Principal Laws and Regulations
The principal laws and regulations governing the banking sector are the Banking Act (Act No 59 of 1981) and the subordinate regulations enacted thereunder, including the Order for Enforcement of the Banking Act (Cabinet Order No 40 of 1982) and the Regulation for Enforcement of the Banking Act (Ministry of Finance Order No 10 of 1982).
The Banking Act defines banking as the business of conducting both the acceptance of deposits and the lending of funds, or providing money transfer services. Any person wishing to engage in banking must obtain a licence and will be subject to regulations under the Banking Act, including:
The purpose of these regulations under the Banking Act is to “preserve the credibility of banking services in view of their public nature; to achieve the sound and appropriate management of banking services in order to ensure protection for depositors and facilitate the smooth functioning of financial services; and to thereby contribute to the sound development of the national economy” (Article 1 of the Banking Act).
Financial Instruments and Exchange Act
Contrary to “universal banks” in Europe, banks in Japan are generally prohibited from engaging in securities business, but this prohibition has gradually been relaxed, and the scope of securities business that banks are allowed to conduct has gradually been expanded. Banks can also conduct certain securities business through their subsidiaries. Securities business (whether conducted by banks themselves or through their subsidiaries) is regulated by the Financial Instruments and Exchange Act (Act No 25 of 1948).
Financial Services Agency
The principal regulator of the banking sector is the Financial Services Agency (FSA), which is authorised under the Banking Act to supervise banks. The authority of the FSA includes:
The FSA issues supervisory guidelines on the interpretation of laws and regulations. Historically, the FSA also issued an inspection manual to be used as a checklist in its on-site inspections, but this manual was abolished in 2019 in an effort to transform the FSA’s supervisory approaches into more substantive, forward-looking and holistic analysis and judgement. The FSA has instead issued certain principles and theme-specific reports to announce its supervisory policies.
The FSA also has authority under the Financial Instruments and Exchange Act to supervise securities business conducted by banks or their subsidiaries. A portion of the FSA’s authority to conduct inspections of securities business is delegated to the Securities and Exchange Surveillance Commission.
Bank of Japan
The Bank of Japan (BOJ) is the central bank of Japan. It does not have regulatory authority under the Banking Act, but it has a right to conduct on-site examinations of banks under the agreements that it enters into with the banks when opening accounts for such banks.
The Banking Act defines banking as the business of conducting both the acceptance of deposits (including instalment savings) and the lending of funds (including discounting of bills and notes), or providing money transfer services. Any person wishing to engage in banking must obtain a licence under the Banking Act.
If a person wishes to conduct only the lending of funds and not the acceptance of deposits, registration as a money lending business under the Money Lending Business Act would suffice. The lending of funds requires a banking licence only when it is conducted together with the acceptance of deposits.
If a person wishes to provide only money transfer services, a registration of such services under the Payment Services Act would also suffice. It should be noted, however, that the Payment Services Act requires the regulator’s approval in addition to a registration of money transfer services when a person wishes to provide money transfer services exceeding JPY1 million per transfer, as explained in 10. Horizon Scanning.
Restrictions on Licensed Banks’ Activities
The Banking Act provides for restrictions on the business scope of licensed banks. In particular, banks are not allowed to conduct any business other than banking, business incidental to banking, and certain business specifically permitted under the Banking Act or other laws. The Banking Act also provides for restrictions on the business scope of subsidiaries of licensed banks, although the restrictions applicable to banks’ subsidiaries are not as strict as those applicable to banks themselves.
Requirements for a Banking Licence
Criteria for examination
The Banking Act requires the regulator to examine whether an applicant for a banking licence satisfies the following criteria:
In addition, the regulator is authorised to impose such conditions on a banking licence as it deems necessary in light of the above criteria.
Statutory requirements under the Banking Act
A bank must be a stock company incorporated under the Companies Act of Japan and must have:
The Banking Act stipulates fit and proper principles requiring certain directors and officers of a bank to have certain knowledge and experience and to have sufficient social credibility. The stated capital of a bank must be no less than JPY2 billion.
If an applicant for a banking licence is a foreign bank, it does not need to be a stock company incorporated under the Companies Act of Japan, but it is required to establish a branch in Japan. The fit and proper principles explained above will apply to the representative in Japan of such foreign bank. A foreign bank branch is required to keep assets corresponding to its stated capital within Japan in an amount of no less than JPY2 billion.
The application process usually consists of the following steps with the FSA:
In the first step, the applicant consults with the FSA and provides such information as is informally requested by the FSA for its preliminary examination. After completing this informal communication with the FSA, the applicant proceeds to the second step and submits the application documents together with supporting materials to the FSA.
The Banking Act provides for a standard processing period for the second step. In particular, the regulator must endeavour to process the application within one month from receiving such application. On the other hand, there is no standard processing period for the first step, as it is not a formal process under the Banking Act. The length of time required for the first step is highly dependent on the circumstances surrounding the individual applicants.
An applicant for a banking licence must pay JPY150,000 as a registration and licence tax for each application. This is the only statutory cost incurred in obtaining a banking licence. In practice, it is usual for an applicant to retain advisers to assist in the application process, and for the applicant to incur fees in relation to such advisers.
Notification of Large Volume Holding
A person who acquires more than 5% of the total voting rights in a bank must submit a notification to the regulator as required under the Banking Act. If the notified percentage of the voting rights increases or decreases by 1% or more, or if there is a change in the information stated in the notification, such person must submit a report on such change to the regulator.
Bank Major Shareholder
A person must obtain prior approval from the regulator to acquire 20% (or, as the case may be, 15%) or more of the total voting rights in a bank. Once approved, such person is called a “Bank Major Shareholder” under the Banking Act and will be subject to the supervision of the regulator. In particular, if the holding ratio of a Bank Major Shareholder exceeds 50%, the regulator has the authority to order the Bank Major Shareholder to submit an improvement plan to ensure sound management of the bank when necessary.
Bank Holding Company
A Bank Holding Company is defined as a holding company that has a bank as its subsidiary. A subsidiary is defined as a company the majority of whose voting rights (ie, more than 50%) are held by another company. A person must obtain prior approval from the regulator to become a Bank Holding Company.
