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TREASURY DEPARTr\'IENT LIBRARY
LIBRARY
ROOM 5030

MAY 061996
TREASURY OEPARTMENT

Treas.
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v.352

u.s.

Department of the Treasury
PRESS RELEASES

DEPARTMENT

THE

TREASURY

NE,WS
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Contact:

FOR RELEASE
August 25, 1995

Rebecca Lowenthal
(202) 622-2960

TREASURY ASSISTANT SECRETARY MUNOZ TO ADDRESS
TREASURY CONFERENCE FOR BUSINESSES
Treasury Assistant Secretary for Management George Munoz will address the
Department's PARTNERSHIPS '95 conference for small, minority and women-owned
businesses in City of Industry, California at 8:30 a.m. on Wednesday, August 30.
The all-day conference will be held at the Industry Hills Sheraton, 1 Industry Hills
Parkway, City of Industry, California from 7 a.m. to 5 p.m.
Assistant Secretary Munoz will discuss Treasury efforts to streamline and reinvent
the procurement process to make it easier for traditionally underutilized companies to do
business with Treasury. Attendees will compete for more than $1.4 million in contract
opportunities, and learn if they have won contracts within two weeks. Treasury bureau
representatives will make smaller purchases with the government purchase card, a credit
card that eliminates paperwork and ensures swift payment to businesses. Conference
activities include hands-on training in electronic commerce and help in registering with
Treasury's vendor database. At least a dozen of Treasury's prime contractors, including
U nisys, Loral Federal Systems, Motorola, and AT&T, will discuss subcontracting
opportunities. Area banks have also been invited to discuss their services.
This is Treasury's fourth such conference, with more than $8 million in contract
opportunities available at previous conferences in Washington, D.C. and Los Angeles. In
Fiscal Year 1994, Treasury awarded more than 42% ($556 million) of its total
procurements to small businesses and 21 % (284 million) to minority and women-owned
businesses. According to the Small Business Administration, more than 99.7% of the
businesses in the United States are small businesses, yet they receive less than 23% of
government prime contract awards.
Businesses should call 818-792-3259 to register or may register on-site the
morning of the conference. Media are welcome to visit the conference at any time.
-30RR-532

Far press releases, speeches, public schedules and official biographies, call our 24-hour fax line at (202) 622-2040

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D::PT OF THE TrEASURY

REPORT TO CONGRESS ON
JAPAJtESE CAPITAL MARKETS AND GLOBAL FINANCE

Regulation and Liberalization
of

Japan's Financial System

August 1995

TABLE OF CONTENTS

LETTER OF TRANSMITTAL
EXECUTTVES~Y

INTRODUCTION
Overview and Background of the Study
Origin and Purpose
Prevailing Concerns in U.S.-Japan Financial Relations
Perceptions of Japan in the Early 1990s
Scope and Organization
Methodology
Related Government Research
National Treatment Study: Reports to Congress on Foreign
Government Treatment of U. S. Commercial Banking
and Securities Organizations (1978, 1980, 1984, 1986, 1990
1994)
International Finance: Market Access Concerns of U.S. Financial
Institutions in Japan (1988)

ll.

STRUCTURE, PRACTICES, AND REGULATION OF THE
JAPANESE FINANCIAL MARKETS
Introduction
Systemic Charactistics
Structure

Segmentation
Concentration and Stable Market Share
Bank-Dominated Finance
Regulatory Framework

Concentration of Regulatory Authority
"Positive n Approach to Regulation
Administrative Guidance
Lack of Transparency
Operations and Practices

Collateral Relationships
Lack of Product Differentiation
Book-Value Accounting
The Banking System
Structure

Private Financial Institutions
Government-Affiliated Financial Intermediaries

TABLE OF CONTENTS

TABLE OF CONTENTS (Continued)

Regulatory Framework

Legal Framework
Regulatory Institutions
Regulatory Implementation
Operations and Practices

The Main Bank System
Collateral-Based Lending
Role of Public and Cooperative Institutions
Recent Reforms

Financial System Reform Act
Interest Rate Deregulation
Changes in Bank Supervisory Policy
Securities Markets
Structure

Securities Markets
Secumies Firms
Regulatory Framework

Legal Framework
Regulatory Institutions
Regulatory Implementation
Operations and Practices

Cross-Shareholding
High Equity Valuations
Reliance on Brokerage Commissions
Underdevelopment of the Corporate Bond Market
Obstacles {, Innovation
Recent Reforms

Easing of Restrictions on Corporate Bond Issuance
Expanding Scope for Innovation
Liberalization of Cross-Border Capital Transactions
U.S.-Japan Negotiations on Financial Services
Yen-Dollar
The Framework
Appendix: A Chronology of Japanese Financial Market Liberalization

CORPORATE GOVERNANCE IN JAPAN
Introduction
Key Characteristcs
Legal Framework
Structures and Practices

TABLE OF CONTENTS

TABLE OF TABLE OF CONTENTS (Continued)

Lack of Outside Directors
Cross-Shareholding
Keiretsu Relationship
Role of the Main Bank
Business-Government Relations
Consequences

Emphasis on Growth over Profits
Weak Shareholders' Rights
Difficulty of Mergers and Acquisitions
Recent Developments
Signs of Change

Unwinding of Cross-Shareholdings
Increase in Derivative Lawsuits
Forces for Change

Cyclical Conditions
Legal/Regulatory Reforms
Demographic Pressures
Conclusion
U.S.-Japan Negotiations on Corporate Governance
The Structural Impediments Initiative
The Framework

IV.

THE "BUBBLE ECONOMY" AND ITS AFTERMATH
Introduction
The Emergence of the Financial Bubble
The International Economic Environment
Causal and Contributing Factors to the Bubble
The Early Stage of Etcess Liquidity: 1986-87

Extension of the Financial Bubble: 1987-89
Land Prices
Equity Prices
Collapse of the Bubble
Monetary Policy
The Collapse in Asset Prices
Other Factors in the Bubble
The Absence of Fiscal Policy
The Impact of the Structure and Practices of
the Japanese Financial System
The Bubble's Aftermath
Economic Stagnation
Weakened Industry Profits
Problems in the Banking Sector

TABIE OF CONTENTS

TABLE OF CONTENTS (Continued)
Non-Performing Loans of Japanese Banks
Bank Rescues
Capital Adequacy of Japanese Banks
Financial Industry Scandals
The "Recruit" Scandal
Loss Compensation Scandal
Stock-Ramping
"Tobashi "
Falsified Deposit Receipts
Historical Rate Rollovers
The Japanese Government's Response
Creation of the Securities Surveillance Exchange Commission
Legal Reforms
Price-Keeping Operations ("PKO")
Ban on New Equity Financing
Use of Public Money
The Cooperative Credit Purchasing Corporation
Macroeconomic Policy Actions

JAPANESE FINANCE: IMPLICATIONS FOR THE UNITED STATES
Introduction
Role of Japanese Finance
Japan's Capital Contributions to. Global Financial Markets
Japan's Capital Contributions to U.S. Financial Markets
Japan's Financial Contributions to Bilateral Development Assistance
Japan's Contributions to the International Financial Institutions
International Monetary Fund
Multilateral Development Banks
The Impact of Japan's Capital Outflows on U.S. Macroeconomic Conditions
U. S. Exposure to Japanese Financial Markets
U.S. Equity Investment in Japan
U.S. Bank Exposure to Japan
Japanese Investment in the U.S.

VI.

CONCLUSIONS

VII.

TABLES

VIll. REFERENCES
IX.

ACKNOWLEDGEMENTS

LIST OF TABLES

National Economy
1.
2.
3.
4.

Gross Domestic Product
Contributions to Total Output Growth, 1985-94
Consumer Price Index
Unemployment Rate

Monetary Policy
5.
6.
7.
8.
9.
10.

Money Supply, Nominal and Growth Rate
Official Discount Rate
Official Discount Rate Adjustments
Long Term Interest Rates, Japan and the United States
Short Term Iriterest Rates, Japan and the United States
Call Money Interest Rates

Government Finance
11. New Japanese Government Bond Issues in the Initial
Budget
12. General Account Borrowing Requirement
13. General Government Budget Balance
14. General Government Financial Balances, Japan and the United
States
15. Government Fiscal Position - All Levels
16. Government Debt
Savings
17.
18.
19.
20.
21.
22.

Government Savings
Household and National Savings Rates
Gross Savings Ratio - International Comparisons - 1991
Household Savings Rates, Japan and the United States
Gross National Savings Rates, Japan and the United States
Savings Rate by Age of Head of Household, 1988 and 1994

Balance of Payments
23.
24.
25.
26.

Balance of Payments 1970-79
Balance of Payments 1980-89
Balance of Payments 1990-94
Current Account Balance

LIST OF TABLES

LIST OF TABLES (Continued)

27. U.S.-Japan Bilateral Trade Balance
28. Yen/Dollar Exchange Rate, Annual Average
29. Yen/Dollar Exchange Rate, End of Quarter
Banking System
30.
31.
32.
33.
34.
35.
36.

The Japanese Banking System: Participants and Total. Assets
World's Top Ten Banks
Assets Under Management by Type of Private Institution
Outstanding Postal. Savings Deposit Accounts
Unrealized Gain on Bank Equity Holdings
Net Income of the 21 Major Banks
Performance Statistics for the 21 Major Banks

Securities Market
37.
38.
39.
40.
41.

Corporate Bond Market
Tokyo Stock Exchange, First Section
Tokyo Stock Exchange, Total. Market Value
Japanese Securities Companies - Profits and Losses
Geographic Distribution of Japanese Net Securities
Purchases, 1980-89
42. Geographic Distribution of Japanese Net Securities
Purchases, 1990-94

International Transactions
43.
44.
45.
46.

International Transactions, 1970-79
International Transactions, 1980-89
International Transactions, 1990-94
Direct and Portfolio Investment

DEPARTMENT OF THE TREASURY
WASHINGTON

ASSISTANT SECRETARY

August 25, 1995

The Honorable Richard Shelby
Chairman
Subcommittee on Treasury, Postal
Service, and General Government
Committee on Appropriations
United States Senate
Washington, D.C. 20510
Dear Mr. Chairman:
Pursuant to the Conference Report on FY 1994 Treasury Appropriations, I am pleased to
submit on behalf of the Secretary of the Treasury the "Report to Congress on Japanese
Capital Markets and Global Finance." This Report outlines the structures, operations,
practices, trends and regulations of Japanese financial markets.
As directed, the Report considers the implications of developments in Japanese financial
markets for the U.S. economy, the role of Japanese finance internationally and in the United
States, and the impact of Japanese financial flows upon U.S. macroeconomic policies. In
addition, this Report discusses the "Measures by the Government of Japan and the
Government of the United States Regarding Financial Services" recently concluded with
Japan on financial market liberalization under the U.S.-Japan Framework for a New
Economic Partnership. The "Measures" include important commitments by Japan to
liberalize fund management, securities trading and underwriting, and cross-border capital
transactions in Japan.
This Report does not constitute, and should not be considered, a comprehensive evaluation of
the health of the Japanese financial system. Nor does the Report seek to evaluate the
adequacy of the Japanese Government's response to recent problems in Japan's financial
sector.
We will continue to consult with Japan regularly to seek to ensure that the commitments it
has made are effective in securing market access in Japan for foreign financial institutions.

-2-

A copy of this report has also been sent to the Honorable Jim Lightfoot of the House
Appropriations Committee.
Sincerely,

12!;,f~d ';l~zJm

. Linda Robertson
Assistant Secretary
(Legislative Affairs and Public Liaison)
Enclosure
cc:

Mitch McConnell

DEPARTMENT OF THE TREASURY
WASHINGTON

ASSISTANT SECRETARY

August 25, 1995

The Honorable Jim Lightfoot
Chairman
Subcommittee on Treasury, Postal
Service, and General Government
Committee on Appropriations
U. S. House of Representatives
Washington, D.C. 20515
Dear Mr. Chairman:
Pursuant to the Conference Report on FY 1994 Treasury Appropriations, I am pleased to
submit on behalf of the Secretary of the Treasury the "Report to Congress on Japanese
Capital Markets and Global Finance." This Report outlines the structures, operations,
practices, trends and regulations of Japanese financial markets.
As directed, the Report considers the implications of developments in Japanese financial
markets for the U.S. economy, the role of Japanese finance internationally and in the
United States, and the impact of Japanese financial flows upon U.S. macroeconomic
policies. In addition, this Report discusses the "Measures by the Government of Japan
and the Government of the United States Regarding Financial Services" recently
concluded with Japan on financial market liberalization under the U.S.-Japan Framework
for a New Economic Partnership. The "Measures" include important commitments by
Japan to liberalize fund management, securities trading and underwriting, and cross-border
capital transactions in Japan.
This Report does not constitute, and should not be considered, a comprehensive evaluation
of the health of the Japanese financial system. Nor does the Report seek to evaluate the
adequacy of the Japanese Government's response to recent problems in Japan's financial
sector.
We will continue to consult with Japan regularly to seek to ensure that the commitments it
has made are effective in securing market access in Japan for foreign financial institutions.

-2A copy of this report has also been sent to the Honorable Richard Shelby of the Senate
Appropriations Committee.
Sincerely,

~tt'i}-~'70I~/'71
Assistant Secretary
(Legislative Affairs and Public Liaison)
Enclosure
cc: Bob Livingston

DEPARTMENT OF THE TREASURY
WASHINGTON

ASSISTANT SECRETARY

August 25, 1995

The Honorable J. Robert Kerrey
Ranking Minority Member
Subcommittee on Treasury, Postal
Service, and General Government
Committee on Appropriations
United States Senate
Washington, D.C. 20510
Dear Senator Kerrey:
Pursuant to the Conference Report on FY 1994 Treasury Appropriations, I am pleased to
submit on behalf of the Secretary of the Treasury the "Report to Congress on Japanese
Capital Markets and Global Finance." This Report outlines the structures, operations,
practices, trends and regulations of Japanese financial markets.
As directed, the Report considers the implications of developments in Japanese financial
markets for the U.S. economy, the role of Japanese finance internationally and in the United
States, and the impact of Japanese financial flows upon U.S. macroeconomic policies. In
addition, this Report discusses the "Measures by the Government of Japan and the
Government of the United States Regarding Financial Services" recently concluded with
Japan on financial market liberalization under the U.S.-Japan Framework for a New
Economic Partnership. The "Measures" include important commitments by Japan to
liberalize fund management, securities trading and underwriting, and cross-border capital
transactions in Japan.
This Report does not constitute, and should not be considered, a comprehensive evaluation of
the health of the Japanese financial system. Nor does the Report seek to evaluate the
adequacy of the Japanese Government's response to recent problems in Japan's financial
sector.
We will continue to consult with Japan regularly to seek to ensure that the commitments it
has made are effective in securing market access in Japan for foreign financial institutions.

- 2-

A copy of this report has also been sent to the Honorable Richard Shelby of the Senate
Appropriations Committee.
Sincerely,

{'~~Pfr

a~Ro~on

Assistant Secretary
(Legislative Affairs and Public Liaison)
Enclosure
cc: Patrick Leahy

DEPARTMENT OF THE TREASURY
WASHINGTON

ASSISTANT SECRETARY

August 25, 1995

The Honorable Steny H. Hoyer
Ranking Minority Member
Subcommittee on Treasury, Postal
Service, and General Government
Committee on Appropriations
U. S. House of Representatives
Washington, D.C. 20515
Dear Mr. Hoyer:
Pursuant to the Conference Report on FY 1994 Treasury Appropriations, I am pleased to
submit on behalf of the Secretary of the Treasury the "Report to Congress on Japanese
Capital Markets and Global Finance." This Report outlines the structures, operations,
practices, trends and regulations of Japanese financial markets.
As directed, the Report considers the implications of developments in Japanese financial
markets for the U.S. economy, the role of Japanese finance internationally and in the United
States, and the impact of Japanese financial flows upon U.S. macroeconomic policies. In
addition, this Report discusses the "Measures by the Government of Japan and the
Government of the United States Regarding Financial Services" recently concluded with
Japan on financial market liberalization under the U.S.-Japan Framework for a New
Economic Partnership. The "Measures" include important commitments by Japan to
liberalize fund management, securities trading and underwriting, and cross-border capital
transactions in Japan.
This Report does not constitute, and should not be considered, a comprehensive evaluation of
the health of the Japanese financial system. Nor does the Report seek to evaluate the
adequacy of the Japanese Government's response to recent problems in Japan's financial
sector.
We will continue to consult with Japan regularly to seek to ensure that the commitments it
has made are effective in securing market access in Japan for foreign financial institutions.

-2-

A copy of this report has also been sent to the Honorable Jim Lightfoot of the House
Appropriations Committee.
Sincerely,

~11(1c4 '7ld~:ltJ/f}

~~ Robertson

Assistant Secretary
(Legislative Affairs and Public Liaison)

Enclosure
cc:

David Obey

EXECUTIVE SUMMARY

PURPOSE:

Language incorporated in the Conference Report for Treasury
Appropriations for FY 1994 mandated that the Secretary of the Treasury
report to the Congress on the structure, operation, practices, and
regulation of Japan's financial markets and their implications for the U.S.
economy. Accordingly, this study examines the structure and the
operation of the Japanese fmancial system, Japan's system of corporate
governance, the impact of these practices on the development and
subsequent collapse of Japan's fmancial bubble, and the role and
importance of Japanese international capital flows for the U.S. economy
and U. S. fmancial interests.
Four central questions are examined in this study:

BACKGROUND:

•

How did the structures and practices of the Japanese financial
system contribute to the financial bubble of the late 1980s and its
subsequent collapse?

•

What has the Government of Japan done to liberalize and
strengthen the Japanese financial system?

•

What impact will these regulatory changes have in terms of
ensuring the safety and soundness of the Japanese fmancial system,
that it is open to foreign capital, and that foreign investors will be
provided with a level playing field?

•

What is the role of Japanese finance in the world economy and
how does it affect U.S. economic and financial interests?

The study focuses on the period 1985-94. Following a general
introduction to the study in Chapter I, Chapter IT examines the structures,
practices, and regulation of Japan's fmancial system and the various
changes that have occurred over the last 10 years to liberalize and
strengthen the system. Chapter ill focuses on Japan's system of corporate
governance and changes made within that system to improve transparency
and strengthen the rights of individual shareholders. Chapter N examines
the principal causes of Japan's late 1980s land and equity-price "bubbles,"
and the factors that subsequently led to the collapse in Japanese asset
prices. Chapter V looks at the role and importance of Japanese capital
outflows for the U.S. and world economies, and the implications of those
outflows for U.S. fmancial interests. Chapter VI provides concluding
comments on the four questions posed above.
The U.S. Treasury has engaged the Japanese Government on many of
these issues over the last 12 years in several different fora: First, on a
structural basis in lithe Working Group on Yen-Dollar Exchange Rate
Issues" (1984-87). Second, in the "Working Group on Financial

Markets" (1988-92) in parallel with the corporate governance section of
the "Structural Impediments Initiative" (1989-92). And most recently in
the "U.S.-Japan Framework for a New Economic Partnership." The last
process produced in February 1995 the "Measures by the Government of
Japan and the Government of the United States Regarding Financial
Services" (the "Measures") between the United States and Japan that will
substantially improve market access for U.S. financial institutions in the
banking, securities, and asset management sectors, and will substantially
strengthen transparency and procedural protections in the provision of
financial services.

PRINCIPAL
CONCLUSIONS:

Structure. Practices. and Re&Wation of the Japanese Financial
System
•

Throughout much of the postwar period, the Japanese financial
system has been characterized by a high degree of segmentation
and functional specialization.

•

Detailed regulatory control also characterized the traditional
postwar approach to Japanese financial system regulation. That
control was most clearly evident in the regulated structure of
deposit interest rates and foreign exchange controls, both of
which in recent years have been largely eliminated.

•

The nature of postwar regulatory administration has included
informal "adffiinistrative guidance;" use of industry groups as
conduits between fi::ancial services firms and the regulatory
authorities; and restricted crossover entry into other lines of
financial services business.

•

Over the last 10 years there has been substantial deregulation of
Japan's financial markets, including the erosion of segmentation
th· Igh limited crossover entry into other lines of business via
suosidiaries; interest rate deregulation; relaxation of foreign
exchange controls on cross-border capital transactions; expansion
of the range of permis <:,ible financial market products and issuers
of securities; opening of existing markets to new entrants; and
expansion of business opportunities for current participants in
existing markets.

•

Many of these changes were the result of bilateral negotiations
between the Government of Japan and the Government of the
United States designed to improve opportunities available to
foreign financial institutions in Japan.

•

Most recently, there have been reforms aimed at providing
procedural protections from non-transparent regulation
and potentially arbitrary actions.

Japan's System of Corporate Governance
•

While many features of corporate governance in Japan parallel
those in the United States, several characteristics distinguish the
Japanese system: a lack of outside directors on corporate boards,
extensive cross-shareholding arrangements among firms, the
network of informal and formal ties among nominally independent
companies known in Japan as "keiretsu" relationShips, and
unusually close government-business ties.

•

These features of corporate governance in Japan have resulted in
an emphasis on short-term growth over profits at major Japanese
corporations; relatively weak shareholders' rights; and resistance
to mergers and acquisitions, particularly hostile takeovers. These
features, reinforced by societal values that put a premium on
consensus, stability, and long-term relationships, have often
deterred outside investors in Japanese companies, especially
foreign investors.

•

A combination of regulatory reforms and short- and long-term
market pressures have brought about changes in traditional patterns
of corporate governance in Japan. These forces have tended to
loosen stable inter-corporate ties and strengthen the rights of
individual shareholders.

