TOKYO -- Japan's financial watchdog is preparing to ease its stringent oversight system for banks, hoping to get loans flowing again and create a more flexible, growth-oriented environment.
When a banking crisis gripped the nation in the late 1990s, the regulatory authority, later named the Financial Services Agency, significantly tightened its inspection rules. While the move brought stability to the sector, it also had a straitjacketing effect on banks, which began reining in lending and taking fewer risks.
The FSA's changes include scrapping the manual for bank inspections it introduced in 1999 and reorganizing its Inspection Bureau -- essentially, reinventing the process for ensuring that banks are healthy and legally compliant, with a focus on giving them greater operational leeway.
"We have been paying attention only to the brakes and airbags," FSA Commissioner Nobuchika Mori told executives from global financial institutions who had gathered in Tokyo in May for the annual meeting of the Institute of International Finance. "From now on, however, we need to look at the overall performance of the vehicle."
As the financial watchdog, the agency is mandated to order banks to take remedial steps when their financial health is at risk, and to maintain an effective safety net to prevent bank failures from damaging the entire financial system. The FSA's oversight manual has been integral to these functions.
After Japan's asset bubble collapsed in the early 1990s, the agency prioritized cleaning up the bad debt mess and dealing with bank failures. Its bank examiners rigorously inspected banks' loans, investments, fund management and risk profiles, taking disciplinary measures when necessary.
Those efforts helped stabilize the banking system, but they also bred a conformist mentality among Japanese banks and stifled their motivation to think creatively and strategically.
There was another side effect: Banks began significantly curtailing corporate lending and cutting off credit lines.
Now that the bad loan ratio has fallen below 3%, Mori believes the strict bank inspection regime is only serving to choke growth of the financial sector and the Japanese economy.
"We need to become an organization that changes constantly to avoid falling behind changes in the environment," he said.
The first big change will be to overhaul the Inspection Bureau, one of the three bureaus under Mori's direct supervision.
The mission of the bureau -- whose operations are being integrated with those of the Supervisory Bureau in fiscal 2017 -- will be redefined as "monitoring." The FSA will in August submit its request for the envisioned organizational changes to the Ministry of Internal Affairs and Communications.
In line with that change, the agency's bank inspectors will be called "monitoring officers." Their "bible," the all-important inspection manual, will be fed to the shredder.
In its place, the officers will receive a new guidebook that addresses far fewer topics. Gone will be the regularly scheduled inspections of all banks, in which the officers take the microscope to specific loans. Instead, the timing and targets of the checks will be decided based on each bank's financial condition.
Plans call for having teams of banking and insurance experts work closely with task forces specializing in corporate governance and legal compliance to ensure that financial institutions are assessed thoroughly from various perspectives and in a flexible manner.
These officers will ask banks such questions as: "Do you place importance on a company's business outlook when making credit decisions?" and, "Do you have a system for managing credit risk tailored to the specific conditions of each borrower?"
Banks will also be asked whether they are making serious efforts to collect and analyze information about economic conditions at home and abroad.
This overhaul is expected to have significant implications for both the FSA and banks.
The main purpose of the reforms is to encourage banks to create new business models. The agency wants to ensure that more of the money in the financial system will be used to fuel economic growth.
The total value of outstanding loans in Japan stands at about 480 trillion yen ($4.36 trillion). While the figure has been trending higher, it is not much different than it was in the early years of the new millennium.
One thing that has changed a lot, however, is bank deposits, which have surged by 50% over the same period to more than 700 trillion yen. The FSA is keen to unlock that cash and see it flow into investments that power economic growth.
Under the new regime, the watchdog will do more than just gauge banks' financial health; it will also assess their business visions.
The idea is to encourage banks to switch from focusing on protecting their current businesses to investing more aggressively for future growth. The FSA also wants banks to provide more customer-oriented services that embrace financial technologies and contribute to revitalizing local communities.
"We will shift the focus of our operations from disciplinary actions to supportive efforts and put our administrative priority on making sure that this shift will not be a temporary change but will continue through changes in the agency's leadership," Mori said.
The agency has already begun taking steps aimed at jolting bank executives out of their conservative mindsets. In September last year, for example, the FSA introduced a new index that regularly measures how many new loans regional banks extend to local businesses. And starting this month, the agency will require financial institutions to disclose information about sales and cancellations of such investment instruments as investment trusts.
Although the watchdog will conduct rigorous bank inspections far less frequently, it will still get tough if it has to.
On May 24, the agency led a probe on Shoko Chukin Bank over questionable loans and the falsification of documents related to a government-backed scheme to help troubled companies.
Financial Services Minister Taro Aso commented at the time that such problems made it difficult for the FSA to focus on efforts to nurture the industry. The agency can ease its oversight only if banks maintain the public's trust by staying in good financial shape and avoiding scandals.
The FSA's predecessor was created by spinning off the bank inspection and supervisory unit from the Finance Ministry after the ministry was hit by a wining and dining scandal in 1998 in the middle of the banking crisis. In other words, the agency was born out of "soul searching" by the financial regulators over the corruption scandal and the lessons they learned.
The FSA's decision to overhaul its inspection regime appears to be coming from a similar brand of reflection, this time over its desire to build more "future-oriented" relations with banks.