If a person wishes to acquire more than 50% of the total voting rights in a bank, there is an issue of whether such person must obtain approval as a Bank Holding Company or a Bank Major Shareholder. Approval as a Bank Holding Company will be required only if such person falls under the definition of a holding company – ie, a company the majority of whose assets (ie, more than 50%) are comprised of shares in its subsidiaries in Japan.
A Bank Holding Company is subject to broader and stricter regulations than those applicable to a Bank Major Shareholder. The regulations applicable to a Bank Holding Company include:
There is no restriction on foreign shareholdings under the Banking Act. The above regulations on shareholdings in a bank (ie, notification of large volume holding, Bank Major Shareholder regulations, Bank Holding Company regulations) apply regardless of whether the shareholder is a domestic or foreign person. It should be noted, however, that the acquisition of a Japanese entity by a foreign investor may be subject to notification or other requirements under the Foreign Exchange and Foreign Trade Act.
Under the Banking Act (Article 4-2), a bank must be a stock company (kabushiki-kaisha) as set forth in the Companies Act, with the following organs:
A foreign bank that has a branch office in Japan is not subject to this organisational requirement (Article 47, Paragraph 2 of the Banking Act).
In addition, III-1 of the “Comprehensive Guidelines for Supervision of Major Banks, etc” issued by the FSA lists supervisory viewpoints to which the FSA would pay attention with respect to the corporate governance of a bank.
Process of Electing Directors and Executive Officers
As a general rule not limited to a bank, a director of a stock company (kabushiki-kaisha) under the Companies Act is elected by a resolution at a shareholders’ meeting (Article 329 of the Companies Act), while an executive officer of a company with a nominating committee, etc (as defined in Article 2, Paragraph (12) of the Companies Act), is elected by a resolution at a meeting of the board of directors. Neither the Companies Act nor the Banking Act stipulate a regulatory approval requirement in respect of the appointment of a director or an executive officer.
Restriction on the Concurrent Holding of Other Positions with Respect to Directors and Executive Officers
A director (or an executive officer, if the bank is a company with a nominating committee, etc, as defined in Article 2, Paragraph (12) of the Companies Act) that is engaged in the day-to-day business operations of a bank must not engage in the day-to-day business operations of any other company without the authorisation of the Prime Minister (Article 7, Paragraph 1 of the Banking Act).
When an application is filed for such authorisation, the Prime Minister must not grant that authorisation unless the Prime Minister finds that the particulars to which the application pertains are unlikely to interfere with the sound and appropriate management of bank services (Article 7, Paragraph 2 of the Banking Act).
A foreign bank that has a branch office in Japan is subject to these rules (Article 47, Paragraph 2 of the Banking Act).
Eligibility for Director or Executive Officer
A director engaged in the day-to-day business of a bank (or an executive officer engaged in the day-to-day business of a bank, if the bank is a company with nominating committee, etc, as defined in Article 2, Paragraph (12) of the Companies Act) must have the knowledge and experience to be able to carry out the business management of a bank appropriately, fairly and efficiently (Article 7-2, Paragraph 1 of the Banking Act).
In addition, no person subject to an order of commencement of bankruptcy proceedings who has not been discharged from bankruptcy and no person who is treated as the equivalent of the foregoing under foreign laws and regulations may become a director or an executive officer of a bank (Article 7-2, Paragraph 2 of the Banking Act).
A foreign bank that has a branch office in Japan is subject to these rules (Article 47, Paragraph 2 of the Banking Act).
A bank must file a prior notification with the Prime Minister when a director representing the bank or a director engaging in the ordinary business of the bank is appointed or resigns (Article 53, Paragraph 1, Item 8 of the Banking Act and Article 35, Paragraph 1, Item 3 of the Regulation for Enforcement of the Banking Act).
A foreign bank that has a branch office in Japan is subject to these rules (Article 47, Paragraph 2 of the Banking Act).
Duties of Directors and Executive Officers
As a general rule under the Companies Act, directors and executive officers owe a duty of care and a duty of loyalty to the company (Article 330, Article 355 and Article 402, Paragraph 2 of the Companies Act, and Article 644 of the Civil Code).
A bank must not extend credit to its directors or executive officers under terms and conditions that are disadvantageous to the bank compared to the ordinary terms and conditions under which the bank extends credit (Article 14, Paragraph 1 of the Banking Act).
The Banking Act provides no rule with respect to remuneration paid by a bank to its directors, executive officers or employees.
III-2-3-5 of the “Comprehensive Guidelines for Supervision of Major Banks, etc” issued by the FSA lists supervisory viewpoints to which the FSA would pay attention with respect to remuneration paid by a bank to its directors, executive officers or employees, as follows:
In cases where the FSA thinks that a bank’s remuneration system is problematic as a result of regular off-site monitoring or inspection, it shall require the bank to submit a report under Article 24, Paragraph 1 of the Banking Act as necessary. If a serious problem is recognised, the FSA shall take administrative action, such as issuing an order for business improvement under Article 26 of the Banking Act.
The principal laws and regulations governing anti-money laundering and counter-terrorist financing are the Act on Prevention of Transfer of Criminal Proceeds (Act No 22 of 2007) and the subordinate regulations enacted thereunder, including the Order for Enforcement of the Act on Prevention of Transfer of Criminal Proceeds (Cabinet Order No 20 of 2008) and the Regulation for Enforcement of the Act on Prevention of Transfer of Criminal Proceeds (Ministry of Finance Order No 1 of 2008).
In addition, the FSA issues “Guidelines for Anti-Money Laundering and Combating the Financing of Terrorism”, which clarify the required actions and expected actions to be implemented by financial institutions, such as banks, and how the FSA shall conduct monitoring going forward.
The Act on Prevention of Transfer of Criminal Proceeds provides for preventative measures in combating money laundering and terrorist financing, by imposing obligations such as customer due diligence, record-keeping and the reporting of suspicious transactions on “specified business operators”. A bank is one such “specified business operator”.
Customer Due Diligence (Article 4 of the Act on Prevention of Transfer of Criminal Proceeds)
When a bank enters into a transaction (“Specified Transaction”) listed in Article 7 of the Order for Enforcement of the Act on Prevention of Transfer of Criminal Proceeds (Cabinet Order No 20 of 2008) with its customers who are natural persons, it is required to verify their identification data (name, address and date of birth), the purpose and intended nature of the transaction, and the customer's occupation, by checking their identification documents, such as a driver’s licence.
