Bank of Japan: On-Site Examination Policy for FY2022

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March 29, 2022

Bank of Japan

On-Site Review Policy for FY2022

1. Introduction

The Bank of Japan (hereinafter, the Bank) formulates the on-site examination policy every fiscal year based on the decision of the Policy Board.1

In recent years, the risk profiles of financial institutions have become increasingly complex, primarily in the context of increased financial and economic globalization, and the environment surrounding the financial system has changed significantly in part due to the impact of the COVID-19 pandemic and heightened geopolitical risks. Moreover, financial institutions are facing new challenges, such as the need to decarbonize our society and economy and adapt to digitalization. Under these circumstances, it has become essential to assess the soundness and risk management of financial institutions in a faster and more continuous manner, and it has also become increasingly important to monitor changes in the financial system in a timely manner. in its entirety.

In March 2021, the Financial Services Agency (FSA) and the Bank published “Efforts to further strengthen coordination between the FSA and the Bank”.2 The aim of these efforts is to perform higher quality supervision while reducing the burden on financial institutions by coordinating the inspection and surveillance activities of the FSA with on-site examinations and off-site supervision by the Bank.

Specifically, the Bank is working to strengthen the integration of on-site reviews and off-site monitoring by further deepening information sharing between examination section and supervisory sections delocalized at the head office and in the branches.

In addition, the Bank is developing joint investigations with the FSA targeting the main

  • 1 The Bank of Japan Law stipulates that “the contents of a contract regarding on-site inspections” and “significant issues regarding the implementation of on-site inspections for each fiscal year” are determined by the Policy Board (Article 15(2)(v).

  • 2 To seehttps://www.boj.or.jp/announcements/release_2021/rel210322c.htm/ (only available in

    Japanese).

establishments. Joint investigations are carried out separately from regular on-site inspections and consist of simultaneous investigations of certain large financial institutions on important topics related to the financial system, making it possible to examine financial institutions by comparing them with each other.3

In light of the above-noted changes in the environment surrounding onsite reviews, the “Fiscal Year 2022 Onsite Review Policy” has been expanded to include descriptions of initiatives related to offsite monitoring, such as joint investigations, while bearing in mind the organic coordination between on-site examinations and off-site monitoring.

2. FY21 On-Site Reviews and General Observations

(1) On-site reviews during fiscal year 2021

The Bank carried out on-site inspections of 59 financial institutions: 18 licensed national banks, 34 shinkin banks and 7 other institutions, including securities companies as well as Japanese branches and subsidiaries of foreign banks.4 While the Bank conducted intensive interviews remotely instead of on-site reviews in FY20, it resumed on-site reviews in FY21 using remote methods, such as web and telephone conferences, mainly in light of the operational situation of the institutions reviewed with regard to the provision of financial support.5

  • 3 The topics of the joint investigations are as follows: in addition to the existing simultaneous prudential stress tests based on common scenarios, in fiscal year 2021, new joint investigations on the management of currency liquidity risk and on the management of cybersecurity were conducted, and pilot climate scenario analysis exercises were conducted. Topics will be reviewed, as appropriate, in consultation with the FSA based on their importance to the financial system.

  • 4 In this document, “securities companies” means companies that carry out commercial activities related to securities among those classified as type I financial instruments activities in Article 28 of the Financial Instruments Act and the exchanges.

  • 5 See “Guidance for Conducting On-Site Reviews in Response to COVID-19” published June 30, 2020.

Number of financial institutions examined

(number of entities)

Financial year 2019

Financial year 2020

Financial year 2021

Nationally Licensed Banks

34

18

18

shinkin banks

43

14

34

Other establishments

8

5

7

Total

85

37

59

Note: For FY2020, the Bank conducted intensive remote interviews instead of on-site reviews.

(2) Problems Identified by Onsite Reviews and Offsite Monitoring

The business management and financial soundness of financial institutions, as well as their risk management examined during on-site reviews and off-site monitoring during fiscal year 2021, are as follows.

