Staff writer

Mild-mannered Japanese -- who not so long ago gave little thought to where their money was placed -- now face the nasty possibility of losing a portion of their nest eggs as the "Big Bang" of financial deregulation leads to failures and mergers left and right.

This is the kind of situation that regulators have been racking their brains to avert for the past year, the end product to be various items of legislation currently being prepared for submission to the upcoming Diet session that convenes later this month.

Since Prime Minister Ryutaro Hashimoto's order in November 1996 to initiate a sweeping reform of Japan's financial structure, both industry and regulators have sought to galvanize existing systems to protect depositors, investors and insurance policyholders.

But the rapidity with which the weaker financial institutions are being overcome by a more deregulated market -- even before core Big Bang reforms are in place -- has pitted them in a race against time.

The successive failures last year of such major financial firms as Yamaichi Securities Co. and Hokkaido Takushoku Bank, along with several smaller and regional financial companies like Nissan Mutual Life Insurance Co., have served as a wake-up call.

Hirohiko Okumura, a professor of economics at Gakushuin University, said he is not surprised by the current predicament faced by the domestic financial sector, pointing out that liberalization is always accompanied by upheaval. He also acknowledged that frameworks to protect deposits and assets are needed for the time being.

At present, legal protection in the face of financial collapse lies with the Deposit Insurance Corp., a body which insures deposits at a failed bank and offers assistance to financial firms willing to take over the operations of a bank that has gone under.

Set up jointly by the government, the Bank of Japan and private sector financial firms, the DIC offers unlimited insurance up to the end of March 2001 for financial products such as deposits and money trusts with principal compensation contracts.

The DIC's member institutions, such as banks and "shinkin" banks (credit cooperatives), and the Labor Bank -- currently pay insurance premiums totaling roughly 462 billion yen annually, but many observers fear this amount is insufficient to handle future bank failures up to March 2001.

From that point on, a cap of 10 million yen per depositor would take effect. In a rush to curb further deterioration of the creditworthiness of the nation's financial sector, the government and the ruling Liberal Democratic Party decided late last year to take steps to galvanize the DIC by issuing 10 trillion yen worth of government bonds that could be converted into cash.

At the same time, the DIC's tasks would be expanded to include capital injection into banks through such means as purchasing their preferred stock, and 20 trillion yen worth of government guarantees would be placed on loans taken out by the DIC for these operations.

A new law tentatively called the Financial System Stabilization Law and revisions to the Deposit Insurance Law are to be submitted to the Diet so that these steps can be taken. But Gakushuin's Okumura, while noting that these stopgap measures are needed in the current crisis situation, expressed concern because the DIC is not as strong and independent an organization as is required in a fully liberalized financial market.

"Depositors need to realize that the DIC system in principle is a form of insurance -- when you pay your premiums, you indirectly hire inspectors to check the management of banking units," he said. The DIC, which currently operates with about 190 people, needs more inspectors with investigative authority like the U.S. Federal Deposit Insurance Corp., which employs roughly 4,000 inspectors to check banks' performance, Okamura pointed out.

In the hope of containing the current financial upheaval, the LDP in its December financial stability package also vowed to consider the use of public funds to improve systems to fully protect securities investors and insurance policyholders up to March 2001.

During the debate to galvanize the DIC, industry bodies such as the Japan Securities Dealers Association and the Life Insurance Association of Japan called on the party for help, saying they cannot shoulder the total burden on their own.

The Finance Ministry over the past year has been studying the possibility of forming legal frameworks to this end, because at present there are only industry-managed funds to help when a brokerage or insurer goes bust.

In the event of a collapse of a securities firm, money from the Compensation Fund for Deposited Securities is used to reimburse investors for assets they had deposited at the brokerage. The fund, established in 1969, is operated as a juridical foundation set up voluntarily by the securities industry and basically limits its compensation to 2 billion yen for every failed brokerage.

This ceiling was scrapped in the case of the failure of Sanyo Securities Co. in early November, when it filed for application of the Corporate Rehabilitation Law.

As of the end of September -- before the collapse of Yamaichi, Sanyo and a smaller brokerage, Echigo Securities Co. -- the fund had about 36 billion yen in assets, but many observers fear that its resources will dwindle as it deals with these failures.

Securities firms had been putting up money for the fund, but have suspended making new donations since 1994, citing poor business. Ministry officials say they are currently working on revisions to the law that would reorganize the existing fund into a new one incorporated into the framework of the Securities and Exchange Law, make contributions mandatory and clarify its role as a body to compensate investors.

At the same time, one official said, the fund should basically offer compensation to small-lot investors who have less knowledge of the potential risks of securities investment and exclude institutional investors such as other financial institutions and executives of the failed firm.

To encourage investors themselves to make sounder judgments in selecting a securities firm to do business with, there should be a limit to the compensation offered by the fund at around the same level as the 10 million yen for bank deposits, he added.

In the case of insurance companies, the issue of policyholder protection is more complex because of the uniqueness of their business and the fact that the continuation of policies, notably life insurance contracts, is a key concern when an insurer goes bust.

Many analysts say that unlike banks, the failure of insurance companies would not directly affect the financial settlements system and jolt capital flows, so that there is little basis for the government to infuse public funds to protect them.

There is also the argument that banks and insurers cannot be handled in a similar fashion, especially since a majority of the life insurance companies are mutual firms that do not list their stock and therefore disclose less information on their operations.

But the collapse of Nissan Mutual last spring -- the first failure of a life insurer in the postwar period -- sent shock-waves throughout the general public, especially because the liquidation scheme that ensued resulted in a reduction of policy benefits for some policyholders. The existing industry-operated policyholder protection funds only offer financial aid to the insurance firm or firms that accept the transfer of the failed company's policies, which in Nissan Mutual's case did not happen.