When a bank enters into a Specified Transaction with its customers who are legal persons, such as corporations, it must verify their identification data (the name and location of the head office or main office), the purpose and intended nature of the transaction, the type of business, and the beneficial owner(s).
When a bank enters into a Specified Transaction with an agent or a representative of a customer, it must verify the identification data in respect of such agent or representative.
When a bank enters into a transaction that has a high risk of being related to money laundering or terrorist financing, such as a transaction where the bank suspects its counterparty is disguising its identity, the bank is required to verify items related to verification at the time of the transaction, using a more robust method.
A bank is required to prepare and preserve verification records collected at the time of the transaction, as well as measures taken for verification of the customer at the time of the transaction, for seven years from the day when the transaction is made or when an agreement related to the transaction is terminated, depending on the type of the transaction (Article 6 of the Act on Prevention of Transfer of Criminal Proceeds).
In addition, a bank is required to prepare records of the date and contents of transactions, and to keep these records for seven years from the date of such transaction (Article 7 of the Act on Prevention of Transfer of Criminal Proceeds).
Reporting Suspicious Transactions (Article 8 of the Act on Prevention of Transfer of Criminal Proceeds)
A bank is required to file a suspicious transaction report with the competent administrative authority in cases where assets received through a transaction are suspected to be criminal proceeds, or where the customer is suspected to be engaged in money laundering.
Scheme Administration and Supervision
The Deposit Insurance Corporation (DIC) is a special corporation organised under the Deposit Insurance Act of Japan (Act No 34 of 1971 – DIA) and administers the deposit insurance system. The Prime Minister generally supervises DIC’s operation of the system, and also determines or approves specific administrative procedures in respect of failed financial institutions or successors thereto. The Prime Minister delegates most of his or her authorities under DIA to the FSA.
Scope of Protection
The deposit insurance system protects depositors by either providing financial assistance to a successor financial institution and thereby indirectly making insurance proceeds available to depositors (Financial Assistance Method), or directly paying insurance proceeds to depositors of a failed financial institution (Insurance Pay-out Method). The Financial Assistance Method is more cost-effective and causes less confusion compared to the Insurance Pay-out Method. DIC has resorted to the Financial Assistance Method in dealing with almost all failed financial institutions.
Either way, only those with insured deposits with insured financial institutions are protected under the system up to the statutory limit (if applicable).
Insured financial institutions
Banks and other deposit-taking financial institutions licensed in Japan are insured under the deposit insurance system, with some exceptions.
One of the exceptions is foreign branches of licensed financial institutions. Another exception is Japanese branches of foreign banks: under the Banking Act, instead of establishing a licensed bank in Japan, foreign banks may obtain a licence and conduct banking business through their branches in Japan, but such licensed branches are not covered by the deposit insurance system. Agricultural/fishery co-operatives and related financial institutions are insured not under the deposit insurance system but under a separate “savings” insurance system.
Governmental financial institutions are not covered by these insurance systems. Insurance and securities firms receive premiums, margins and other types of funds from their customers, the economic nature of which funds is similar to deposits; however, these firms are not deposit-taking financial institutions and are thus not insured under the aforementioned insurance systems. Nonetheless, part of such customer funds is covered by separate customer protection systems. As described in 9.1 Legal and Regulatory Framework, these firms are also subject to the new resolution regime established in line with the FSB Key Attributes.
Deposits for payment and settlement (Settlement Deposits) with the insured financial institutions are fully covered by the deposit insurance system (ie, without being restricted by the statutory limit applicable to General Deposits – defined below). To qualify as Settlement Deposits, the deposits must bear no interest, be redeemable on demand, and be used for payment and settlement.
Deposits other than Settlement Deposits (General Deposits) are also protected but only within the statutory limit of JPY10 million in principal plus interest thereon, per depositor, per insured financial institution.
Certain deposits are disqualified as Settlement Deposits and General Deposits. For example, foreign currency deposits are disqualified, given the volatility of exchange rates. Negotiable certificates of deposit, bearer deposits and deposits under an alias or fictitious name are also disqualified due to difficulties in identifying the true depositors. Other examples of disqualified deposits are deposits from insured financial institutions and deposits in respect of Japan offshore market accounts.
In addition to Settlement Deposits and General Deposits, when an insured financial institution is processing a fund remittance or certain other settlement transactions requested by a customer, obligations in relation to the customer are also fully protected. If the settlement transactions are denominated in a foreign currency or requested by other insured financial institutions, the obligations thereunder are disqualified and not insured.
Uninsured deposits or obligations may be paid as tenders or dividends through bankruptcy/rehabilitation proceedings, depending on the status of assets of the relevant failed financial institution (see 9.1 Legal and Regulatory Framework).
Funding of Deposit Insurance System
DIC is funded mainly by the receipt of insurance premiums from insured financial institutions and capital contributions from the government, BOJ and certain financial institutions. DIC also raises funds by issuing bonds or by borrowing from financial institutions.
Duty of Confidentiality
Neither the Banking Act nor any other act contains any provision in respect of bank secrecy requirements. In Japan, banks’ duty of confidentiality has been established and developed by the case law of the Supreme Court, which has held that a financial institution owes its customers a duty of confidentiality, which is based on business practices or an agreement between the financial institution and its customer; the financial institution may not disclose information on transactions between itself and its customer, information on a customer’s credit risk, or any other customer information to another person, unless for good reason.
Based on such established case law, Article 12-2, Paragraph 2 of the Banking Act provides that a bank must appropriately handle customer information it acquires in the course of its services. In addition, III-3-3-3 of the “Comprehensive Guidelines for Supervision of Major Banks, etc” issued by the FSA states that the FSA would pay attention to whether or not a bank has established an appropriate information management system.
It is generally understood that a bank may disclose customer information upon reasonable grounds, such as when the customer explicitly or implicitly consents to such disclosure, or when the bank is legally required to disclose customer information. It should be noted that a bank is not always allowed to transfer its customer information to its affiliates under such duty of confidentiality. Because the bank’s duty of confidentiality has been established and developed by the case law, it is sometimes unclear whether or not a bank may disclose certain customer information without breaching its duty of confidentiality, including the case where a bank shares certain customer information with its affiliates.
