidly deteriorating situations where there is insufficient time for measures to stabilize the bank.
- Conclusion: The FSA’s direct ability to ensure banks’ ongoing capital adequacy needs to be strengthened; legislative amendment is required to provide the FSA with a full suite of capital powers and appropriate thresholds.

### Strengths, operational observations, and resourcing
- Strengths:
  - Emphasis on banks taking ownership of remediation and the FSA’s ability to communicate clear messages and execute orderly follow-ups.
  - Clear escalation process: supervisory dialogue, more intensive supervision, hearings, then formal powers; FSA can immediately issue a BIO under Article 26(1) when required.
- Operational challenges:
  - Emphasis on supervisory dialogue can delay issuance of a BIO, potentially losing valuable time for rectification when speed is critical.
  - Resources for supervisory relationships with regional and smaller banks are stretched thin, making corrective actions more likely to be reactive and less timely.
- Mitigants:
  - Enhancing data, the EWS, and developing a revised supervisory risk methodology will assist the FSA in identifying potential concerns earlier, absent enhanced resourcing.
- Reference: The Comprehensive Guidelines for Supervision of Major Banks (June 2021), II-5 -1 Basic Workflow for Administrative Action (Adverse Action) describes the workflow for executing major adverse actions such as issuing a BIO and process for requesting reports under Article 24 prior to issuing a BIO.

### Recommendations (supervisory practice, methodology, and capital powers)
- Supervisory practice and approach (selected recommendations):
  - Given that the Early Warning System does not capture all risks, the FSA should enhance its baseline supervision requirements for all banks to improve a minimum level of supervision activity (including on-site inspections) is undertaken over a prescribed period of time.
  - The FSA should be encouraged to continue to invest in its data analytical capabilities.
  - The FSA should consider the development of its own supervisory risk methodology to strengthen its existing supervisory framework.
  - The FSA should continue to develop the EWS, especially for credit and liquidity risk, to ensure more forward-looking metrics, and make more use of non-financial information for supervision.
  - The FSA should establish a periodic cycle to review and update the SGs (e.g., every five years) to incorporate and/or repeal supplementary material as necessary.
  - The BOJ should maintain alignment of its supervisory practices and approach with the FSA.
  - The FSA’s ability to ensure banks’ ongoing capital adequacy should be strengthened. The following measures are strongly urged and the first is essential for compliance with the Basel framework:
    - Provide the FSA with the power (“Pillar 2” power) to set and adjust individual bank capital ratios (above the minimum requirements) in response to either a bank’s heightened risk profile or deteriorating financial position.
    - Raise the thresholds set out in the Prompt Corrective Action regime. That is, recalibrate the trigger points for action in Cabinet Order in relation to Article 26(2) of the Banking Act.
    - Amend the Order in relation to Article 26 Paragraph (2) of the Banking Act to permit the FSA to issue a business improvement order to raise capital in a wider range of circumstances than currently prescribed, e.g., if it has reasonable grounds to believe a bank could fall within one of the categories within a short period of time (e.g., 6 months).
  - The FSA should supplement or amend its Supervisory Guidelines to clarify the principles under which it would reserve the right to move directly to issuing a BIO under Article 26, in order to avoid undue delay in applying appropriate corrective action.

*Source: 1jpnea2024004.*

### 88.      As discussed above, under the current legal framework (Table 3), the FSA does not

### 1jpnea2024004 - 88.      As discussed above, under the current legal framework (Table 3), the FSA does not

### Pillar 2 powers and capital supervisory remit
- The FSA does not have complete Pillar 2 powers: it lacks the “ability to require banks to hold capital in excess of the minimum.”
- The FSA requires major and regional banks to submit Internal Capital Adequacy Assessment reports (ICAAPs).
- The FSA assesses the ICAAPs submitted by the major 9 banks and will enter into a supervisory dialogue as needed.
- If the FSA considers a bank’s regulatory capital to be insufficient for its risk profile and capability, additional capital cannot be formally required; the FSA must rely on persuasion and encouragement.
- Absent formal compulsion, a difference of view between a bank and the FSA means the power of compulsion is missing.