•

In bilateral negotiations over the past 6 years, the U.S.
Government has raised a number of concerns about legal
provisions and regulatory practices that artificially sustain elements
of the Japanese system of corporate governance and that have an
adverse impact on foreign investment in Japan.

•

In response to these concerns, the Japanese Government has taken
various steps to reform corporate governance, including enhancing
disclosure requirements, facilitating derivative lawsuits, and
strengthening antitrust enforcement.

Causes and Consequences of the Japanese Asset Bubble

•

Japan's land and equity prices nearly tripled in value between yearend 1985 and year-end 1989. At the height of the financial
bubble, the capitalization of the Japanese stock market represented

111

42 percent of the total capitalization of world stock markets. The
largest land price increases were concentrated in Japan's three
major cities: Tokyo, Osaka, and Nagoya.
•

Japan was not the only country to experience asset price inflation
in the mid-to-Iate 1980s. Other countries, including the United
States, also experienced rising stock and real estate prices during
this period, as well as some economic dislocation when real estate
markets eventually corrected for the overshooting. In Japan,
however, these trends were considerably stronger than elsewhere.

•

Most independent observers attribute the financial bubble to
excessive reliance on easy credit conditions that lasted too long,
even after the economy had recovered from the shock of the yen's
steep appreciation in 1985 and 1986.

•

Because the priority of Japanese fiscal policy at the time was to
shrink government spending relative to GNP, monetary policy was
assigned the dual policy task of stimulating the economy and
slowing the yen's appreciation.

•

During the expansion of the financial bubble, other features of the
economic system tended to amplify price pressures in certain asset
markets. These included the system of stable cross-shareholding,
which reduced the availability of tradable stocks; and certain land
policies that limited the amount of urban w(i available for sale.
The net effect was less scope for diffusing puce pressures across
a broader supply of assets.

•

Classic features of asset market bubbles also appeared: traditional
valuation rules were discarded as expected capital gains were
expected to justify paying any price.

•

The financial bubble eventually collapsed with the tightening of
monetary policy in 1989 and 1990. Stocks eventually lost over
60 percent of their value peak-to-trough, and land prices
lost over 40 percent of their peak value.

•

Following the collapse of the bubble and continuing to this
day, the Japanese economy and Japanese asset prices have
remained weak and under pressure. The non-performing loan
problems of Japanese banks have risen.

•

Weak balance sheets of banks and other financial institutions and
a pulling back from risk-taking contributed to weak credit growth
as the Japanese economy virtually stagnated in the 1990s.

•

To respond to these challenges, the Government of Japan has
reduced interest rates to new historic lows and developed four
. fiscal stimulus programs that have included elements to support the
stock market and increase land transactions. More recently, the
government has announced the formulation of a new study group
to develop new means to help financial firms dispose of their nonperforming loans.

•

Disclosure requirements have been tightened in an attempt to avoid
the hiding of weak performance and non-performing loans. The
government has acknowledged that bad or restructured loans total
rougbly 6 percent of all credit institutions' assets. Some bank
losses have been acknowledged, but there are still gaps in
reporting portfolio problems.

•

The financial bubble and its aftermath brought a series of financial
scandals which have made Japanese as well as foreign investors
more wary of markets where some privileged market participants
have enjoyed advantages over others. U.S. investors, however,
have been large net buyers of Japanese equities since 1991,
investing over $25 billion during the period 1991-94.

•

To respond to irregularities in the financial markets, the
government created a new watch-dog body, the Securities
Exchange Surveillance Commission, to monitor securities trading
activities and to recommend criminal proceedings in cases of
misconduct. In addition, under various reforms laws were
amended and administrative notices codified.

Japanese Finance Internationally; Implications for the United States
•

Japan's emergence as the world's largest net exporter of capital in
the 1980s is a reflection of the persistent excess of domestic
savings over domestic investment in Japan.

•

Japan's capital outflows have amounted to 18 percent of the
world's flows of foreign direct investment (1985-92), 31 percent
of the savings shortages of countries running savings-investment
gaps (1985-93), and 18 percent of the world's official development
assistance (1988-92).

EXECUllVE SUMMARY

•

As Japan's financial resources have increased, Japan has become
a major contributor to the international financial institutions.
Japan is the second largest creditor of the IMF and the largest
donor to the MDBs for concessional lending to the poorest
countries. In addition, Japan made a major fmancial contribution
of $13 billion in 1991 to Desert Storm.

•

Japanese banks account for 9.4 percent of total U. S. banking
system assets and 17 percent of total U.S. business loans. Many
of these assets were funded with funds raised in the United States.
Roughly 90 percent of Japan's banking activity is concentrated in
New York and California.

•

Principai mvestments in the United States from Japan have
included direct investments, where in 1992 Japanese investors
overtook United Kingdom investors as the largest single national
group of foreign investors; and U.S. Treasury securities, where
Japanese purchases, inclusive of purchases by the Bank of Japan,
have totaled 9.3 percent of newly issued U.S. Government debt
since 1986.

•

Despite Japan's significant purchases in recent years of U.S.
Treasury securities, Japanese investors, inclusive of the Bank of
Japan, own a relatively small fraction of privately-held U.S. debt
outstanding: 4.0 percent.

•

Japanese investors have made relatively small investments in U.S.
equities.

This report does not constitute, and should not be considered, a
comprehenensive evaluation of the health of the Japanese banking system.
Nor does this report seek to evaluate the adequacy of the Japanese
Government's response to recent problems.

I. INTRODUCTION

OVERVIEW AND BACKGROUND OF THE STUDY
This introductory chapter flrst discusses the origin and purpose of this study, and with
reference to the legislative history, reviews some of the key issues in U.S.-Japan fmancial
relations identifled at the time of the study's inception. The chapter then describes the scope
and organization of the study, before closing with a brief description of the methodology and
a survey of other major U.S. Government reports on Japanese capital markets.
Origin and Purpose
During the summer of 1991 a series of financial market-related scandals in Japan, in
combination with sharp declines in Japanese stock and land prices and related concerns about
the capital adequacy and asset quality of many Japanese banks, heightened concern about the
possible negative repercussions of developments in Japan for global financial markets.
In the United States, a series of Congressional hearings were held on fmancial conditions
in Japan, culminating in the introduction of legislation mandating that the Secretary of the
Treasury report to the Congress on the structure, operation, practices and regulation of Japan's
flnancial markets and the implications of those practices for the U.S. economy. Although the
original bill, House Resolution 3423, was included in legislation that was ultimately vetoed,
some of the issues persisted as the Japanese equity and real estate markets underwent protracted
declines and U. S. financial services fmns continued to seek effective market access in Japan.
Language mandating this study was eventually incorporated into the Conference Report for
Treasury Appropriations for FY 1994.

Accordingly, the purpose of this study is to examine the structure and the operation of
the Japanese financial system, Japan's system of corporate governance, the impact of these
practices on the development and subsequent collapse of Japan's fmancial bubble, and the role
and importance of Japanese international capital flows for the U.S. economy and U.S. fmancial
interests.
Prevailing Concerns in U.S.-Japan Financial Relations
In examining the legislative history, several issues pertaining to the Japanese fmanciaI
system were identified as worthy of further exploration:

•

First, a series of fmancial market scandals gave rise to concern, both inside and
outside of Japan, that Japan's flnancial market playing fleld was uneven and
vulnerable to manipulation;

•

Second, given the steep fall of share prices in the Japanese equity market,
concerns arose about the ability of Japanese banks to meet the Basle capital
adequacy requirements, which would be entering into force in March 1993;

INTRODUCTION

•

Third, falling real estate prices also created problems for Japanese banks -- that
of rising levels of non-performing loans, many of which had been collateralized
with land;

•

Fourth, there was concern about the potential transmission of the economic side
effects of these problems to the United States, as well as about the safety of U.S.
financial investments in Japan;

•

Fifth, the cost of capital for Japanese fums was seen as being very inexpensive
and possibly constituting an unfair competitive advantage, undermining the efforts
of U.S. fums to compete in world fmancial markets;

•

Sixth, Japan's system of corporate governance was seen as providing an uneven
playing field for foreign investors; and

•

Finally, Japanese institutions were seen as playing a critical role in providing
international liquidity, in extending overseas development assistance (ODA) ,
financing a portion of the U.S. government budget deficit, and extending
commercial and industrial loans in the U.S. banking market.

Perceptions of Japan in the Early 1990s
Some of the concerns listed above were valid at the time this study was being conceived
by the Congress and retain some relevance today. Others have been shown over time to be not
as serious as first thought.
First, Japanese banks have been able to meet the Basle capital adequacy ratios without
exceptional di£"ficulty despite past closure of the equity market to new equity financing and
erosion of much of their unrealized equity gains. In the 3 years since the risk-weighted capital
adequacy ratios went into effect, Japan's largest 21 banks have exceeded the minimum required
8 percent ratio each year by an average of 150 basis points.
Second, sharply lower real estate prices have resulted in a sharp rise in non-performing
bank loans and general stagnation in Japanese bank profits (net of write-offs).
Third, many large institutional investors from the U.S. and other countries have
continued to invest actively in Japan, despite difficulties encountered by some large foreign
investors. These problems are common to all unaffiliated investors in Japan, a group that
includes many domestic individual and institutional investors as well as foreign investors.
Fourth, Japanese investors have maintained a high profile in the U.S. Treasury T-bill and
government bond markets at certain points in the late 1980s and early 1990s, but their ownership
share of the stock of outstanding Treasury securities is quite low.

INTRODUCnON

Finally, although U.S. financial markets cannot be fully insulated from a major systemic
CnSlS, U.S. stock exchanges, up to this point, have not been particularly sensitive to
developments in Japanese equity markets.

Scope and Organization
This study considers four basic questions:

•

How did the structure and practices of the Japanese financial system contribute
to the financial bubble of the late 1980s and its subsequent collapse?

•

What has the Government of Japan done to liberalize and strengthen the Japanese
financial system?

•

What impact will these regulatory changes have in terms of ensuring the safety
and soundness of the Japanese financial system, that it is open to foreign capital,
and that foreign investors will be provided with a level playing field?

•

What is the role of Japanese finance in the world economy and how does it affect
U.S. economic and financial interests?

This report does not constitute, and should not be considered, a comprehensive evaluation
of the health of the Japanese banking system. Nor does this report seek to evaluate the adequacy
of the Japanese Government's response to recent problems.
The study is organized into six chapters. Chapter n provides background information
on the structure, operation, and regulation of Japan's financial system, including a description
of the principal steps taken by the Japanese Government over the last decade to liberalize and
strengthen the financial system in Japan. Chapter ill describes some of the key characteristics
of Japan's system of corporate governance and the implications of that system for foreign
investors. Chapter IV examines the beginnings and the aftermath of the "bubble economy·
period and what role, if any, the structure and practices of the Japanese financial system had in
either initiating or exacerbating the rise and fall of Japanese asset prices. Chapter V looks at
the international role of Japanese finance and the implications of Japanese global capital flows
for the U. S. economy. Chapter VI returns to the four questions posed above.

Methodology
In developing this study, a substantial range of literature was consulted on Japanese

financial institutions and markets, Japan's system of corporate governance, and Japanese global
investment trends. Related papers, speeches, and internal memoranda from the Department of
the Treasury, the Securities and Exchange Commission, and the Federal Reserve Board also
were used. Numerous interviews were conducted with U.S. and Japanese government officials;
university professors in the U.S. and Japan; representatives of major U.S. and foreign financial
institutions in Tokyo; and various private sector companies, organizations, and private investors.

INTRODUCTION

RELATED GOVERNMENT RESEARCH REPORTS
National Treatment Studies
The Department of the Treasury and other U. S. government agencies have published
studies previously on Japanese fmancial markets. Section 9 of the International Banking Act of
1978 called upon the Treasury Department to produce a report, commonly referred to as the
National Treatment Study, to evaluate the treatment of U.S. banks in foreign financial markets.
The first report, issued in 1979, reviewed the degree of national treatment accorded to u.S.
banks in over 140 foreign banking markets, including Japan. Updates to the 1979 report were
produced in 1984 and 1986. The 1986 report went beyond banking to include for the first time
an assessment of the treatment of U.S. firms in securities markets in eight industrial countries,
including Japan.
The Financial Reports Act of 1988 established the National Treatment Study as a
permanent report to be produced by the Treasury Department every four years beginning in
1990. The most recent National Treatment Report was issued in 1994, just prior to the
Measures reached with Japan in February 1995 under the U.S.-Japan Framework for a New
Economic Partnership.
GAO Reports
In March 1~~8, the General Accounting Office (GAO) published a Congressional briefmg
report assessing the competitive environment of Japanese fmancial markets. The Treasury
Department discussed the contents of that report with staff of the GAO, but did not provide any
official commentary on the draft. The GAO report discussed the barriers encountered by U.S.
financial institutions in attempting to do business in Japan, and it reviewed the fmancial
liberalization measures being implemented by the Japanese authorities at that time. However,
the study did not provide recommendations for future action by the Japanese government.

STRUCTURE, REGULATION, OPERATIONS AND PRACTICES OF THE
JAPANESE FINANCIAL SYSTEM

INTRODUCTION
This chapter describes the postwar Japanese fmancial system. It is designed to provide
the necessary background to answer all four of the basic questions raised in Chapter 1.
As defmed here, the "fmancial system" consists of banking and securities; insurance is
discussed only as it relates to other fmancial services. The chapter begins by outlining a number
of structural, regulatory, and operational characteristics of the Japanese financial industry as a
whole. This is followed by separate sections examining the banking and securities sectors,
including recent reforms in each area.
The chapter closes with a section on the role of U.S.-Japan negotiations, since the
commencement of the so-called Yen-Dollar Talks in 1983, in opening and liberalizing Japan's
financial markets -- enhancing access by foreign institutions to the Japanese fmancial system,
expanding the scope of allowable activities for all participants, and lowering barriers to the
integration of Japan's financial system with global markets. An Appendix is included at the end
of this chapter describing financial liberalization changes over the last 25 years.
SYSTEMIC CHARACTERISTICS
A number of common themes run throughout the structure, regulation, and operations
of Japan's fmancial system. Some of these features are unique to the fmancial sector. Others
-- e.g., market concentration and collateral relationships -- can be seen in other Japanese
industries as well, but are particularly pronounced in the fmancial sector. Similarly, many are
common to other countries to some degree, but together they make Japan's fmancial system
umque.

Structure

Segmentation
Segmentation among the principal components of the financial services industry (banking,
securities, and insurance) and within each component (e.g., among city, trust, and long-term
credit banks), has been a consistent feature of the postwar Japanese fmancial system. To some
extent, this segmented structure was based on the U.S. model: Article 65 of Japan's Securities
and Exchange Law, for example, which separates the banking and securities businesses, was
patterned after the Glass-Steagall Act. In the United States, fmancial market segmentation was
intended to remedy perceived conflicts of interest and concentration of fmancial power. In
Japan's case, it has been argued that, while prudential considerations were also important, the
postwar fmancial structure was designed in part to allocate market shares and preserve the
primacy of banks as fmancial intermediaries.

STRUCTIlRE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FlNANCIAL SYSTEM

As discussed below, recent legal reforms have produced significant changes to the
traditional segmentation of the Japanese financial system, notably by lowering barriers to entry,
including by foreign institutions, and permitting limited crossover entry, via subsidiaries, among
and within fmancial industry segments. Nevertheless, it is still largely accurate to describe the
Japanese fmancial system in terms of its segmented structure.

Market Concentration
Another feature of the Japanese fmancial system is the concentration of market power
among relatively few firms. This is true in both the banking and securities sectors. In banking,
the 21 largest banks in Japan account for 70 percent of banking system assets. In securities, the
"Big Four" securities firms account for more than half of the total revenues of domestic
securities firms, nearly two-thirds of underwriting revenues, and 40 percent of securities industry
employment.

Bank-Dominated Finance
Banks have stood at the apex of the Japanese fmancial system throughout the postwar
period, absorbing the bulk: of household savings and meeting the bulk: of corporate financing
needs. Through the 1970s, Japanese corporate borrowers depended on borrowing, mostly from
banks, for over 40 percent of their total funding needs and around 85 percent of funds raised
externally. The banks' dominance has been eroded somewhat since the mid-1980s as a result
of progress in liberalization, securitization, and internationalization. However, banks retain
certain prerogatives vis-a-vis other lines of financial business, which continue to make banks
"first among equals" in the Japanese financial system.

Regulatory Framework

Concentration of RegUlatory Authority
In contrast to the more diffused fmancial regulatory systems of many other countries
(notably the United States), regulatory authority in Japan is largely concentrated in one
institution: the Ministry of Finance (MOF). Japan's banking, securities, and other fmanciallaws
grant MOF a much greater degree of formal authority than its counterparts in most other
industrialized countries. The rule-making and supervisory functions of the Treasury Department,
Federal Reserve, Securities and Exchange Commission, and several other agencies in the United
States all fall within MOF's jurisdiction in Japan. Formally, MOF shares some of these
functions with a number of other government entities: bank supervision with the Bank of Japan,
for example; supervision of non-bank financial entities with the Ministry of International Trade
and Industry; and regulation of the pension fund business with the Ministry of Health and
Welfare. In practice, MOF is first among equals in virtually all areas of financial regulation.

Administrative Guidance
Together with formal powers of approval and SupefVIslon, informal administrative
guidance has traditionally been used by the Japanese authorities to implement and enforce
regulations. MOF has used administrative guidance to "discourage" securities firms from
6

STRUCTIJRE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

introducing new products before a formal application to do so has been flied, and to lIencourage
the entire banking industry to make a strategic move in a certain direction.

In theory, compliance with administrative guidance is voluntary. In practice, domestic
and foreign firms have often complained that MOF uses a combination of carrots and sticks to
encourage compliance. For example, it has been alleged that MOF may threaten to deny a
company's application to sell a new product, or simply delay processing the application until the
firm complies; or that it may offer the fIrm -- implicitly or explicitly -- assistance in other areas
if it follows MOF's wishes.
In recent years, the Japanese Government has recognized the need to enhance
transparency of regulatory procedures, including administrative guidance. The most notable
action by the Government to achieve this end was the implementation of the Administrative
Procedures Law (APL) in October 1994. The APL establishes tough and far-ranging standards
to ensure transparency and fairness of administrative action. Among other things, the Law
requires that licensing and approval standards be made available to the public, entitles interested
parties to a clear explanation of administrative decisions that may affect them, and confrrms that
compliance with administrative guidance is strictly voluntary. In the Measures (discussed later
in this chapter), the Japanese Government restated its commitment to transparency and confrrmed
that the APL fully applies to regulatory procedures in the fmancial services area.

Operations and Practices

Business Relationships
The importance of equity relationships between fmancial and business interests in Japan
has been widely noted. These relationships have played a particularly important role in the
fmancial sector. In the absence, until recently, of objective credit evaluation in Japan, corporate
affiliations with borrowers have typically been a central factor in bank lending decisions. In
part, the importance of relationships in business decisions reflects Japanese cultural preferences
and traditional business practices, including cross-shareholding (discussed below and in Chapter
III). It is also the product of a regulatory environment that permitted or encouraged such ties.
Lack of Product Differentiation

A related feature of Japan's traditional fInancial system is the relative lack of
differentiation in price and design of fmancial products and services. Deposit instruments
offered by Japanese banks, for example, tend to carry virtually identical interest rates, maturity
structures, and other features. Again, this lack of differentiation partly reflects societal
preferences, but it is also a legacy of Japan's postwar regulatory structure. Among other things,
the Finance Ministry's relatively narrow interpretation of what constitutes a IIsecurity" (as
discussed below) has limited frrms' scope for product innovation. Moreover, until recently,
interest rates and fees on most fmancial instruments and services were tightly regulated.
Deregulation has removed many of these restrictions and expanded the variety of fmancial
products that can be offered in the Japanese market.

STRUC1URE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

Book- Value Accounting

Under traditional Japanese accounting practices, fIrms in principle carry fmancial assets
on their books at the original purchase price, or "book value," rather than current market value.
A full examination of Japanese accounting rules is beyond the scope of this study. In general,
however, gains on assets may not be recognized until they are sold, while latent, or "appraisal,"
losses must be recognized in some cases, depending on the type of asset and fum that holds
them. 1 Appraisal losses do not need to be recognized on most unlisted securities or other assets
for which current market prices are not readily available.
The traditional use of book-value rather than market-value accounting introduces a
number of anomalies into the Japanese fInancial system. Perhaps most important, it provides
a broad degree of discretion in the timing of fIrms' recognition of securities gains and losses,
reducing the utility of fInancial disclosure statements. These accounting practices provide an
incentive for investors to avoid listed securities in favor of unlisted instruments in order to avoid
being forced to recognize appraisal losses. This may lead investors to limit their holdings of
more liquid instruments, perhaps increasing their exposure to market risk.
The Japanese Government has taken steps in recent years in a number of areas to
encourage movement from book-value to market-value accounting. Among other things, it
agreed in the Measures to revise pension actuarial standards from the current book-value basis
to a market-value basis by 1997. This should increase pressure on pension fund sponsors to seek
better investrr: .. t performance and thereby promote competition among fund managers.

THE BANKING SYSTEM
Structure
Japan's banking system is highly segmented geographically and functionally. On one
level, this means distinguishing among major banks, (usually) smaller regional banks, a third
set of cooperative-based fInancial institutions, and other nondepository lenders, such as insurers
and specialized housing loan companies. Among the major banks there is functional
specialization among "city," trust, and long-term credit banks. Finally, Japan has public and
government-affiliated depository and lending institutions which playa very important role in the
fmancial system, separate from that of the private fInancial institutions.