When a bank breaches such duty of confidentiality, it would be liable for damage to the customer arising from such breach. In addition, if, as a result of regular offsite monitoring or inspection, the FSA thinks that a bank’s information management system is problematic, it shall require the bank to submit a report under Article 24, Paragraph 1 of the Banking Act as necessary. If a serious problem is recognised, the FSA shall take administrative action, such as issuing an order for business improvement under Article 26 of the Banking Act.
Personal Data Protection
If a bank’s customer is a natural person, the customer information would fall under “personal data” under the Act on the Protection of Personal Information (Act No 57 of 2003), and the disclosure of such customer information would be subject to personal data protection regulations, including the Act on the Protection of Personal Information. A bank is required to prevent the leakage, loss or damage of customer information that falls under personal data, and to conform to the requirements regarding the scope and purpose of any shared use.
A bank is subject to the so-called firewall regulations that prohibit banks and securities firms sharing their non-public customer information (limited to certain material information) with their affiliates without a customer’s prior approval; however, the sharing of non-public customer information for internal management purposes is permitted, and the sharing of non-public corporate customer information is permitted if the relevant bank provides a corporate customer with an opt-out opportunity in advance. After a recent amendment, the sharing of foreign corporate customer information is now permitted.
As explained in 10.1 Regulatory Developments (Discussion on amendment of firewall regulations), a working group hosted by the regulator has proposed an overhaul of the firewall regulations.
Adherence to Basel III Standards for Internationally Active Banks
Under the Banking Act, banks must meet capital, liquidity and related risk control requirements. Banks are also required to avoid having large exposures to single counterparties. To enable group-level risk management, the Banking Act and regulations thereunder cover not only banks but also Bank Holding Companies.
This risk control framework aims to be consistent with the Basel III standards set by the Basel Committee on Banking Supervision (BCBS), to the extent applied to internationally active banks (ie, banks having a branch or a banking subsidiary overseas).
Reviews of this risk control framework under the BCBS’s Regulatory Consistency Assessment Programme (RCAP) have assessed the framework as being “compliant” with the requirements of the Basel III standards that relate to risk-based capital, liquidity (LCR) and G-SIBs and D-SIBs.
No results of assessments of other requirements, such as the stable funding ratio (NSFR) and large exposure framework, are currently available; however, the FSA has continuously amended the relevant regulations with a view to adhering to the updated Basel III standards in these areas.
The FSA has announced that the national implementation of the finalised Basel III standards has been postponed until the fiscal year ending March 2023, in light of the related announcement of the Group of Central Bank Governors and Heads of Supervision (GHOS), the oversight body of the BCBS.
Risk Control Framework for Domestic Banks
Domestic banks are also subject to the aforementioned risk control framework, but under less strict requirements than internationally active banks. For instance, domestic banks are only required to meet a minimum capital ratio (the ratio of “core” capital amount to risk asset amount) of 4%; on the other hand, several types of threshold are set as the minimum capital ratio of internationally active banks (eg, 8% for “Tier 1” plus “Tier 2” equity, 6% for “Tier 1” equity and 4.5% for “Common Equity Tier 1”). Domestic banks are not subject to capital buffer requirements and certain other risk management rules.
Risk Management and Correction Measures
Under the aforementioned risk control framework, banks are primarily responsible for managing their risks. The FSA continually monitors the risk status of banks, and takes early correction measures if a bank fails to meet the minimum capital requirement, such as the order to file an improvement plan, the order to enhance capital and the order to suspend or abolish the whole or part of a business. As a preventative measure, the FSA may also issue an early warning to a bank that satisfies the minimum capital requirement but in relation to which bank there is still a risk-related concern requiring improvement. With respect to internationally active banks, a failure to meet capital buffer requirements leads to an order from the FSA to restrict capital distribution.
Ordinary resolution procedures
The FSA appoints DIC as a “financial administrator” of a financial institution that has excessive liabilities or is at risk of suspending the repayment of deposits, if its operations are extremely inappropriate or if its dissolution seriously hinders smooth fund flows and the convenience of its customers in relevant regions or sectors.
Once appointed as financial administrator, DIC is authorised to control the operations and manage the assets of the failed financial institution. With such authority, DIC is expected to promptly transfer such institution’s business, including deposits, to a successor financial institution so that DIC may be able to provide financial assistance to such successor financial institution for the protection of depositors under the Financial Assistance Method. The amount of such assistance is limited to the amount of the insurance proceeds. If DIC fails to identify a successor financial institution promptly, the FSA directs DIC to establish a bridge bank to which the business of the failed financial institution is transferred for the time being. DIC attempts to re-transfer the business from the bridge bank once a successor financial institution is identified.
Only financial institutions insured under the deposit insurance system (see 6.1 Depositor Protection Regime) are subject to these resolution procedures.
Resolution procedures in the face of systemic risk
In the face of an extremely serious threat to the maintenance of the credit stability of Japan or relevant regions (systemic risk), the Prime Minister convenes the Financial System Management Council and determines the necessity of financial assistance in relation to a failed or insolvent financial institution (the so-called Item 2 Measure). Unlike the Financial Assistance Method under the ordinary resolution procedures, this Item 2 Measure enables financial assistance exceeding insurance proceeds, given the necessity to address the emerging systemic risk. Following the determination by the Prime Minister, the FSA appoints DIC as financial administrator, and DIC provides financial assistance exceeding the insurance proceeds.
If the financial institution is insolvent and has failed, and if the systemic risk is too serious to be avoided by the Item 2 Measure, the Prime Minister determines the necessity of the acquisition of shares in such financial institution (so-called special crisis management or Item 3 Measure). Following such determination by the Prime Minister, the FSA directs DIC to acquire shares in the failed and insolvent financial institution, and thereby substantially nationalises such institution.
Financial institutions that are not eligible for these measures (ie, those which neither are insolvent nor have failed) may still receive a capital injection from DIC to recover their capital adequacy ratio in line with the direction of the FSA (so-called Item 1 Measure).
Only financial institutions insured under the deposit insurance system (see 6.1 Depositor Protection Regime) are subject to these resolution procedures.
A new regime in line with FSB Key Attributes
The FSB Key Attributes were implemented by amending DIA in 2013, thereby granting the Prime Minister and DIC authority to resolve financial institutions
Under the amended DIA, the Prime Minister may determine that, following the convening of the Financial System Management Council, it is necessary to take recovery or resolution measures for financial institutions where, without such measures, there is a risk of extreme disruption to the Japanese financial market or other financial systems.
