Ashikaga Bank Nationalization - International Law Office

Process of Nationalization
Applying the Item 3 Measure

On February 6 2004 the Financial Services Agency announced a management plan submitted by the nationalized Ashikaga Bank in accordance with Article 115 of the Deposit Insurance Law (34/1971, as amended). Ashikaga Bank Ltd, a failed second-tier regional bank, was nationalized on December 1 2003 pursuant to Article 102, Paragraph 1, Item 3. This measure is often referred to as the 'Item 3 Measure'. Ashikaga Bank remains under national control as a bank under special crisis management and is therefore supported by public funds. Under a newly appointed management team, the bank is working to dispose of bad loans and to return to normal operation. The management plan will be carried out as part of the special crisis management process.

Process of Nationalization

Nationalization and protection of depositors and creditors
On November 29 2003, following the submission of notice by Ashikaga Bank in accordance with Article 74, Paragraph 5 of the Deposit Insurance Law, the prime minister acknowledged the necessity of taking the measures set forth in the Item 3 Measure and made the decision to commence special crisis management in accordance with Article 111, Paragraph 1. This decision was announced on December 1 by public notice and the Deposit Insurance Corporation (held jointly by the government, the Bank of Japan and private financial institutions) acquired all shares in the Ashikaga Bank in accordance with Article 112, Paragraph 1, essentially nationalizing the bank.

The prime minister also announced that Ashikaga Bank will continue to operate under special crisis management, and will continue to restructure and dispose of bad loans under the new management team. This team is to find a financial institution to assume the business of the bank, thus terminating the special crisis management, as quickly as possible. During the intervening period, the full amount of debts such as deposits are guaranteed, irrespective of their classification, and the bank will work carefully to provide funding to sound borrowers. Under Article 38 of the Bank of Japan Law, the Bank of Japan has also committed to providing liquidity as necessary for the repayment of such debts.

Background and the Item 3 Measure
The events were precipitated when Ashikaga Bank recorded large losses in its interim settlement of accounts at the end of September, a result of its disposal of bad loans and the elimination of deferred tax assets. On November 29 the bank reported that:

"The assets of the bank are insufficient to honour its financial obligations, and the business and financial condition of the bank are such that there is a genuine concern that it will cease to repay deposits."

It reported this statement to the prime minister in accordance with Article 74, Paragraph 5 of the Deposit Insurance Law. The prime minister convened a meeting of the Financial System Management Council, at which the following points were confirmed:

• The business and financial condition of the bank were such that there was a genuine concern that it would cease to repay deposits, and the bank could be classified as a 'failed financial institution';(1)
  
  
• The bank had excessive liabilities and the assets of the bank were insufficient to clear outstanding debts; and
  
  
• In order to avoid the danger of serious impediment to the maintenance of an orderly financial system in Japan or in a certain region in Japan where the bank conducted its business, it would be necessary to follow the Item 3 Measure.

It was decided that the bank would be placed under special crisis management in accordance with Article 111, Paragraph 1.

Measures for failed financial institutions
The Ashikaga Bank was not therefore dealt with through the standard proceedings applied to failed financial institutions. The failure was treated as a special case that required additional measures to avoid financial crisis. Under the Deposit Insurance Law, a failed financial institution would normally be brought under management by a financial administrator, dispose of bad loans and take other measures while receiving public funds. Another financial institution would then assume certain functions of the failed institution, such as insured deposits, via transfer of the business, merger or another method. A legal insolvency proceeding, such as civil rehabilitation, would also take place. The scope of public funds which may be injected is generally limited to the 'pay-off cost', which Article 64, Paragraph 2 defines as the estimated costs necessary in case of paying insurance claims for insurable contingencies affecting the failed financial institution. Unless special provisions are made under the Deposit Insurance Law, the amount of guarantee provided for deposits is limited to the amount stipulated under this law. The full amount is not guaranteed without special provisions to such an effect (currently, there is a special measure in place). Therefore, the injection of public funds in relation to the repayment of deposits with a failed financial institution is also limited by the amount of the guarantee. However, in some cases the absence of an injection of public funds in excess of the pay-off cost may risk critically significant disturbances affecting the financial system in Japan or in the region where the bank conducts its business. In respect to this, there are two measures stipulated by Article 102, Paragraph 1: the Item 2 Measure and the Item 3 Measure (there is an Item 1 Measure, but it does not concern failed financial institutions). Ashikaga Bank was nationalized under the Item 3 Measure, which is a last resort applied where systemic risk cannot be averted through the Item 2 Measure.

Measures for avoiding financial crisis
To maintain credit order in Japan and in the region in which a financial institution operates, Article 102, Paragraph 1 stipulates three measures which the prime minister may adopt to avoid financial crisis, through a meeting of the Financial System Management Council. These are as follows:

• Item 1 Measure - increasing the net worth of a financial institution through subscription in new shares and other methods by the Deposit Insurance Corporation. This measure is limited to financial institutions that are not failed financial institutions and which do not have excessive liabilities;
  
  
• Item 2 Measure - ordering a financial institution which is a failed financial institution or is burdened with excessive liabilities to be managed by a financial administrator and providing financial support in excess of pay-off costs; and
  
  
• Item 3 Measure - the management of a bank which is a failed financial institution with excessive liabilities under special crisis management (essentially nationalization, with the acquisition of all shares by the Deposit Insurance Corporation).