For example, ordinary corporations have a wide degree of latitude in determining whether
an appraisal loss must be recognized on their listed securities holdings. Banks, on the other
hand, must recognize appraisal losses on their listed equity holdings and on bonds held for
trading purposes, but need not do so on unlisted securities, subsidiaries' shares, or bonds held
for investment purposes.
1

STRUCTURE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

Private Financial Institutions
Ordinary Banks
Ordinary banks are commercial banks that accept deposits and provide a broad range of
banking services. Ordinary banks include "city" banks (analogous to U.S. "money center"
banks), regional banks, and foreign commercial banks.
City Banks

At present, there are 11 city banks in Japan. (With the planned merger of Mitsubishi
Bank and Bank of Tokyo in 1996, this number will fall to 10.) Nearly two-thirds of city banks'
liabilities consist of deposits of large corporations, the remainder being mostly consumer deposits
and short-term money market instruments. Loans to large corporations (generally short-term
loans) account for one-third of assets, with loans to small- and medium-sized enterprises (SMEs)
and individuals accounting for most of the rest. All of the city banks have nationwide branch
networks and a substantial overseas presence. All of the city banks are concurrently licensed
as Foreign Exchange Banks, which gives them uniquely broad authority to conduct foreign
exchange market transactions. Among the city banks, the Bank of Tokyo is a specialized foreign
exchange bank which still enjoys certain Government-granted privileges in the foreign exchange
business. Another city bank, Daiwa, is authorized to engage in a full range of trust banking
business. The city banks' assets totaled 1326.9 trillion ($3.8 trillion)2 as of March 31, 1995,
and accounted for 35 percent of total assets in the Japanese banking system.

Regional Banks
Regional banks are primarily commercial banks with a prefectural focus. However, 16
regional banks are also authorized to engage in a limited range of trust business. Unlike city
banks, regional banks may not branch throughout Japan, but some city banks and regional banks
share the same city as headquarters (in some cases, outside Tokyo). Some regional banks are
authorized foreign exchange banks, and some have overseas operations. The largest regional
bank (Bank of Yokohama) is larger than the smallest city bank (Hokkaido Takushoku).
At present, there are 64 fIrst-tier regional banks and 65 second-tier regional banks. (The
second tier was created in 1989 by converting mutual savings and loans institutions, or sogo
banks into regional banks). As a group, over one-half of regional banks' liabilities are
individual savings deposits. Some 70 percent of their assets take the form of loans to S:MEs,
but assets also include domestic securities and some foreign assets. Taken together, regional
banks held 1263.8 trillion ($3.1 trillion) in assets, or 28 percent of total banking system assets,
as of March 31, 1995.

The exchange rate used throughout this chapter is $1 = 185 unless otherwise noted.

STRUCnJRE, REGULATION, OPERATIONS AND PRACTICES OF 'I1IE JAPANESE FlNANCIAL SYS1EM

Foreign Commercial Banks
From a total of 16 in 1968, the foreign bank: presence in Japan mushroomed to 90 banks
(20 of them U.S. banks) by 1993; the number has held steady at this level since then. Foreign
financial fIrms may establish bank: subsidiaries, bank: branches, or representative offices in
Japan. (Branches may engage in a full range of wholesale and retail banking activities, and
require a license to establish. Representative offices require no license, but serve mainly as
liaison with the home office and may not engage in banking activities.) There were 142 foreign
bank branches (of which 38 were U.S.) and 107 foreign bank representative offices (10 U.S.)
in Japan as of the end of March 1995. Foreign banks and securities companies operating in
Japan were permitted crossover entry before Japanese domestic banks and securities companies
were. Hence, some foreign bank branches in Japan are operated by foreign securities
companies. Foreign b2.~ ~~ had 117.8 trillion ($209 billion) in assets, or 2 percent of total
banking system assets, a~ ..>f March 31, 1995.
Trust Banks
The Japanese Government developed a trust banking system separate from the
commercial banks between 1954 and 1960. Trust banks receive and manage funds on behalf of
clients. Sources of funds include pooled individual and corporate deposits in instruments known
as loan trusts and money trusts, as well as pension fund assets managed by trust banks. Uses
of funds include long-term loans and financial investments.
There are seven trust banks among the major 21 banks. In addition, one of the city
banks, Daiwa, also has a grand fathered trust bank operation licensed to do the full range of trust
bank business. Also, one of the seven major trust banks, Nippon Trust, was acquired by a city
bank, Mitsubishi Bank, in 1994 when Nippon Trust was experiencing fmancial difficulties.
Besides the "major" domestic trust banks, there are nine foreign trust bank subsidiaries, 16
regional banks with trust operations, and seven trust bank subsidiaries of other fmancial
institutions established after crossover entry was permitted. Both the newly established trust
bank subsidiaries of other financial institutions and the regional bank trust operations are
excluded from certain core areas of the trust business, including pension fund management.
Regional banks are not required to establish separate subsidiaries to do their limited trust
business. Foreign trust banks are not excluded from the pension fund management business,
although their success in winning management mandates has been fairly limited thus far.
Assets of the seven major trust banks were 1251.9 trillion ($3.0 trillion) as of March 31,
1995, or 27 percent of the banking sector total.
Long-Term Credit Banks
Three long-term credit banks operate under the Long-Term Credit Bank Law of 1952.
They specialize in long-term loans to industrial clients for fixed capital investments, funded
primarily by medium-term bank debentures. The long-term credit banks, the Bank of Tokyo,
Norinchukin Bank, Shoko Chukin Bank, and Zenshinren have an exclusive right to issue longterm debentures. However, these banks have more limited branch networks than commercial
banks. The long-term credit banks have expanded into international and other lines of business
10

STRUCTURE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

(including establishing subsidiaries in other sectors since crossover entry by banks and securities
firms into each others' businesses was permitted). Total assets of the long-term credit banks
were 173.6 trillion ($866 billion) as of March 31, 1995, accounting for 8 percent of the total
assets in the banking system.
Cooperative-Based Institutions
In addition to ordinary banks, there are other lending and deposit-taking institutions

which are cooperative-based, often with a tiered structure at the local, prefectural and national
levels. These institutions have already experienced considerable consolidation and are expected
to experience more in the coming years.
The cooperative-based institutions differ from ordinary banks in that they were originally
intended as mutual aid associations to serve defined local clienteles. There are essentially three
systems of cooperative-based institutions for small business, and another system for agricultural,
forestry, and fisheries. Each of the systems is organized as a federation, and some are capped
by a central bank.
There are 421 credit associations (shinkin banks) in the National Federation of Credit
Associations, capped by the Zenshinren Bank, with total assets of 1106.7 trillion ($1.26 trillion)
as of March 31, 1995. There are 373 credit cooperatives in the National Federation of Credit
Cooperatives, with combined assets of approximately 129.8 trillion ($350 billion) as of March
31, 1995. Some credit associations and credit cooperatives may be converted to banks in the
coming years, or merged with or taken over by banks, according to a proposal included in a
package of measures announced by the Finance Minister on June 8, 1995, aimed at enhancing
financial system soundness. There are 47 labor credit associations (one per prefecture) in the
National Federation of Labor Credit Associations, with assets of approximately 113.1 trillion
($153.6 billion) as of March 31, 1995. The Central Bank for Commercial and Industrial
Cooperatives (Shoko Chukin Bank) is a quasi-governmental special corporation that also receives
funds from small and medium-sized cooperatives, local governments, other fmancial institutions,
and nonprofit organizations, and lends money to SMEs. Shoko Chukin has approximately 116.5
trillion ($194 billion) in assets as of March 31, 1995.
By far the most extensive cooperative system is the agricultural cooperative system, with
around 2,500 cooperatives (each with deposit-taking and lending operations) throughout Japan.
These are supposed to be reduced to 570 cooperatives by the year 2000, according to a
resolution at the September 1994 convention of agricultural cooperatives. There is also a system
of fishery cooperatives, with over 1,500 cooperatives nationwide. Each system is organized in
a federation at the prefectural level, and the entire system is capped by the Central Bank for
Agriculture and Forestry (Norinchukin Bank), with 143 trillion ($506 billion) in assets as of
March 31, 1995.

STRUCTIJRE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

Nondepository Lenders

Insurers
Both non-life and life insurance companies are important lenders in the Japanese financial
system, primarily supplying long-term loans for corporations and home buyers. Of the 27 life
insurance companies, five are foreign-owned, while three of the 25 non-life insurance companies
are foreign-owned. As of the end of February 1995, insurers had a total of 173.2 trillion ($861
billion) in loans outstanding.

Specialized Housing Loan Companies ("Jusen")
There are currently eight iusen, or specialized housing loan companies, established by
banks, insurers, and securities c\ panies in the 1970s to lend money to home buyers and real
estate developers. In the 1980s, the jusen lent heavily to real estate development. Many of
those loans are now non-performing. Seven of the eight jusen have been in a 10-year
restructuring program since the frrst half of 1993, in which most of their interest payments to
major banks have been reduced to zero. As of March 31, 1995, the seven problem jusen had
110.8 trillion ($122 billion) in outstanding assets, of which around 60 percent are considered
non-performing, according to bank analysts.

Consumer Finance ("Shimpan" and "Sarakin")
Like the jusen, credit charge companies (shimpan) and sarakin lenders (sarariman ldnyu,
or "salaried employees' finance") are not legally defined as "financial institutions." Shimpan
companif "''Pically provide installment credit, including credit cards, as well as cash credit.
Sarakin L ..Jers typically provide a moneylending function at rates often double or more rates
on bank consumer loans, but with fewer restrictions on eligibility. The top 300 firms among
the non-bank lenders (there are over 30,000) have 160 trillion ($706 billion) in outstanding loans
as of March 31, 1994.

Government-Affiliated Financial Intermediaries
At present, there are two gvvernment banks (Japan Development Bank and Export-Import
Bank of Japan) and nine public finance corporations in Japan. In addition to these governmentaffiliated fmandal institutions, the Postal Savings Special Account and the Postal Insurance Fund
perform important financial intermediary functions (see below); and Shoko Chukin Bank, which
receives some government funding, is an important lender to SMEs. The Export-Import Bank
of Japan is scheduled to merge with the Overseas Economic Cooperation Fund in 1999.
The two government banks and nine public fmance corporations have specialized missions
(e.g., housing loans; Hokkaido and Okinawa development; small business finance and credit
insurance; overseas development assistance; and export and import promotion). The function
of the Postal Savings and Postal Insurance Funds is different. These funds provide 38 percent
of the funding for the Fiscal Investment and Loan Program (FILP), the so-called "second
budget." FILP funds in turn provide one of the sources of funds for the government-affiliated
banks and public finance corporations through the Trust Fund Bureau of the Ministry of Finance.
12

STRUCTURE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

Although not organized as a fmancial institution, the Japanese postal savings system has
been called the world's largest bank because its over 12OO trillion ($2.4 trillion, as of June 1995)
in deposits easily dwarf those of any competing institution. The postal savings system accepts
deposits only from individuals (up to a ceiling of I10 million, or $120,000), in post offices
throughout Japan; savers can then borrow against these savings. The most popular savings
instruments are teigaku deposit certificates. Some postal savings interest rates, even following
interest rate liberalization (see below) maintain an advantage over comparable competing interest
rates on deposits at private financial institutions. In addition, postal savings enjoy certain tax
advantages, and are free from reserve requirements and the payment of deposit insurance.
The public sector financial institutions also compete with private sector institutions on the
lending side. In 1993 and 1994, public sector lenders accounted for virtually all lending growth
and now equal 26 percent of all bank loans outstanding. In particular, growth in housing loans
by the Housing Loan Corporation was seven times growth in banks' housing loans in 1994.

Regulatory Framework

Legal Framework
The Banking Law of 1981 fully amended the 1927 Banking Law. It establishes
the requirements for a banking license; defines banks' scope of business; sets lending limitations
with regard to capital; establishes reporting and disclosure requirements, and provides for bank
supervision and examination; sets legal earned reserve requirements with regard to dividend
distributions; and prohibits bank directors (except outside directors) from holding office and
attending to routine work of another company unless approved by the Ministry of Finance. All
of the above requirements also apply to foreign banks operating in Japan. The Law on the
Reserve Deposit System of 1957, last amended in 1986, requires banks (including foreign banks)
and certain other financial institutions to maintain non-interest bearing deposits with the Bank
of Japan. The Temporary Interest Rates Adjustment Law (TIRAL) of 1947 established a
mechanism for setting maximum limits on private financial institutions' interest rates (including
deposit, lending, and money market rates). As interest rate deregulation proceeded (see below),
exemptions to TIRAL were widened. Even though the process of interest rate liberalization has
been completed, the TIRAL law remains in place. The Deposit Insurance Law of 1971,
established the Deposit Insurance Corp.; set an insured deposit ceiling of II0 million ($120,000)
per depositor; established premiums; and provided that deposit insurance funds could be used
to fmance mergers with troubled fmancial institutions. Foreign banks are not covered by the
Deposit Insurance Law.

In addition to the above laws directly aimed at the banking business, there are other laws
with important implications for financial institutions in Japan. The Bank of Japan Law of 1942
(60 years after the establishment of the central bank itself) establishes the Bank of Japan (BOJ)
as the only bank of issue, the bank of banks, and the bank of the Government. As the bank of
banks, the BOJ makes loans, receives deposits, and engages in bond and bill transactions with
other fmancial institutions or money market dealers (not with non-fmancial corporations or with
individuals). Besides its monetary policy function, the BO] is responsible, with the Ministry of

STRUCTURE, REGULAnON, OPERAnONS AND I'RAcncES OF THE JAPANESE FINANCIAL SYsn:M

Finance, for maintaining the soundness of the fmancial system. Bank of Japan Law Article 25
provides for the BOJ to take any and all necessary steps to ensure the soundness of the financial
system.
The Foreign Exchange and Foreign Trade Control Law of 1979, essentially reserves the
foreign exchange business exclusively for banks, and establishes a licensing requirement for
authorized foreign exchange banks. U.S. efforts have resulted in substantial relaxation of
approval and notification requirements for cross-border capital transactions over the years (see
below). The Financial System Reform Law of 1992 allowed crossover entry of banks and
securities firms into each other's businesses (to a limited extent). However, the law preserved
certain core business areas and established physical and operational "firewalls" between parents
and subsidiaries. (These exclusions do not affect foreign banks, whose operations enjoy "better
than national treatment" in this regard.)
Besides the more general laws listed above, there are numerous other laws relating to
specific fmancial intermediaries. Consumer fmance is regulated by the Ministry of Finance
under the Money-Lending Business Regulation Law and the Revised Usury Law, for instance,
and there are specific laws relating to credit cooperatives, agricultural cooperatives, etc.
Another law worthy of mention in this context is the Law Regarding Regulation of
Business Concerning Specified Claims, which gives MOF and the Ministry of International
Trade and Industry the authority to regulate certain types of non-bank credit.

Regulatory Institutions
Formal Regulatory Agencies
The Ministry of Finance and the Bank of Japan share responsibility for bank regulation,
supervision, and examination. Under the Banking Law, MOF licenses bank operations,
including establishment of branches. MOF also enforces the other provisions of the Banking
Law mentioned above, including reporting and disclosure. MOF is responsible for the
enforcement of restrictions on cross-border capital transactions under the Foreign Exchange and
Foreign Trade Control Law (although approvals and notifications under the law are processed
by the BOJ), and the enforcement of other laws, such as the Securities and Exchange Law,
which have an impact on bank and bank subsidiary business but are dealt with elsewhere in this
study. Under the Deposit Insurance Corporation Law, the Deposit Insurance Corporation's
Management Committee decides when it should provide deposit insurance funds to assist a
financial institution merger or liquidation.
Under the Bank of Japan Law, the BOJ's Policy Board is the supreme decision-making
body on monetary policy. The Policy Board meets twice a week. Its members are the Governor
of the Bank of Japan, four voting members appointed by the Cabinet with Diet approval, and
one non-voting member each from MOF and the Economic Planning Agency. The Policy
Board' s monetary policy decisions affect the interest rate at which the BOJ lends to customer
institutions (the official discount rate), and market interest rates, including the principal interbank
interest rate the BOJ targets, the unsecured overnight call rate. The BOr also sets reserve
requirements under the Law on the Reserve Deposit System, and (as directed by MOF) sets
14

STRUCTURE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

regulated interest rates under the TIRAL. As mentioned above, the BOJ may, after consulting
with MOF, take any and all actions to ensure the soundness of the fmancial system, including
actions which go beyond the scope of its normal business (Bank of Japan Law Article 25). MOF
and the BOJ share responsibility for bank supervision and examination, in practice alternating
their examinations of a given institution.
While MOF and the BOJ are responsible for the banking system and the soundness of
the financial system as a whole, there are other entities, on the local, prefectural, and national
levels, involved in the oversight of other parts of Japan's fmancial system. Responsibility for
supervising and examining credit cooperatives, for example, was delegated to prefectural
authorities as a decentralization measure, but MOF and the BOJ have recently taken a more
active role in supervision, in the interest of financial system soundness. The Ministry of
Agriculture, Fishery, and Forestry (MAFF) and the Ministry of Labor have oversight
responsibilities for the agricultural and fishery cooperative and the labor cooperative fmancial
institutions, respectively; based on this function, MAFF has reportedly played an active role in
discussions with MOF on ways to address the agricultural cooperative fmancial institutions'
exposure to non-performing loans. The Ministry of Posts and Telecommunications is responsible
for the postal savings and insurance system. The Ministry of Health and Welfare (MHW) is
responsible for oversight of pension plans; the Pension Service Welfare Public Corporation
(Nempuku) , a quasi-governmental entity affiliated with MHW, assigns pension management
mandates to trust banks and others. Finally, the Ministry of International Trade and Industry
(MITI) shares regulatory and supervisory authority with MOF over three small business-related
government-affiliated fmancial institutions (including Shoko Chukin Bank); regulates certain nonbank financial intermediary services (leasing, installment sales, and shopping-related credit card
services) under the MIT! Establishment Law; and regulates with MOF the .. securitization" of
leasing rights and credit card assets under the Law Regarding Regulation of Business Concerning
Specified Claims.
Industry Associations and Advisory Groups
Beyond the formal regulatory structure, self-regulating industry associations have
occasionally played a role in regulatory enforcement in Japan. In the banking sector, the
Federation of Bankers' Associations has sometimes served as the channel through which MOF
communicates with the major banks. The Association of Regional Banks, the National
Association of Shinkin Banks, and the Federation of Credit Cooperatives, are primarily industry
self-help organizations.
Industry associations have at times engaged in cartel-like behavior. As an example, when
Jonan Shinkin Bank, Japan's largest Shinkin bank, in November 1994 introduced the first deposit
account in Japan linked with the chance to win a cash-prize lottery, the National Association of
Shinkin Banks immediately asked its members to refrain voluntarily from offering similar
lottery-linked deposit accounts. Soon after, the Federation of Credit Cooperatives followed suit
with a similar request to its members. In this case, the industry association pressure did not
succeed, and the Japan Fair Trade Commission began an investigation of whether the two
associations' actions were anticompetitive in nature.

STRUCnJRE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

The regulatory rule-making process in Japan also goes beyond the formal framework.
Government advisory bodies are often responsible for the initial discussion of major regulatory
issues which ultimately culminates in ministerial ordinances or legislation. In the banking
sector, the Financial System Research Council (FSRC), an advisory committee to the Minister
of Finance, was the starting point for discussion of fmancial reform issues which culminated in
the Financial System Reform Act. The FSRC is currently engaged in discussions of measures
to enhance financial system soundness, including expanded disclosure requirements for financial
institutions.

Regulatory Implementation
A number of features have characterized the traditional regulatory environment in Japan.
As discussed below, many of these features have undergone significant reform in recent years.
Regulated Interest Rates
Under the Temporary Interest Rate Adjustment Law of 1947, which remains on the books
today, all short-term deposit rates offered by Japanese banks were determined according to an
elaborate formula, ultimately linked to the Bank of Japan's official discount rate.
Bank of Japan "window guidance" supplemented and reinforced formal interest rate
controls. "Window guidance," as originally applied, referred to the BOJ's instructions to
individual private banks setting quarterly ceilings on the growth of the banks' yen loans as a
principal tool of monetary policy adjustment. As with other forms of administrative guidance,
compliance was ostensibly voluntary, but since the banks were beholden to the BOJ for loans
at the discount window, the BOJ had considerable leverage over the banks' supply of credit,
even beyond the conventional tools of monetary policy. During most of the postwar period, BOJ
lending to private banks allowed the banks to "overlend" beyond the amount which their deposit
bases could support by themselves; in doing so, the banks became "overborrowed" and heavily
dependent on the BOJ's provision of funds.
Together with the creation of specialized institutions to channel funds toward industrial
development and other specific sectors, interest-rate controls and window guidance supported
a policy of credit control and credit allocation that continued through the first 40 years of the
postwar period.
After a 15-year program of deregulation (discussed in more detail below), all controls
on bank deposit rates were abolished as of October 1994. The BOJ had earlier abolished
window guidance formally with effect from the third quarter of 1991.
Foreign Exchange Controls
In the post-war financial structure, foreign exchange controls closed the circle of
segmentation by foreclosing access to fmancial markets outside Japan. The Foreign Exchange
and Foreign Trade Control Law of 1949 and the Foreign Investment Law of 1950 generally

STRUCnnu:, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

prohibited foreign transactions (including foreign currency transactions between residents),
except where expressly permitted. Banks benefitted from this system both by acting as the sole
providers of foreign exchange, and by facing no competition from outside their home market.
In 1980, the Japanese Government enacted a major revision of the Foreign Exchange
Law. As a result of this change, capital flows were made "free in principle, restricted only by
exception." Further deregulation of foreign exchange controls continued throughout the 1980s
and 1990s, culminating in the major relaxation program announced in the Measures of February
1995.
Bank Supervision Policy

"No Failures"
There has not been a single failure in the sense of a bankruptcy followed by a payoff of
depositors of any bank, large or small, in Japan in the entire postwar period. However, there
have been numerous official interventions to deal with problem banks; banks and other
institutions which were de facto insolvent or were on the brink of failure have been merged with
other banks. In recent cases involving Tokyo credit cooperatives, successor institutions assumed
the assets and liabilities of the de facto insolvent institutions. Many incentives have been
available to the authorities in encouraging mergers, including the ability to use deposit insurance
to help finance a merger. Japan did not have a system of deposit insurance until 1971, and
deposit insurance funds have thus far only been used to help fund mergers of failing institutions,
never yet to payoff depositors directly after allowing a bank to fail. Deposit insurance has been
used seven times to facilitate such mergers, for a total of 1119.2 billion ($1.4 billion) thus far
(including one merger scheduled for the end of July 1995). Local governments, responsible for
the supervision of credit cooperatives, have also contributed at least 112 billion ($141 million)
towards mergers of credit cooperatives.
In implementing the "no failures" policy, the banking supervision authorities have taken
a case-by-case approach. This approach has relied on main banks and other banks with
connections to fmancially troubled institutions to assume responsibility for resolving problems - in some case by injecting funds, in some cases by providing officers to run the institution, and
in some cases by mergers.

