Download 1. A general view on financial stability policy and statistics

Statistics, Knowledge and Policy
OECD World Forum on Key Indicators
Palermo, 10-13 November 2004
FINANCIAL STABILITY POLICY AND STATISTICS
TOSHIO IDESAWA
1.
A general view on financial stability policy and statistics
Policy and statistics are two sides of the same coin. Statistics give objectiveness to policy. Any policy in a
democracy needs to be objective. And policy gives meaning to statistics. Any statistics need to be linked
with the policy target.
A good example is the relationship between inflation targeting monetary policy and the consumer price
index. The policy objective is the stability of the value of money. Price stability, a synonym of the
stability of the value of money, can be expressed by some statistics, in most cases the consumer price
index, or its rate of change. Once statistics are defined, monetary policy is objectively exercised. When
monetary policy takes the style of inflation targeting, the policy is said to be quite transparent and
objective.
This relationship between policy and statistics holds true with financial stability policy no less than
monetary policy. Financial stability policy, however, has some difficulty when we try to set its policy
target linked with statistics. The policy objective can be described in various ways. Let me define it as
maintaining the function of money. The money in this context is deposit money that functions as an
instrument of payment and settlement run by the banking industry. To put it differently, the financial
stability policy objective is to maintain a state in which payments and settlements are executed across the
accounts of banks without disruption. Then the policy target is no bank failure or even no anticipation of
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bank failures. Describing the degree of the anticipation of bank failure in terms of statistics is technically
difficult and sometimes politically inappropriate.
Anticipating a bank failure can be self-fulfilling. If any statistics related to the probability of a bank
failure are released to the public, a bank failure would actually occur with a higher probability than the
originally measured probability. This is why the bank supervising authorities very cautiously handle the
disclosure of banks’ financial states in any form. Private rating agencies also face similar difficulties
when they lower the rating of a bank.
Bank supervising authorities would rather look at the banks’ financial soundness indirectly and
multilaterally than approach directly the probability of a bank failure. They would not, even if they could,
try to calculate the probability of a bank failure. They try to figure out the banks’ financial soundness
through data like capital ratio, liquidity ratio, and coverage ratio of bad loans by provisions. When
completed, IMF’s work on “Financial Soundness Indicators” will provide a framework of a set of data
relevant to banks’ financial soundness.
Objectiveness in financial stability policy may be somewhat different from that in monetary policy.
Monetary policy affects a whole economy in a general way and it is not involved in any individual
conflict of interests. Monetary policy is objective, provided the authorities explain logically why the
policy measure could attain the policy target which is expressed by statistics. Financial stability policy,
however, is more often than not involved in an individual conflict of interest when the policy measure is
exercised to attain the policy target. To maintain financial stability the authorities sometimes need to
rescue a failing private bank by public funds. That policy measure definitely needs objectiveness to prove
fairness as well as objectiveness. Objective statistics help the authorities claim fairness.
“Prompt Corrective Action” is one of the bank supervisory measures to enforce recapitalization in weak
banks. The authorities trigger the PCA when weak banks fail to keep a certain capital ratio. To make the
policy measure objective, the threshold capital ratio is stipulated by a law and the capital ratio is a welldefined statistic. The Basel Committee on Banking Supervision has been contributing to providing a
framework for the capital ratio.
The Committee recently proposed a new framework for banks’ risk management. The new framework,
so-called Basel 2, encourages banks to build a reliable and extensive database related to their risk profiles
so that a more meaningful capital ratio can be established.
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2.
Japan’s case study of statistics for financial stability policy
(Japan’s economic conditions in the 90’s and after)
In the late 80s an unprecedented boom occurred in Japan. The boom took place prominently in the stock
market and the real estate market while the general inflation rate remained moderate around 3% per
annum.
Some say that a boom was inevitable. Japan witnessed a miracle recovery after the last war and by 1970 it
grew to be one of the world economic powers. It overcame the oil-shocks twice, which made people feel
the country’s resilience. Japanese money and goods started to outflow overseas in the 70s and 80s. A kind
of euphoria caught Japan. People simply believed that stock prices and land prices could never be too
high for an ever-growing country like Japan.
