Several important regulations concerning the Basel III rules have been implemented in Japan this year. This update summarises the changes.
In December 2010 the Basel Committee issued the Basel III rules text, which details the global regulatory standards on bank capital adequacy and liquidity agreed by the Group of Governors and Heads of Supervision and endorsed by G20 leaders at a Seoul summit.(1) According to the text, the main aims of the Basel III rules are to:(2)
- raise the quality of the regulatory capital base;
- enhance risk coverage of the capital framework;
- increase minimum capital requirements;
- build up the capital conservation buffer and countercyclical buffer;
- implement new liquidity standards (ie, a liquidity coverage ratio and net stable funding ratio); and
- introduce a leverage ratio requirement.
The first three of these main points were implemented in Japan by way of a March 31 2013 notification(3) published by the Financial Services Agency (FSA), an agency of the Cabinet Office.
In 2015 Japan implemented rules on the liquidity coverage ratio and disclosure of the leverage ratio.
The liquidity coverage ratio is a measure used to determine whether a bank has sufficient high-quality liquid assets to survive in a 30-day financial stress scenario. According to the Basel III rules text,(4) this ratio is calculated by dividing stock of unencumbered high-quality liquid assets by total net cash outflows over the next 30 calendar days. The term 'stock of unencumbered high-quality liquid assets' refers to liquid assets which:
- can easily and immediately be converted into cash with little or no loss of value, even in times of stress; and
- are available for the bank to convert into cash with no restriction on the use of the liquidity generated(5) and comprise Level I assets (eg, coins, banknotes, central bank reserves and sovereign or central bank debt securities which satisfy certain conditions) and Level II assets (eg, corporate debt securities (including commercial paper) and covered bonds which satisfy certain conditions).(6)
The term 'total net cash outflows over the next 30 calendar days' is defined as the total expected cash outflows minus total expected cash inflows in the specified stress scenario for the subsequent 30 calendar days.(7)
The objective of the liquidity coverage ratio is to promote the short-term resilience of the liquidity risk profile of banks by ensuring that they have adequate stocks of unencumbered high-quality liquid assets that can be converted easily and immediately in private markets into cash to meet their liquidity needs in a 30-calendar day liquidity stress scenario.(8)
In March 2015 the FSA issued a notification(9) which prescribes the minimum liquidity coverage ratio. The minimum ratio for 2015 is set at 60% and will increase annually by 10% to 100% by 2019. In line with this notification, the FSA guideline(10) applicable to the main Japanese banks was amended. According to this guideline, when a bank or bank holding company with overseas business operations fails to meet the minimum liquidity coverage ratio, it must report immediately to the FSA. If the FSA determines that the business operations of the bank or bank holding company need improvement, it may issue a business improvement order.
In addition, in February 2015 the FSA issued a notification(11) (implemented in June 2015) which requires banks to disclose their liquidity coverage ratio.
The Basel III rule on the leverage ratio focuses on bank leverage. 'Leverage' in this context refers to the exposure-to-capital ratio. The leverage ratio is calculated by dividing the amount of capital by the amount of total exposure. This rule requires the leverage ratio to be above a prescribed level.(12) The Basel Committee has introduced the leverage ratio requirement to constrain leverage in the banking sector, thus mitigating the risk of destabilising deleveraging processes which can damage the financial system and the economy, as well as supplementing the risk-based measure of capital with a simple, transparent and independent measure of risk.(13)
In March 2015 the FSA issued a notification(14) which requires banks to disclose their leverage ratio. However, the FSA has yet to issue a notification which prescribes the minimum leverage ratio requirement. According to the Basel III rules text,(15) the minimum leverage ratio requirement will be implemented following a transitional period (from January 1 2013 to January 1 2017). Accordingly, the minimum leverage ratio requirement is expected to be implemented in Japan in March 2018.(16)
On August 7 2015 the FSA published a draft notification(17) on the capital buffer requirement. The notification is expected to become effective on March 31 2016, following a public comment period and other rule-making processes. This draft notification provides for a capital conservation buffer and a countercyclical buffer as a capital buffer. The capital conservation buffer is a numerical buffer requirement which is implemented to absorb any losses arising from changes in the financial market or economic climate. The draft notification sets this numerical buffer requirement at 2.5% (provided that it is initially set at 0.625% and will gradually increase). The countercyclical buffer is a numerical buffer requirement which is implemented to absorb any losses arising from changes in the economic climate caused by excessive lending by banks. It further extends the capital conservation buffer. The draft notification sets this numerical buffer requirement at 0%.