Profitability and financial strength

With regard to the financial soundness of financial institutions, we first note that their capital levels are adequate in relation to the amounts of the different types of risk assumed, and that they have sufficient capacity to absorb losses. Despite the impact of the spread of COVID-19 on economic and financial conditions at home and abroad, the smooth functioning of financial intermediation has been maintained thanks to the positive effects of large-scale fiscal and monetary policy measures. ladder.

With regard to profitability, large financial institutions have increased the efficiency of their domestic deposit and lending activities, on the one hand, while on the other hand they have continued to develop their activities abroad. , including through inorganic growth strategies involving acquisitions and investments, to strengthen group-wide profitability in commercial banks, securities companies, trust banks, non-banks, etc. belonging to the same holding company, and diversify their sources of income.

A growing number of regional financial institutions are striving to improve their profitability by increasing the efficiency of their operations, for example by consolidating their branch networks (including so-called “branch-by-branch consolidation”) and revising their ATM networks and staff distribution. , as well as improving financial services, in asituation in which their core profitability has trended downward due to structural factors such as declining population and the prolonged low interest rate environment. There have also been capital and business alliances between financial institutions and with companies in other sectors to further strengthen the foundations of companies. On the other hand, faced with the continued decline in profitability, some regional financial institutions have not sufficiently planned and implemented countermeasures.

Meanwhile, through digitization, including the use of open application programming interfaces (APIs) and cloud computing, a growing number of financial institutions have improved the efficiency of their operations and improved remote services for customers. Moreover, there has been a growing interest in climate change in terms of financing, as evidenced by the increase in the number of not only major but also regional financial institutions that agree with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).

Credit risk

Financial institutions continue to actively provide financial support to businesses and households. Some large financial institutions have focused on financing institutional investors, including investment funds, and hybrid loans, while some regional financial institutions focus on “cross-border” loans and medium-risk corporate loans. While credit costs rose in fiscal 2020 against this backdrop, in part due to higher loan loss provisions for industries heavily impacted by the pandemic, they stabilized over the course of the year. fiscal year 2021. There is, however, uncertainty about the business outlook for borrowers and the cost of credit. , as the future course of the pandemic and economic developments in Japan and abroad remain unclear. While a wide range of financial institutions were reviewing their provisions for cancellations and loan losses as part of their credit management based on the financial condition and future prospects of corporate borrowers, there were also instances where financial institutions had difficulty in understanding corporate borrowers’ financial and funding conditions, analyzing their repayment capacity and providing effective support to underperforming businesses to improve their business terms, as well as in credit selection and monitoring of loans in the areas on which regional financial institutions have focused (border loans and medium-risk business loans).

Market risk

In the protracted low interest rate environment, both major and regional Japanese financial institutions have been actively taking market risks, particularly in credit products and overseas investment trusts, seeking yield. In this situation, some large financial institutions have diversified their investments into overseas credit products such as secured loan obligations (CLOs) and bank loan funds, or increased alternative investments, including equity funds. – investment (PE) and hedge funds. In addition, some institutions suffered considerable losses in the prime brokerage business for institutional investors.

Meanwhile, given the large-scale redemptions of bonds with higher coupon rates than recently issued bonds and an increase in demand for investment purposes due to the retention of deposits such as pandemic-related subsidies, regional financial institutions continued to buy products such as corporate bonds, foreign bonds, private real estate investment trusts (REITs) and multi-asset investment trusts. As a result, the diversity of risk factors inherent in their securities portfolios has further increased. Under these circumstances, establishing a market risk management framework commensurate with changes in risk profiles, such as accurately identifying risk factors and reviewing risk tolerance, is seen as a challenge for many many financial institutions.

Liquidity risk

As they expand their business overseas, large financial institutions are faced with the challenges of securing stable foreign currency funding based on appropriate management of foreign currency liquidity risk, and they are striving to diversify their funding instruments, such as increasing long-term market funding and attracting deals. account deposits, refine their stress tests and develop data systems. While many regional financial institutions have sufficient liquidity in yen assets and have no problem managing them, some that actively invest in foreign currencies in illiquid assets face difficulties in setting up and managing stable foreign currency investment and financing structures.

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