The Item 1 Measure is aimed at averting the failure of a financial institution before it happens (as in the case of Resona Bank in 2003), whereas the Item 2 and Item 3 Measures deal with failed financial institutions. In both the Item 2 and the Item 3 Measure the scope of public funds which may be used differs from the standard procedure for dealing with failed financial institutions in that it is possible to inject funds in excess of the pay-off costs to avoid financial crisis (Articles 118 and 119, and Article 110, Paragraph 3).

Applying the Item 3 Measure

The following is a general description of matters which are required to be undertaken following the application of the Item 3 Measure. The description does not relate the order in which events must occur, but conveys the process with respect to Ashikaga Bank.

Stage one
All shares of the bank are acquired by the Deposit Insurance Corporation under Article 112 of the Deposit Insurance Law, providing effective nationalization as a bank under special crisis management.

On December 1 the commencement of special crisis management of Ashikaga Bank was announced by public notice and the Deposit Insurance Corporation acquired all shares in Ashikaga Bank. All former share certificates of the bank became invalid at this point.

Stage two
A public announcement is made of the finances (assets and liabilities) of the bank under special crisis management in accordance with Article 113.

Stage three
A new management team is appointed to lead the bank under special crisis management in accordance with Article 114.

In the case of Ashikaga Bank, the Deposit Insurance Corporation elected Norito Ikeda as head of the bank upon his nomination by the commissioner of the Financial Services Agency and he assumed the post from December 16. Under Ikeda, the new management team is restructuring the banks operations and disposing of bad loans, among other things.

Stage four
A management plan is prepared and submitted concerning management of the bank under special crisis management in accordance with Article 115.

On February 6 2004 the management plan submitted by Ashikaga Bank was announced by the Financial Services Agency. Under this plan, the bank will:

• facilitate finance in the region, and work toward rejuvenating small and medium-sized businesses;
  
  
• strengthen governance and improve transparency;
  
  
• ensure appropriateness and transparency of business operations; and
  
  
• significantly rationalize management.

Under these four policies the management team plans to reform the management of the bank, increase its value and terminate the special crisis management at an early date, keeping the cost to the public at a minimum. The first policy includes giving due consideration to sound borrowers to facilitate financing in the region, while still actively disposing of bad loans. Complementing the appointment of a new management team, the second policy led to the creation on February 6 of an advisory board comprised of concerned external parties from the region, who are providing advice to the board of directors on management issues. After the ordinary general shareholders meeting in June this year, the bank plans to switch to a 'company with committees' system. The third policy includes the creation of an operations auditing committee comprised of external directors, lawyers and certified public accountants to oversee, among other things, investments, loans and the disposal of assets. Ashikaga Bank announced on February 13 that it had created such a committee.

Stage five
The liability of executives of a bank under special crisis management is clarified in accordance with Article 116.

A bank under special crisis management is under an obligation to take necessary measures for ascertaining civil responsibility and filing necessary criminal charges against present or former directors and auditors responsible for the bank's failure.

According to the management plan announced on February 6, this will be achieved through the creation of an independent internal investigation committee, under the direct control of management, comprised of lawyers and accountants, and including the Deposit Insurance Corporation as an observer. The committee will assess the legal responsibility of former managers and report to the board of directors. On February 13 Ashikaga Bank announced on that such a committee had been created.

Stage six
Financial assistance is provided to a bank under special crisis management in accordance with Articles 118 and 119 and Article 110, Paragraph 3. The financial institution that acquires the business is eligible for financial assistance in excess of the pay-off costs.

Stage seven
Early conclusion of the Item 3 Measure is made in accordance with Article 120.

The business of the bank under special crisis management must be assumed by another financial institution via merger, transfer of the business or another method pursuant to Article 120 as soon as possible, for the early conclusion of the special crisis management. This goal is incorporated into the management plan of Ashikaga Bank.

For further information on this topic please contact Hiroo Atsumi or Philip Ryan at Atsumi & Partners by telephone (+81 3 5501 2111) or by fax (+81 3 5501 2211) or by email (h.atsumi@apap.gr.jp or p.ryan@apap.gr.jp).

Endnotes

(1) 'Failed financial institution' is defined in Article 2, Paragraph 4 as "a financial institution that has suspended repayment of deposits...or is at risk of suspending repayment thereof, due to business conditions or the situation of its assets". In addition, the measures provided under the Deposit Insurance Law applicable to failed financial institutions also apply to financial institutions under management (as defined in Article 2, Paragraph 12) that are deemed to be failed financial institutions in accordance with Article 74, Paragraph 3.