A clear change in tone signaled by Mr Hatoyama

We know little of the detail of the DPJ's plans for financial sector regulation but the themes and priorities are apparent from recent comments by Prime-Minister-designate Yukio Hatoyama, in the DPJ's policy statement "Index 2009"1 and in the backgrounds of the shadow financial affairs spokesmen, who are likely to become the future ministerial team.

Mr Hatoyama himself has recently signaled that there should be a less slavish pursuit of the free-market system given its excesses and that the financial sector should be properly restricted. He has stated that a "moderate degree of tension", presumably as opposed to closeness, is necessary between the state and the free enterprise economy2. Enhanced regulation and direction of financial flows to SMEs (small and medium sized enterprises) are also constant themes in the Index 2009.

At this stage it remains to be seen whether this amounts to little more than posturing: Mr Hatoyama's occasional anti-Americanism, for example, does not seem that deep-rooted, so the criticism of market capitalism may have not have a strong effect on the policy and behaviour of the FSA. However, the regulatory environment for Japanese banks could be much less favourable and the FSA, if only to please the DPJ for political reasons, may choose to demonstrate its harsher side.

New ministerial team

The DPJ keeps a shadow ministerial list on its website, entitled "next_cabinet"3. Mr Akihiro Ohata (62) is listed as the next Minister for Financial Affairs: his "vision statement"4 on his website highlights his strong interest in social and regional issues and support for SMEs. He is likely to be assisted by Mr Mitsu Shimojo (54) and Mr Tsutomu Okubo (48) as deputy ministers. Mr Shimojo worked in the finance sector at one stage, but his three policy promises on his website relate to support for SMEs, maintenance of old age pensions and support for the agricultural sector. Mr Okubo worked for The Bank of Tokyo (now part of Mitsubishi MUFG) in New York and was a managing director at Morgan Stanley Securities. The team is certainly an interesting mix, although Mr Okubo's authority (if not knowledge) may be limited by the fact that he only became an MP in 2004, whereas Mr Ohata is on his seventh term and Mr Shimojo is on his third. Overall, their focus on SME interests is clear: the DPJ and its supporters believe that the domestic banking system is dysfunctional and has starved small companies and the regional economy of Japan of funds.

New policy priorities and political manoeuvring focused on SME sector and banks

This same theme is evident in the Index 2009 policy statement. There is little detail provided but the priorities that relate to financial sector regulation are stated as:

  • Response to financial risk: expand deposit insurance, flexibility (i.e. softening) of loan classification criteria to SMEs, support for individuals at risk of mortgage default.
  • Development of healthy financial system: reform of SESC to make it stronger and with a broader reach across all financial products.
  • New law for listed companies: to clarify responsibilities of all stakeholders.
  • Comprehensive regulation of financial services and markets: all financial products should be covered by a comprehensive system of consumer protection.
  • Softening of (FSA) loan classification criteria to SMEs: more stress on cash flow-based lending, classification of SME bad loans restricted to those loans where no interest is being paid. These policies pursued with the larger goal of ending credit squeeze.
  • Regulations to alleviate credit squeeze and promote financial system competition in the regions: no detail is provided as to what this might be, although public disclosure might be required (possibly, this might be some form of "name and shame" policy for the banks).


The desire to support small companies, mortgage borrowers and individual investors against large financial institutions is clear, even at the risk of damage to financial institution balance sheets. It is notable that there is no mention of deregulation, even in the mild form currently promoted by the FSA. Regulation looks likely to increase and inspections could become more aggressive if the DPJ reforms the SESC. However, unless the DPJ is prepared to fund more inspectors to enforce its proposed comprehensive regulation, that particular goal is unlikely to remain unrealisable.

Finally, the DPJ has to decide how to deal with the SME bad loan problem, as represented by the ongoing problems of ShinGinko Tokyo and the Incubator Bank of Japan. Whilst the DPJ wants to see more funds flowing to SMEs, a public keelhauling of Governor Ishihara's pet bank would provide a golden opportunity to embarrass the LDP. Of course, the DPJ is now at great risk of creating its own future disasters in the field of SME financing unless it is extremely careful.

How the FSA might respond: a chance for more funding and a need to be hawkish

That the FSA has been preparing for the arrival of the DPJ is apparent from its pre-election moves to encourage its bank inspectors to show flexibility in applying loan classification criteria to SME-related loans and to be flexible in any recapitalisation of regional banks (that lend to SMEs). Wisely, the FSA has reserved public comment on banks with bad SME loans, such as ShinGinko Tokyo. From a more practical perspective, if the DPJ is serious about revitalizing the SESC and enforcing comprehensive regulation, the FSA's budget and personnel might be expanded very significantly, which must be attractive to any bureaucrat.

Nevertheless, the new Commissioner of the FSA, Mr Katsunori Mikuniya, has to decide what elements of the FSA's "Better Regulation" initiatives to keep and how to present the FSA's stance on loans to SMEs, bank inspection and bank recapitalization. For the moment no change in regulatory policy is officially expected. But, if the DPJ starts to live up to its pro-regulation instincts, the FSA will need to adopt a harsher tone in its policy and inspections.

Domestic banks have the most reasons to be nervous

The DPJ's roadmap is still hard to read but it would seem likely that the biggest losers from a regulatory perspective are likely to be the large Japanese banks. They are likely to come under political pressure to lend to SMEs or semi-insolvent consumers where the risks of bad loan generation and management cost are high. The FSA has, rather surprisingly, already indicated its willingness to take a lenient view on bad SME and residential property loans. At the same time, the DPJ may be in favour of reinforcing bank capital adequacy, possibly even with public money, as a way of limiting the capacity of banks to speculate in global financial markets, but also because the extra cushion of new bank capital provides a way of covering growing SME loan write-offs that a pro-SME loan policy would probably entail. It is far too early to predict whether such a backdoor partial nationalisation of the sector will really take place, but the DPJ's attitudes to SME finance, loan growth, bank regulation and recapitalisation will merit special attention.