"Convoy System"
In addition to no bank having failed in the postwar period, no major bank even posted
a loss for any business year until Japanese fiscal year 1994 (ended March 31, 1995). Until quite
recently, banks' business results, and their dividends based on those business results, moved in
lockstep, as did their interest rates. This "safety in numbers" approach, which protected weaker
banks by making it hard to differentiate their results from the results of stronger banks, is called
the "convoy system" in Japan. Banks were able to report essentially similar results over the
years because of limited financial disclosure requirements and unique and flexible accounting
standards. This aspect of the "convoy system" distorted economic incentives by making it

STRUCTURE. REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

difficult to distinguish between the performances of individual banks and by forcing banks to
take economically irrational steps (selling off their higher quality stock and land assets to realize
capital gains) to avoid showing a loss at the end of a business year.

Operations and Practices
The Main Bank System
One of the peculiarities of the Japanese banking business is the "main bank" relationship,
which is often but not necessarily rooted in a keiretsu relationship (see Chapter ITI). There is
no formal or legal defInition of a "main bank"; instead, this term refers to the relationship
between a bank (usually a larger city bank, but also including long-term credit banks, such as
the Industrial Bank of Japan) and a corporate client, defmed by:
•

a long-term lending relationship, with the main bank usually but not always acting
as the client's largest lender;

•

reciprocal holdings of bank's and client's shares;

•

provision to the client of management services, possibly including the dispatch of
directors;

•

facilitation of corporate bond issuance, including acting as "commissioned bank"
(see Securities section below), and more recent!y, bond underwriting through the
bank's onshore and offshore securities subsidiaries; and

•

provision of other fmancial services, including operation of payment settlement
accounts; foreign exchange dealings; and investment banking and advisory
services.

The main bank relationship is also generally defmed in terms of the main bank's
responsibility to the client, to other banks which have lent to the client, and to the fmancial
system. This responsibility becomes particularly evident when the client is experiencing
financial distress. Part of the main bank's function is to monitor the client's business
performance, and bank staff may be dispatched to the client even in normal times. If the client
faces serious financial problems, it is viewed as the main bank's responsibility -- to other
lenders, to the client's employees, to the regulatory authorities, ultimately to the financial system
-- to take steps to resolve the situation with minimum disruption to the interest of the other
stakeholders. The cost to a bank's reputation can be high if it puts its own interests flIst, by
either winding down its own loans before other lenders become aware of the client's problems,
or by cutting off the client and bringing the case to liquidation proceedings. Instead, the main
bank may choose to lead a restructuring program.
Regulatory policies of forbearance, segmentation and restricted entry (e.g., a licensing
requirement to obtain "major" bank status allowing nationwide branching) provided a supportive
environment for the main bank system throughout most of the postwar period. Interest rate
regulation, which kept nominal lending rates low, did not adversely affect main banks either,

STRUC11JRE, REGULATION. OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

as they required clients to maintain "compensating balances" on deposit in return for a favorable
lending stance -- in effect raising the actual lending interest rate. As long as the banking
business was segmented and the issuance of corporate bonds was limited to a few select fIrms
(mostly public utilities), there were few alternatives to the main bank relationship, and the banks
in question were able to capture the resulting economic "rents." In return for this favorable
regulatory environment, main banks were expected to assume the primary role in heading off
or smoothly resolving fmancial difficulties of client fIrms.
Equity (or equity-linked securities) issuance and internal fmancing have assumed more
important roles in corporate fInance in Japan in the last ten years, and interest rate deregulation
and cross-sectoral entry have changed the landscape in which banks operate. However, the main
bank system continues to be an important feature of the Japanese fmancial system.

Collateral-Based Lending
Japanese banks and other lenders have traditionally extended loans against collateral,
usually in the form of land or securities. Loans by the major Japanese banks have been
generally collateralized at around 70 percent of the assessed value of the borrower's real
property (mostly land) in recent years.
The tendency to lend only against collateral has meant that Japanese banks have been less
willing to lend against cash-flow -- a factor which is thought to discourage start-up companies
such as software companies, which have not accumulated much collateral. In addition, because
of the emphasis on lending against collateral, and the emphasis on business relationships in
banking, local bank analysts report that Japanese banks have until recently had little experience
with objective credit evaluation as a basis for lending decisions. It is only in the last two to
three years that "asset-liability management" or" ALM" has become a buzzword in Japan, with
major Japanese banks setting up ALM sections one after the other. Besides this indication of
increased awareness of asset and liability management, banks are said to be scrutinizing credit
risk more carefully as well, following the collapse of the "bubble."
In its June 27, 1995 package of "Measures for Implementing and Supplementing the

Emergency Measures for Yen Appreciation and the Economy," the Japanese Government
recognized the problems inherent in the traditional focus on collateral in lending decisions:
"Financial institutions are requested to improve further their credit-providing stance by
decreasing the emphasis on collateral and by increasing the emphasis on the future
prospects of the borrowing companies; this will not only help to achieve a smooth
provision of funds to existing companies but also help create more new businesses."

Role of Public and Cooperative Institutions
Public sector financial institutions and the cooperative-based financial intermediaries have
been important parts of Japan's postwar fInancial system, complementing and occasionally
competing with the banks. During the period of rapid growth, 1955-1973, public institutions
are said to have accounted for almost 20 percent of total fInancial intermediation, rising to 30
percent in the mid-1980s. During the period of slow growth since 1991, public lenders' share
19

STRUCnJRE, REGULA1l0N, OPERA1l0NS AND l'RACllCES OF THE JAPANESE FINANCIAL SYSTEM

of total lending has grown as loan growth by private lenders has stagnated. The use of public
lending in countercyclical demand management in this period is evidenced by the inclusion of
113.7 trillion ($161 billion) in funds for public lending programs in the four economic stimulus
packages totaling 145.4 trillion ($534 billion), since August 1992.
Growth in public housing loans at below-market rates has outpaced growth in private
housing loans since 1991, providing support which helped (along with lower nominal interest
rates) maintain growth in residential investment in 1993 and 1994 while other components of
economic growth were stagnant or falling. As of the end of 1994, outstanding housing loans
by the public Housing Loan Corporation (HLC) accounted for 41 percent of housing loans by
all lenders. Whether or not this public intermediation represents "crowding out" of private
sector intermediaries, the HLC ultimately relies on postal savings, postal life insurance, and
public pension funds, recycled through MOF's Trust Fund Bureau through the Fiscal Investment
and Loan Program (FILP) , for its funding. In other words, public financial intermediaries
compete with private ~termediaries in Japan on both the lending and deposit-taking side.

Recent Reforms
Financial System Refonn Act

In April 1993, the Financial System Reform Act (FSRA) entered into effect, ten months
after Diet passage and eight years after initial discussions began between the Ministry of Finance
and the financial services industry. The legislation provided for crossover entry into certain
portions of the banking and securities businesses for the flrst time in postwar Japan.
However, in the course of eight years' debate, the scope of the fmancial liberalization
that initially had been under discussion was considerably reduced. The legislation as passed no
longer included a comprehensive deflnition of permissible securities under the Securities and
Exchange Law. For technical reasons, crossover entry between the insurance business and other
fmancial services sectors was not included at the time (but has since been made possible by a
recent revision of the Insurance Law). The crossover entry permitted between the banking and
securities businesses in the end excluded certain "core" areas of the respective businesses. In
addition, the Ministry of Finance continued to control the process of crossover entry, and
granted approvals on a staggered basis, for instance allowing certain banks to establish securities
company subsidiaries one full year before other banks were allowed to do so. Finally, the Act's
implementing regulations erected high "fuewalls" between parents and subsidiaries, arguably
increasing the cost of establishing a subsidiary to a degree that makes it possible only for larger
banks and securities companies to do so.
As a result of these limitations, financial reform under the FSRA constituted a
continuation of the process of controlled change rather than a radical break from the postwar
regulatory approach.
Under the FSRA, Japanese banks' newly-established securities subsidiaries are permitted
to underwrite and broker fIXed-income securities, but not to underwrite or broker equities.
Exceptions were made for some equity-related instruments (convertible bonds and equity warrant
bonds); for foreign banks' securities subsidiaries, which-were "grandfathered" in; and Japanese
20

STRUCTIJRE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

banks' securities subsidiaries created by a Japanese bank's bail-out merger with or acquisition
of an existing Japanese securities company. Daiwa Bank's acquisition of Cosmo Securities is
the only example so far of the latter exception, but MOF held out the prospect of similar access
to the entire range of securities business through bail-out mergers, as a "carrot" for banks, in
announcing implementation of the FSRA.
Securities companies' and non-trust banks' trust bank subsidiaries, on the other hand, are
pennitted to engage in discretionary management of corporate funds and custodianship for
securities investment trusts (mutual funds) under the FSRA; however, they are excluded from
non-discretionary management of corporate funds ("tokkin It) and of public and corporate pension
and postal savings and insurance funds ("shiteitan"). An exception was made for the bail-out
acquisition of or merger with an existing trust bank, as when Nippon Trust Bank was permitted
to continue a full range of trust banking business following its acquisition by Mitsubishi Bank.
The frrewalls created by the implementing regulations of the FSRA (and in part included
in the 1991 revision of the Securities Exchange Law) require physical and operational separation
between parents and subsidiaries. Subsidiaries must be separately capitalized. Sharing of board
members or auditors is not permitted. Sharing of employees, computer systems, office space,
and non-publicly available information is restricted. No "tie-in" sales are permitted whereby
parent banks provide incentives to use their securities subsidiaries. No parent bank may sell
securities underwritten by its own subsidiary. A securities subsidiary may not underwrite its
parent's issue. Trading on favorable terms (e.g., a securities subsidiary selling bonds at a
reduced price to its parent) is not permitted. In addition, a securities subsidiary of a lead
commissioned bank for a corporate issue is prohibited from lead-managing the issue, unless the
issuer has net assets of 1500 billion ($5.9 billion) or more.
Crossover entry was initially staggered to give a head start to weaker financial institutions
and to control the numbers of entrants and the degree of competition. Two long-term credit
banks, the Central Bank for Agriculture and Forestry (Norinchukin), and two trust banks were
allowed to establish securities subsidiaries in July 1993, one year before city banks.
At present, there are 16 banks with securities subsidiaries; three non-trust banks and four
securities companies with trust bank subsidiaries; and seven banks and one life insurance
company with investment trust management subsidiaries. Banks' securities subsidiaries have
been successful in underwriting straight, convertible and samurai bond issues.

Interest Rate Deregulation
Dismantling Japan's postwar interest rate control structure occurred over 15 years. The
process began in 1979 with the introduction of certificates of deposit (CDs) and ended in
October 1994 with the liberalization of interest rates on non-time deposits. Significant steps
along the way included the beginning of the phased deregulation of large time deposits, in 1985;
removal of the ceiling on CD issuance in 1987; and the establishment in 1991 of a three-year
timetable to gradually widen the range of market-determined deposit and similar (e.g., money
market certificate) rates, beginning with time deposits. As a measure of progress, 84 percent

STRUCTURE, REGULATION, OP£RATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

of deposits were held at controlled interest rates in 1985, compared with only 5 percent at
present. (The only remaining "regulated" interest rates are "current" deposits equivalent to
checking account balances, which continue to bear no interest).
Even following interest rate liberalization, an important non-market feature continues to
characterize Japanese interest rates: a differential in favor of postal savings deposits. The
Ministry of Finance and the Ministy of Posts and Telecommunications agreed in Apri11994 on
rules to govern the setting of non· ';me deposit interest rates on postal savings accounts. The
rules preserved a positive one percentage-point gap between postal savings "ordinary" non-time
deposit interest and private banks' interest rate on similar deposit accounts, thus maintaining an
advantage for postal savings in attracting this type of deposit.
Private banks have criticized the advantage accorded to postal savings, arguing that the
postal savings system has a nationwide branch network provided by the Government, no reserve
requirement and no deposit insurance requirement, and pays no taxes. On the other hand, many
commentators have observed that there is nothing preventing private banks from raising their
ordinary non-time deposit interest rates (although it seems likely that postal savings would also
raise its ordinary non-time deposit interest rate to preserve the differential).
Instead, interest rates have moved in lockstep on similar types of deposits among similar
types of private financial institutions, even following interest rate deregulation. For instance,
the rate on a one-year deposit of X100,OOO ($1,200) is currently set by virtually all city banks
at the same 0.5 percent.
Changes in Bank Supervisory Policy

Cross-sectoral entry and interest rate deregulation, described above, modified the
segmentation and credit control aspects of the postwar fmancial regulatory framework.
Liberalization of cross-border capital transactions also affected the regulatory structure for the
banking sector; this liberalization is described below, in the section on U.S.-Japan negotiations.
In addition, some analysts have speculated that the traditional "no failures" and "convoy"
approaches may be modified, in order to cope with the problems created by the bursting of the
late 1980s "bubble."
"No Failures" Reconsidered
As of June 1995, there has still not been a single bank failure in postwar Japan; however,
both the Bank of Japan and the Ministry of Finance have suggested in both words and deeds
over the past year that revisions to the traditional "no failure" policy may be imminent.
On June 8, 1995, the Ministry of Finance announced a set of measures to address the
non-performing loan problems of banks and other financial institutions. The package, entitled
"Reorganizing the Japanese Financial System," committed MOF to drawing up policy guidelines
on possible methods to dispose of failing or failed financial institutions:

STRUC'roRE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

"The Ministry shall prepare a framework in which the principle of selfresponsibility can be fully applied to Japanese depositors as soon as possible,
within five years at the latest. "
This provision has been widely interpreted as establishing a five-year grace period during
which no pay-offs of depositors will take place -- in effect continuing the "no failures" policy,
from the depositor's perspective. In the interim, to lay the groundwork for possible future
failures and pay-offs, MOF has committed to enhance financial institutions' disclosure of their
non-performing loans, strengthen the deposit insurance system, and strengthen financial
institution examination and supervision, particularly for credit cooperatives.
There is still a strong reliance on main banks and banks with other connections to
troubled institutions to take the initiative in aiding those institutions. The June 8 package of
banking measures emphasized banks' own responsibility for dealing with the non-performing
asset problem as a precondition to the use of public funds. Part of the debate over the use of
deposit insurance and Bank of Japan funds in a plan to secure the depositors of two failed Tokyo
credit cooperatives revolved around the role of the cooperatives' main bank. Intense Diet and
media attention focused on, among other questions, why the main bank had not led a rescue of
the two institutions, and whether the bank had been aware of problems at the two early on since
it had cut off lending to a real estate developer associated with one of them in the summer of
1993 - over a year before the two credit cooperatives' problems became public.
Two other recent examples show the current strains on the merger-based approach to
financial system problems and the beginning of a possible new approach based on allowing some
failures. In early 1994, MOF sought to bring about a merger of three banks in northeastern
Japan in order to rescue one of the three. The employees' union and the major corporate
customers of the soundest of the three banks objected to the merger, which in the end did not
go through. In the second example, in the spring of 1995, three regional banks in the Kansai
region of Japan (the region surrounding the city of Osaka) initiated proceedings to liquidate 11
non-bank affiliates.
Discussion of further steps to address the banks' non-performing asset problems is
ongoing, but the division of labor between taxpayer funds and lenders' own responsibility is
certain to remain a subject of debate.
Public Funds Used to Secure Depositors in Two Failed Tokyo Credit Cooperatives
On December 9, 1994, the Bank of Japan announced a plan to secure the depositors in
two Tokyo credit cooperatives (Tokyo Kyowa and Anzen) which had de facto failed. The plan
was to use a combination of public and private funds to establish Tokyo Kyodo Bank, an
ordinary bank which would assume the assets and liabilities of the two failed cooperatives. In
addition, a bad asset purchase mechanism would be created to dispose of the estimated 1110
billion ($129 billion) in uncollectible loans of the two cooperatives. The package was agreed
on among the BOJ, MOF, the Tokyo metropolitan government, the National Federation of
Credit Cooperatives, the Tokyo Association of Credit Cooperatives, the Long-Term Credit Bank,
and other private financial institutions, all of which were supposed to contribute to the scheme.

STRUCnJRE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FlNANCIAL SYSTEM

The plan almost immediately ran into criticism because of the planned use of public funds
to secure depositors who had been receiving above-market interest rates on deposit balances well
above the deposit insurance ceiling; the refusal of the two institutions' "main bank" to take full
responsibility for the cleanup; the practice of the two cooperatives' presidents of lending to their
own real estate and golf course development companies (which later resulted in both being
arrested on charges of breach of trust); and the two presidents' connections to prominent
bureaucrats and politicians (which resulted in Diet hearings and disciplinary measures against
several Ministry of Finance staff).
The Finance Ministry and the Bank of Japan's response to this criticism was that their
other options had been foreclosed: the institutions' problems were too severe for a restructuring
program to succeed; no merger partner could be found; and it was not feasible in this case to
close down the two institutions and payoff depositors because the groundwork had not been laid
for a pay-off, and it might have caused a run on banks. Further, MOF and the BOJ argued that
this was not a bail-out: even if the two institutions had engaged in questionable lending practices,
their presidents had been removed, and the scheme to secure the depositors was necessary to
preserve [mancial system soundness.
In March 1995, the Tokyo Metropolitan Assembly voted to freeze the city's 130 billion
($353 million) planned contribution to the vehicle to dispose of the two failed cooperatives' nonperforming loans.
Convoy System "Under Review"
In June 1994, a subcommittee of the Financial System Research Council issued a report
entitled "On Financial Deregulation and Ensuring the Sound Management of Financial
Institutions." The subcommittee's chairman said the report represented a "180 degree turn"
from previous financial institution regulatory practice. The report suggested that the "convoy
system, " in helping hide individual financial institutions' problems, created a "moral hazard and
impeded development of sound banking practices and adequate risk management. The report
urged enhanced disclosure and better internal controls, including greater use of credit ratings and
independent auditing, with the authorities playing only a "supplementary role" in helping banks
improve their internal rules and risk-management systems. The subcommittee also urged
removal of government regulations restricting competition, including financial market
segmentation and restrictions on permissible products.
II

In attempting to address the non-performing loan problem faced by financial institutions,
the banking authorities have recently shown signs of moving toward a regulatory approach based
somewhat more on market discipline than has been the case in the past. Two additional
indications of a modified regulatory approach are the requirement for increased [mancial
disclosure and the fact that banks are now allowed to report losses.

Disclosure
Prior to 1993, Japanese banks, including the largest banks, were not required to disclose
any of their non-performing loans. Following a recommendation made in December 1992 by
a subcommittee of the FSRC, the 21 major banks, the Norinchukin Bank, the Shoko Chukin
24

STRUCTURE. REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

Bank, and the Zenshllren Bank began to disclose their bad loans Ooans to borrowers that had
since gone bankrupt) and delinquent loans (loans on which interest payments were in arrears for
six months or more) as of the end of March 1993, for the FY 1992 business year. At the same
time, regional banks (first- and second-tier) began to disclose their loans to bankrupt borrowers
only.
This limited disclosure of non-performing loans left significant gaps in coverage.
Regional banks' delinquent loans were excluded, all banks' restructured loans Ooans on which
interest payments have been reduced or forgone as part of a restructuring program) were also
excluded, and many financial institutions (shinkin banks and credit cooperatives) were not
required to disclose at all. As a result of these gaps in coverage, there was a great deal of
uncertainty regarding the true level of non-performing assets in the banking system. The official
estimate at the time of around 113 trillion ($152.9 billion) for the major 21 banks was commonly
thought to understate the size of the problem. These suspicions were confirmed when one
Japanese city bank listed on the New York Stock Exchange in the spring of 1994, and declared
twice the level of non-performing assets under U.S. disclosure requirements as it had done in
Japan.
In the spring of 1995, the disclosure subcommittee of the FSRC proposed expanding the
disclosure requirements for Japanese fmancial institutions. The Japanese Government, in its
Apri114, 1995, "Emergency Measures for Yen Appreciation and the Economy," and again in
the June 8, 1995, package of banking measures, endorsed the need for enhanced disclosure as
part of its commitment to achieve "disposal of non-performing assets, including interest-reduced
or exempted assets, over a time span of about five years. "
The June 8 package requires, effective as of the end of the FY 1995 business year
(March 31, 1996), the following enhanced disclosure:
•

The major banks (city, trust, and long-term credit banks), the Norinchukin Bank,
the Shoko Chukin Bank, and the Zenshinren Bank will be required to add
restructured loans to their current disclosure of bad and delinquent loans.