### Capital supervisory approach and corrective powers
- Supervisory approach focuses on conserving the supply of capital rather than requiring fresh capital.
- Due to the corrective action system, the FSA cannot require more capital until minimum capital thresholds have been breached.
- The FSA has clear powers to require banks to:
  - suspend business lines,
  - dispose of high-risk assets,
  - conserve dividends.
- The FSA’s powers are concentrated on the denominator (risk-weighted assets / balance sheet adjustments) rather than the numerator (fresh capital injections).
- The Early Warning System (EWS) provides forward-looking insight and enables early deployment of powers to protect capital, but fresh capital injections act more quickly than de-risking the balance sheet.
- If persuasive (“soft”) powers succeed, obtaining more capital is the swiftest remedy; if a bank is reluctant, fallback legal powers act more quickly.

### Recommendation on introducing Pillar 2 powers
- Past FSAPs have recommended furnishing the FSA with powers to require banks to increase capital or to operate at a higher minimum capital ratio.
- Introducing such powers would be a major change and a cautious, phased approach could be considered:
  - focus first on the G-SIBs,
  - followed by the D-SIBs and other internationally active banks,
  - then to other institutions.
- Corresponding Cabinet Order specifying the corrective action regime for capital-related matters would need amendment to allow a phased approach.
- The FSA could update its Supervisory Guidelines (SGs) to explain its philosophy, decision-making framework, and criteria for additional capital add-ons to give confidence to the industry.
- Law should enable but not constrain supervisory discretion; requiring a bank to raise capital will be occasional and likely in a tight timeframe, whereas adjusting minimum capital requirements to a bank’s full risk profile should be standard practice.

### Capital standards (excerpt from Table 3)
- Minimum Ratio:
  - CET1 Ratio ≥ 4.5 percent
  - Tier 1 Ratio≥ 6 percent
  - Total Equity Ratio≥ 8 percent
  - Core Capital Ratio ≥ 4 percent
- Note: Banks adopting the Internal Ratings-based Approach (IRB) must meet the Basel CET 1 ratio.
- Risk Weighted Assets: Basel Framework (with national discretion and transitional measures based on international agreements may apply).
- Source: FSA (as shown in Table 3).

### Credit risk supervision and provisioning
- Supervisory approach shifted from compliance checking and the Inspection Manual to supervisory judgement and assessment of banks’ own credit risk processes.
- Horizontal reviews and FSA Progress Reports provide feedback to industry; example: provisioning for a group of industries affected by the COVID-19 crisis.
- Provisioning under current accounting standards in Japan remains based on the incurred loss approach.
- The now abolished Inspection Manual had fostered uniform loan loss provisioning but inhibited forward-looking perspective.
- The new supervisory approach encourages forward-looking perspectives while acknowledging banks may continue existing accounting practices.
- As of March 2022, only around 5 percent of banks were using an Expected Loss provisioning approach.
- The FSA encourages banks to identify and assess future credit risks in loan classification, write-offs and provisioning, supervision and monitoring.

### Large exposures and concentration risk
- The FSA has implemented the Basel Committee framework for large exposures since the last FSAP; Japan was assessed under the Basel RCAP in 2022 and made further amendments to national implementation.
- RCAP assessment: implementation largely compliant with findings under scope of application and value of exposures.
- RCAP findings included:
  - some securities groups (final designated parent companies) designated as internationally active and as D-SIBs were not subject to the large exposure (LEX) framework while subject to other Japanese regulatory standards.
  - calculation of exposure values of swaps, futures, forwards, credit derivatives and options in the trading book under Japanese LEX regulations is not clearly specified.
- Authorities have been amending regulatory treatment in light of RCAP; changes will come into force in 2024.
- Connected counterparties and economic interdependence are now recognized; SGs updated in 2019 and broadened under the LEX framework to capture economic interdependence (e.g., reliance on third-party profit generation or guarantees, network chain-of-default).
- Only internationally active banks are required to identify economic interdependence; exposures are reported to the FSA when greater than 10 percent of Tier 1 capital.
- Other concentration limits are not imposed; exposure for the top 20 counterparties is reported to the FSA.
- Supervisory practice example: FSA examined the top 100 exposures held by regional banks (data received on a 6 monthly basis); the RAD is considering obtaining the entire exposure list on a quarterly basis.