The draft notification provides that the sum of these buffers is the minimum capital buffer ratio. As a general rule, this minimum capital buffer ratio is added to the minimum capital requirement of common equity Tier 1 capital in order to establish a standard value. If the amount of common equity Tier 1 capital is less than this standard value, the regulation to be adopted by draft order of the FSA (as described below) will apply.
Under the draft notification, an additional capital buffer set by the commissioner of the FSA may be added to the minimum capital buffer ratio for global systemically important banks (as determined by the Basel Committee(18)) and domestic systemically important banks (as determined by the relevant national authority(19)). The FSA has yet to announce the amount of these additional capital buffers.
The FSA has also issued a draft order(20) which provides that if the ratio of the portion of common equity Tier 1 capital which exceeds the minimum capital requirement mentioned above (ie, the buffer portion) is less than the minimum capital buffer ratio, certain restrictions will be imposed on discretionary distributions of earnings (eg, dividend payments, share buy-backs and staff bonus payments).
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(2) Kazuhiro Yoshii, Toshimitsu Suzuki, Yuki Kanemoto and Yasuo Kanno, Basel Rules and their Practice 98 (2014).
(3) FSA Requirements for Banks to Determine the Appropriateness of Adequacy of Equity Capital in Light of Assets, etc under Article 14-2 of the Banking Act.
(4) Basel Committee on Banking Supervision, "Basel III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools" (Part 1, II; definition of 'liquidity coverage ratio' at Section 22).
(5) FSA/Bank of Japan, "Publication of Basel III Text on Liquidity Rules (Liquidity Coverage Ratio): Finalization of Main Items of Liquidity Coverage Ratio" (January 2013).
(6) Supra note 4, at Sections 50, 51 and 53.
(7) Supra note 4, at Section 69.
(8) Supra note 4, at Section 1.
(9) Supra note 3.
(10) FSA Comprehensive Supervision Guideline for Main Banks.
(11) FSA Matters to be Separately Prescribed by Commissioner of Financial Services Agency on the Soundness of Liquidity Management under Article 19-2, Paragraph 1, Item 5(e), etc of the Ordinance for Enforcement of the Banking Act.
(12) Kazuhiro Yoshii, Toshimitsu Suzuki, Yuki Kanemoto & Yasuo Kanno, Basel Rules and their Practice 100 (2014).
(13) Basel Committee on Banking Supervision, "Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems" (Introduction, A. "Strengthening the Global Capital Framework", Section 7).
(14) FSA Consolidated Leverage Ratio and Non-consolidated Leverage Ratio to be Separately Prescribed by Commissioner of Financial Services Agency under Article 1, Paragraph 1, Items 5 and 6 of Matters to be Separately Prescribed by Commissioner of Financial Services Agency on the Soundness of Liquidity Management under Article 19-2, Paragraph 1, Item 5(e), etc of the Ordinance for Enforcement of the Banking Act.
(15) Supra note 13, at Sections 165, 166 and 167.
(16) Kazuhiro Yoshii, Toshimitsu Suzuki, Yuki Kanemoto & Yasuo Kanno, Basel Rules and their Practice 103 (2014). According to this book, due to the fact that the fiscal year of many Japanese banks ends in March and new Basel III rules are implemented on January 1, if any new Basel III rule is implemented, it will likely be adopted in Japan on March 31 of the same year (when a Basel III rule was implemented in on January 1 2013, it was adopted in Japan on March 31 2013).
(17) FSA Proposal for Partial Amendment to Requirements for Banks to Determine the Appropriateness of Adequacy of Equity Capital in Light of Assets, etc under Article 14-2 of the Banking Act, etc.
(18) The list of banks identified by the Financial Stability Board in November 2014 is available at www.financialstabilityboard.org/2014/11/2014-update-of-list-of-global-systemically-important-banks/.
(19) None have been identified as yet in Japan.
(20) FSA Proposal for Partial Amendment to Order Prescribing Categorisation, etc as Prescribed in Article 26, Paragraph 2 of the Banking Act.
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