It is noteworthy that not only insured financial institutions (ie, insured banks and other deposit-taking financial institutions – see 6.1 Depositor Protection Regime) but also Japanese branches of foreign banks, licensed insurance and securities firms and holding companies thereof may be subject to this new regime. DIC plays an important role under this regime, including through the provision of financial assistance to successors of insolvent financial institutions with a view to ensuring the performance of important transactions in the financial market. DIC also provides liquidity even to solvent financial institutions as necessary.
This new regime is generally in line with the FSB Key Attributes, including the recovery planning, the temporary stay, contractual bail-in mechanism and ex post recovery of costs from the industry.
The commencement of the aforementioned administrative procedures does not exclude the possibility of judicial procedures being initiated against a failed financial institution in relation to its bankruptcy/rehabilitation. Rather, to achieve the aim of each of these administrative procedures, it is essential to concurrently commence bankruptcy/rehabilitation proceedings and thereby prevent the deterioration of such failed institution’s assets and enable it to perform its obligations (eg, with respect to uninsured deposits; see 6.1 Depositor Protection Regime) to the extent permitted under such proceedings. Although DIA sets out certain provisions addressing the conflict between the administrative and judicial procedures, there are no insolvency preference rules applicable to deposits.
Amendment to the Act on Sales, etc, of Financial Instruments (ASFI) and the Payment Services Act (PSA)
On 5 June 2020, the Diet passed a bill to amend the ASFI and the PSA for the purposes of introducing a new regulatory framework for the brokerage of financial products, and revising the regulatory framework for payment and settlement. This Amendment was promulgated on 12 June 2020. A portion of the Amendment related to the PSA became effective on 1 May 2021, while a portion of the Amendment related to the ASFI became effective on 1 November 2021.
New framework for brokerage of financial products
The Amendment has introduced a new regulatory framework entitled “Financial Service Brokerage” in order to facilitate a one-stop service by brokers to offer financial products throughout all sectors of banking, insurance and securities. In particular, this is expected to encourage online service providers or platforms to add financial products to the services they offer to users. From the viewpoint of the banking sector, this would be regarded as the creation of a new sales channel. Banks would need to consider whether and how to collaborate with this new sales channel.
The new regulatory framework has two unique characteristics:
Under the previously existing legislation, brokers wishing to provide a one-stop service must obtain the necessary licence under each relevant statute for each sector (eg, the Banking Act, the Insurance Business Act and the Financial Instruments and Exchange Act).
The Amendment has revised the ASFI (and renamed it the Act on Provision of Financial Services) to introduce the new regulatory framework of “Financial Service Brokerage”, which allows brokers to offer financial products in any or all sectors across banking, insurance and securities with only one licence (registration) as a “Financial Service Broker”. Having said that, the previously existing regulatory framework for brokerage under each sectoral statute also continues in parallel with the new regulatory framework introduced under the amended ASFI.
Under the amended ASFI, Financial Service Brokerage comprises four categories:
Registration as a Financial Service Broker will be required for each of these categories. In particular, applicants for registration as a Financial Service Broker will need to disclose in their application documents which of the four categories they wish to operate within. The regulator will then proceed to examine the applicants according to the categories indicated. Brokers that wish to change the categories under which they are registered will need to apply to the regulator again to become registered under the desired new categories.
Non-adoption of the affiliation framework
The previously existing regulatory framework for brokers under each relevant statute generally adopts an “affiliation framework”, under which brokers are affiliated with (or belong to) specific financial institutions (eg, banks, insurance companies or securities firms). In turn, the affiliated financial institutions are responsible for the supervision of the affiliated brokers and are liable for any damage caused to customers thereby.
The amended ASFI does not apply the same affiliation framework to Financial Service Brokers. Consequently, Financial Service Brokers will be able to offer the products of multiple financial institutions more easily than existing brokers, who would need to be affiliated with specific financial institutions under the affiliation framework.
On the other hand, as there will be no supervision over the conduct of Financial Service Brokers by affiliated financial institutions, the amended ASFI imposes the following restrictions on Financial Service Brokers in order to protect customers:
Furthermore, no affiliated financial institutions will owe any liability for damage caused by Financial Service Brokers to customers. In other words, customers will not be able to claim damage against affiliated financial institutions and will only be able to make claims against the Financial Service Brokers themselves. Therefore, the amended ASFI generally requires Financial Service Brokers to set aside a security deposit of a certain amount to ensure their financial ability to pay compensation for damage to customers if necessary.
Revision to framework for payment and settlement
Under Japanese law, money transfer services are regulated by either the Banking Act or the PSA.
Historically, only banks licensed under the Banking Act were allowed to provide money transfer services. In 2009, the PSA was enacted to allow registered service providers to provide money transfer services, subject to an upper limit of JPY1 million per transfer.
The Amendment has made several revisions to the regulatory framework for payment and settlement under the PSA, with the most notable change being an amendment to the aforementioned upper limit imposed on money transfer service providers registered under the PSA. This would have an impact on the banking sector as it is expected to promote competition between money transfer service providers registered under the PSA and banks licensed under the Banking Act.
New type of services for a large amount transfer
The Amendment has introduced a new type of money transfer service, under which it will be permitted to transfer amounts exceeding JPY1 million, albeit subject to stricter regulations (Type I Money Transfer Services).
To conduct Type I Money Transfer Services, a banking licence under the Banking Act will not be necessary, but approval will be required in addition to registration under the PSA. The PSA also imposes the following stringent restrictions regarding the retention of money on the approved providers of Type I Money Transfer Services:
New type of services for a small amount transfer
The Amendment has also introduced a type of money transfer service under which it will only be permitted to transfer amounts not exceeding JPY50,000 per transfer, which will be subject to less strict regulations (Type III Money Transfer Services).
Money transfer service providers are generally required under the PSA to protect in-transit money by way of statutory deposit, bank guarantee or trust agreement. However, the Amendment allows providers of Type III Money Transfer Services to protect in-transit money by way of simple deposit in a segregated bank account, as an alternative to statutory deposit, bank guarantee or trust agreement. In relation to this method of simple bank deposit, external auditing of such bank account will be required.
