Banking Crisis and the Japanese Legal Framework

Japan went through a severe banking crisis in the 1990s that prompted the country to overhaul its existing framework through a number of reforms, incorporating new recovery and resolution instruments and enhancing those already in place. In part because of this, Japan placed itself ahead of the world’s leading financial economies and was able to withstand the post-Lehman financial crisis better than most –if not all– developed countries.

Recently, Japan added new features, in line with the Financial Stability Board’s (‘FSB’) recommendations concerning globally systemic financial institutions. This paper presents an overview of the current system to deal with the distress of financial institutions in Japan. The object of analysis concerns only banks individually considered (excluding groups), but of all sorts and sizes, providing a classification of the regulation and remedies based on the level of systemic risk of the troubled entity. The paper differentiates between the types of actions available to the supervisor and the resolution authorities, and analyses in detail the instruments and their application.

While the regulation is dispersed across a number of legal texts (of disparate hierarchical level) and its full apprehension is complicated for a foreign reader, it can be concluded that Japan counts on a modern, thorough and most adequate group of institutions and instruments to tackle bank distress. In line with its best international counterparts, the Japanese system of bank recovery and resolution has three aims: it tries to avoid the business and financial distress of institutions active in its financial market; it purports to maximize the value of the business and the assets of the troubled entities with a view to protecting the interests of creditors, shareholders and other directly involved stakeholders; and, above all, its principal objective is to create the mechanisms that ensure financial stability, by protecting depositors, discouraging bank runs and cutting off the contagion channels. These three aims are achieved through a compound of laws, regulations and institutions that can be assessed as complete, up to date and adequately implemented. Perhaps its most notable feature is the proportionality of measures and the flexibility enjoyed by a resolution authority that may tailor its intervention to the characteristics of the case and to the degree of contagion risk.

Although the Japanese system is mainly inspired by the American model, with the Deposit Insurance Agency being the main institution, a comparison is also drawn with the newly enacted Bank Recovery and Resolution system of the European Union, and a reference to compliance with FSB recommendations is included in the analysis. Some critical remarks are also introduced. The degree of coordination and consistency between the bank resolution and the general insolvency system could be improved. The low thresholds of capital requirements for small banks regarding early action mechanisms, or the absence of mandatory recovery plans for the majority of financial institutions differentiate the Japanese system from its European counterpart. This gap is filled with strengthened and highly detailed supervision.  Although the system includes bail-in provisions, they are not easy to identify in the regulation and, arguably, their design is somewhat ‘shy’.

In summary, although consideration could be given by the Japanese authorities to reflect on a few elements of their system, the high institutional level and the aforementioned flexibility make the Japanese system one capable of dealing with financial crises at both national and international levels.

Ignacio Tirado is Professor (Titular) of Corporate and Insolvency Law at the Universidad Autónoma of Madrid, and a member of the Academic Board of the European Banking Institute.