No. 2 — January 14, 2000


Weekly Review

--- by Douglas Ostrom

April 1, 2001 no longer is such a critical day for the Japanese financial world or for the Deposit Insurance Corp. A 1996 amendment to Japan's Deposit Insurance Law had guaranteed the safety of deposits, regardless of size, at virtually all banking-type institutions through the end of FY 2000, after which government protection in the event of a bank failure would be limited to ¥10 million ($83,300 at ¥120=$1.00) per depositor per institution. On December 29, however, senior policymakers of the Liberal Democratic Party, the Liberal Party and the New Komeito agreed to delay implementation of the cap by a year. Prime Minister Keizo Obuchi's cabinet confirmed the move January 7. The decision, which came in for some stiff criticism at home and abroad, represented a victory for politicians who must face voters fairly soon in lower house elections over bureaucrats and business leaders.

At issue was the scheduled return to the deposit insurance system that existed, at least on paper, between 1971 and 1996. Under it, the government insured deposits up to a maximum of ¥10 million ($83,300) each. This guarantee was not seriously tested until the mid-1990s when long-ignored bad-loan problems began to catch up with financial institutions large and small.

The onset of the banking crisis increased the chances that a commercial bank or other financial institution might fail and be unable to find a buyer willing to pay a premium over book value. With this prospect looming, the cap on deposit insurance, which compares with the Federal Deposit Insurance Corp.'s $100,000 limit, became a more meaningful consideration for Japanese savers. To allay their concerns as well as those of banks' international creditors, Tokyo adopted a more relaxed policy, making a wide variety of deposit-type instruments eligible for unlimited insurance. In some cases — for example, the debentures issued by the three long-term credit banks active at the time — coverage was provided even when banks explicitly had refused to be brought into the deposit insurance system and traditionally had not paid premiums.

Since 1996, bank executives as well as government regulators have proceeded on the assumption that the cap on insurance coverage would be reimposed in April 2001. For example, banks introduced new products for the high-net-worth individuals who would be most affected by the pending change. Moreover, consumers increasingly made choices about where to put their money on the basis of the perceived health of various financial institutions. Tokyo gave Japan's largest banks a huge assist in this regard last year when it put in place a system that led to the injection of government-supplied capital into virtually all big banks but — initially at least — only a handful of smaller ones (see JEI Report No. 43A, November 12, 1999). Five failures among so-called second-tier regional banks in 1999 were attributed in part to depositors' fears that small banks could fail after April 2001 as a result of a flight of savings to bigger, presumably safer banks, leaving large depositors with only partial protection against loss. Still-smaller institutions were even more vulnerable to depositor anxiety.

Even though savers understandably were not enthusiastic about the cap on DIC coverage, economic policymakers argued last year that implementation of this relatively modest reform was necessary to introduce market principles into the nation's financial system. Furthermore, they said, it would minimize the problem of moral hazard, in which the existence of insurance and other government guarantees, real or implicit, encourages excessive risk-taking by financial institutions. The origins of the banking crisis proved that moral hazard could develop even when deposit insurance coverage was limited. Without a cap, the problem could be even worse.

Up until the day before the politicians acted, key members of Mr. Obuchi's cabinet were leading the charge to keep the April 2001 DIC reform on track. Repeating remarks that he had made previously, Finance Minister Kiichi Miyazawa said at a December 28 press conference that the ceiling on guaranteed deposits should be reimposed on schedule.

By then, however, the political ground had shifted. Proposals were floated in late fall to make exceptions to the coverage cap for certain types of financial institutions, particularly struggling shinkin (credit associations). Even Financial Reconstruction Commission head Michio Ochi advocated a two-year grace period for shinkin on the grounds that not enough time remained before April 2001 to fix their problems. The Liberal Democratic Party had a far more ambitious goal: delaying the imposition of the ceiling across the board. The New Komeito wanted the reform to proceed on schedule, while the Liberal Party, the LDP's other junior partner, leaned toward some sort of compromise.

The LDP prevailed. While its position was not popular with corporate supporters, which were licking their chops over the prospect of lower banking costs and the likelihood that the deposit insurance ceiling would increase business for large financial institutions, the party's flip-flop went over well with voters. Although a ¥10 million ($83,300) cap on insured deposits might seem to affect primarily wealthy individuals, most Japanese keep a large share of their considerable financial assets in savings accounts (see JEI Report No. 31A, August 14, 1998). At leading nationwide commercial banks, first-tier regional banks and their second-tier counterparts, a reported 54 percent of total deposits of ¥463 trillion ($3.9 trillion) is in accounts that exceed ¥10 million ($83,300) in value. This statistic suggests that limiting deposit insurance coverage could have widespread effects.

The coalition parties' late December decision loosened the deposit insurance system in other ways as well. For instance, reinvested interest income will be covered after the cap is reimposed in April 2002. Moreover, so-called settlement-type accounts will be protected until April 2003.

Domestic critics of the postponed reform, perhaps forgetting the fear prevalent four or five years ago that foreigners would limit their business dealings with Japanese banks unless they were given extensive protection against losses, expressed concern that the policy switch would lead to a perception at home and abroad that the recovery of Japan's financial system was not as complete as widely believed. The same sources also feared the possible return of the "Japan premium," under which Japanese banks sometimes have paid more for interbank funds than rival institutions elsewhere. In the past, the premium has varied relative to the perceived health of Japan's banking system. An even greater number of critics worried aloud that Tokyo was backsliding on an international promise. The most frequent criticism was that the decision proved that the government was not really serious about introducing market-based reforms as part of the process of restructuring the economy.

Other changes are possible in the aftermath of the decision to delay implementation of the deposit insurance ceiling. The LDP would like to extend the fall 1998 bank recapitalization law beyond its scheduled March 31, 2001 expiration date. The Ministry of Finance, in contrast, wants to keep the deadline as it is. It understands that maintaining a system under which the government in effect buys parts of financial institutions in exchange for fresh capital would raise even more questions about Tokyo's adherence to market principles.

In the meantime, the government reportedly will move more aggressively to shore up the capital positions of such small financial institutions as shinkin and shinkumi (credit cooperatives). However, this process will require changes in the laws governing these bank-like firms, which have no shareholders.

Top Obuchi administration economic officials insist that the postponement of the reintroduction of the cap on insured deposits until April 2002 will be the only delay. After saying initially that there would be no grace period, these insiders may be right this time. Injections of public money into smaller financial institutions would enhance the reality as well as the perception that money deposited in them is safe, arguably enabling these competitors to surmount the risk to their business that a limit on insurance coverage otherwise might bring. In fact, officialdom's failure back in 1996 to appreciate the consequences of indirectly helping large banks while leaving small financial institutions to fend for themselves is surprising.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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