Amendment to existing type of services
Lastly, the previously existing money transfer services that had been regulated under the PSA before the Amendment are categorised as Type II Money Transfer Services under the amended PSA. Regulations applicable to Type II Money Transfer Services basically remain unchanged except for certain revisions, including the introduction of a general requirement to take measures to prevent the retention of money that is not related to a remittance (which could be viewed as the acceptance of deposits without a banking licence).
Amendment to Banking Act
On 19 May 2021, the Diet passed a bill to amend the Banking Act for the purpose of relaxing business scope restrictions and other related regulations thereunder. This Amendment was promulgated on 26 May 2021 and became effective on 22 November 2021.
Restrictions on scope of business of banks
As explained in 2. Authorisation, banks are not allowed to conduct any business other than banking, business incidental to banking, and certain business specifically permitted under the Banking Act or other laws. The Amendment has expanded the scope of incidental business that banks are allowed to conduct.
Specifically, the scope of incidental business has been expanded to explicitly include management consulting business, worker dispatching business, the business of developing, selling and maintaining IT systems and programmes, the provision of advertisements, survey and data analysis services, and the provision of care services by way of making cyclic visits to customers.
Restrictions on scope of business of banks’ subsidiaries and sister companies
As explained in 2. Authorisation and 3. Control, the Banking Act provides for business scope restrictions not only in relation to banks themselves but also in relation to subsidiaries of banks and subsidiaries of Bank Holding Companies (ie, sister companies of banks). The Amendment has also relaxed such restrictions in respect of banks’ subsidiaries and sister companies.
The Banking Act had previously allowed banks and Bank Holding Companies to own a company that “provides services that contribute to or are expected to contribute to increased sophistication in the banking conducted by the bank or to enhanced convenience for bank users, through the use of information and telecommunications technology or other technologies” (“Sophistication Service Company”), subject to prior approval from the regulator.
The Amendment has expanded the scope of business that a Sophistication Service Company is allowed to conduct. Specifically, the scope has been expanded to include the provision of services that contribute to or are expected to contribute to the creation of a sustainable society, such as regional revitalisation and the improvement of industrial productivity.
The Amendment has also relaxed the criteria that banks and Bank Holding Companies are required to satisfy when applying for prior approval to own a Sophistication Service Company, on the condition that the business of the relevant Sophistication Service Company falls within a certain scope, to be stipulated under the amended Banking Act.
Furthermore, the Amendment has allowed Bank Holding Companies to own a Sophistication Service Company upon mere prior notification to the regulator (ie, without obtaining prior approval), on the condition that the relevant Bank Holding Companies satisfy certain capital and governance requirements, and that the business of the relevant Sophistication Service Company falls within a certain scope, to be stipulated under the amended Banking Act.
Restrictions on acquisition of foreign companies
The Banking Act provides for an exemption from the business scope restrictions pertaining to subsidiaries of banks and to Bank Holding Companies, for the purpose of promoting and facilitating overseas M&A conducted by banks and Bank Holding Companies.
The Banking Act had previously allowed banks and Bank Holding Companies to acquire a foreign company that owned subsidiaries conducting business that would normally violate the business scope restrictions under the Banking Act, on the condition that the business of such foreign company being directly acquired by the banks or Bank Holding Companies fell within a certain scope as provided under the Banking Act, and that the banks or Bank Holding Companies would in principle be required to divest such indirect foreign subsidiaries conducting unpermitted business, within five years from the acquisition.
The Amendment has expanded this exemption to further promote and facilitate overseas M&A by banks and Bank Holding Companies. The grace period of five years has been extended to ten years and can also be indefinite with approval from the regulator. Furthermore, the Amendment allows banks and Bank Holding Companies to directly acquire a foreign company that is partly engaged in unpermitted business, on the condition that such foreign company is mainly engaged in certain financial business that falls within the scope of business permitted under the amended Banking Act.
Discussion on amendment of firewall regulations
On 18 June 2021, the Working Group on Capital Market Regulations of the Financial System Council published its second report discussing the creation of an attractive capital market in a post-pandemic world. The second report proposes an overhaul of the regulations for the purpose of enhancing the provision of growth capital to business corporations and lifting restrictions on licensed financial institutions under the firewall regulations.
As explained in 7.1 Bank Secrecy Requirements (Firewall Regulations), banks and securities firms are generally prohibited from sharing material non-public customer information with their affiliates. The regulations were originally introduced at the time of the relaxation of the separation between banking and securities businesses in Japan. At that time, with a view to addressing the concern regarding undue influence on customers resulting from the concurrent operations of both businesses by the same group, the regulations required that a customer’s prior written consent be obtained prior to the sharing of information (the opt-in system).
Over the years, the regulator has optimised the regulations by introducing certain exceptions to the prohibition, such as:
However, the second report refers to the criticism that the current opt-out system has not been used often, because banks and securities firms are required to provide a detailed explanation to their customers about how information will be shared. The second report also compares the Japanese regulations and practices thereunder with those in the EU/US and points out that the prohibition may have prevented Japan-licensed financial institutions from providing group-wide consolidated services to their customers and posed an obstacle to the growth of Japan as an international financial centre.
Against this background, the second report proposes that said regulations be relaxed at several points. Among others, it suggests considering excluding information about listed companies, a certain scope of unlisted companies (eg, pre-IPO companies) and their group companies from said prohibition. To protect them, the second report also suggests that such excluded companies be provided with an opportunity to request that information stops being shared (the so-called “new” opt-out system, which is expected to be less burdensome than the current opt-out system). Even after the regulations are amended as proposed, banks and securities firms will still need to obtain consent from most unlisted companies and individuals. On this point, the second report proposes a shift from the current paper-based consent to digital consent (eg, consent by email).
While relaxing the firewall regulations, the second report also addresses the concerns expressed by customers of financial institutions about undue influence resulting from the concurrent operations of bank and securities businesses by the same group. It focuses on the prevention of such undue influence by adding regulations on customer information management, enhancing regulatory monitoring on conflict of interests, and implementing co-ordination between financial regulators and competition authorities regarding the abuse of dominant bargaining positions by financial institutions.