Others say that the boom was nothing but a result of miss-conducted economic policies. Facing the
unprecedented sharp appreciation of the Japanese yen after the Plaza Meeting in 1985, the Government
and the Bank of Japan continued to employ stimulating economic policies for too long. The Government
and the Bank of Japan overreacted to the exporting industries’ depression due to the appreciation of Yen.
The boom occurred for whichever reason. And it burst when the Bank of Japan tightened monetary policy
in late 1989. First stock prices nosedived, and two years later real estate prices collapsed. The banking
industry gradually suffered deterioration in its loans. The deterioration came in two ways; borrowers’
bankruptcies and insufficiently collateralized loans due to decreasing value of the real estate submitted as
collateral against the loans.
The Bank of Japan soon geared up to the crash. The economy seemed to hit bottom around 1993 but the
recovery was sluggish. Real estate prices continued to fall and the banks’ loans deteriorated further. The
slump in the real estate market affected not only the banking industry but almost all the sectors, corporate
and household alike. The stock market continued to crawl. Investors stayed away from the market,
suffering heavy capital losses. Japan was in depression after the crash (see Chart 1).
By the way, two myths prevailed in Japan at that time; banks were immortal and real estate prices never
fell (see Chart 2). Banks were rigorously supervised by the authorities. Failing banks, if any, could be
bailed out before it was too late. In other words failing banks could well expect a rescue in due course. Its
corollary was that immortal banks could decide the fate of failing borrowers. Borrowers never go
bankrupt as long as the lending bank provides liquidity. And real estate was believed to be the most
reliable asset to possess because Japan had long been facing over–population and real estate had always
been in short supply.
Given these myths, people naturally hesitated to cut a loss. They could well anticipate that the time would
come when they could sell what they possessed without a loss as long as they were protected by the
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immortal banks. Businesses postponed selling stocks and land they held at a loss. Banks postponed
writing
off non-performing loans they lent to businesses. The Government postponed enforcing the
recapitalization of failing banks. From time to time the economy seemed to get out of the depression and
only to realize that it was too early to say so. This continued till 1997 and finally a financial crisis came.
Once the crisis occurred, the Government and the Bank of Japan decisively took action; the Government
poured public funds into the banking industry and the Bank of Japan lowered the interest rate to zero,
which meant infinite provision of liquidity, if necessary. Structural reform has been tried everywhere,
public and private. It took a long time for these measures to make a visible impact on the economy but at
last Japan is now out of the depression.
(Statistics related to financial stability policy)
The target of financial stability policy in Japan may appear to be “no bank failure”. The target has been
deliberated from time to time in relation to other social and economic concerns in the era; efficiency of
banks, moral hazards, depopulated local economies. Still that target seems to be widely shared by people,
explicitly or implicitly.
To measure the soundness of banks the bank supervising authorities monitor financial data; liquidity ratio,
capital ratio, and others. Besides disclosed financial data, banks are required to report more detailed data
to the bank supervising authorities. Financial data of banks are made according to the Japanese
Accounting Standards and rules and regulations are stipulated by the Banking Law. Statistics are well
defined and are accurately calculated.
The Relevancy of data, however, was not necessarily guaranteed before. Bad loans, for example, used to
be recognized only as legally defaulted loans. This recognition was narrow, compared with the current
one that includes doubtful loans and special attention loans. Nonetheless it had some relevancy in the era
when the tax authorities regarded only legally defaulted loans as deductible. In theory banks were free to
make any provisions or write-offs when they believed them prudent. But in practice they dared not to do
that because of the unfavourable tax treatment for loans that had not gone under yet. Therefore banks did
not focus on doubtful and special attention loans as much as they should have done if they had been more
prudent.
When banks were in a position to virtually decide the fate of failing borrowers, disclosing possible default
loans was regarded as an irresponsible action on the side of banks. Therefore banks were not required to
disclose data on bad loans, but only report to the regulatory authorities (see Chart 3).
