Banking Act

The principal legislation regulating local banks in Japan, including “bank holding companies” and foreign bank branches in Japan, is Act No 59 of 1981 (the “Banking Act”) (as amended). The Banking Act, among others, governs the following matters in respect of local banks:

• licensing;
• organisation and governance;
• business scope;
• customer protection;
• prohibited acts;
• capital adequacy;
• business scope of subsidiaries and shareholders;
• accounting;
• disclosure; and
• procedures of mergers and acquisitions.

The Financial Services Agency of Japan (the “FSA”), which is the regulator of local banks in Japan, issues various guidelines (the “Guidelines”) concerning banking activities. Local banks are, in practice, required to comply with the Guidelines and may be subject to administrative actions in cases of non-compliance.

Financial Instruments and Exchange Act

Local banks in Japan may engage in securities-related services within the prescribed scope. Local banks in Japan are, in principle, required to obtain a licence from the FSA if they wish to provide securities-related services in Japan. This licensing requirement is in addition to the banking licence that banks in Japan have to obtain for the provision of banking services.

Registered banks are permitted to provide a wide range of securities-related services, including brokerage of government bonds. However, banks are not allowed to conduct certain categories of securities-related business, including underwriting of corporate bonds and stocks. Banks have to have a securities firm as their subsidiary to engage in the securities-related business. The key legislation regulating banks’ provision of securities-related services is Act No 25 of 1948 (the “Financial Instruments and Exchange Act” or FIEA) (as amended).

Regulatory Body

The principal regulator that exercises oversight of local banks in Japan is the FSA, which has the authority to supervise local banks if the power is delegated to it by the Prime Minister. The FSA supervises banking activities (including the securities-related businesses), issues banking licences, and imposes administrative advisories (eg, business improvement orders and business suspension orders) on local banks for wrongdoing, lack of adequate internal control systems and/or lack of adequate capital.

Off-site monitoring and on-site inspections of local banks in Japan are also primarily performed by the FSA. Inspections of banks’ securities-related services, on the other hand, are conducted by the Securities and Exchange Surveillance Commission of Japan.

No person is allowed to engage in “banking business” in Japan or with a person in Japan without having obtained a banking licence from the FSA first.

“Banking business” refers to:

• the acceptance of deposits and lending of funds (including discounting of bills or notes); or
• the conduct of fund remittance transactions.

Registration as a money lender under Act No 32 of 1983 (the “Money Lending Business Act”) would suffice in the case of a person who only engages in the lending of funds. Registration as a fund service under Act No 59 of 2009 (the “Payment Services Act”) would also suffice for persons who only engage in fund remittance transactions subject to certain limitations.

With regard to foreign banks, there are two ways by which a foreign bank may engage in “banking business” in Japan. The first is to establish a local subsidiary or a local affiliate in the form of a stock company (kabushiki kaisha). The second is to establish a foreign bank branch in Japan and obtain a banking licence for the branch in Japan.

Local banks in Japan are, in principle, required to obtain a licence from the FSA if they wish to provide securities-related services in Japan. This licensing requirement is in addition to the banking licence that they are required to obtain. Local banks are required to have a subsidiary securities firm to engage in securities-related business. This is because the scope of securities-related businesses that local banks are permitted to engage in is restricted compared to their subsidiaries that provide securities-related services in Japan.

The Banking Act is premised upon the separation of “banking” and “commerce”. Under the Banking Act, banks are only permitted to engage in core banking activities (ie, deposit taking, lending and funds remittance), a limited scope of ancillary activities to banking activities, and certain securities-related businesses specified in the Banking Act.

Under the Banking Act, activities, which are considered ancillary to banking activities, include, among others, guaranteeing obligations, securities lending, and acquiring and transferring monetary claims. Furthermore, the scope of the ancillary activities has been expanded following amendments to the Banking Act and relevant regulations, including the Guidelines. Recent amendments to the Banking Act clarify that the following constitute ancillary activities:

• services that support the livelihood of customers;
• IT systems and applications originally developed by banks for internal use;
• data analysis, marketing and advertising services;
• temporary staffing services; and
• consulting and business-matching services.

Anyone seeking a banking licence must apply and submit supporting materials (such as articles of incorporation and a certificate of registered information in respect of the company) to the Prime Minister through the Commissioner of the FSA.

The Prime Minister will endeavour to decide on the application within one month from their receipt of the official application. In practice, however, a preliminary consultation with the FSA and a review of the draft application will be conducted before submission of the official application. During the preliminary consultation and review process, the government will scrutinise the application to determine whether it meets the relevant requirements. There is no stated statutory period for the duration of the preliminary consultation and review.

Shareholders of local banks may be subject to regulation pursuant to the Banking Act if they qualify as “principal shareholders” or “bank holding companies”.

A “principal shareholder” is defined in the Banking Act as a shareholder who has obtained approval from the regulator to acquire and hold 20% (or, if certain conditions apply, 15%) or more of the voting rights of a local bank. A “bank holding company” is defined in the Banking Act as a company that has obtained approval from the regulator for:

• acquiring and holding shares in its Japanese subsidiaries for a price exceeding 50% of the total assets of the company itself; and
• that holds more than 50% of the voting rights in a local bank. A shareholder that constitutes a “bank holding company” will be subject to regulations applicable to a “bank holding company” rather than a “principal shareholder”.

Any legal entity that wishes to become a “bank holding company” must obtain the prior approval of the FSA. Approval as a “bank holding company” is granted at the sole discretion of the FSA.

In principle, the criteria required to be met to obtain approval as a “bank holding company” include the:

• ability to generate income and pay for its own and its subsidiaries’ operating expenditure;
• capital adequacy;
• sufficiency of knowledge and experience on the part of relevant personnel who engage in banking business; and
• sufficient social credibility.

A “bank holding company” is subject to strict regulations compared to those applicable to a major bank shareholder. Under the Banking Act, the regulations applicable to a “bank holding company” include:

• restrictions on the permitted scope of business of a “bank holding company” and its subsidiaries;
• governance requirements;
• capital adequacy requirements; and
• disclosure requirements.       

Any person wishing to be a “principal shareholder” must obtain prior approval from the FSA. Additionally, the following criteria must also be satisfied.

• In light of matters concerning funds for the acquisition of shares, the purpose of holding shares in the local bank, or other matters concerning the holding of shares, will pose no risk of impairment to the sound and appropriate management of the business of the local bank.
• In light of the property, income and expenditure of the person and their subsidiaries, there is no risk of impairment to the sound and appropriate management of the business of the local bank.
• The person must have sufficient understanding of the public nature of the local bank’s business and must also have sufficient social credibility.

A “principal shareholder” may be required by the FSA to submit reports or materials, be inspected by the FSA at its offices, be required to respond to questions put by the relevant FSA officer and be required to present its accounting books and other documents to the FSA for inspection. A “principal shareholder” that fails to meet any of the conditions imposed by the FSA may be subject to any action that the FSA may order the bank’s “principal shareholder” to take as the FSA deems necessary.

Furthermore, a “principal shareholder” with more than 50% of the voting shares of a local bank may be ordered by the FSA to submit an improvement plan or otherwise take such measures as the FSA deems necessary to ensure the sound and appropriate management and operation of the local bank.

Other than the above, pursuant to the Foreign Exchange and Foreign Trade Act, foreign investors that acquire shares in a local bank may be subject to certain requirements, such as notification requirements.

Under the Banking Act, a local bank must have a board of directors and accounting auditors. Additionally, under the Companies Act, a local bank must have:

• a board of corporate auditors; or
• a subcommittee of the board of directors comprising either an audit and supervisory committee, or an audit committee, remuneration committee and appointment committee.

Under the Banking Act, directors and executive officers engaging in the ordinary operations of a local bank must have the knowledge and experience to be able to manage and operate the bank appropriately, fairly and efficiently. Additionally, they must have sufficient social credibility. Furthermore, the Guidelines stipulate the appropriate governance system for local banks.

For example, representative directors of local banks with a board of corporate auditors must:

• take command of the establishment and maintenance of the bank’s internal compliance framework;
• make risk management a primary concern;
• establish an adequate internal control framework for proper disclosure of the bank’s corporate information to the public; and
• ensure that appropriate internal audits are performed on the bank.

The board of directors of a local bank must:

• proactively oversee the performance of the bank’s representative directors;
• establish and review the bank’s business management plans in line with the bank’s business objectives;
• establish a clear risk management policy by taking certain objectives into consideration; and
• ensure appropriate performance and review of internal audits of the local bank.

The Guidelines also require listed banks or listed bank holding companies to comply with Japan’s Corporate Governance Code published by the Tokyo Stock Exchange. In light of this, listed banks should appoint at least two independent external directors who are able to contribute to the bank’s sustainable corporate growth and corporate value.

Under the Banking Act, a local bank must file a notification with the Prime Minister when a director representing the local bank or a director engaging in the ordinary business of the local bank is appointed or resigns. Under the Banking Act, directors and executive officers engaging in the ordinary operation of a local bank must have both sufficient social credibility and the requisite knowledge and experience to manage and operate the bank appropriately, fairly and efficiently.

Under the Banking Act, a director who is engaged in the ordinary operation of a local bank may not engage in the ordinary operation of any other company without the authorisation of the Prime Minister. The authorisation will not be granted unless the Prime Minister is of the view that the double-hatting is unlikely to interfere with the sound and appropriate management of the local bank.

The Banking Act does not contain express stipulations with respect to matters of remuneration. Nevertheless, in line with discussions at the Financial Stability Board (the “FSB”), the Guidelines impose general requirements on local banks established in Japan and branches of foreign banks to establish systems that ensure appropriate remuneration of management and employees in light of the need to avoid excessive risk-taking.

Furthermore, under the Banking Act, all local banks must disclose matters concerning remuneration in their business reports, including:

• the internal committee or governance body that determines or otherwise supervises the determination of remuneration;
• matters concerning the evaluation of remuneration systems and the operation of these systems;
• consistency between remuneration systems and risk management and performance-linked remuneration; and
• other matters concerning remuneration systems.

A listed bank is required under the FIEA to publicly disclose the remuneration given to each of its directors if the aggregate annual remuneration of directors exceeds JPY100 million.

The Act on Prevention of Transfer of Criminal Proceeds (the “APTCP”), which is the primary legislation regulating AML and CFT, requires local banks to conduct the following due diligence on customers.

Verification at the Time of Transaction

The APTCP requires local banks to verify the following items at the time of specific transactions.

• The identity of customers, including their names, domiciles and dates of birth.
• The purpose of the relevant transaction.
• Customers’ occupations (for natural persons) and the nature of their businesses (for juridical persons).
• Information on the beneficial owner(s) of customers (for juridical persons) by verifying documents of identification presented by customers.

The verification is required at the time of specific transactions, which include opening deposit accounts, cash transfers of more than JPY100,000 and lending money.

Under the APTCP, local banks are required to prepare and preserve records of the verified information collected at the time of transactions and the measures taken to verify customers for seven years from the day of termination of the relevant transactions. Local banks are also required to prepare and preserve the records of transactions for seven years from the day of commencement of the relevant transactions.

Local banks are required to determine whether property accepted from a customer is suspected to have come from criminal proceeds in light of the results of verification at the time of a transaction and other circumstances, considering the recommendations of the National Risk Assessment of Money Laundering and Terrorism Financing Report published by the National Public Safety Commission every year. If property accepted from a customer is suspected, based on the results of verification at the time of transaction and other circumstances, to have come from criminal proceeds or the customer is suspected of committing a certain crime, local banks must promptly report the transaction to the FSA.

The FSA, upon receipt of the report, will promptly notify the National Public Safety Commission. If the National Public Safety Commission believes the information to be useful for investigation of criminal cases conducted by public prosecutors, the police or other investigators, it will provide the information to the investigators.

The FSA published the Guidelines for Anti-Money Laundering and Combating the Financing of Terrorism (the “AML/CFT Guidelines”) to clarify the Japanese government’s basic stance on risk management practices against money laundering and terrorism financing to encourage financial institutions to improve their internal systems for the prevention of money laundering and terrorism financing.

Based on the risk-based approach recommended by the Financial Action Task Force (the “FATF”), the AML/CFT Guidelines clarify “required actions”, which, if not taken, may result in administrative actions being imposed by the FSA, such as the issuance of reporting orders and business improvement orders against offenders. The AML/CFT Guidelines also stipulate the management systems and actions expected to be implemented by each financial institution, such as the formulation of “plan-do-check-act” (“PDCA”) procedures.

This is to ensure the involvement and understanding of management in the prevention measures and define the respective roles and responsibilities of the business, system control and internal audit divisions.

The FSA has also provided clarification on the manner in which it will monitor the implementation of these actions and provided examples of best practices based on its monitoring activities and the experience of financial institutions overseas.

Japan has a deposit insurance system that protects depositors in the event of a systemic failure in the banking sector. Act No 34 of 1971 (the “Deposit Insurance Act”) (as amended) provides for an insurance framework in respect of bank deposits in Japan. The Deposit Insurance Corporation, which was established under the Deposit Insurance Act, provides a public safety net to protect depositors.

Local banks headquartered in Japan are protected under this system. Annual insurance premium payments are made by insured banks to the Deposit Insurance Corporation.

The insurance coverage is subject to certain limitations, including the following.

• The deposit insurance system primarily covers ordinary deposits and does not cover foreign currency or derivative deposits.
• While deposit accounts for settlement purposes generally receive full coverage, other insured deposit accounts are generally covered up to JPY10 million per person and per bank.

The framework for regulating local banks’ capital adequacy under the Banking Act has been amended to align with the implementation of Basel III.

Local banks with international operations are required to maintain a minimum common equity Tier 1 ratio (CET1) of 4.5%, a minimum Tier 1 ratio (including AT1) of 6% and a capital adequacy ratio (including Tier 2 ratio) of 8.0%, pursuant to the administrative notice published by the FSA, which is in line with the Basel III regulatory framework.

Meanwhile, local banks who do not have international operations are required to maintain a core capital ratio of 4% (on both a non-consolidated and consolidated basis), and those banks employing the internal ratings-based approach are required to have a core capital ratio of 4.5%.

The leverage ratio of local banks with international operations must be kept at 3.15% (or 3.20% in the case of G-SIBs) or higher, following the amendments to the relevant regulations that came into force in April 2024. Furthermore, a leverage buffer of 0.5% to 0.75% for Japanese G-SIBs has been applicable to G-SIBs since 2023. When a local bank’s ratio falls below this level, the FSA can issue an early corrective action order to the local bank.

Liquidity requirements concerning liquidity coverage ratios and net stable funding ratios have been introduced in line with the implementation of Basel III. Both liquidity coverage ratios and net stable funding ratios must be kept at 100% or higher. These requirements only apply to local banks with international operations.

Furthermore, the 2.5% capital conservation buffer, the countercyclical buffer (2.5% maximum, 0% in Japan at present) and G-SIBs/D-SIBs buffer (3.5% maximum, and 0.5% to 1.5% for each local bank (G-SIBs/D-SIBs) selected in Japan at present) have been phased in for local banks with international operations. G-SIBs are also required to meet the total loss-absorbing capacity requirement.

The legal framework for the liquidation of banks is laid out in the Deposit Insurance Act. The Deposit Insurance Act classifies liquidation procedures into the following three categories.

• Ordinary procedures, which are resolution regimes.
• Procedures for financial crisis management, which are essentially bail-out regimes for the protection of bank deposits.
• Procedures under an orderly resolution regime, based on the “Key Attributes of Effective Resolution Regimes for Financial Institutions” adopted by the FSB, involving an arrangement which largely mirrors a bail-in scheme.

The Deposit Insurance Corporation performs the main role of protecting depositors and the entire financial system in the process for liquidation of banks.       

Ordinary Procedures

In principle, ordinary liquidation procedures should be used unless the failure of the local bank is systemically important. Under the ordinary procedures, only a certain amount of deposits (usually JPY10 million per depositor) is protected under the deposit insurance system. Ordinary procedures fall under two categories.

• Payout method: this is where deposits are paid off directly to depositors through the Deposit Insurance Corporation’s deposit insurance funds. The failed local bank is subject to bankruptcy procedures, such as civil rehabilitation proceedings or corporate reorganisation proceedings.
• Purchase and assumption method: this is where all or part of the business operations of a failed local bank are transferred to an assuming financial institution. Under this method, a financial administrator is appointed to manage the failed local bank until the operations of the failed local bank are transferred. The Deposit Insurance Corporation provides financial assistance (including monetary grants) within the scope of payout costs to ensure the smooth transfer of the local bank’s business.

Generally, the purchase and assumption method is preferred over the payout method, as the former would generally be better equipped to address the concerns of depositors and avoid financial turmoil.

Procedures for Financial Crisis Management

The Deposit Insurance Act provides certain measures in cases where serious problems arise in maintaining the stability of the financial systems in Japan or in regions where a bank operates its business. These measures, which include capital injection, full deposit protection and temporary nationalisation, may be initiated subject to deliberation by the Financial System Management Council.

Capital injection is designed to allow a bank with positive net worth to increase the amount of its capital through subscription by the Deposit Insurance Corporation of shares in the local bank. Full deposit protection is provided for banks with a negative net worth coupled with suspension or possible suspension of repayment of deposits. Temporary nationalisation is used for banks with negative net worth coupled with suspension or possible suspension of repayment of deposits.

Orderly Resolution Regime

The orderly resolution regime was introduced by amendments to the Deposit Insurance Act in 2014. The purpose of the amendments was to implement the “Key Attributes of Effective Resolution Regimes for Financial Institutions” adopted by the FSB. Under this regime, the Prime Minister can implement certain measures to prevent serious financial turmoil.

Under the orderly resolution regime, the Prime Minister may, subject to consultation with the Financial System Management Council, take the following actions for financial institutions that are not experiencing a deficit in funds.

• Impose oversight of the local bank’s management by the Deposit Insurance Corporation.
• Provide liquidity support to fulfil the obligations of the financial institution.
• Order a capital injection.

For financial institutions that are experiencing a deficit in funds, the Prime Minister may:

• impose oversight of the local bank’s management by the Deposit Insurance Corporation;
• take over the management of the local banks’ business and assets under those circumstances specified in the Deposit Insurance Act;
• transfer contracts that are necessary to maintain the stability of the financial system to a bridging bank; and
• provide financial assistance to the bridging bank to enable the performance of its obligations under those contracts.

The orderly resolution regime is generally in line with the “Key Attributes of Effective Resolution Regimes for Financial Institutions”, including recovery and resolution planning, temporary stay of early termination rights and implementation of a contractual bail-in mechanism.

The Banking Act does not require local banks to satisfy ESG requirements. However, under the Guidelines, a listed local bank is required to comply with Japan’s Corporate Governance Code issued by the Tokyo Stock Exchange. Under the Corporate Governance Code, listed companies are required to establish a basic policy for and make disclosures regarding their sustainability initiatives.

Furthermore, the FIEA was amended in 2023 to require listed companies to disclose certain sustainability-related matters in their annual securities reports and other disclosure materials. Accordingly, listed local banks are required, as a practical matter, to take ESG requirements into consideration in their disclosure documents.

In 2022, the FSA also published “Supervisory Guidance on Climate-related Risk Management and Client Engagement”. The guidance, which was published to enhance the development of initiatives to be taken by local banks, requires the management of climate-related risks by local banks as well as the support they should provide to their clients on the climate-related risks and opportunities relating to climate change.

The FSA has amended the Guidelines in efforts to strengthen the cybersecurity management of local banks and, as part of these efforts, also published the Guidelines for Cybersecurity in the Financial Sector in October 2024.

These Guidelines stipulate, among other things, that local banks should take the following measures.

• Maintain a management system dedicated to cybersecurity.
• Identify, evaluate and control cybersecurity risks.
• Ensure the security measures of its internal systems.
• Prepare contingency plans in anticipation of cybersecurity incidents. investigating cybersecurity incidents and preparing post-incident reports for the prevention of similar incidents.
• Control third-party risks.

Regulations regarding AML and sanctions have been tightened following the Fourth Round Mutual Evaluation of Japan by the FATF, which was published in 2021, in which Japan was rated as a country requiring enhanced follow-up. Following the evaluation report, the deadline for full compliance with the FSA’s AML/CFT Guidelines was the end of March 2024.

According to a report published by the FSA in June 2024, 99% of financial institutions have fully complied with the AMT/CFT guidelines based on reports from the financial institutions. However, as the on-site monitoring of the Fifth Round Mutual Evaluation of Japan by the FATF is planned in 2028, the Japanese government (including the FSA and the Ministry of Finance), plans to ensure that the AML/CFT management systems of local banks are appropriate and to enhance the AMT/CFT initiatives taken by local banks. To help achieve this, the FSA may also provide updates to the AML/CFT Guidelines as it deems necessary.

Tightened regulations and engagement of the FSA may result in increased burdens on local banks to develop frameworks and personnel structures or to invest in systems relating to AML/CFT. Local banks that fail to adapt to these tightened regulations will be exposed to regulatory risks, such as receipt of business improvement orders from the FSA.