Three Classifications of Fund Transfer Services
On 6 March 2020, the Financial Services Agency (the FSA) submitted a bill to the Diet for the revision of the Payment Services Act (the PSA), which classified fund transfer services into three categories according to certain maximum limits on remittance amounts. The Bill passed on 5 June 2020. An amendment to the PSA, together with its subordinate regulations (ie, Enforcement Ordinance, Cabinet Office Ordinance and related Guidelines for Administrative Processes) came into effect on 1 May 2021. This article provides an overview of the new classification of Fund Transfer Service Providers (FTSPs), covering issues such as the maximum remittance amounts for each type thereof, licensing procedures, methods for preserving and managing user funds and measures to ensure there is no retention of user funds that are not likely to be used for fund transfer transactions. Please note that, in this article, we refer to the Enforcement Ordinance of the PSA as the “Enforcement Ordinance”, the Cabinet Office Ordinance on the Fund Transfer Service Providers as the “Cabinet Office Ordinance”, and the Guidelines for Administrative Processes (Vol. 3: Financial Companies; 14. FTSPs) as the “Guidelines”.
Background of establishment of the types of fund transfer services
Prior to the amendment, under the PSA, the maximum amount of money that an FTSP could process was equivalent to JPY1 million per transfer. However, while there were instances whereby a certain number of users required the processing of amounts that exceeded such remittance limit, most existing FTSPs were handling remittances in the range of tens of thousands of yen per transaction, which was also the scale of the balance of most user funds per person. Therefore, the decision was made to divide FTSPs into three types and apply the appropriate level of regulations – neither too strict nor too lenient – with respect to each.
Hence, the PSA was revised to create the three types of fund transfer services (PSA, Article 36-2).
Type I Fund Transfer Services
“Type I Fund Transfer Services” means any fund transfer services that are not Type II or Type III Fund Transfer Services (PSA, Article 36-2, Paragraph 1). As described below, the maximum remittance amounts for Type II and Type III Fund Transfer Services are set at JPY1 million and JPY50,000 per transfer, respectively (Enforcement Ordinance, Article 12-2, Paragraphs 1 and 2). Accordingly, Type I Fund Transfer Services relate to fund transfer transactions that exceed JPY1 million per transfer. While Type I Fund Transfer Services may include transfers of less than JPY1 million each, as long as those are processed using a Type I FTSP’s account (ie, unless a registration as an FTSP engaged in Type II Fund Transfer Service (Type II FTSP) or an FTSP engaged in Type III Fund Transfer Services (Type III FTSP) is separately obtained and fund transfer transactions are carried out based on those qualifications in a separate account from the Type I accounts), they are subject to Type I Fund Transfer Services regulations, including with respect to the retention of funds, as described below.
Retention of funds
A Type I FTSP is not allowed to assume any obligation vis-à-vis its users with respect to Type I Fund Transfer Services whereby the amount of funds to be transferred, the day on which the funds are to be transferred and the identity of the receiving party to which the funds are to be transferred are not clear (PSA, Article 51-2, Paragraph 1; Cabinet Office Ordinance, Article 32-2, Paragraph 1).
Additionally, the Type I FTSP is not allowed to assume any obligations for transactions lasting beyond the period necessary in order to complete the administrative process relating to the transfer of funds (PSA, Article 51-2, Paragraph 2). According to the Guidelines, the “period necessary in order to complete the administrative process relating to the transfer of funds” means the time that is operationally and technically required, calculated while taking into consideration the minimum amount of time necessary to process each transaction, such as AML/CFT, communications with overseas bases and banks and remittance to bank accounts.
Furthermore, providing services whereby users of Type I Fund Transfer Services perform the following is deemed an assumption of obligations beyond the period necessary for carrying out the administrative process in connection with the transfer of funds:
These activities constitute a potential violation of Article 51-2, Paragraph 2 of the PSA. In addition, when funds reach the person they are remitted to, certain measures are required in order to avoid the unnecessary retention of funds prior to the completion of the transaction, such as making a direct deposit into a bank account previously registered by such person.
As illustrated above, since the funds deposited by users must be immediately transferred and immediately paid out to the person receiving them, providing fund transfer services in the form of wallet services is prohibited in the case of Type I FTSPs.
In order to meet the asset security obligation under the revised PSA, an FTSP can combine the three permitted methods of asset preservation: security deposits, guarantee agreements and trust agreements. If the FTSP selects the security deposit as its preservation method, it has to make a security deposit within the period specified in the Cabinet Office Ordinance for each type of fund transfer service it offers (PSA, Article 43, Paragraph 1, Items (i) and (ii)). For Type I Fund Transfer Services, it is required to make a security deposit for each business day in an amount equal to or higher than the highest amount required under the PSA. Such deposit must be executed within the period specified by the FTSP, but not exceeding two business days from the business day indicated above (Cabinet Office Ordinance, Article 11, Paragraph 1). The required amount is calculated each day, based on the outstanding liabilities (ie, the funds in the process of being transferred), which are assumed by the FTSP at a certain time of the day, as designated by it.
The PSA stipulates that, when an entity registered as an FTSP intends to operate Type I Fund Transfer Services, it must establish a business implementation plan and obtain authorisation (PSA, Article 40-2, Paragraph 1). Among other factors, a business implementation plan should include the “maximum amount” if “the Type I FTSP has a plan to set the maximum amount of funds to be transferred through each fund transfer transaction” (PSA, Article 40-2, Paragraph 1, Item (i)) and the “method of managing the electronic data processing system used for processing fund transfer transactions” (Item (ii) of the same Paragraph).
Type II Fund Transfer Services
“Type II Fund Transfer Services” entail processing fund transfers of amounts not exceeding JPY1 million (excluding Type III Fund Transfer Services) (PSA, Article 36-2, Paragraph 2; Enforcement Ordinance, Article 12-2, Paragraph 1).
Retention of funds
The PSA requires an FTSP to take measures to ensure that it does not retain any funds received from users for purposes other than fund transfer transactions (PSA, Article 51). To satisfy this requirement, the Cabinet Office Ordinance stipulates that, with respect to Type II Fund Transfer Services, if the amount of obligations for fund transfer transactions owed to each user exceeds JPY1 million, the FTSP must establish a system to verify that those funds, as used by the creditors of such obligations, are indeed intended for fund transfer transactions related to Type II Fund Transfer Services (Cabinet Office Ordinance, Article 30-2, Paragraph 1).
