Japan To Beef Up Bank Oversight Daiwa Bank Scandal Triggers Ambitious Plans For Reform

The Finance Ministry on Tuesday unveiled an ambitious plan to revamp Japan’s banking-inspection system, a reform effort triggered by U.S. protests over Japan’s handling of Daiwa Bank’s $1.1 billion bond-trading loss.

The plan aims to transform Japan’s banking-regulatory system from one based on informal “guidance” from regulators to one based on clearly defined rules and more dependent on outside inspections.

Under the old system, the Finance Ministry has depended on banks to report problems to the agency, rather than initiate investigations itself. The Finance Ministry has 420 inspectors, compared with about 8,000 in the United States. While the Finance Ministry plans to add 66 inspectors, the new system will require financial institutions to make greater use of outside auditors.

The new system would set up three levels of inspection for banks’ inhouse reviews with specific guidelines for evaluating the quality of assets, the adequacy of internal controls, and the adequacy of risk management for market-related businesses such as derivatives. The Finance Ministry plans to use external audits to review these in-house assessments by financial institutions.

If banks cannot meet the established criteria, corrective actions will be taken to try to remedy the problem, said Sei Nakai, deputy director-general of the Finance Ministry’s banking bureau. Those actions might include ordering a bank to stop payment of bonuses to employees, to forgo a dividend payment or to close an unprofitable branch, said Nakai.

Banks will be required to adopt appropriate vacation policies, to provide for more checks and balances. Toshihide Iguchi, the senior bond trader responsible for the $1.1 billion loss, was able to cover up his losses because he never took a long vacation. Nakai said the length of vacation requirements had not been worked out yet, and said the ministry was evaluating vacation policies in other countries.

Banks also will be required to develop more sophisticated and detailed risk-management policies, including guidelines for measuring risks, and procedures for handling problems.