The two myths about real estate and bank failure had been already dead when a financial crisis occurred
in 1997. The bank supervising authorities no longer kept public confidence as much as they once did.
Their concern was how to respond to scepticism about Japanese financial stability. The scepticism
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prevailed both at home and abroad. At last the authorities let statistics replace the role of myths, hoping
the banks would regain public confidence.
The authorities revised the regulatory definition of bad loans so that statistics could cover bad loans
extensively. Bank examiners introduced the cash discount approach to identify non-performing loans
when they visited banks for on-site examination. Despite the unfavourable treatment in taxation with
regard to provisioning and writing-off against any loans other than legally defaulted loans, the regulatory
authorities ordered bank to cover credit risks by more prudent provisioning and writing-off. Banks started
to disclose data on bad loans comprehensively under the new regulation in 1998. Ahead of Basel 2
implementation in 2006, banks started in 2004 quarterly disclosure of banks’ financial data relevant to
bad loans.
Along with the series of reforms of banks’ prudential policy, the Government launched an unprecedented
recapitalization program for weak banks. Rigorous classification of loans would possibly get weak banks
into fatal trouble; insufficient capital or even deficit. Measures that were intended to enhance financial
stability in the long run could cause financial instability in the short run. The objective of financial
stability policy at that time was to avoid a financial catastrophe.
Today we seem to be back from the merge of a financial catastrophe. The Financial stability policy
objective is to make the banking industry more resilient. The bank supervising authorities encourage
banks to build a framework for better risk management.
By 2006 the Basel 2 will be implemented in Japan. Basel 2 encourages banks to build a reliable and
extensive database related to their risk profiles. Major Japanese banks are steadily preparing for Basel 2.
During the last decade we learned a lot of things. The most important thing was that we should be always
on alert with a historical perspective to perceive instinctively a structural change taking place in financial
circumstances. We must review the policy objective if the perception tells us to do. We need to redefine,
if necessary, statistics so as not to lose their relevance to the reviewed policy objective. Then the
appropriate relationship between policy and statistics would be restored.
(Views in this paper are personal and do not necessarily represent those of the Bank of Japan or the
Japanese Government)
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Chart 1 The Crash and After
①　Real GDP
（％）
7
6
5
4
3
2
1
0
-1
-2
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04*
* Fiscal Year forecast published by Cabinet Office
②　Stock Prices (Nikkei 225)
(thousand yen)
40
30
20
10
0
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
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Chart 2 Two Myths prevailed till the Crash
①　Numbers of Bank Failures
80
60
No Bank
Failures
40
20
0
1900
2000
90
80
70
60
50
40
30
20
10
②　Real Estate Price Index
(Urban Districts, National Average, March 2000=100)
150
Real Estate Price
Never Fell
100
50
0
55
60
65
70
75
80
85
90
95
00
03
Source : Japan Real Estate Institute
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Chart 3 Non Performing Loans of Japanese Banks
Amount of Non Performing Loans
(trillion yen)
45
30
No
Disclosure
15
0
90
91
92
93
94
95
96
97
98
99
00
Source : Financial Services Authority
01
02
03
(fiscal year)
(Footnote)
= Loans to Borrowers in Legal Bankruptcy (LBB) + Past Due Loans in arrears
by 6 months or more (PDL)
=
+ Restructured Loans
=
+ Loans in arrears by 3 months or more and less than 6 months (3PDL)
= Bankrupt and de fact Bankrupt Loans + Doubtful Loans + Special Attention Loans
*
Bankrupt and de fact Bankrupt Loans = LBB + de fact Bankrupt Loans
** Doubtful Loans = PDL - de fact Bancrupt Loans
*** Special Attention Loans = 3PDL + Restructured Loans
,
,
= covers loans only
= covers securities loaned, foreign exchanges, interest receivable, suspence
payments and customers' liabilities for acceptances and guarantees as well as
loans
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