•

Certain large regional banks (tiers one and two) will be required to add delinquent
loans to their current disclosure of bad loans.

•

Certain cooperative-type financial institutions will be required to do some, as yet
unspecified, disclosure of their asset quality.

On June 6, 1995, the Director-General of the MOF Banking Bureau testified before the
Diet Lower House Budget Committee that the total amount of non-performing loans in all of
Japan's financial institutions (including all banks and cooperative-based institutions, but
excluding insurers and non-bank lenders) was 140 trillion ($475 billion).3 The figure, which
was much higher than any ever previously cited publicly by official sources, was repeated in the

He later said publicly that one-quarter to one-third of these loans were likely to be
uncollectible.
3

STRUCTURE, REGULAnON, OPERAnONS AND PRACnCES OF 1BE JAPANESE FlNANCIALSYsn:M

June 8 package of banking measures. According to newspaper accounts, MOF arrived at the
figure by adding estimated restructured loans to the 112.5 trillion ($147 billion) in disclosed bad
and delinquent loans of the major 21 banks as of March 31, 1995, then extrapolating from this
figure to estimate regional banks' and other smaller institutions' non-performing loans.
Even the most recent figure cited by MOF, and the proposed expanded disclosure
requirements, leave some gaps in coverage. The disclosure subcommittee of the FSRC
acknowledged that "it is difficult to defme clearly what constitutes a restructured loan." In order
to estimate such loans, the subcommittee proposed a least-common-denominator approach:
"At least, banks should disclose those loans whose terms they have restructured
to have interest rates equal to or below the level of the [official] discount rate on
the day ofrestructuring ... because those loans are likely to have a negative impact
on bank earnings. "

First Losses By Major Banks
Sumitomo Bank announced in January 1995 that it would report a loss in FY 1994 in
order to write off more than 1800 billion ($9.4 billion) worth of non-performing loans. (Because
write-offs are subtracted from operating profits to yield recurring or pre-tax profits, taking a
larger write-off means reducing recurring profits or even taking a loss.) A subsequent fall in
stock prices expanded Sumitomo Bank's loss above its original projection; Hokkaido Takushoku
Bank (another city bank) and Nippon Trust Bank also reported recurring losses, and three
second-tier regional banks also reported recurring losses for the FY 1994 business year.
The reporting of differentiated results among the major banks signals a break with one
of the past practices of the "convoy system." International credit rating agencies have also
exposed the major Japanese banks to market discipline, by providing objective ratings which
have resulted in higher borrowing costs for the weaker banks.
SECURITIES MARKETS

Structure
Japan's securities markets are second in size and importance only to those of the United
States. In terms of structure, Japan's markets offer most of the securities activities available in
other major financial centers, although, as discussed later in this chapter, the range of
permissible products and services has traditionally been limited by regulation and administrative
practice.

Securities Markets
Equity Markets
There are eight licensed securities exchanges in Japan, the largest of which are located
in Tokyo, Osaka, and Nagoya. There is also a small "over the counter" (OTC) equity market,
which in 1994 accounted for less than 5 percent of the total value of stock trading in Japan. The

STRUCTURE, REGULA1l0N, OPERA1l0NS AND PRACllCES OF THE 1APANESE FINANCIAL SYSTEM

Tokyo Stock Exchange (TSE) is by far the most important securities exchange in Japan. In
1994, the TSE accounted for nearly three quarters of the value of all stock trading in Japan, and
fIrms listed on the TSE represent more than 90 percent of the total market capitalization of
publicly traded Japanese companies. The Osaka Stock Exchange remains important primarily
as a center for derivatives trading.
In 1989, at the peak of the "bubble economy," the market capitalization of Japanese

publicly traded stocks briefly surpassed that of U.S. stocks, and the value of trading on the TSE
exceeded that on the New York Stock Exchange. Both the size of the market and equity trading
activity have fallen sharply in recent years, in line with the sharp decline in stock prices. After
peaking at nearly 39,000 at the end of 1989, the benchmark Nikkei 225 stock average fell to less
than 24,000 at the end of 1990, and to less than 15,000 as of mid-June 1995. The total market
capitalization of the firms traded on the TSE fell to 1306 trillion ($3.6 trillion) at the end of
April 1995, 50 percent below its peak (in yen terms) at the end of 1989. Daily average trading
volume fell from 1,020 million shares in 1989 to 328 million shares in 1994. New equity
financing (including convertible and warrant bonds) fell to 13.7 trillion ($44 billion), only 14
percent of the new issue activity in 1989.
Debt Markets
Government securities dominate the medium- and long-term debt securities market. Total
domestic bonds outstanding at the end of 1994 amounted to 1340 trillion ($4 trillion), of which
70 percent were Japanese municipal and central government bonds. Bank debentures accounted
for 23 percent of the total, while Japanese corporate bonds accounted for the remaining 7
percent. Outstanding yen bonds issued in Japan by foreign entities ("samurai" bonds) totaled
18.1 trillion ($95 billion) at the end of 1994.
The corporate bond market has grown fairly rapidly in recent years, but from a very low
base. Until the 1990s, corporate bond issuance in Japan had been stagnant for more than 15
years. Issues of corporate straight bonds (as opposed to convertible or warrant bonds) rose
from only 11.0 trillion ($12 billion) in FY 1974 to 11.1 trillion ($13 billion) in FY 1989, and
declined from 0.8 percent of GDP to 0.3 percent over the period. Corporate bond issuance rose
to 13.4 trillion ($40 billion) in 1994, but this still represents only 0.7 percent of GDP, compared
to about 16 percent of GDP in the United States. It also paled by comparison with Japanese
government bond (JGB) issuance in 1994, which totaled 155.9 trillion ($658 billion), or 12
percent of GDP.
In contrast to straight bonds, convertible and equity warrant bond issuance increased
rapidly during the 1980s. New equity-linked bond issuance rose from 1354 billion ($4.2
billion), or 0.2 percent of GDP, in 1979, to 18.6 trillion ($101 billion), or 2.2 percent of GDP,
in 1989. Equity-linked bonds have generally faced fewer obstacles than straight bonds. One
reason may be that commissioned banks see these equity-linked bonds as less direct competitors
to their lending business than straight bonds, viewing them more as equity instruments than as
debt instruments. Also, the Finance Ministry's informal minimum qualification requirements
have been less stringent, and there have been fewer restrictions on maturity and interest rate
structures. Furthermore, the booming stock market of the late 1980s allowed corporations to
offer convertible bonds with extremely low coupons, further increasing their attractiveness as
27

STRUCTIJRE, REGULAnON, OPERAnONS AND l'RACnCES OF THE JAPANESE FINANCIAL SYSTEM

a financing instrument. New convertible and equity warrant bond issues dropped sharply to 11. 3
trillion ($15.3 billion) in 1990, after limits on equity financing were imposed in the wake of the
sharp decline in Japanese stock prices that year.
Japanese corporations also issued 11.1 trillion ($13 billion) worth of bonds overseas in
the Euro-yen market during 1994.
Short-Term Money Markets
Japan's money markets are divided into two broad categories. Only banks and other
financial institutions are allowed to participate in the inter-bank markets, either as borrowers or
as lenders. Any corporation may participate in the so-called "open" market as a lender, although
not necessarily as a borrower, as some of the instrumen~ traded in these markets are issued only
by banks or by the Japanese Government.
The interbank market consists of the call-money market and the bill discount market.
The call-money market, the equivalent of the federal funds market in the United States, is
Japan's largest money market. With 142.8 trillion ($504 billion) outstanding at the end of 1994,
the market accounted for more than 40 percent of Japan's total 1104 trillion ($1.2 trillion)
money market. The call market grew nearly 80 percent between 1990 and 1994 in response to
a series of market reform measures. These include the liberalization of limits on maturities for
unsecured call-money transactions and the move to a bid/offer system to replace the money
broker system used previously. The bill discount market shrank by more than 50 percent over
the period, as banks increased their reliance on the call-money market.
The "open" money markets consist of negotiable bank certificates of deposit (CDs),
repurchase (gensala) agreements, Japanese government Treasury bills (T-bills) and financing bills
(F-bills), and commercial paper (CP). The largest of these is the CD market, which totaled
118.5 trillion ($218 billion) at the end of 1994, followed by the gensaki market at 111.7 trillion
($138 billion). T-bills, first issued in February 1986, totaled 111.3 trillion ($133 billion).
F-bills, which may be issued to cover temporary cash shortfalls reflecting differences in timing
between expenditures and receipts, amounted to 11.5 trillion ($17.6 billion). The Japanese
government first permitted firms to issue CP in November 1987. There has been some
liberalization of the limitations on firms allowed to issue CP, but some restrictions still remain
in place on which firms are allowed to issue CP and on the uses of the funds raised. Direct
issuance of CP is prohibited, and the fees charged by banks and securities firms to arrange CP
issues raise the cost to borrowers. These various restrictions have limited the growth of the CP
market, which totaled 19.9 trillion ($116 billion) at the end of 1994.
Participation in the Euro-yen deposit market is restricted to authorized foreign exchange
banks. Prior approval from MOF is required for Japanese corporations and individuals seeking
to hold overseas yen accounts, a requirement that has served in effect as a blanket prohibition.

STRUCTURE. REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

Derivatives Markets
Most derivatives trading in Japan is focused on Japanese government bond (JGB) futures
and options, which were first introduced in 1985 and trade on the Tokyo Stock Exchange. The
most actively traded derivatives instrument in Japan is the 10-year JGB futures contract -- with
trading amounting to 11,300 trillion ($15.3 trillion) in 1994 -- followed by the 20-year JGB
futures contract, at 1319 billion ($3.8 billion). Trading in options on JGB futures came to 1169
trillion ($2 trillion) in 1994. The Ministry of Finance estimates trading of OTe bond options
at 1175 trillion ($2.1 trillion) in 1993 (the most recent data available).
While large in absolute terms, bond futures trading is substantially smaller in Japan than
in the United States. The 1994 figures given above are also substantially below their peaks in
the late 1980s. Trading in 10-year JGB futures, for example, peaked at 11,870 trillion ($22
trillion) in 1989, 44 percent larger than the figure in 1994.
Trading in banking-related derivatives -- such as Euro-yen interest rate futures and
options, and yen-dollar exchange rate futures -- takes place on the Tokyo International Financial
Futures Exchange (TIFFE). Trading in Euro-yen futures has quadrupled since TIFFE was
established in 1989.
Trading in equity derivatives is limited by law to exchange-traded futures and options on
stock indexes or other baskets of stocks. Options and futures on individual stocks are not
permitted. Trading in Nikkei 225 futures, listed on the Osaka Stock Exchange, fell to 1124
trillion ($1.5 trillion) in 1994, down nearly 80 percent from its peak in 1991. The decline in
trading reflects both lower trading volume in the cash market and restrictions imposed by the
Finance Ministry and the stock exchanges in an effort to reduce volatility in the cash market.

Securities Firms
As of June 1995, there were 230 securities companies in Japan, including 52 foreign
securities :firms with branches in Japan. U.S. securities firms accounted for 18 of the 52 foreign
fmns. The number of securities company employees fell from a peak of 158,600 at the end of
1990 to 127,500 at the end of 1994. This primarily reflects declining employment at Japanese
firms. The number of employees of foreign securities firms was virtually unchanged over the
period at about 6,500. The 20 percent decline in employees and other cost-cutting measures
implemented over the four-year period were not sufficient, however, to offset a 60 percent drop
in total revenues following the sharp decline in stock prices. Net income of the Japanese
securities industry went from profits of 12.2 trillion ($25.9 billion) in FY 1990 to a loss of 1400
billion ($4.7 billion) in FY 1994 (preliminary data).
The Japanese securities industry is dominated by the so-called "Big Four" frrms:
Nomura, Nikko, Yamaichi, and Daiwa. In 1994, the Big Four accounted for nearly 40 percent
of the industry's 127,500 employees, and 18 percent of the 2,900 securities offices in Japan.
They also account for more than 40 percent of all brokerage commissions, nearly two-thirds of
the industry's underwriting revenues, and more than half of the total revenues of Japanese
securities fmns.

STRUCTURE. REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYsn:M

Regulatory Framework
Legal Framework
The primary law governing the securities industry in Japan is the Securities and Exchange
Law (SEL). The SEL restricts the securities business to licensed securities companies, and
participation in each of the major secu'ties activities -- dealing, brokering, and underwriting requires explicit approval from MOF. As of June 1995, of the 230 Japanese securities firms,
139 were licensed to do the full range of securities business, as were 44 of the 52 foreign fInns.
Until recently, commercial banks were strictly prohibited from entering the securities
business. The SEL was revised in 1992 (effective in 1993) to allow banks to establish securities
subsidiaries. These subsidiary flnns are not allowed to engage in the full range of securities
operations, particularly in areas such as equity trading and underwriting. The Finance Ministry
allowed fIve Japanese banks to establish securities subsidiaries in 1993, eight in 1994, and three
in the fIrst half of 1995, and also allowed one bank to acquire an ailing securities fum in 1993.
The SEL also enumerates the classes of instruments that qualify as "securities." This
relatively restricted list of permissible instruments has, as discussed below, limited the ability
of securities flnns to market innovative products tailored to the needs of specifIc clients.
The Foreign Exchange and Foreign Trade Control Law (FX Law) requires either prior
notice to, or prior approval from, MOF for a wide range of cross-border securities transactions.
Revisions to the FX Law dating to 1980 made all cross-border capital transactions "free in
principle and restricted only by exception. As discussed below, recently announced changes
under the Measures produced a signifIcant relaxation of prior notice and prior approval
requirements and other remaining restrictions under the FX Law.
II

Japan's Commercial Code covers a number of issues that affect the securities industry.
It recognizes only a limited range of corporate debentures and other debt instruments. The Code
also sets forth the terms under which companies are permitted to issue bonds, equity, and
preferred stock. It also imposes broad disclosure requirements on all publicly listed corporations

REgulatory Institutions
The Ministry of Finance has primary responsibility for regulating the securities industry.
MOF has exclusive authority to license secunties fums and exercises broad discretion in the
implementation of the regulatory and legal framework.
The Securities and Exchange Surveillance Commission (SESC) investigates securities law
violations. The SESC was established in 1992 after a series of fmancial scandals (discussed in
Chapter IV) raised concerns about MOF's dual roles as industry advocate and industry regulator.
The SESC has limited powers compared with the U. S. Securities and Exchange Commission.
Its authority is limited to the investigation of suspected violations of Japan's securities laws; if
it determines that a violation has occurred, the case is then turned over to the Justice Ministry
for prosecution.

STRUCTURE. ImGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

Self-regulatory organizations include the securities exchanges and the Japan Securities
Dealers Association (JSDA). The exchanges and the JSDA carry out a wide range of regulatory
functions under MOF's supervision.

RegUlatory Implementation
As noted earlier this chapter, MOF has traditionally exercised broad authority in
implementing the legal and regulatory framework governing Japan's fmancial sector, including
securities markets. In addition to its formal authority, MOF has established a range of informal
rules to regulate the securities business. These informal rules have included restrictions on
eligible corporate bond issuers and on interest rates and maturity structures of domestic corporate
bond issues; application of these restrictions to Japanese issuers in the Euro-yen bond market;
and restrictions on the sale of stock index-linked bond issues to Japanese investors.

Operations and Practices
A number of unique features distinguish Japanese securities markets on an operational
level. These include:

Cross-Shareholding
One of the often-noted characteristics of the Japanese equity markets is the prevalence
of cross-shareholding among Japanese corporations. An estimated two-thirds of all outstanding
shares on Japanese exchanges are held by other corporations. The bulk of this crossshareholding is designed to secure business relationships, such as between buyers and suppliers,
or between banks and their clients. One private estimate puts the shares held in this form of
cross-shareholding at about 50 percent of total shares outstanding. Another 15 percent
represents portfolio investment by corporate treasurers, not necessarily related to an underlying
business relationship. The implications of cross-shareholding for Japan's system of corporate
governance are discussed in Chapter m.

High Equity Valuations
Even after the steep equity price declines of recent years, the value of Japanese shares,
as measured by price-earnings (P-E) ratios, is extremely high by international standards. At the
end of March 1995, the average P-E ratio of all firms listed on the first section of the TSE was
64.9.
Although P-E ratios in Japan have historically been higher than in the United States, the
very large differentials currently observed are a fairly recent phenomenon. From 1975 to 1985,
the P-E ratio on Japanese stocks fluctuated between 20 and 46 (on a year-end basis), and
averaged out to 30 for the period. The tripling in the Nikkei 225 stock average, from ¥4,359
at the end of 1975 to ¥13,113 at the end of 1985, primarily reflected growth in corporate
earnings, as the P-E ratio rose only modestly, from 27 to 35. The near tripling in the Nikkei
225 to ¥38,916 at the end of 1989, by contrast, was accompanied by a doubling of the P-E ratio
over the period.

STRUCTURE, REGULATION, OPERATIONS AND PRACTICES OF 1m JAPANESE FINANCIAL SYS1l:M

The collapse in stock prices following the collapse of the bubble brought the average P-E
ratio down to 38 by the end of 1991, close to its historical norm. However, the sharp drop
in corporate earnings during the 1992-93 recession, in combination with relatively stable stock
prices, have brought P-E ratios back to near their end-1989 peak.
A number of analysts have concluded that Japan's P-E ratios do not provide an entirely
accurate basis for cross-country comparisons of equity valuations. These analysts found, for
example, that adjusting for different tax and accounting treatment of corporate cash flow between
Japan and the United States reduced the average P-E ratio in Japan in 1988 from 4-5 times the
U.S. level to roughly twice the U.S. leve1. 4
Japanese stock valuations are currently not as extreme when measured on a price to bookvalue basis, although they show the same pattern of rapid rise during the late 1980s. Between
1975 and 1985, prices of the Nikkei 225 stock average ranged from just above 2 times the
companies' underlying book value to just under 3 times, on an end-year basis. The price to
book-value ratio then rose to 5.88 at the end of 1988, before slipping slightly to 5.67 at the
stock market peak at the end of 1989. 1:..! ratio then fell to just above 2 by the end of 1992.
The price to book-va: ! ratio of the Nikkei 225 was at 2.12 as of the end of April 1995.
Price to book-value ratios, like P-E ratios, are not a perfect guide to analyzing stock
market valuations in Japan. A large portion of Japanese corporations' net worth, or book value,
consists of land and share-holdings. As discussed earlier, these are carried on the corporations'
books at original acquisition cost rather than current market value. The corporations' net worth
on a book-value basis therefore may be either understated or overstated at any given till' '.
depending on the relationship between the original acquisition cost and the current market value
of those assets.

Relian(.: on Brokerage Commissions
Japanese securities firms have traditionally relied heavily on brokerage commissions as
a major source of revenues. In 1989, commissions accounted for nearly 55 percent of overall
industry revenues. The sharp decline in trading activity since 1989, together with a reduction
in regulated brokerage fees, reduced securities firms' brokerage commission revenues by more
than 64 percent between 1989 and 1993. Underwriting fees fell sharply as well, also by 64
percent, as new equity and equity-linked bond issues declined in line with the stock market,
bringing a 60 percent reduction in the firms' overall revenues.
The Big Four were somewhat less reliant on brokerage commissions than were the
smaller firms, with commissions accounting for about 45 percent of the four firms' revenues in
1989. However, the drop-off in underwriting revenues meant that the Big Four frrms' revenues
fell almost as sharply as that of the average firm, dropping 57 percent between 1989 and 1993.

Paul Aron, "Japanese P-E Multiples: The Shaping of a Tradition, .. Daiwa Securities, 1988;
Kenneth R. French and James M. Poterba, "Are Japanese Stock Prices too High?," NBER
working paper no. 3290, March 1990; Ellen E. Meade, "Price-Earnings Ratios in Japan and the
United States," internal Federal Reserve Board Paper, October, 1992.
4

STRUCnJRE. REGULATION, Ol"ERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

Underdevelopment of the Corporate Bond Market
The historically limited size of Japan's corporate bond market can be traced to a number
of regulatory factors and market practices that have had the effect of favoring bank borrowing
over bond issuance and preserved the bond market for government issues. A number of
regulatory reforms in recent years (discussed below) have removed some of these obstacles,
permitting fairly rapid growth of the market in the past few years.
An important obstacle to the growth of the corporate bond market was the role of
"commissioned banks." Before its recent revision, the language in the Commercial Code that
defined the role of commissioned banks had been relatively broad and ambiguous. The language
was interpreted, however, to provide banks with broad authority to intervene in any aspect of
a .corporate bond issue for which they were the commissioned agent. The banks had no
incentive to facilitate bond issues, which competed directly with their corporate lending, and
from which they were prohibited by law from acting as underwriters. They therefore reportedly
used their broad authority to intervene in the underwriting process to limit the relative
attractiveness of bond issues compared to bank lending. The banks faced little competitive
pressure to provide efficient and low-cost service, moreover. Until recently, the authorities
tolerated a cartel-like arrangement in which only major Japanese banks acted as commissioned
agents. The resulting high fees charged by commissioned banks acted as a further disincentive
to bond issuance.
A notable feature of the commissioned bank business is the domination of Industrial Bank
of Japan (IBJ), which served as lead commissioned bank for 40 percent of the corporate bond
issues outstanding in 1994.
A number of other legal and regulatory factors also inhibited the growth of the corporate
bond market. Until the recent revisions, the Commercial Code restricted the amount of bonds
individual corporations were allowed to issue to an amount not to exceed the frrm' s net worth.
This played some role in limiting the growth of the market, although probably only at the
margins, as there were relatively few firms which approached these limits. Informal restrictions
imposed by MOF on maturity, interest rate, and product design structures limited frrms'
flexibility in structuring bond issues, which helped reduce the attractiveness of bond financing
relative to bank borrowing. (Corporate bonds with a 5-year maturity, which would compete
with bank debentures issued by IBJ and other long-ten'n credit banks, were not permitted, for
example.) Administrative guidelines on minimum rating requirements and financial criteria have
also limited the number of firms eligible to issue corporate bonds.
Another obstacle to growth of the corporate bond market is the lack of active secondary
trading. In 1992, for example, JGBs accounted for 95 percent of all bond secondary market
trading, and bank debentures for 2.5 percent. The remaining 2.5 percent was split among local
government bonds, samurai bonds, government-guaranteed bonds, convertible bonds, equity
warrant bonds, and, finally, corporate straight bonds. In part, this lack of turnover is a legacy
of the legal and regulatory barriers to bond issuance. It is also a product of Japan's antiquated
corporate bond settlement and delivery system, in which trades can take up to one month. This
barrier to trading reduces the advantage of greater liquidity that bonds ordinarily enjoy over bank
loans, and therefore raises the cost of borrowing.

