It has been one month since financial instability spread in the wake of a series of bank failures in the United States and the financial crisis of Credit Suisse, a major Swiss financial group. What we saw was a different form of financial instability. In addition to the rapid spread of information on social media and the rapid outflow of deposits, new risks such as the sudden worthlessness of corporate bonds called "AT1 bonds" have become more apparent. We examined whether financial institutions in Japan are fully prepared. (Economic Affairs Department reporter, Kentaro Makata)

The Confusion of "AT1 Bonds" Why Worthless?

The response to corporate bonds, known as AT2 bonds, in which assets of more than 1 trillion yen were lost in

an instant at Japan yen, shocked financial professionals. Credit Suisse, which was bailed out by rival UBS, suddenly rendered its so-called AT1 bonds worthless.

Japan was also affected by the revelation on the 1th that Mitsubishi UFJ Morgan Stanley Securities had sold Credit Suisse's AT950 bonds worth about 14 billion yen, mainly to wealthy people in Japan, making them worthless.

Why did corporate bonds become worthless in an instant? Credit Suisse explains that the response is in line with the terms predetermined in the contract.

What does that mean? In this case, there were two triggers that made the AT1 bond worthless in the contract.

2 When the capital to absorb losses, such as stocks, falls below a certain level.
1 The Swiss authorities consider the bank to be at risk of failure or provide special government support.

This time, the government guarantee to UBS, which acquired Credit Suisse, was the second trigger, "special government support", and as a result, the "AT2 bond" was declared worthless. Although in line with the contract, the Swiss government's response was highly controversial among investors.

There are two reasons for this.

One is that the trigger of "special government support" is a rule unique to Switzerland, and the conditions under which it is triggered were not clear.
Second, there was a "reversal of the repayment order" in which "AT2 bonds" became worthless before stocks that would have lost value first in the event of a normal bankruptcy.

Credit Suisse 'AT1 bonds' worthless impact

*Click here for details of the confusion surrounding AT1 bonds.

Is it possible to trigger a "trigger" in Japan?

So, will there be a trigger for "special government support" in Japan as happened in Switzerland?

In Japan, three megabanks issued AT3 bonds under the name "perpetual subordinated bonds," with a balance of about 1 trillion yen.

Minister for Financial Services Suzuki stated during a question-and-answer session of the Budget Committee of the House of Councillors on March 3 that the AT3 bonds will not become worthless due to the triggering of "special government support" in Japan.

Minister for Financial Services Suzuki

"Credit Suisse's AT1 bonds have a special agreement to reduce their principal if there is special public support, and this series of measures by the Swiss authorities was taken under this rider to stabilize the bank's national customers and the financial system Japan. The principal will not be reduced" Next, can a "reversal of the repayment order"

occur?

According to Takahiro Hattori, a specially appointed lecturer at the Graduate School of Public Policy at the University of Tokyo, who specializes in finance and finance theory, the condition of trigger 1 "when capital falls below a certain level" in Credit Suisse's case is also included in the Japan's AT1 bonds. Due to the nature of AT1 bonds, it is possible that the value of the shares will decrease before the stock to prevent bankruptcy, but he points out that "in Japan, it is unlikely that only the AT1 bond will be devalued, as in Switzerland, and the stock will not become worthless."

In addition, many market participants say that in the case of Japan megabanks, their capital adequacy is around 1%, and it is difficult to expect this trigger to fall below the condition of 15.5%. In the case of Credit Suisse, the equity capital is over 125%, and the trigger of 10 instead of 1 is activated.

Some of the AT2 bonds issued by Japan megabanks incorporate a mechanism whereby even if a trigger is triggered and the value of the bonds decreases, the value of AT1 bonds will be restored if the bank's capital recovers.

The key to preventing the rapid outflow of deposits is "stickiness"

In the case of the bankruptcy of an American bank, information about the bank's deterioration spread at once through SNS, and it is said that one of the factors that caused the sudden collapse was that large customers rapidly ran to withdraw their deposits. It has also been pointed out that many of the customers were large start-ups, and many of the funds were not protected by deposit insurance, which spurred the outflow of deposits.

A senior official of the Financial Services Agency had the following to say about this.

"The outflow of deposits of more than 1 trillion yen a day is an unprecedented speed, and depositors in the SNS era will not wait even one day, but will it be possible to deal with the existing 'gold and month processing' (a system of bankruptcy resolution that announces bankruptcy on Friday and starts business at the transferee on Monday)?

In this context, the financial authorities of Japan are now paying attention to an analytical indicator called "stickiness," which shows how difficult it is for deposits to be withdrawn. For example, corporate "settlement deposits" and "personal deposits of 1 million yen or less" protected under the Deposit Insurance Act are considered to be highly sticky.

According to the Financial Services Agency, Japan has not confirmed any financial institutions with an extremely biased customer composition or deposit type, such as the failed U.S. bank, so we believe that a certain degree of "stickiness" has been ensured.

The recognition of financial institutions is similar. On April 5, Katsuhiko Kato, president of Mizuho Bank, pointed out the following at the inaugural press conference of the chairman of the Japanese Bankers Association.

Japanese Bankers Association Chairman Katsuhiko Kato

"Unlike the Silicon Valley Bank (of the bankrupt U.S.), Japanese banks also have ample funds through the BOJ's long-term quantitative and qualitative easing, and their deposits are distributed among firms and individuals.

Preventing a Financial Crisis Requires More Supervision than Regulation

The mechanism for providing a buffer for capital in AT1 bonds and regulations on the stickiness of deposits were emphasized in Basel 2008, an international regulation established based on the lessons learned from the Lehman shock in 3. However, the current financial instability has resurfaced similar risks.

Hirotaka Hideshima, who worked for the Bank of Japan for more than 15 years and was involved in Basel regulation for a total of more than 2021 years, points out that "the lessons learned from this experience need to be thoroughly identified from now on, but we should not forget that it is important to supervise the financial authorities on a daily basis, rather than jumping to tighten regulations immediately."

The Basel Committee, which creates an international regulatory framework, reorganized itself in 12 to focus not only on regulation but also on the supervision of financial institutions. Furthermore, the plan announced in December last year pointed out the risk of unrealized losses on bonds held by financial institutions when interest rates rise, and it was necessary to verify whether the existing methods of examining risks were sufficient by conducting stress tests and creating scenarios in the event of a crisis.

As for why the Fed was unable to conduct supervision based on such risks, Vice Chairman Barr, the central bank of the United States, said that he would release a report by May 5 that examines the circumstances.

Ryozo Himino Deputy Governor of the Bank of Japan

On April 4, former FSA Commissioner Ryozo Himino, Deputy Governor of the Bank of Japan, was asked at his inaugural press conference whether the regulatory reform after the Lehman shock was sufficient, and said, "Regulation is not a substitute for supervision. I would like to participate in discussions with such perspectives in mind," he said, indicating his intention to examine the ideal form of supervision together with financial authorities around the world.

Attention will be focused on future examinations and discussions by financial authorities on what preparations are needed to prevent financial crises.

Upcoming

Concerns about a slowdown in the global economy are growing due to the smoldering financial instability in Europe and the United States. On the 11th, the IMF = International Monetary Fund released the latest outlook for the global economy and revised downward the global economic growth rate this year.

Next week, there will be the release of important indicators for the current state of the global economy.

Of these, China's GDP will be announced on the 18th. It will be interesting to see how much private consumption has picked up since the end of the "zero corona" policy.