When determining the relationship between user funds and fund transfer transactions, the Guidelines require the FTSP to engage in a comprehensive analysis of the following aspects with respect to each user:
For example, when recognising that the amount received in an account exceeds the JPY1 million threshold, the FTSP must verify whether a fund transfer transaction is indeed scheduled to take place and whether the larger size of funds is retained as compared with the relevant user’s transaction history. If the conclusion is that the funds are unlikely to be used for fund transfer transactions, the FTSP must transfer the funds in excess of those likely to be used for fund transfer transactions to the user’s pre-registered bank account. In addition, the FTSP is also required to return to the user those funds that are equivalent to or below JPY1 million, or to otherwise take measures to ensure it does not retain funds, if they are not intended to be used for fund transfer transactions. Hence, wallet services are subject to restrictions even when operating below the JPY1 million threshold.
If a Type II FTSP selects security deposits as its preservation method, it is required – for each period, as specified by it, but not exceeding one week – to make a security deposit in an amount equal to or higher than the highest amount required under the PSA. Such deposit must be executed within the period specified by the FTSP, but not exceeding three business days from the end of the relevant period (Cabinet Office Ordinance, Article 11, Paragraph 2). The required amount is calculated each day within the up-to-one week specified period, based on the outstanding liabilities (ie, the funds in the process of being transferred), which are assumed by the FTSP at a certain time of the day, as designated by it.
Type III Fund Transfer Services
“Type III Fund Transfer Services” entail processing fund transfers of amounts not exceeding JPY50,000 (PSA, Article 36-2, Paragraph 3; Enforcement Ordinance, Article 12-2, Paragraph 2).
Retention of funds
When assuming obligations in connection with, and engaging in, Type III Fund Transfer Services, FTSPs are prohibited from assuming any obligations exceeding JPY50,000 for each user thereof (PSA, Article 51-3; Enforcement Ordinance, Article 17-2). The Guidelines require a Type III FTSP to take measures to ensure it does not engage in transactions exceeding the JPY50,000 maximum amount for both remittance per transaction and retention per user; therefore, a Type III FTSP must establish a system that ensures no fund transfer transactions exceeding JPY50,000 are accepted from users, and a system to ensure that the obligations owed to each of the users do not exceed such threshold. For example, if a user transfers JPY45,000 to another user who already has JPY35,000 in their account, the resulting balance of the recipient (if received in the account in full) will be JPY80,000; this would breach the JPY50,000 ceiling for the amount that may be retained and, therefore, preventative measures would be called for. Examples of such measures provided in the Guidelines include prohibiting the remittance when the sum in the recipient’s account and the transferred amount exceed JPY50,000 in total or entering into an agreement to automatically transfer JPY30,000 – the excess of the maximum threshold in our example – to a bank account of the remittee.
If a Type III FTSP selects security deposit as its preservation method, it is required – for each period, as specified by it, but not exceeding one week – to make a security deposit in an amount equal to or greater than the highest required amount under the PSA. Such deposit has to be made within a period specified by the FTSP, but not exceeding three business days from the end of the relevant period (Cabinet Office Ordinance, Article 11, Paragraph 2). The required amount is calculated each day within the specified up-to-one week period based on the outstanding liabilities (ie, the funds in the process of being transferred), which are assumed by the FTSP at a certain time of the day, as designated by it.
Other preservation methods
A Type III FTSP may be exempted from asset preservation requirements (using security deposits, guarantee or trust agreements) by submitting a notification indicating its bank deposit and savings management ratio (ie, the ratio of the amount of outstanding liabilities consisting of funds in the process of being transferred that are segregated and managed separately by bank deposits and savings). In such cases, the FTSP is required to manage, through a management method for deposits and savings, an amount of money that is at least equal to the amount calculated by multiplying the amount of outstanding liabilities, which consist of funds in the process of being transferred, by the bank deposit and savings management ratio (PSA, Article 45-2, Paragraph 1). Assuming the bank deposit and savings management ratio is 100%, the Type III Fund Transfer Services can function without using methods such as security deposits, by segregating bank deposits and savings. In such cases, the Type III FTSP is required to provide information to users, by delivering documents or other appropriate methods, regarding the bank deposit and savings management ratio and the fact that, upon bankruptcy, they would not be deemed preferred creditors of the FTSP (Cabinet Office Ordinance, Article 29-2, Item (iv)).
Required measures applicable to all types of fund transfer services
Measures required when engaging in two or more types of fund transfer services
An FTSP engaged in two or more types of fund transfer services must take measures to ensure users can readily obtain information regarding the amount of obligations owed to each user by the FTSP with respect to each type of fund transfer service and such user’s status therefor (Cabinet Office Ordinance, Article 30-4, Paragraph 1; Guidelines, VI-1-1(1)(i)). In addition, when an FTSP engaged in both Type I and Type II Fund Transfer Services receives funds related to Type II Fund Transfer Services from users and assumes obligations therefor, it is required to take measures to prevent such obligations from falling within the category of obligations in connection with fund transfer transactions related to Type I Fund Transfer Services (Paragraph 2 of the same Article).
Measures to ensure there is no retention of funds that are not used for fund transfer transactions
An FTSP must return to users funds received and deemed not intended to be used for fund transfer transactions, or otherwise take measures to ensure it does not retain, such funds (Cabinet Office Ordinance, Article 30-2, Paragraph 2). More specifically, according to the Guidelines, there has to be a specified method to return funds that are deemed not intended to be used for fund transfer transactions to the relevant users. If any measure other than a bank transfer to a registered bank account is taken to return funds, the FTSP has to ensure that such method is appropriate from the perspective of expediency and convenience; furthermore, the FTSP has to put in place a system to receive advance information from users that would be necessary in order to return funds, based on the specific method selected.
In this connection, the payment of interest on the balance of users’ funds would be deemed to be engaging in the solicitation of user funds that is unrelated to the purpose of fund transfer transactions and would be in violation of the deposit regulations under Article 2, Paragraph 1 of the Act Regulating the Receipt of Contributions, the Receipt of Deposits, and Interest Rates.
Measures to prevent user funds from being used as funds for loans
An FTSP must take measures to prohibit the use of funds received from users for loans, etc (Cabinet Office Ordinance, Article 30-3). According to the Guidelines, the following steps must be taken: