## Bank of Japan presents summaries of articles published in the November edition of i Quarterly Bulletin
Bank of Japan, Communication, 1/12/98.
## Profits and Balance-Sheet Developments of Japanese Banks in Fiscal 1997
## Overview
Operating profits of Japanese banks in fiscal 1997 amounted to ¥5.4 trillion, down by the previous fiscal year. 1 This decrease was primarily due to the following factors: (1) disappearance of a temporary increase in trust fees (income) of trust banks in fiscal 1 modest fall in net interest income on domestic operations due mainly to narrowing margins; and (3) the slight decrease in gross profits on international operations as a expansion of the 'Japan premium' and the downsizing of overseas branches and subsidiari 2
Transfer to the special loan-loss provisions (SLP) and loan write-offs including tho accounts 3 amounted to ¥13.3 trillion, which is almost the same figure as the peak rec fiscal 1995. 4 Due to a considerable amount of transfer to the SLP and loan write-offs recurring losses (¥5.2 trillion) and net losses (¥4.8 trillion) marked record highs. 5
Risk-based capital adequacy ratios at end-March 1998 at many banks exceeded those at March 1997. This improvement was due mainly to banks' efforts to reduce their risk-a
- 1 'Japanese banks' refers to All Banks, comprising the member banks of the Federation of Ban Associations of Japan ( Zenginkyo ), which consists of 10 city banks, three long-term credit banks, seven banks (excluding foreign-owned trust banks and trust banks that started business after October 199 member banks of the Regional Banks Association of Japan (referred to as regional banks), and member banks of the Second Association of Regional Banks (excluding Hanwa Bank, which was liquidat in January 1998; referred to as regional banks II). Figures in this report exclude data for Hokkaid Bank, Tokuyo City Bank, and Kyoto Kyoei Bank.
- 'Operating profits' signifies earnings from core banking operations and is calculated by subtractin to the allowance for possible loan losses,' 'general and administrative expenses,' and 'debenture expenses' from the sum of 'net interest income' (the excess of interest income on such items as l securities over interest expenses on such debts as deposits and debentures), 'net fees and commiss income on fees and commissions received/paid on funds transfers and other service transactions), 'n revenue' (applied to banks with trading accounts; gains/losses on transactions for trading purpos trading-related derivative transactions and gains/losses on year-end valuation at market or fair 'net other operating income' (e.g. net gains related to bond and foreign currency transactions).
- 2 The temporary increase refers to profits resulting from the write-back of the special reserve fu trust banks. Special reserve funds are accumulated to provide for situations in which the value of falls below the amount of the principal. The ratio of required reserve funds to the amount of the p lowered from 3% to 0.5% by a revision of a government ordinance. Trust banks wrote off nonperfor loans in trust accounts, using part of the temporary profits in trust fees. The remainder of th accounted as trust fees included in net fees and commissions in banking accounts.
- 3 In accordance with the Loan Trust Law and the Trust Business Law, trust banks guarantee the princ banking-type trusts (loan trusts and jointly managed money trusts). Therefore, loan write-off accounts are included in the total figures of transfer to the SLP and loan write-offs.
- 4 The amount includes loan write-offs, transfer to the SLP, losses from the sales of nonperforming lo Cooperative Credit Purchasing Company (CCPC), and other re nunciations of claims.
- 5 Reflecting the fact that banks began to be allowed to value listed stocks at cost, losses from stock declined significantly. As a result, net stock-related gains increased to ¥2.9 trillion, three ti those in the previous fiscal year. Net stock-related gains/losses are calculated by subtracting the from stock selling operations and stock write-downs from gains on stock selling operations.
assets and various measures taken by the government in December 1997 to stabilize the J financial system.
Although several years have elapsed since the bursting of the economic 'bubble', transf SLP and loan write-offs reached levels as high as the peak recorded in fiscal 1995. Thi the emergence of large corporate bankruptcies and the introduction of a new self-as system on banks' asset quality to primarily determine appropriate loan-loss provisioning write-offs under the Prompt Corrective Action (PCA) directives.
One of the key policies for Japanese banks will be to remove nonperforming loans fro balance sheets by such means as selling collateral real estate, in addition to steadil nonperforming loans and disclosing further information about their business. These effo moderate serious impacts of fluctuations in collateral real estate prices on the ass Japanese banks, and thus ensure the reliability of the information included in the sheets, and finally restore market confidence in their soundness. In addition, th collateral real estate enable banks to plan flexible management strategies; and reinv the cash inflow from the sales will improve banks' profitability.
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## Checklist for Risk Management (Revised 1998 Edition)
## Objectives of the Checklist
The Bank Supervision Department of the Bank of Japan initially compiled the Checklist f Management (hereafter: the Checklist) in December 1987. To provide examiners with guid in reviewing the adequacy of risk management at individual banks during on-site examin the Bank completely revised the Checklist in May 1996, and it was distributed to f institutions under the Bank's supervision as well as to various other financial instit belief that it could serve as a reference as they undertake initiatives to check and st risk management systems.
Over the two years since the last revision, major revisions of institutional systems undertaken in Japan reflecting drastic changes in the financial and social environmen order to deal with the deterioration in business performance of Japanese financial i Furthermore, consensus has been reached and various reports have been released relatin management in the international arena such as that of the Basle Committee on Ba Supervision, against the background of steady progress in financial deregulation and r of risk management skills.
Meanwhile, as part of the review of its bank supervision functions accompanying the en of the Bank of Japan Law of 1997, the Bank Supervision Department revised and expanded 1996 edition of the Checklist for Risk Management, and distributed the revised 1998 ed the Checklist to financial institutions under the Bank's supervision and various othe institutions on June 19. With a view to securing transparency of bank supervision, th 1998 edition of the Checklist has been made generally available as much of it should be nondepository financial institutions not directly subject to the Checklist (securitie tanshi companies, etc.), depository financial institutions not under the Bank's superv
shinkin banks, credit cooperatives, agricultural cooperatives, labor credit associatio nonfinancial business firms. 6
## Major Features of the Revised 1998 Edition
The new edition of the Checklist for Risk Management has been revised and expanded to developments in the financial conditions and institutional reforms in Japan since th revision (May 1996), as well as international discussions regarding risk managem compiling this edition, the Bank also considered and applied experience gained us previous editions of the Checklist and opinions and comments gathered from fin institutions under the Bank's supervision.
The overall framework in the new edition is unchanged from the 1996 edition. The Check categorized by type of operation (I. Management and Internal Controls, II. Lending Ope III. Market Operations and Asset and Liab ility Management [ALM], and IV. Business Operations and Electronic Data Processing [EDP]). The sample questions for examining the progress management of financial institutions under each checkpoint are organized starting fr matters and progressing to technical details. Like its predecessor, the revised 19 includes some items which even banks with advanced risk management skills require more to achieve. The Checklist is therefore not a minimum standard by which all banks must rather, it is meant to be used flexibly by as many financial institutions as possible for their business operations.
Concretely, items related to legal compliance have been largely expanded in Sec (Management and Internal Controls) to include important points such as whether management fully recognizes the importance of legal compliance and takes the le establishing compliance awareness within the financial institution, and whether th systematic framework with concrete procedures for implementing legal compliance and whe it functions adequately. In its revision of Section I, the Bank considered and included forth in the 'Framework for the Evaluation of the Internal Control Systems' release Basle Committee on Banking Supervision. In Section II (Lending Operations), a new regarding financial institutions' self-assessment of assets has been added in respo introduction of the self-assessment system. Necessary amendments have been made in Sect (Market Operations and ALM) to deal with the inclusion of the trading account, wi consideration given to the 'Principles for the Management of Interest Rate Risk' releas Basle Committee on Banking Supervision.
## Application of the Checklist in the Bank's Examinations of Risk Management
The Bank's examinations review both the strength of financial institutions and th management ability, which prevents the emergence of losses and sustains their soundne Checklist for Risk Management is used as a handbook by examiners when assessing the management capability of financial institutions. Simultaneously, with a view to s carrying out our on-site examination of risk management and to have a sufficient exch opinions with the subject financial institution, the Bank requests the institutions evaluate their abilities using the Checklist at each examination.
Needless to say, financial institutions must take the initiative in establishing th management system based on their own judgment, hence the actual system will differ acc to the individual institution's management strategy and business performance. In this Bank does not intend to apply the Checklist uniformly to all financial institutions, bu it giving full consideration to the situation of each bank.