### Related party risks
- Article 13-2 of the Banking Act prohibits transactions not on an arm’s length basis regardless of whether the counterparty is related; exceptions require prior FSA approval.
- The updated related party framework identifies related parties mostly but not wholly as corporate entities and places a risk management onus on banks to identify and manage related party exposures.
- Banks are expected to have limits for maximum related party exposures, but the FSA does not prescribe numeric limits.
- Gap: the definition of related parties does not extend to natural persons other than major shareholders; spouses or children of directors are not identified as related parties under current rules.
- Recommendation: extend the definition of related parties to cover individuals and apply to all banks.
- Reporting related party transactions as an exposure class (as opposed to large exposures) is recommended for monitoring purposes and should apply to all banks.

### Interest Rate Risk in the Banking Book (IRRBB)
- The FSA applies the Basel standard on interest rate risk to internationally active banks (since 2018) and on a simpler basis to domestic banks (since 2019).
- For internationally active banks:
  - full suite of Basel interest rate shocks applied,
  - a ΔEVE in excess of 15 percent of Tier 1 capital is used as threshold for the materiality test.
- For domestic banks:
  - narrower set of shocks applied (parallel up, parallel down and steepening),
  - a ΔEVE in excess of 20 percent of core capital is used as threshold for the materiality test.
- Both thresholds are included in the published Supervisory Guidelines.
- Interest rate risk data is collected and monitored monthly; EWS contains additional measures which may trigger supervisory dialogue even if key thresholds are not exceeded.
- The BOJ also collects and monitors interest rate risk data and engages with banks as necessary.
- The FSA Risk Analysis Division has a team of around ten staff covering IRRBB, traded market risk and liquidity.
- After the March 2023 banking turmoil, the FSA evaluated impacts including:
  - credit losses against Silicon Valley Bank (SVB),
  - holdings of AT1 bonds in Credit Suisse,
  - and the potential capital impact of upward pressure on domestic interest rates.
- Regional banks are primarily monitored through the EWS; the BOJ reported monitoring bank liquidity, capital and changes in the financing environment while keeping close contact with the FSA.

### Liquidity risk and minimum liquidity requirements
- For internationally active banks, the FSA applies the Basel LCR and NSFR standards:
  - minimum LCR requirement applied monthly since March 2015 (all-currencies and major currencies basis),
  - initial minimum LCR at introduction was 60 percent, phased by an additional 10 percentage points annually until reaching 100 percent in 2019.
  - NSFR implemented from September 2021.
  - Banks subject to these requirements must disclose LCR and NSFR quarterly.
  - Basel Committee’s RCAP found LCR and NSFR implementation compliant overall.
- For domestic banks, there is no quantitative minimum liquidity requirement.
  - FSA collects monthly liquidity profile information and uses EWS metrics; it requires banks to report one of two simplified LCR measures.
  - No minimum liquidity requirement is prescribed in the FSA’s regulatory framework.
- Recommendation: The FSA should consider whether the absence of a minimum level of liquidity holdings remains warranted.
  - Domestic banks generally have stable retail deposit funding and relatively large holdings of liquid assets (cash, central bank deposits, JGBs and municipal bonds).
  - The FSA stated it does not believe there are banks with business models similar to SVB in Japan.
  - The absence of a prescribed minimum liquidity is unusual and inconsistent with the Basel Core Principles.
  - A minimum requirement, even if not calibrated high, would provide an important backstop; introduction now would be relatively easy given abundant industry liquidity and low likelihood of binding constraints.

### Operational risk and resilience
- Supervisory expectations for operational risk for major banks are established in the FSA’s supervisory guidelines, currently being updated.
- Provisions on operational risk (SG III-2-3-7-2) are relatively new (not yet translated into English on the FSA website) and are supported by existing SG sections on outsourcing and IT risk.
- Emergence of cyber threats and third-party service provider risks increases importance of these SGs for all banks, including small and regional banks.
- FSA issued discussion papers:
  - IT and Governance paper issued in 2019 (updated in 2023),
  - Operational Resilience paper issued in 2023 (based on international discussions such as the Basel Committee).
- Supervisory Guidance for major banks has been updated based on results of the Operational Resilience discussion paper.
- A monthly FSA newsletter facilitates awareness and includes a meaningful precis of critical content.

*Source: Extracted text from content unit "1jpnea2024004 - 88.      As discussed above, under the current legal framework (Table 3), the FSA does not" (PDF).*

### 108.      The FSA is conscious of the need to assess and raise the skills capacity in the sector,

### 1jpnea2024004 - 108.      The FSA is conscious of the need to assess and raise the skills capacity in the sector,

### Operational resilience, skills, and supervisory tools
- Specialist staff for operational risk and resilience (e.g., the IT Cyber Monitoring Team) are located in the horizontal team in the Risk Analysis Division and are a resource for the entire FSA; in practice a significant proportion of its time is devoted to the banking sector.
- Industry-wide questionnaires and exercises used to educate and focus banks:
  - Cybersecurity Self-Assessment (industry-wide questionnaire).
  - Delta Wall (voluntary industry-wide cybersecurity exercise).
    - Delta Wall has been running for 7 years since 2016 and in 2022 covered 160 financial institutions.
- Local Finance Bureaus (LFBs), who share supervisory responsibility for small and regional banks, can contact the FSA to request cyber experts.
- Data on operational and IT failures:
  - Submitted to the FSA according to a format set out in the SGs.
  - Shared with the cyber team and, in aggregate, made public on an annual basis.
  - Incident reporting rules: an incident must be reported immediately; full details can be provided in due course. Reported information includes area impacted, damage, cause, response by bank, and action taken to prevent recurrence.
- Assessment challenges:
  - Operational Resilience and Operational Risk Management is hard to assess without direct inspection.
  - The FSA is largely reliant on indirect and reactive monitoring techniques, such as incident reporting or loss data.
  - Significant incident or failure to meet standards may lead to a BIO under Article 26 of the Banking Act, with multiple FSA teams (e.g., IT/cyber, corporate governance/risk management, AML/CFT) following up. Formal order issued by a division in the Supervision Bureau; subsequent reports from the bank provided to all teams.

### Skills scarcity and supervisory communication
- Both supervisory authorities and industry face scarcity of skills in the cyber and IT space.
- The FSA has deployed a supervisory communication strategy using discussion papers and a supervisory newsletter to raise the profile of operational resilience and highlight core elements.
- Exercises and questionnaires guide banks to focus on areas needing improvement.
- The report states: "It is essential for this pressure to continue and even increase."

### Third-party providers, interconnections, and critical nodes
- Industry feedback:
  - Some industry professionals indicated foreign banks were surprised that cyber risk/threat was not seen as a chief priority in Japanese banks; review of public documents, including annual reports, supported this view.
  - Concerns about banks' ability to probe and understand cyber protection adequacy in third-party service providers.
- Outsourcing guidance:
  - Banks ought to have suitable access to information if the SG under Outsourcing (III-3-3-4) were fully met.
  - It may be necessary to consider stronger measures (potentially regulatory and including monitoring) to ensure access to information from third-party service providers that may have considerable economic strength and market control.
- Recommendations for interconnection analysis:
  - The FSA is strongly advised, as in the Cyber Technical Note, to further strengthen analysis of how the financial sector is operationally interconnected.
  - For the banking sector this entails developing network analysis of how banks are connected through common technologies and service providers to identify critical nodes.
  - The mapping and analysis of outsourcing should be broader than cyber interconnectedness alone and address operational risk and resilience.

### Governance and risk management (Corporate governance, boards, and supervisory engagement)
- Corporate governance framework:
  - Requirements set out in the Companies Act and the Corporate Governance Code (CGC), enforced via a comply or explain mechanism.
  - The CGC aligns with recent Basel Committee discussions and reflects findings from the last FSAP.
  - The FSA established the Japan Corporate Governance Forum (JCGF) to gather stakeholder opinions, including overseas investors.
  - The Council of experts reports regularly on progress on the CGC and the Stewardship Code; CGC and Stewardship Code seen as treating “defensive governance” and “growth oriented governance.”
- Reform themes receiving attention:
  - Enhanced board structure and enhanced challenge by independent non-executive directors.
  - Enhanced board oversight of risk appetite and strategy.
  - Enhanced fit and proper (F&P) processes to assess collective board experience and expertise and application at senior management level.
- Observed progress:
  - Advances observable in major banks and larger regional banks.
  - Larger banks have established and disclosed Audit, Nomination and Remuneration Committees.
  - Firms listed on the Prime Market are required to have at least one third external, independent directors (two directors if listed on other markets).
  - More than 60 percent of regional banks have audit and supervisory committees.
  - Banks required to have policies with measurable targets for women in mid management positions and diversity in talent; banks disclose roles and expertise of directors.
- Supervisory engagement:
  - FSA holds meetings with the chairman and chief executive at least annually; for megabanks, meetings with external directors also held.
  - Interviews with senior executives (e.g., Chief Risk Officer, Chief Auditor) every one to two months for major banks.
  - In principle, the FSA or LFB interviews CEOs of all regional banks once a year.
  - Since 2022, FSA and LFB hold dialogue with regional banks’ top management, various officers, and outside directors on governance, shareholder exercise, and human resource investment and development initiatives.
- Risk management evolution:
  - Risk architecture (risk committees, risk management committees, risk appetite statements, enterprise-wide risk frameworks) has been developed across major and regional banks.
  - Joint annual stress tests by the FSA and BOJ support these efforts.
  - Hearings with major banks focus on overall risk management and risk culture; hearings with regional banks are less common unless EWS thresholds are triggered.
  - The FSA is advised to build on progress with strengthened monitoring of regional and smaller banks and to design, with LFBs, a review to identify institutions with deficiencies and target awareness programs.

### Financial reporting and external audit
- 2017 FSAP finding reiterated:
  - The FSA had not been granted the breadth of powers in respect of the appointment of external auditors as set out in the BCPs.
  - Although auditor standards tightened since 2017, the FSA’s powers have not been amended in line with the BCPs.
- Rationale for enhanced powers:
  - To ensure the FSA can indicate if an auditor is not acceptable before the fact, providing a “safety net” so audit firms appointed have skills and resources commensurate with banks they audit.
- Oversight arrangements:
  - Certified Public Accountants and Auditing Oversight Board established in 2004 as an independent authority under the FSA.
  - Disciplinary powers of an auditor oversight board are not the same as the preventive supervisory powers envisaged; practical benefit would be to allow supervisor to indicate an auditor lacks resources/experience prior to appointment.
- Legal amendment noted:
  - An amendment to the Certified Public Accountants Act (No 103 of 1948) now requires all Certified Public Accountants to be registered with the Japanese Institute of Certified Public Accountants.

### Recommendations (explicit list from the report)
- The FSA should establish a minimum liquidity requirement for domestic banks.
- The definition of related parties should be broadened to include individuals connected to a bank beyond board members. Related party supervision should apply to all banks and include regular reporting to the FSA.
- The authorities should strengthen the ability of banks to access third-party service providers and consider the need to place on a regulatory footing, if needed, to ensure cyber security and operational resilience in banks.
- The FSA should further strengthen the analysis of how the banking sector is operationally interconnected, through developing network analysis of how the banks are connected through common technologies and service providers, allowing the identification of critical nodes and taking any appropriate action accordingly. The analysis should not be limited to cyber-risks, but address operational risk and resilience.
- The FSA and LFBs should carry out a corporate governance and risk management review of regional and smaller banks in order to identify institutions with deficiencies, and target awareness programs.
- The authorities should provide the FSA with the power to reject and rescind the appointment of an external auditor who is deemed to have inadequate expertise or independence, or is not subject to or does not adhere to established professional standards. This will act as a “safety net” provision to ensure that audit firms will be appointed whose skills and resources are commensurate with the firms they are appointed by.

*Source: 1jpnea2024004 - 108.      The FSA is conscious of the need to assess and raise the skills capacity in the sector,*

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_Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1jpnea2024004.pdf_