Utilization of Financial Institutions' Self-Assessment in Enhancing Credit Risk Management

The government's Prompt Corrective Action (PCA) measures to be implemented from April 1998 require financial institutions to conduct adequate assessment of their assets and to calculate appropriate "loan-loss write-offs and provisions" based on their own internal rules and referring to guidelines of the authorities. The Japanese "Big Bang" reform package is expected to be conducted by the year 2001. Given these situations, large financial institutions in Japan are making great efforts to enhance credit risk management. Medium and small-sized financial institutions are on their way to establish basic credit risk management systems under the PCA measures. Since information derived from self-assessment can be useful in a wide range of activities -- from strengthening risk management systems to formulating business strategy -- large differentials in business management are likely to arise among financial institutions depending on the utilization of this valuable information. The Bank of Japan introduced the Tracing Method of asset assessment and loan losses in order to support financial institutions to maximize the use of their own assessments as a management tool. The Tracing Method is used to observe changes in the condition of individual assets in a time series and is one way to utilize financial institutions' self-assessment of assets. The Bank conducted a follow-up analysis in the recent on-site examination to analyze how many of the loans classified in the previous examination (1993-94) were later "written off and others" in relation to financial losses ("others" are defined as specific loan-loss provisions, losses from support by renunciation of claims, and losses from sales of nonperforming loans to the Cooperative Credit Purchasing Company [CCPC]).