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## Foreign Exchange and Derivatives Markets Turnover Survey (April 1998)
Outline of Survey
In April 1998, the Bank of Japan conducted the Foreign Exchange and Derivatives Mar Turnover Survey. This survey is conducted once every three years by the central ba monetary authorities of participating countries and regions, and is coordinated by th International Settlements (BIS). 7
The April 1998 survey was conducted by the central banks or monetary authorities countries and regions, which collected the data from approximately 3,200 reporting in in total. 8
The Bank of Japan obtained the data from 255 Japanese banks, 101 foreign banks, 3 Ja securities companies, 6 foreign securities companies, and 10 FX brokers. 9
The BIS will aggregate and publish the data collected from participating central monetary authorities on a global basis.
In this survey, the foreign exchange transactions are classified into three instrumen derivatives activities are classified into five instrument types. 10 Transactions of each type of instrument are further broken down by currency or currency pairs, category of counterpar location of counterparties (local or cross-border).
The daily volume of turnover is adjusted for the local double-counting of transaction
- 7 The first survey coordinated by the BIS started in 1986 for foreign exchange activity, and the section was added to the survey in 1995.
- 8 Participating countries and regions are as follows (the 26 countries and regions that particip previous survey are underlined): Argentina, Australia, Austria , Bahrain , Belgium , Brazil, Canada , Chile, China, the Czech Republic, Denmark, Finland , France , Germany , Greece , Hong Kong , Hungary, India, Indonesia, Ireland, Italy , J pan , Korea, Luxembourg , Malaysia, Mexico, Netherlands , New Zealand , Norway , the Philippines, Poland, Portugal, Russia, Saudi Arabia, Singapore , South Africa , Spain , Sweden , Switzerland, Taiwan, Thailand, the United Kingdom , an the United States .
- 9 Foreign exchange brokers are to report only foreign exchange transactions (including crossswaps and FX options), and securities companies are to report only derivatives activities.
- 10 Classification of transactions:
- (1) Foreign exchange activities:
Spot, outright forwards, foreign exchange swaps
- (2) Derivatives activities: Interest rate-related derivatives: forward rate agreements (FRAs), interest rate swaps ( interest rate options (IR options) Foreign exchange-related derivatives: cross-currency swaps, foreign exchange options options)
two reporting institutions in Japan. Meanwhile, double-counting of cross-border tra between two reporting institutions will be adjusted by the BIS. Thus, a simple aggregat results of all participating countries and regions will not be equivalent to the glo released by the BIS.
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## Regular Derivatives Market Statistics in Japan (Yoshikuni Statistics) (end-June 1998)
## Outline of Survey
The central banks of the G-10 countries 11 and the Bank for International Settlements (BIS) hav combined efforts to introduce new global derivatives market statistics based on the ' for Improving Global Derivatives Market Statistics (Yoshikuni Report)' published by the July 1996. The data were first collected at end-June 1998. In this paper, the Bank releases the results of this first Regular Derivatives Market Statistics pertaining to 12 The BIS will later publish the global results of outstanding derivatives positions of t institutions.
The aim of the BIS in implementing a survey on global derivatives markets is to increas transparency and to facilitate monitoring by central banks of these markets in rega macroeconomic and macroprudential concerns through two reporting frameworks, the first semiannual statistics on derivatives outstanding covering only primary dealers, and t being triennial statistics on derivatives turnover and outstanding covering a wider dealers. This first release of the Regular Derivatives Market Statistics corresponds while the April 1995 Central Bank Survey of Derivatives Market Statistics 13 and the succeeding April 1998 Derivatives Market Turnover Survey - whose results in Japan are also publi the same time - correspond to the second.
The survey is based on the voluntary cooperation of reporting institutions, and 18 prima participated from Japan (out of 75 institutions globally).
The survey consists of data on consolidated outstanding derivatives positions (notional gross positive and negative market values) of the reporting institutions, broken down b factors (foreign exchange, interest rate, equity, and commodity), instrument, counterparty type, and maturity.
The main features of the survey results for Japan are summarized in the following an more details, please refer to the Bank of Japan website at www.boj.or.jp/en/index.htm.
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## Responses to Comments on the Proposed Revision of the Flow of Funds Accounts: The
- 11 Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, the Un Kingdom, and the United States.
12 The results were released on September 30, 1998.
13 For the results of the April 1995 survey in Japan, please refer to 'Results of the Survey of Market Activity in Japan' in the May 1996 issue of the Bank of Japan Quarterly Bulletin .
## Bank of Japan's Final Decisions on the Revision
## Introduction
The Bank of Japan compiled the flow of funds accounts (hereafter: FFA) first in 1958, data for the years from 1954 to 1957. Since 1996, it has been conducting a study aime comprehensive revision of the FFA. Based on this study, the Bank made provisional propo details of the revision in early 1997, inviting users of the statistics to submit t suggestions to the Bank. 14
The comments submitted were generally in favor of the revision. They also indicated th hoped to employ the new FFA as a tool for monitoring the effects of financial system re so-called Japanese 'Big Bang') and the continuing internationalization of the financia With regard to the details of the proposed revision, some comments supported the approach, while others suggested alternatives relating to such aspects as sectoral and classifications, and the methods and format used for publishing the FFA.
Substantial progress has been made with regard to the detailed treatment of Japan's accounts and the availability of data, both of which were not entirely clear when the proposals for the revision were drafted. In conducting the study on the details of t since mid-1997, the Bank has kept these developments in mind and examined whether comments submitted meet such criteria as (1) appropriateness of statistical treatment recording methods; and (2) the usefulness of revisions based on those comments. The Ba also reviewed issues that were still undecided in the provisional proposals. The Ba decisions made through the above process are shown in tables, and this paper tries to e thinking behind them. 15
Based on these final decisions, the Bank is now in the process of compiling the new with a view to publishing them in 1999.
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## Year 2000 Readiness in the Financial Industry in Japan
## Introduction
With less than one and a half years before the year 2000, various industries in Japan a making a wide range of efforts to address the 'Year 2000 problem'. The Year 2000 pr arises because many computers and application programs recognize the year by the la digits instead of four. On January 1, 2000, those computers and application progra represent the year as '00' and may assume the year to be 1900 instead of 2000. This ca incorrect processing of date-sensitive calculations by computers, which may cause disru computer systems.
- 14 For details, refer to 'Revision of Japan's Flow of Funds Accounts' in the August 1997 issu Bank of Japan Quarterly Bulletin .
- 15 In addition to the points covered in this paper, numerous minor changes were made from the pro proposals. This paper covers only the major points, and detailed explanations of individual s transaction classifications will be provided separately.
If computer disruptions materialize, the adverse effects on financial institutio substantial because financial institutions rely heavily on computers, for example, host for the main accounting systems and information systems, and decentralized systems (i area networks [LANs] and personal computers [PCs]). If a financial institution fails Year 2000 readiness, it may not be able to confirm or manage settlement dates or tra data, calculate interest rates or carry out accounting procedures, which can be a poten its fundamental business of taking deposits, extending loans, and carrying out settleme
There is a possible systemic risk if one financial institution or one payment and system fails to achieve Year 2000 readiness. Banks and securities companies are m connected through various payment and settlement systems for settling transactions. If institution fails to achieve Year 2000 readiness, the computer disruption could be pa other ones through their interdependence in financial transactions and settlement. If failure due to a lack of Year 2000 readiness materializes in a settlement system, financial institutions but also end-users or customers will be affected because they able to withdraw or transfer funds through cash dispenser (CD) and automated teller (ATM) networks.
The Year 2000 problem could seriously affect the business of individual financial inst well as the stability of payment and settlement systems. The Bank of Japan, with the co of market participants, is therefore promoting Year 2000 readiness of individual institutions and payment and settlement systems.
This paper discusses how Japan's financial sector is addressing key issues of the Y problem and provides information on its progress in achieving Year 2000 readiness. 16 After a overview of the results of the Year 2000 problem survey of financial institutions con the Bank of Japan in June 1998, the paper presents (1) plans for external tests of p settlement systems; (2) global initiatives taken by international organizations includi for International Settlements (BIS); and (3) an upcoming issue.
The paper focuses exclusively on the preparations being made by financial institut payment and settlement systems for the Year 2000 problem. It does not deal with prepa made by social infrastructures, such as telecommunications or utilities that support system operations, nor does it cover Year 2000 preparations of companies supplying computers and software, although these deserve careful attention of financial instituti
16 This paper was originally published in the form of a brochure on August 14, 1998. For in regarding the brochure, please contact the Financial and Payment System Office (tel: +81-3-32 [x2954], fax: +81-3-5255-6752) or the Bank Supervision Department (tel: +81-3-3279-1111 [x64 fax: +81-3-5255-6755), Bank of Japan, at 2-1-1, Hongoku-cho, Nihonbashi, Chuo-ku, Tokyo 103-86 Japan.