STRUCTIJRE, REGULATION, OPERATIONS AND l'RACTICES OF THE JAPANESE FINANCIAL SYSTEM

Obstacles

Innovation

The range of permissible securities products in Japan has traditionally been limited by
law and regulatory application. The Japanese securities market has consequently been
characterized by a high degree of standardization, with limited scope for financial innovation.
The principal obstacle to fmancial innovation has been the relatively narrow interpretation
by MOF of what constitutes a "security" under Article 2 of the SEL. This has tended to limit
the scope for introduction of innovative financial products. The law stipulates that additional
instruments may be designated as ) ~c1e 2 securities by Cabinet order. Only one instrument - foreign certificates of deposit -- h. een designated a "security" through this mechanism since
the SEL was drafted in the late 19-1 JS, although MOF has "reinterpreted" Article 2 on several
occasions to recognize other instruments as "securities."
Other legal ar ~gulatory restrictions on the range of permissible securities include: the
Commercial Code, WL.;h limits corporate bond issuance to straight bonds, convertible bonds,
and warrant bonds; Article 201 of the SEL, an anti-gambling provision, which has been
interpreted to prohibit such instruments as cash-settled OTe equity options; and other regulatory
restrictions, such as informal restrictions on interest rate and maturity structures. The prior
notification and prior approval requirements under the FX Law have also been used to
discourage Japanese corporations from issuing instruments abroad in the Euro-yen market that
are not permitted in Japan.

Recent Reforms

Easing of Restrictions on Corporate Bond Issuance
The Japanese Government has taken a number of steps in recent years to liberalize some
of the restrictions on corporate bond issuance. Since the late 1980s, MOF has gradually eased
a number of the informal, unwritten restrictions on corporate straight-bond issuance.
Specifically, MOF has lowered the minimum rating and minimum financial criteria for corporate
bond issuers and eased restrictions on interest rate, maturity, and product design structures.
This gradual easing of the informal restrictions on bond issuance was complemented by
two major legal reforms that took effect in 1993 -- revisions of the Commercial Code and
implementation of the Financial System Reform Law. These reforms have limited banks' ability
to intervene in corporate bond issuance and reduced their incentive to limit the growth of the
market. The revised Commercial Code now de facto limits the role of commissioned banks to
the period after the bonds are issued, reducing their ability to intervene in the underwriting
process. The revised Code also eliminates quantitative restrictions on individual corporations'
bond issuance. The revisions also allow institutions other than banks, such as securities fums
or the issuers themselves to perform some of the functions traditionally performed by the
commissioned banks. This increases the competitive pressure on the big banks to lower their
fees and improve their service. The Financial System Reform Law allows banks to enter the
corporate bond underwriting business through their securities subsidiaries. This has given them
an incentive to promote, rather than restrict, the growth of the market.

STRUCnJRE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

The government also took a number of steps to further liberalize the corporate bond
market under the Measures. MOF agreed to remove its informal restrictions on maturity
structures and to "steadily promote the diversification" of interest rate and product-design
structures of corporate bonds. MOF also agreed to relax its informal minimum rating and
financial criteria requirements under the Measures, effective January 1, 1996.

Expanding Scope for Innovation
The Finance Ministry has gradually expanded the range of instruments permitted in Japan
in recent years, in addition to liberalizing restrictions on corporate bond interest rate and
maturity structures noted above. In the late 1980s, the Government first permitted firms to issue
commercial paper and also encouraged the development of a number of fmancial futures and
options contracts. In the 1990s, MOF expanded its interpretation of what constitutes a security
slightly to include commercial paper, foreign certificates of deposit, and a few asset-backed
products. MOF also has allowed firms to issue a number of other financial instruments in Japan
or abroad in recent years. These include: limited forms of floating-rate notes; currency option
products; certain other asset-backed securities not specifically designated as Article 2
"securities;" zero-coupon convertible bonds (but not straight bonds); dual currency bonds; stepup/step-down bonds; subordinated-term and perpetual bonds; commodity funds; and preferred
stocks.
Substantial further liberalization of permitted instruments was agreed to under the
Measures. MOF agreed to define a fairly wide range of new instruments as Article 2
"securities," and confirmed that some instruments already informally permitted in Japan met the
Article 2 definition of "security." MOF also clarified and formalized the process by which it
would interpret instruments as Article 2 securities, and committed to "accommodate the
development of new securities products." These steps have helped to expand the scope for
innovation in the Japanese securities market.

Liberalization of Cross-Border Capital Transactions
The Finance Ministry has steadily liberalized its informal restrictions on domestic firms'
issuance of non-yen securities abroad since the 1980s, as well as on non-residents' issuance of
yen-denominated securities abroad. MOF also eased a number of informal restrictions on
equity-linked bonds abroad during the 1980s and early 1990s. The informal restrictions on
corporate straight bond issuance in the Euro-yen market were relaxed in line with the easing of
restrictions on domestic bond issuance.
As noted in the next section, significant further liberalization was agreed to under the
Measures. Perhaps most important, the Japanese government made some important revisions
to its prior notification and prior approval requirements under the Foreign Exchange and Foreign
Trade Control Law, notably, the introduction of a new comprehensive prior approval/notification
system for Euro-yen issues. This system -- roughly equivalent to a "shelf registration" system
for securities issues -- allows multiple Euro-yen issues over a one-year period under one
notification or approval form.

STRUCTURE, REGULA110N, OPERA110NS AND PRAC11CES OF THE lAPANESE FINANCIAL SYSTEM

U.S.-JAPAN NEGOTIATIONS ON FINANCIAL SERVICES
For over a decade, the U.S. Government has encouraged financial market liberalization
in Japan through a series of bilateral negotiations. Throughout these talks, U.S. objectives have
remained largely unchanged. A primary objective has been to increase access by and expand
business opportunities for competitive foreign providers of fmancial services, including U.S.
firms, in the Japanese market. In addition, the U.S. has sought market liberalization, enhanced
regulatory transparency, and elimination of competition-limiting practices in order to improve
the smooth functioning of Japanese domestic capital markets for the sake of all market
par 'ipants, including foreign firms. Finally, the U.S. has sought reforms that would increase
the mtegration and compatibility of the Japanese financial markets with other global fmancial
markets, in the interest of promoting the free international movement of capital and enhancing
the global provision of liquidity.
The Yen-Dollar Committee
In November 1983, the U.S. Treasury Secretary and the Japanese Finance Minister
agreed to establish a Joint Ad Hoc Group on Yen/Dollar Exchange Rate Issues. The broad goals
of these talks were to promote the internationalization of the yen and ensure that the yen-dollar
exchange rate more fully reflected economic fundamentals. To achieve these objectives, the
Yen/Dollar group examined measures to create deeper, more liquid money markets in Japan;
improve the access of foreign fmancial institutions to the Japanese fmancial system; and develop
the market for Euroyen instruments so as to make yen-denominated products more widely
available to non-Japanese borrowers and investors.

The group met six times between February and May 1984, and issued its fmal report on
May 29, 1984. In the report, Japan agreed to take steps in a number of areas to:
•

"Liberalize spontaneously and positively in a step-by-step manner domestic capital
markets, which will result in a greater variety of attractive yen-denominated
financial instruments with market-related interest rates and a more efficient
allocation of capital;
It

•

"Ensure that foreign fmancial institutions are accorded national treatment
and the opportunity to participate fully in Japan's domestic financial
system, including in new and wider varieties of business areas;" and

•

"Provide for the development of Euroyen bond and banking markets
which would make yen-denominated instruments more widely available to
non-Japanese borrowers and investors."

Among other things, the Y en-Dollar report gave strong impetus to the process of interestrate deregulation in Japan, prompted substantial growth of the Euroyen markets, and allowed
foreign trust banks to enter the asset management business in Japan for the first time.

STRUCTURE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

In the years that followed the Yen-Dollar accord, the Treasury Department and the
Japanese Finance Ministry continued to discuss [mancial market opening and liberalization.
These discussions produced a number of significant actions by the Japanese Government to
liberalize its financial markets during the late 1980s and early 1990s.
The U.S.-Japan Framework
At the Tokyo Economic Summit in 1993, President Clinton and then Japanese Prime
Minister Miyazawa agreed to a new set of bilateral discussions, the "U.S.-Japan Framework for
a New Economic Partnership." The objective of these discussions is:
..... to deal with structural and sectoral issues in order substantially to increase access and
sales of competitive foreign goods and services through market-opening and
macroeconomic measures; to increase investment; to promote international
competitiveness; and to enhance bilateral economic cooperation between the United States
and Japan."
Japan also agreed to actively pursue the medium-term objectives of promoting strong and
sustainable domestic demand-led growth and increasing the market access of competitive foreign
goods and services, including from the United States.
The "structural and sectoral issues" were divided into five "baskets": government
procurement; regulatory reform and competitiveness, including [mancial services market access
issues; "other major sectors," including autos and auto parts; economic harmonization, including
investment and buyer-supplier relations; and implementation of existing agreements and
measures, including the Structural Impediments Initiative.
After 18 months of negotiations in the financial services working group, the Secretary
of the Treasury and Japan's Ambassador to the United States signed the "Measures by the
Government of Japan and the Government of the United States on Financial Services" on
February 13, 1995. The Measures include market access and liberalization actions in the areas
of asset management, securities, and cross-border capital transactions. They also include
provisions concerning regulatory transparency and procedural protection to address the concerns
mentioned earlier in this chapter. A brief outline of the Measures' main provisions regarding
access to the Japanese financial markets follows:

Asset Management
•

Complete, unrestricted access for Japanese and foreign investment advisory
companies (lACs) to the $200 billion public pension fund market.

•

Substantial expansion in access for IACs to the private pension market, making
an additional $130 billion in assets immediately available to management by
foreign and domestic IACs, and a commitment to further future deregulation.

STRUCTURE, REGULATION, OPERATIONS AND PRACTICES OF 1lJE JAPANESE FINANCIAL SYSTEM

•

Elimination of balanced fund requirements on the bulk of pension assets open to
IACs, enabling foreign and domestic IACs and trust banks to sell specialized fund
management services.

•

Commitment to move toward market-value accounting for pension liability
calculations and disclosure of fund manager performance on a market-value basis.

•

Deregulation of the investment trust (mutual fund) business to reduce entry and
operating costs, permit greater flexibility in investment instruments, require
increased disclosure of performance data, and relax restrictions on sales of
foreign mutual funds into Japan.

Securities
•

Liberalization of restrictions on the introduction of new financial instruments, and
commitment to future liberalization to allow introduction of products developed
in other major financial centers.

•

Commitment to introduce a domestic asset-backed securities market to Japan and
to eliminate restrictions on the offshore securitization of Japanese assets.

•

Transparency and procedural protections analogous to the U.S. Securities and
Exchange Commission's "no action" procedure for new financial instruments.

Cross-Border Capital Transactions
•

Elimination of restrictions on securities offerings by residents and non-residents
and elimination of the seasoning period on non-resident Euro-yen issues.

•

Unlimited access by resident corporate investors to virtually all financial
instruments available outside Japan.

•

Elimination of restrictions on specific cross-border transactions, such as offshore
issuance of derivatives based on Japanese stock indices.

•

Expanded scope for foreign securities companies to engage directly in foreignexchange-related business.

Transparency and Procedural Protections
•

Comprehensive obligations, building on the recently enacted Administrative
Procedures Law, to provide transparency in financial regulations and protection
from administrative abuse.

The Measures also establish a follow-up mechanism providing for regular consultations
between the Treasury Department and the Finance Ministry to monitor implementation of the

STRUCTURE, REGULATION, OPERATIONS AND PRACTICES OF THE JAPANESE FINANCIAL SYSTEM

measures contained therein and to address other issues affecting foreign fmancial institutions in
the U.S. and Japanese financial markets. The Measures also establish a set of qualitative and
quantitative criteria to assess progress in opening and liberalizing the fmancial markets.
CONCLUSION
Measures undertaken by the Japanese Government in recent years have increased the role
of market forces in the Japanese fmancial system and reduced the extent of government
intervention in the fmancial markets. In large part, these deregulation measures reflect
recognition on the part of Japanese officials that a more flexible and open financial system is
needed at this stage in Japan's economic development. They are also a product of international
pressure for increased competitive opportunities for foreign firms in the Japanese market.
A central element of financial reform measures implemented by the Japanese Government
has been the removal of direct government controls on the fmancial markets. The most
important step undertaken in this area was interest rate deregulation, allowing market
determination of the cost of funds. The complementary elimination of Bank of Japan "window
guidance" further diminished the Japanese authorities' ability to intervene directly in the
allocation of credit to favored frrms or industries.
The Japanese Government also has eased" diminated many of the regulatory barriers
to entry preventing new domestic or foreign fmanclal firms from establishing in Japan. Many
of these market-opening measures have been in the asset management business. For instance,
Japan allowed foreign firms to establish trust bank subsidiaries in Japan in 1984. The
government also permitted foreign and additional domestic firms to establish investment trust
(mutual fund) companies in 1989. And in 1990, the pension fund management business,
formerly open only to trust banks and life insurers, was partially opened to investment advisory
companies. Another important step in liberalizing the establishment of new financial fums is
the permission of crossover entry between banks and securities flrms under the Financial System
Reform law of 1992. These reductions in the barriers to the establishment of new firms will
tend to promote competition, and therefore efficiency, in Japan's fmancial system.
Other recent reform measures have widened the range of financial products and
instruments permitted in Japan and broadened the scope for financial innovation. The Finance
Ministry's easing of informal restrictions on corporate bond interest rate, maturity, and product
design structures were an important step in this regard, as were measures limiting the role of
the commissioned banks in corporate bond issuance and underwriting. The government has also
promoted the issuance and trading of a number of financial instruments that until recently had
not been permitted in Japan, including commercial paper and fmancial derivatives such as futures
and options contracts. MOF's recent interpretation of the defmition of a "security" under Article
2 of the Securities and Exchange law to include a number of a new instruments will further
broaden the range of permitted instruments.
Finally, the government has implemented a number of measures intended to enhance
transparency in the financial system. Requirements for increased disclosure of banks' problem
loans and the recent moves away from the "convoy system" in the reporting of bank earnings
are important steps toward increased openness and transparency in fmancial reporting.

smUCnJRE, REGULAnON, Ol'ERAnONS AND PRACnCES OF THE JAPANESE FINANCIAL SYSTEM

Similarly, the Finance Ministry's recent recognition under the Measures with the United States
of the applicability of the Administrative Procedures Law to broad areas of financial regulation
will enhance transparency of the regulatory system.
These measures represent steps in the direction of market discipline and away from direct
or de facto administrative control of private financial decisions. This transition to a marketdirected system, while as yet incomplete, can in time be expected to help to strengthen and
deepen Japan's financial system.

APPENDIX TO CHAPTER IT
A Chronology of Japanese Financial :Market Liberalization

1970
December:

First "Samurai" bond issue (yen-denominated bonds issued by non-residents in
Japan).

1972
April:

Interbank foreign currency transactions permitted in Tokyo with start of dollarcall market.

1975
December:

The first law permitting deficit-financing bonds (Le. bonds to cover current
government deficits -- as distinct from construction bonds). Requires annual
renewal.

1976
March:

Official recognition of Gensaki. transactions.

1977
January:

First issue of 5-year government bonds ("discount" bonds).
Securities Dealers Association starts new OTe bonds quotation system (separate
"bid" and "ask" quotations followed in August).

April:

Members of the syndicate purchasing government bonds permitted to resell
deficit-financing bonds that have been held for at least a year (extended to
construction bonds in October).

May:

First issue of Euro-yen bonds by a non-resident.

1978
June:

Greater flexibility in bidding in the call money market: further measures in
October (7-day call trading) and November (one-month bill trading).

APPENDIX TO CHAPTER n

Continuation 1978

June:

First issue of medium-term coupon government bond (the flrst to be issued by
auction; 3-year bonds on the occasion followed by 2-year bonds in June 1979 and
4-year bonds in June 1980).

October:

Ceiling on Gensaki selling for city banks increased from 120 billion (raised to
150 billion in April 1979 and abolished in April 1980).

1979
February:

The ban on the acquisition of yen-denominated bonds by non-residents removed.

March:

First issue in Japan of unsecured yen-denominated bonds by a foreign private
company.

April:

Further deregulation of the interbank call rate.
First issue of an unsecured convertible bond.

May:

Permission granted to banks to introduce short-term "impact loans" (i.e. foreign
currency loans to residents) subject to certain conditions.
Ban on Gensaki transactions by non-residents lifted. Non-residents allowed to
purchase yen-denominated CDs.

October:

Deregulation of over 2-months interbank bill rate.

1980
January:

Securities companies introduce the medium-term government bond ("Chukoku")
fund.

March:

Foreign exchange banks allowed to make medium and long-term impact loans.
Ceiling on foreign banks' issues of yen-denominated CDs raised to 20 % of yendenominated assets by the second quarter of 1981.
Deregulation of interest rates of free yen deposits held by non-resident offlcial
institutions.

APPENDIX TO CHAPTER n

Continuation 1980

November:

Large securities companies allowed to borrow in the call market (subject to
limits).

December:

New Foreign Exchange and Foreign Trade Control Law comes into effect:
further liberalization of impact loans;
non-resident bank accounts permitted, replacing non-resident free yen
accounts;
Japanese residents allowed to hold interest-bearing foreign currency
accounts with Japanese banks;
the designated-company restriction (under which foreign ownership could
not exceed 25% of the individual company's assets) to apply to eleven
companies only;
banks authorized to participate in overseas syndicated yen-denominated
loans subject to certain ceilings.
Reporting and prior notice provisions (and for some transactions approval)
remam.

1981
April:

Members of government-bond purchasing syndicate permitted to resell bonds that
have been held for at least 100 days.
City banks allowed to buy in the Gensaki market.

May:

Bank of Japan starts to sell short-term government securities (Financing Bills) on
the open secondary market.

June:

New maturity-designated bank time deposit introduced.
New type of loan trust fund ("Big") account introduced by trust banks.

July:

Japanese banks' overseas subsidiaries allowed to lend Euro-yen (for one year or
less) to finance trade with Japan.

October:

New government-bond fund account authorized for securities companies.
New type of bank disclosure ("Wide") authorized for long-tenn credit banks.

APPENDIX TO CBAP'I1Ill n

Continuation 1981

December:

First issue of corporate bonds with non-detachable warrants.
Medium-sized securities companies allowed to borrow in the call market (limits
on large companies raised).

1982
March:

Securities companies banned from selling foreign-currency zero-coupon Eurobonds to residents (ban lifted subject to certain restrictions in February 1983).

April:

Increased yen-foreign currency conversion limits for foreign banks operating in
Japan.
New Bank Law and Securities and Exchange Law take effect.

May:

Japanese banks permitted to lend overseas yen on a long-term basis to borrower
of their choice (earlier priority system for overseas yen lending abolished).

October:

Criteria for the issuance of unsecured bonds by Japanese residents in overseas
markets defined.

1983
January:

Regulations for the issue of "Samurai" bonds further relaxed:
approval period reduced from about one year to 3-6 months;
AAA borrowers and private corporations allowed first time access
to market;
interval requirement (that two quarters had to elapse between
successive issues by the same borrower) relaxed.
(These restrictions were progressively eased in later years).
Eligibility standards for issuing unsecured convertible bonds relaxed (further
measures of relaxation progressively adopted in later years).

February:

City banks' overseas subsidiaries allowed to float bond issues abroad to finance
parent banks' offshore lending.

APPENDIX TO CHAPTER n

Continuation 1983

April:

The global ceiling on foreign banks' yen/foreign currency conversion limits raised
(further raised in December).
Banks authorized to sell long-term government bonds over the counter.

May:

Postal insurance system permitted to invest in foreign bonds.

June:

MOP lifts the restriction on short-term (less than one year) yen lending by
Japanese banks' overseas subsidiaries to non-residents. Euro-yen lending plans
remain subject to reporting requirements.
Securities houses authorized to extend personal loans with public bonds as
collateral.

October:

Banks allowed to sell medium-term government bonds over the counter.

December:

The quota for the issue of yen-denominated CDs by foreign banks increased to
50% of its yen-denominated assets.
1984

April:

Domestic companies permitted to trade in foreign currency denominated
commercial paper and CDs in the domestic market.
Restrictions relaxed on Japanese residents' issuance of straight and convertible
yen-denominated Euro-bonds; measures to facilitate flotations include permission
for swap agreements and hedging of forward foreign exchange transactions.
(Further measures of relaxation progressively adopted in later years.)
"Real demand" rule whereby banks could trade in forward yen only as the
counterpart of actual international trade transactions of their customers abolished.
Rules applicable to "Samurai" bonds relaxed (two further relaxations took place
later in the year).

APPENDIX TO CHAPTER IT

Continuation 1984

May:

Publication of Yen/Dollar Exchange Rate Report (Joint report of the Japanese
Ministry of Finance-US Department of the Treasury Working Group).
Measures agreed to include (1) liberalization of non-resident issue of Euro-yen
bonds; (2) freer issuance of yen-denominated CDs in Japan; (3) permission for
foreign and Japanese banks to issue Euro-yen CDs with maturities of six months
or less; and (4) qualified foreign banks allowed to enter trust banking business.
Bill abolishing "designed company system" passed by the Diet (see the note under
December 1980).

June:

Yen foreign currency conversion limits for banks abolished.
Short-term Euro-yen loans to residents liberalized.
Banks allowed to deal in the secondary market for government bonds.

December:

Liberalization of Euro-yen bond issues by private non-residents:
collateral requirement dropped;
foreign securities houses allowed to be lead managers for Euro-yen
bond issues.
First issue made in this month.
(Additional measures of liberalization adopted progressively m later
years.)
Issues of yen-denominated CDs in the Euro-market by Japanese and foreign banks
and by securities companies' overseas bank subsidiaries allowed.

1985
January:

Withholding tax on the interest earnings of non-residents on Euro-yen bonds
issued by Japanese residents removed (effective April 1985).
First unsecured straight corporate bonds issued (criteria applied to the issuance
of such bonds progressively relaxed in later years).

APPENDIX TO CHAPTER D

Continuation 1985

March:

Money market certificates allowed to be sold by banks (from April for city banks)
with an interest rate ceiling of 0.75 percentage points below weekly average new
CD issue.

April:

Wider non-resident access to Euro-bond and "Samurai" bond market allowed.
Medium and long-term Euro-yen loans to non-residents liberalized (the remittance
of such loans by Japanese foreign subsidiaries to head office not allowed).

June:

Nine foreign banks allowed to participate in trust banking business in Japan.
Yen-denominated Bankers' Acceptance (BA) market established. (Restrictions on
this market were subsequently relaxed in stages but market never really developed
and is now defunct.)
Securities companies open CD trading: prohibition on their purchase of bills
relaxed.
5-6 month bill transactions started.

July:

Call market transactions without collateral authorized.

August:

First "Shogun" bond issue (foreign currency denominated bond issued by nonresidents in Japan).
2-3 week call market transactions started.
First sales of large-scale public bond investment trusts.

October:

Foreign banks start trust business.
Interest rate ceilings on large-denomination time deposits (I 1 billion and over;
2 years and less) removed.

APPENDIX TO CHAPTER n

Continuation 1985
October:

Government bond futures market established.

November:

First Euro-yen straight bond issued.
Issuance of corporate bonds with detachable warrants permitted (first issue in
December).
1986

January:

BOJ starts repurchase agreements in government bills (FB Gensaki).

February:

First regular foreign members of the TSE (six securities companies).
First issue of short-term government bonds (TB) (minimum lot of l500 billion;
6-month maturity).
Banks and other financial institutions allowed to resell government bonds after
holding them for at least 40 days, instead of 100 days as earlier (for own
portfolio account; 10 days for dealing account).

April:

Credit rating system introduced for Euro-yen bonds issued by non-residents.
Floating rate notes and currency conversion bonds introduced for Euro-yen issues
by residents.

August:

Uncollateralized call money transactions diversified.

October:

Public issue of 2-year government bonds.

December:

Japan Offshore Market (JOM) opened:
inflows of funds from offshore accounts to domestic accounts of
parent bank "banned in principle", although some transfers allowed
to alleviate short-term shortages of funds;
offshore accounts cannot be used as basis for issuing CDs;
minimum deposit lot ll00 million;
minimum time 2 days.

APPENDIX TO CHAPTER n

1987

February:

Japanese banks' overseas branches allowed to deal in foreign CPo
Major change in the criteria for issuance of straight and convertible bonds; rating
system for domestic bonds introduced (with effect from July).

March:

Deposit rate of postal savings and other official funds with the Trust Fund Bureau
reformed to move with interest rates on government bonds (previously set by
statute and linked to the official discount rate).

May:

Liberalization of rules governing the issuance of privately-placed bonds; largerscale issues now permitted (first issue in July).
Banks, securities houses and insurance companies permitted to trade in overseas
financial futures markets.
First straight bond issuance pursuant to the "proposal" method (adopted to
increase competition).

June:

Packaged stock futures market established on the Osaka Stock Exchange (Osaka
Stock Futures 50) ending a ban introduced in 1945.

July:

Credit rating system for Euro-yen bond issues by residents introduced.
Call money transactions without collateral diversified (2-6 days).

August:

A subsidiary in Japan of a foreign bank obtains a license for securities business.
Minimum lot ofTBs and FBs reduced (Il00 to ISO million) and for TBs and FBs
purchased by sovereign tax-exempt entities, introduction of a system under which
an amount equivalent to the tax withheld to be refunded at the time of purchase
(rather than redemption as hitherto).
Banks allowed to sell government bonds from date of issue instead of having to
hold them for at least 40 days as earlier.

September:

Auction method for 20-year government bond issues introduced.

APPENDIX TO CHAPTER n

Continuation 1987

October:

Membership of the government bond underwriting syndicate opened to any
foreign bank but only 0.85% of bonds to be allocated to them (1.57% for foreign
securities fmns).
Ceiling on CD issue removed.

November:

Restrictions on Buro-yen CP issues by non-residents removed.
Domestic CP market established.
Partial auction method (viz. "volume bidding") of the underwriting amount for
10-year government bond issues introduced.
1988

January:

Restrictions on domestic yen ("Samurai") CP issues by non-residents relaxed.

February:

Issue abroad of warrants on 10-year government bonds permitted (fIrst issue in
March).

March:

Liberalization of overseas fInancial options by domestic fmancial institutions with
non-residents.

April:

Postal saving system allowed to progressively increase foreign investments and
to diversify domestic investments (Le., no longer obliged to place all its funds
with the Trust Fund Bureau).
Major tax reform: securities transactions tax on bond transactions reduced; wider
capital gains taxation; tax exemption for interest on small savings deposits
(Maruyu) abolished.
Post offIces and life insurance companies start to sell newly issued government
bonds to subscribers.

May:

Sixteen foreign securities companies· are admitted as new members of the TSE,
bringing total to twenty-two.
Participation of residents in overseas financial futures markets permitted.

APPENDIX TO CHAPfER n

Continuation 1988
September:

Financial Futures Law enacted.

October:

MOF increases the share of foreign [mancial institutions in underwriting 10-year
government bonds from 2.5 to 8 % of monthly volume.

November:

Introduction of share-index futures market (TOPIX in Tokyo and Nikkei 225 in
Osaka).
Introduction of new method of monetary control: operations on paper with
shorter maturities to reduce the BOJ's institutional influence on money market
rates; extension of the maximum contract period in the unsecured call market
from 3 weeks to 6 months. Open market operations in CP to follow later.

December:

Relaxation of restrictions on issuing Euro-yen CP by non-residents.
Relaxation of restrictions on domestic issues of CP.
MOF requires the thirty-five Japanese banks with overseas branches or
subsidiaries to observe, by March 1993, the minimum capital requirements of the
Basle Agreement.

1989
January:

Introduction of new short-term prime rate, linked to market rates.

February:

All but one sogo bank reclassified as regional banks.

March:

MOF allows after-issuance sales of detached warrants and ex-warrant bonds with
maturities of more than 4 years from lst April.

April:

Relaxation of restrictions on the JaM. Ceiling on daily net inflow of funds from
offshore accounts raised from 5 to 10 percent of banks' average non-resident
transactions in the previous month and 5 percent ceiling on daily net outflow
removed.
Ceiling for maturity of bills and calls raised to one year.

APPENDIX TO CHAPTER U

Continuation 1989

April:

For the first time IO-year government bonds issued by competitive tender ("pricebidding method"): the tender share set at 40% with the other 60% sold under the
old syndicate system based on average auction price.
Tokyo International Financial Futures Exchange established, with operations
starting in June. (3-month Euro-yen deposit futures, 3-month Euro-dollar deposit
futures and yen-dollar currency futures).

May:

Medium and long-term Euro-yen loans to residents permitted.
Banks and other financial institutions allowed to trade as brokers in overseas
fmancial futures markets.

June:

Banks allowed to broker government bond futures for the first time.
Introduction of small-lot money market certificates (MMCs) (minimum lot of 13
million).
Share price index option trading in the Osaka Stock Exchange begins (the Nikkei
224 Option).

July:

Non-bank residents allowed to hold deposits of up to 15 million with banks
overseas without prior authorization.
Banks permitted to securitize loans to local governments.

September:

Introduction of 3-month government bills (Treasury bills).

October:

Introduction of small-lot MMCs with 3-month, 2 and 3-year maturity (in addition
to existing 6-month and I-year maturity).
Beginning of share price index option trading at the Tokyo Stock Exchange
(Topix Option) and the Nagoya Stock Exchange (Option 25).

December:

Introduction of trading of U.S. Treasury Bond futures at the Tokyo Stock
Exchange.

APPENDIX 1'0 CJIAFI'ER n

Continuation 1989

December:

MOF decides on a substantial increase in the amount of 3-6 month Treasury bills
to be issued by auction. (Further significant growth subsequently.) BOJ to
undertake open market operations in Treasury bills.
1990

January:

Regulations governing commercial paper issuance by domestic firms eased:
securities houses allowed to issue commercial paper (to add to
their own funds only);
qualification standards for prospective issuers relaxed.

March:

Banks allowed to sell securitized corporate loans to institutional investors.

MOF restricts banks' property lending.
April:

Investment advisory companies (lACs) allowed for the first time to manage
Employee Pension Funds.

May:

Tokyo Stock Exchange launches options on government bond futures.

June:

Banks allowed to issue subordinated debt (where lenders have a lower claim to
repayment in the event of the borrowers' bankruptcy) to help them meet capital
adequacy standards. (In November, MOF asked banks not to make excessive use
of subordinated loans given equity market weakness.)

July:

Non-bank residents allowed to hold deposits of up to 130 million with banks
overseas without prior authorization. Authorization for amounts up to 1100
million virtually automatic.

September:

Market for 200 Euro-dollar warrants launched with the Japan Bond Trading
Company (brokers' broker) providing prices. (previously, 350 Euro-doilar
warrants had been traded over the counter, with only limited regulation.)

October:

Several foreign securities companies given a license to conduct investment trust
business.

November:

Collateralized call-money transactions liberalized (offerlbid system introduced).

APPENDIX TO CBAPI'ER n

1991
February:

MOF allows two Japanese branches owned 50% by U.S.-based securities
companies to undertake free foreign exchange trading (traditionally reserved for
banks).

March:

Foreign securities houses' subsidiaries in Japan given banking licenses.

June:

BOJ announces intentions to abandon "window-guidance" on banks' lending
growth.

July:

TIFFE launches options on 3-month Euro-yen.

August:

After a number of fmancial scandals, MOF announces it will cease issuing nonbinding verbal directives to the institutions under its supervision and instead rely
on tighter rules set by self-regulating bodies.

October:

Discretionary investment accounts banned; compensating customers for
investment losses to incur criminal penalties.

November:

Pension funds and investment trusts allowed to buy securitized corporate loans.
Requirement to seek debtor's permission to sell waived.

1992
January:

MOF replaces requirement for fmancial institutions to hold the growth in property
lending below their current overall lending growth with new measures to be
triggered in the event of rising in property lending significantly above overall
lending.
Tokyo Stock Exchange announces policy to relax listing standards.

February:

The government proposes to create a new agency to supervise the securities
markets, enhance the regulatory power of the Japan Securities Dealers
Association, and increase penalties for securities companies which manipulate
stock prices or compensate customers for their losses.

March:

Government proposes fmancial market reform.

April:

Securities houses allowed to offer money market funds (minimum deposit of II
million) provided that more than one-half of such funds invested in securities.

APPENDIX TO CHAPTER n

Continuation 1992

June:

Financial system reform legislation passes the Diet.

July:

Securities and Exchange Surveillance Commission established under the
jurisdiction of MOF.
Japan Securities Dealers Association reorganized into a corporation licensed under
the Securities and Exchange Law.
MOF relaxes the issuing requirements of the corporate bond issuance and
registration system.
A system for designating credit-rating agencies is introduced.

August:

Bond issuance restrictions eased: more companies allowed to issue bonds overseas
and restraints on "Samurai" bonds relaxed.
Government announces various measures to support equity and real estate prices,
and announces readiness to provide funds to help banks liquidate non-performing
loans.
Government announces first economic stimulus package in the post-Bubble
period.

December:

MOF outlines implementation of fmancial system reforms.
1993

April:

Financial System Reform Law enforced.
Government announces second economic stimulus package.
As part of overall fInancial system reform, the defmition of a "security" under
Article 2 of the Securities Exchange Law (SEL) expanded slightly. Domestic
commercial paper, "cards", and housing-loan-backed beneficiary certificates
added to the list of recognized securities.
Qualification criteria eased for domestic corporate bonds. The minimum rating
requirements for unsecured straight and equity warrant bonds were lowered from
single A to triple B.

APPENDIX TO CIIAP'IER n

Continuation 1993

Stock brokerage commissions on transactions of II billion and over liberalized.

April:

MOF eased "three-bureau agreement," permitting offshore subsidiaries of
Japanese banks to lead manage Japanese corporate bond issues abroad. The
agreement will be phased out over a five-year period and eliminated completely
by end-March 1998.
May:

MOF opened ITM industry to banks and insurers, permitting them to access the
market only indirectly, via their investment advisory vehicles, with a minimum
of three years experience in discretionary fund management required.

June:

Completion of deregulation of interest rates on time deposits.
Non-banks permitted to issue commercial paper. MOF set issuance ceilings and
restricted use of the proceeds to fmance capital investment, purchase of lease
assets and redemption of CP.
MIT! implemented new legislation to govern securitization of leasing rights and
credit card assets.

July:

MOF lowered the minimum contract size for corporate pension fund management by
investment advisors to II00 million, from II billion for Japanese advisors and
I500 million for foreign advisors.

September:

In a 30-point liberalization/simplification program,

MOF's Securities Bureau
confirmed that fees and remuneration are not administratively controlled.

As part of a 30-point liberalization/simplification package, MOF's securities
bureau permitted issuance of five-year bonds and floating-rate notes and
confirmed that there are no restrictions, other than eligibility criteria, on issuance
of two-year, very-long-maturity, and parent-company-guaranteed bonds.
October:

Banking institutions permitted by MOF to introduce two new types of savings
instruments: four-year time deposits bearing fixed interest rates, and floating rate
time deposits with maturities of up to three years.
Commercial Code revised to narrow the role of commissioned banks to afterissuance, which increased pressure on commissioned banks to further cut fees for
handling domestic corporate bond issues.

APPENDIX TO CHAPl'ER n

Continuation 1993

December:

In a 70-point securities deregulation package, MOF permitted ITMCs to engage
in interest rate and currency swaps, securities lending and short-term borrowing,
while eliminating restrictions on investment in unsecured call money.
MOF permitted securities [ums to engage in bond issues as foreign exchange
swap partners. Only Japanese straight bond issues abroad were initially qualified.
Japan's major banks started engaging in offshore (U.S.) securitization of Japanese
companies' trade credit receivables, with ultimate goal of engaging in this activity
in Japan as well.
MOF permitted Japanese banks to engage in foreign exchange "Close-out" netting
with U.S. banks.
MOF announced limited resumption of new public equity issues at market prices
after a four-year suspension, as a major element of its 70-point deregulation
package for the securities industry.

In practice, the number of potential issuers is limited to about ten blue-chip [ums
due to strict conditions imposed by MOF.
1994

January:

Minimum rating requirement for foreign private Samurai straight bond issuers
lowered from single A to triple B.
MOF eliminated the 90-day seasoning rule on Euroyen bonds issued by
supranational and sovereign issuers.
Minimum rating requirement for Japanese resident offshore issues of unsecured
straight and equity warrant bonds, including Euro-yen bonds, lowered from single
A to triple B.

February:

MOF issued new policy guidelines on financial institutions' non-performing loans,
including expanded recognition of taxable loan-loss reserves for restructured loans
and creation of new special purpose companies to transfer restructured loans off
banks' balance sheets.

APPENDIX TO CHAPTER n

Continuation 1994

March:

Raised to 1100 million from 110 million the limit on the amount of non-bank
lending and borrowing between Japanese residents and non-residents that is not
subject to prior notification and seasoning period rules. The ceiling on inward
and outward portfolio investment free from the notification rule was raised to
1100 million from 130 million and the ceiling on outward direct investment
exempt from this requirement was raised from 130 million to 1100 million.
Raised the ceiling on the amount of foreign-currency-denominated deposits
individual or corporate Japanese residents are permitted to hold offshore without
obtaining prior approval from 130 million to 1100 million.
Introduced in the Diet an overall pension reform bill, including proposal to
eliminate the distinction between old and new money for employee pension funds
(EPFs), effective October 1, 1994.
MOF changed accounting standards to allow insurance companies to value listed
bond holdings at acquisition cost. Previously, insurers were required to value
such holdings at the lower of acquisition cost or market price. The change was
intended to make JGBs more attractive investment instruments but prompted
concerns that the change was a step backward in terms of establishment of more
sound accounting principles.

April:

The ceiling on the amount of cross-border transactions eligible for netting
between the head office of trading houses, and a few other select corporations and
their branches or subsidiaries was raised from the equivalent of 110 million to the
equivalent of 1100 million. The period during which payment can be left on the
books for settlement through the offsetting method was extended to six months
from three months.

May:

MIT! and MOF agreed to ease controls on corporate bond issues by venture
capital firms.

June:

MOF announced that it would permit securities firms to participate in a broader
range of Japanese offshore bond issues as currency swap partners by March 1995.

APPENDIX TO CHAPTER IT

Continuation 1994

June:

As part of the 279-item deregulation package, MOF announced that it would
permit all designated fmancial institutions to trade offshore listed stocklstockindex cash options by March 1995.
As part of the 279-item deregulation package, MOF announced it would permit
domestic trading of over-the-counter fmancial derivatives products, specifically
forward rate agreements and forward exchange rate agreements, effective October
1994.
MOF also announced that, effective July, it would permit brokers to sell listed
financial futures products in the same category without obtaining separate
approvals once they obtain a license for the frrst product.
MOF permitted floating-rate housing loans to be securitized. Previously, only
fixed-rate housing loans were qualified.
MOF lifted the moratorium on convertible bond issues by insurance companies.
Japan's stock exchanges and the Japan securities dealers association increased the
number of firms allowed to go public for the first time to 3-5 per week from 2-3
per week, increasing the total number of firms allowed to go public to 160.

July:

As part of the June 28 deregulation package, MOP eliminated the minimum net
worth requirement of 120 billion imposed on foreign private Samurai issuers rated
triple B.
MOF slightly eased qualification criteria for Japanese offshore unsecured
corporate bond issues, including Euro-yen bonds, by eliminating the minimum net
worth requirement of 120 billion for triple-B-rated issuers.
Slightly eased qualification criteria for Japanese unsecured straight and equity
warrant bond issues, eliminating the minimum net worth requirement of 120
billion for triple-B-rated issuers.

APPENDIX TO CHAPTER n

Continuation 1994

July:

MOF allowed banks to set up subsidiaries to buy collateral property at auction.

October:

Completion of deregulation of interest rates on non-time deposits (marks the
completion of a 15-year process of interest rate liberalization).
Non-time deposit rates fully liberalized.

December:

Deregulation of investment trust management business announced by MOF.
Licensing, minimum capital, permissible investment product, and disclosure
requirements are liberalized; changes are incorporated in Framework fmancial
services agreement (of January 1995).
1995

January:

Agreement reached on financial services under the U.S.-Japan Framework for a
New Economic Partnership: "Measures by the Government of Japan and the
Government of the United States Regarding Financial Services." Measures
include commitments in the following areas: transparency and procedural
protections, fund management activities, securities, cross-border capital
transactions, banking, competition policy, consultations, and assessment of
implementation of the Measures.

CORPORATE GOVERNANCE IN JAPAN

lNTRODUCTION
Corporate governance can be defmed as the manner in which corporations are directed
and controlled by various constituent parties: shareholders, directors, managers, employees,
creditors, customers, and suppliers. The relationships among these parties are determined by
a set of rights and obligations, and the interaction among them determines the direction and
performance of the corporation.
Patterns of corporate governance vary widely among countries, depending on legal and
institutional arrangements, structure of the financial system, and historical and cultural factors.
However, the ultimate goal of corporate governance is generally the same everywhere: to
maximize business performance while ensuring the accountability of corporate decisionmakers.
The concept of corporate governance as a discrete field of study is relatively new in
Japan. There is no direct translation for the term in Japanese; it is borrowed as is from English.
However, many features of the Japanese industrial organization which fall under the rubric of
corporate governance -- for example, the cross-shareholding of shares, the relationship between
directors and managers, and the rights of company shareholders -- have long been the subject
of study and debate among academics and officials both in Japan and abroad.
Corporate governance issues have been an explicit topic of negotiations between the
United States and Japan over the past six years, first in the Structural Impediments Initiative
(SIT) and more recently in the U.S.-Japan Framework for a New Economic Partnership (the
Framework). The reason for U.S. Government interest in this subject, and one of the reasons
it is taken up in this report, is that it is an important aspect of the receptivity of the Japanese
economy to foreign trade and investment.
This chapter begins by examining the unique characteristics of corporate governance in
Japan, both in structure and in practice. It then looks at recent developments that suggest the
traditional system of corporate governance is undergoing change. The chapter ends with a brief
description of the negotiations between the United States and Japan on this subject in the SIT and
in the Framework.
KEY CHARACTERISTICS

Legal Framework
A variety of Japanese laws govern the activities of corporations in specific industries
(e.g., the various banking laws) but three in particular -- the Commercial Code, the Securities
and Exchange Law, and the Antimonopoly Act -- contain most of the rules on corporate
governance affecting all industries.

COIlPOIlA'IE GOVERNANCEIN' JAPAN

Commercial Code
The Commercial Code was enacted in 1899 and is administered by the Ministry of
Justice. Volume 2 of the Code, referred to as the Company Law, contains the basic legal
framework for corporate governance in Japan, including provisions on advance notice of
shareholders' meetings, proxy voting, derivative lawsuits, disclosure, and shareholder access to
company books.
•

Article 232 requires companies to notify shareholders two weeks prior to the
annual general. meeting.

•

Ankle 239 permits proxy voting, to enable beneficial owners of Japanese
companies to vote their proxies, while Article 239.2 allows them to do so in a
"disunited" or "partial" form.

•

Articles 267-268.2 cover derivative lawsuits.

•

Article 282 regulates disclosure of corporate information.
Disclosure
requirements under the Commercial Code are less onerous than under the
Securities and Exchange Law but have broader coverage, extending to privately
held companies.

•

Article 293.6 gives shareholders access to the company books under certain
conditions.

Supplementing the Commercial Code is the Law on Special Exceptions concerning
Audits. Prior to a 1992 revision, large corporations (those with capital of at least 1500 million
($5.9 million) or total liabilities of 120 billion ($235 million) were required to appoint at least
two statutory auditors, both of whom could be from inside the firm. Since October 1992, large
firms have been required to appoint a three-member audit committee, including one outside
auditor, defined as a person who has not been a director, manager, or employee of the company
or one of its subsidiaries for five years prior to his or her appointment. The terms of auditors
were also lengthened from two years to three.
Securities and Exchange Law
Enacted in 1948, the Securities and Exchange Law governs all publicly listed
corporations in Japan. Administered by the Finance Ministry, the SEL is analogous to the U.S.
Securities Act of 1933 and the Securities Exchange Act of 1934. It includes numerous
provisions relevant to corporate governance, notably those on disclosure requirements and
takeover bids. Specifically:

COlU'OJlA1E GOVERNANCE IN SAPAN

•

Article 24 requires all publicly listed corporations (including those registered on
the over-the-counter market) to disclose certain financial information. The article
briefly lists the kinds of information required, and implementing regulations spell
out the details, which include disclosure of certain related-party transactions,
consolidated financial statements, and segmented financial information.

•

Articles 27.2-27.22 regulate the takeover bid system.

•

Article 27.23 lays out the so-called "5 percent rule," which requires any
shareholder owning more than 5 percent of a company's outstanding shares to file
a disclosure statement.

•

Article 198 describes the penalties (up to one year in jail or a 11 million
($12,000) fine) for failure to disclose or engaging in fraudulent disclosure.

Antimonopoly Act
The Antimonopoly Act (AMA) was enacted in 1947 and is enforced by the Japan Fair
Trade Commission (JFfC) , an independent regulatory agency of the Japanese Government.
Modeled after the Sherman Antitrust Act, Clayton Act, and other antitrust laws in the United
States, the AMA today differs in many respects from U.S. law. The most notable of these
differences in the context of corporate governance is the AMA' s total ban on holding
companies. 1
Articles 9-18 of the AMA contain most of the provisions related to corporate governance,
including those on holding companies, cross-shareholding, interlocking directorates, and mergers
and acquisitions. Specifically:
•

Article 9 prohibits the establishment or operation of holding companies, which are
defined as those whose principal business is to control the business activities of
one or more Japanese companies or subsidiaries by means of shareholding.

•

Article 10 prohibits companies from acquiring stock in another company if the
acquisition causes a substantial restraint of competition in a particular field of
trade.

The Japanese Government said in its five-year deregulation plan announced on
March 31, 1995, that it is "considering" lifting the ban on holding companies, a proposal
strongly supported by the Ministry of International Trade and Industry but opposed by the
JFfC.
1

COJU"OJtA'IE GOVERNANCEJN 1APAN

•

Anicle 11 places certain restrictions on the holding of shares by foreign and
domestic financial institutions; notably, banks may not hold more than 5 percent
of the outstanding shares of any Japanese corporation, and insurance companies
may not hold more than 10 percent of such shares.

•

Anicle 13 regulates interlocking directorates, prohibiting a director from
concurrently serving as a director of another domestic corporation if this
effectively restricts competition in a particular field of trade.

•

Anicle 15 bans mergers of companies if the merger is likely to result in a
substantial restraint of competition. The company effecting a merger must give
the JFfC 30 days' notice before the merger takes effect.

Structures and Practices
Lack of Outside Directors
In theory, public corporations in Japan are governed in much the same way as they are
in the United States, with three groups playing a central role. Overall corporate strategy and
policies are set by a board of directors, which is elected by - and thus accountable to -shareholders. The board appoints and monitors managers who implement its policies. Managers
hire employees and make day-to-day decisions about the company's interaction with customers,
suppliers, and creditors. Shareholders, as beneficial owners of the company, enjoy fmancial
returns on their investment in the form of dividends and capital gains.
In reality, the relationships among the three groups of corporate actors are very different
in Japan and the United States. One feature that distinguishes the Japanese system is the relative
lack of outside directors on the corporate board. The majority of directors in a typical Japanese
corporation are current or former employees of the company. One survey of nearly 2,000 large
Japanese firms conducted in 1990 found that roughly 91 percent were company men. Employees
of larger corporations traditionally spend their entire career with the company, rising through
the ranks to management positions primarily on the basis of seniority. More talented individuals
are then appointed to directorships, while they often retain their day-to-day responsibilities for
running the company.

In most firms, the only outsiders on the board are representatives of major creditors,
former government officials, or representatives of major business partners (notably members of
the same corporate group - see Keiretsu section below). Of the remaining directors in the
survey mentioned above, 4 percent were from lender banks, 3 percent were retired government
officials, and 0.1 percent were from major business partners. (The last figure would be higher
for small firms.) Independent shareholders - no matter how large a stake they have in the
company -- are rarely found on the board of directors.

CO:Rl'ORAlE GOVERNANClUN lAPAN

Because of the blurring of the lines between directors and managers, and the seniority
system that produces managers from among lifetime employees, the boards of major Japanese
corporations tend in reality to represent the interests of employees fIrst and foremost. This is
very different from the system of corporate governance in the United States, in which the
presence of outside directors produces broader accountability, most importantly to shareholders.

Cross-Shareholding
Another distinguishing feature of corporate governance in Japan is the relative passivity
of shareholders. Individuals represent the largest group of shareholders in Japan, but they hold
a minority of shares and have relatively little voice in company affairs. The bulk of shares
(often 60-80 percent) are held either by lenders to or business partners of the company, or by
institutional investors. Companies typically exchange small amounts of stock with suppliers,
customers, and creditors in order to seal a long-term business relationship. Similarly, insurance
companies, pension funds, and other institutional investors have a small stake in most major
Japanese corporations to support a relationship of mutual rights and obligations.
According to the Tokyo Stock Exchange, the "average" listed company in 1992 had
12,941 shareholders, of whom 12,350 (95 percent) were individuals, 394 were nonfInancial
corporations, and 59 were fInancial institutions. (The rest were foreign investors (93), securities
companies (39), and investment trusts (5).) Although the corporate and institutional investors
as a group represented less than 4 percent of the shareholders in this typical fum, they held
some 70 percent of the shares. (Individuals held less than 25 percent; in the United States,
individuals account for over 50 percent of stockholdings.) As much as 64 percent of the typical
fum's stock was held by the 21 largest shareholders. Most or all of these large shareholders
were corporate or institutional investors, and most likely had some form of business affiliation
with the firm.
These cross-shareholding arrangements create a block of stable and friendly shareholders
who seldom reallocate their portfolios or challenge corporate decisions. In this way, crossshareholding underpins keiretsu relationships, encourages companies to focus on long-term
growth rather than short-term profItability, weakens shareholders' rights, and makes hostile
takeovers all but impossible in Japan.

Keiretsu Relationships
Lying at the core of the Japanese system of industrial organization is the pattern of
relationships among nominally independent companies known as keiretsu. There is no direct
English translation for this uniquely Japanese phenomenon: the term literally means "rank
order" or succession," but a more descriptive translation would be "business groupings.
Despite recent signs of change (see below), keiretsu remain a vital force in the Japanese
economy.
II

The concept of keiretsu encompasses a variety of different types and degrees of business
affiliations. In its most formal sense, it refers to the six horizontal groups that are the
descendants of the powerful prewar zaibatsu conglomerates. These six groups - Mitsubishi,
Mitsui, Sumitomo, Fuyo, Sanwa, and Dai-Ichi Kangyo - revolve around at least one main bank
and a general trading company and incorporate companies from a variety of business sectors.
There are also vertical, or hierarchical, keiretsu. These are pyramid-shaped groupings
consisting of a major manufacturer and its large and small suppliers (an upstream keiretsu), or
a major fmn and its network of dedicated wholesalers and retailers downstream. Toyota Motor
Corp. is often cited as a typical example of an upstream keiretsu, and Matsushita Electric Co.
a downstream one.
More generally, keiretsu can refer to an array of formal and informal ties among
nominally independent firms that, to one degree or another, promote preferential business
dealings among the related parties. Although not necessarily designed to exclude outsiders,
keiretsu relationships often have this effect.
Keiretsu are held together by a variety of mutually beneficial exchanges among affiliated
companies. These include exchanges of:

•

Equity: As discussed above, Japanese companies typically exchange small
amounts of stock with business partners to solidify long-term relations.

•

Debt: The main bank in a keiretsu group has traditionally been responsible for
ensuring that adequate amounts of credit and other forms of fmancing are
available to member firms.

•

Goods and services: Keiretsu companies generally engage in preferential trade
with affiliated firms, agreeing to buy another company's products or services in
exchange for being able sell its own wares to that company. (For example, an
insurance company might procure all of its office equipment from a particular
computer firm in exchange for exclusive rights to insure the computer firm's
employees. )

•

Personnel: As noted above,

to the limited extent that companies maintain outside

directors on their boards, they are often representatives of affiliated firms. At the
managerial and employee level as well, personnel exchanges among affiliated
firms are very common in Japan.

•

Information: In addition to the informal information flow that is a natural byproduct of all the linkages listed above, keiretsu groups typically have regular,
formalized meetings of the presidents of group companies, known as shacho-kai.

CORPORA'IE GOVDNANCEIN JAPAN

The significance of various aspects of keiretsu ties for corporate governance in Japan is
a recurring theme in numerous sections of this chapter. Signs of change in the keiretsu system,
and U.S.-Japan negotiations on keiretsu issues, are also discussed in this chapter.

Role of the Main Bank
As described in Chapter TI, the main bank system has been a linchpin of the keiretsu
structure and of postwar Japanese industrial organization more generally. Most firms in Japan
- including, but not limited to, those in keiretsu groups -- have an identifiable main bank
relationship with at least one city, long-term credit, or regional bank. The main bank is
responsible for extending loans (usually the majority of loans) to the firm, for arranging
financing from other affiliated banks as necessary, and for monitoring management of the firm
(often holding a directorship on the board). In times of financial distress, the main bank will
intervene more actively in management, to the point of effectively taking over a troubled firm.
As with other corporate groupings in Japan, main bank relations are sealed through crossshareholding: the main bank takes a shareholding position in the affiliated firm (often just below
the legal ceiling of 5 percent), and the firm in turn holds a stake in the bank. Banks tend to be
even more closely held than corporations, with as much as 90 percent of their shares held by
other corporations, compared with average corporate holdings of about 70 percent for listed
companies as a whole. (This does not imply that corporate shareholders have more effective
control over banks than they do over other corporations; rather, it means that banks enjoy an
even larger block of stable shareholders than do other corporations.)
As large Japanese firms have been increasingly able to access capital markets to meet
their financing requirements, the role of the main bank has diminished in recent years (discussed
below).

Business-Government Relations
Close and generally friendly ties between Japanese corporations and the Japanese
Government are another important feature of corporate governance in Japan. Beyond its formal
role as regulator, the Japanese Government acts in an informal capacity as promoter, protector,
and supervisor of industry to an extent not paralleled in the United States. This informal
interaction operates through a number of channels, including:
Administrative Guidance
As described in Chapter TI, the Japanese Government frequently uses informal advice,
encouragement or discouragement, and warnings to supplement its formal regulatory powers
over industry - a practice known as "administrative guidance." The degree to which such

infonnal guidance is used varies by regulatory agency and industry, and may have diminished
over time, but it remains a significant element of the Japanese system. Because of administrative
guidance, Japanese corporations rarely make a major business decision without infonnally
vetting it with the authorities first. This makes government a central player in the system of
corporate governance, often on a par with directors and managers.
Amakudari
Another means by which government agencies enforce administrative guidance, and more
generally playa central role in corporate governance, is by placing retired officials in strategic
positions in the industries they used to regulate. This practice, known as amakutiari, or "descent
from heaven," is wielded particularly effectively by the Ministry of Finance, which tends to
place the largest number of amakudari officials each year in the country's most important
financial institutions. These fonner bureaucrats keep their old agency informed of the
company's activities and ensure that the finn remains responsive to infonnal guidance from the
ministries.
Consequences
The rules, structures, and practices described above define the major characteristics of
the Japanese system of corporate governance. They also give rise to a number of issues that
have often frustrated outside investors in Japanese companies, especially foreigners.
Emphasis on Growth over Profits

As mentioned earlier in this chapter, the large majority of shares in Japanese corporations
are locked up in stable cross-shareholding arrangements. These arrangements are motivated not
by a desire to generate short-tenn profits, but rather to seal a long-tenn business relationship.
Stable shareholders therefore tend to be satisfied with minimal dividend payouts from
corporations, expecting to be more than compensated by a combination of long-tenn capital gains
and increased business opportunities. As a result, corporate dividends of keiretsu group
companies tend to be lower than those of non-affiliated companies, and dividends as a whole in
Japan tend to be lower than in other industrialized countries. According to the Japanese Finance
Ministry, the average dividend yield on Japanese shares was only 0.79 percent in 1993,
compared with 2.77 percent in the United States.
The predominance of stable shareholders who invest for the long haul enables Japanese
corporations to focus on the growth of the company and worry less about profitability. The bulk
of profits that are generated tend to be ploughed back into the company to promote future
development, thereby benefiting employees and shareholders over the long-term.

CORPOKAm GOVERNANCEJN 1APAN

Weak Shareholders Rights
I

Implicit in the discussion above of the structural features of Japanese corporate
governance is the relatively weak position of shareholders vis-a-vis other corporate actors. In
the United States and many other countries, ownership of the company is generally equated with
a voice in the company's affairs. In Japan, by contrast, the lack of outside directors on the
board, stable cross-shareholding arrangements, and close-knit keiretsu relationships all work to
separate outside shareholders from directors, business affiliates, the main bank, etc. This makes
it extremely difficult for an outside investor or group of outside investors to influence the
direction of a business. The company is thereby insulated from challenges to its corporate
strategy and from takeovers.
In addition to the structural factors described above, three other operational rules and
practices have traditionally served to weaken the rights of shareholders in Japan:
Access to Comorate Information
As discussed above, under the Commercial Code, the Securities and Exchange Law, and
other statutes, Japanese corporations are required to regularly and publicly disclose basic
financial information, including the company balance sheet and profit and loss statement. These
rules have historically been less onerous, and therefore less revealing of actual corporate
performance, than those of the United States. In particular, segmented fmancial disclosure by
product line and geographic region and disclosure of related-party transactions have been limited.
However, recent legal changes have strengthened disclosure requirements in a number of areas
(see SIT section below).
Moreover, shareholder access to unpublished company records, such as the income tax
return and shareholder register, has traditionally been more restrictive in Japan than in the
United States. Under revisions to the Commercial Code implemented in October 1993, the stock
ownership threshold enabling a shareholder to have unrestricted access to the company books
was lowered from 10 percent to 3 percent. However, this still excludes most individual
shareholders. Although many U.S. states maintain relatively high thresholds for access to the
company books, these rules are generally relaxed after a shareholder, no matter how small his
holdings, has held the company's stock for a specified period of time (often six months).
In addition, while U.S. shareholders usually must specify in writing a reason for
inspecting the books, the burden is on the company to establish a reason for denying access.
The following are not legitimate reasons in the U.S. for denying access: takeover intent, intent
to change management, poor relations with management, intent to sue the company, intent to
oppose a management-approved merger plan, or intent to solicit other shareholders to sell stock.
In Japan, the "best interests" of the company is the standard for determining access to a
company's books.

COJll'OIlA'm GOVERNANCEIN' JAPAN

Relatively limited disclosure and restricted access to company records has made it
difficult for shareholders in Japan -- particularly unaffiliated investors -- to obtain a true picture
of a company's operations and fmancial health. This weakens their position in the corporate
governance structure vis-a-vis directors and managers, who typically enjoy unlimited access to
corporate information.
Proxy Voting

In principle, Japan has a fair proxy voting system that conforms to the "one share, one
vote" rule. However, certain features of the system tend in practice to weaken the franchise of
shareholders, especially independent shareholders.
Under the Commercial Code (Article 239), companies are required to give shareholders
only two weeks' notice of the annual meeting, and proxy materials may be sent by regular mail.
This makes it difficult for shareholders to read and absorb the materials and make an informed
decision about how to vote, especially if they own multiple companies. Nonresident
shareholders are at a particular disadvantage in this regard.
Another practical constraint on proxy voting by nonresident investors is that Japanese
banks who serve as their agents tend to use large omnibus accounts to hold nonresident shares,
each of which gets one set of proxy voting cards. Agents typically use these proxy blocks to
support management and rarely break them up for "no" votes.
Derivative Lawsuits
A derivative lawsuit is a legal claim filed by shareholders in the name of the corporation.
In the United States, derivative suits may be brought against directors, managers, majority
shareholders, or third parties who are allegedly injuring the corporation. There are some limits
to derivatives suits: to protect directors from harassment by minority shareholders, the courts
will not interfere with corporate acts that are the result of a reasonable business decisions.
Rather, these suits are intended to address cases of fraud, "sweetheart" deals, or truly egregious
management errors.
Similar to U.S. rules, Japan's Commercial Code (Article 267) authorizes derivative
lawsuits "to enforce the liability of directors." However, until very recently, derivative law')uits
were extremely rare in Japan. Part of the reason for this may have been the non-litigious nature
of Japanese society. But this has been supported by the relatively narrow interpr~tation by the
Japanese courts of directors' liability and the prohibitive expense of filing a derivative lawsuit
in Japan. Before the Commercial Code amendments of October 1993, a refundable, progressive
stamp duty of between 0.4 and 0.5 percent of damages sought was assessed at the time of filing.

CORl'ORA'IE GOVERNANCEIN' JAPAN

(For example, a $50 million damage request would have required payment of stamp duties of
$250,000.) Moreover, even if the shareholders won the suit, they were liable for all expenses
other than the board's own legal fees.
The amended Commercial Code has lowered the stamp duty on derivative lawsuits to a
uniform 18,200 ($96) and required the board to bear a larger share of the legal expenses. As
will be discussed below, these changes have led to a sharp increase in the number of derivative
lawsuits in Japan over the past 2 years.

Difficulty of Mergers and Acquisitions
Mergers and acquisitions (M&A), a well-accepted form of business consolidation in the
United States, are much less common in Japan. According to the Tokyo Stock Exchange, there
were only 28 cases of M&A involving listed Japanese corporations in 1994. Mergers are
generally used as an alternative to bankruptcy for very weak firms, and even then only as a last
resort after all other options have been exhausted. The board of the target firm must be
convinced that the consolidation will not harm the company or its employees. "Unfriendly"
takeovers are virtually unheard of in Japan.
This resistance to M&A is often explained by cultural factors. Because of the
identification of the company as a "family" unit in Japanese society, it is argued, buying and
selling companies is seen as "anti-social" behavior. An equally plausible and more pragmatic
explanation is that Japanese companies want to prevent outsiders from upsetting the balance of
mutual benefits within keiretsu groupings.
Whatever the reasons, Japanese companies have built up defensive mechanisms that are
extremely effective in discouraging M&A, particularly hostile takeovers. The most important
of these is cross-shareholding. By reducing the number of floating shares available for purchase
and creating a majority block of stable, "friendly" shareholders, cross-shareholding virtually
eliminates the potential for unwelcome advances on a target company.
Together with strengthening shareholders' rights, facilitating M&A in Japan has been a
central objective of the U.S. Government's negotiations on structural issues with the Japanese
Government in both the SIT and Framework fora (described below).
RECENT DEVELOPMENTS

Signs of Change
There has been much debate recently about changes underway in traditional features of
Japan's economic and industrial structure. This debate covers a wide variety of issues, many

COltl'OlrA.D GOVDNANCIUN lA.PAN

of which go beyond the scope of this report. Among them, however, is the issue of whether the
traditional patterns of corporate governance in Japan are breaking down. Two types of evidence
can be cited to support this claim:

Unwinding of Cross-Shareholdings
After steadily building up their mutual equity holdings between World War IT and the end
of the 1980s, Japanese corporations began to unwind some of their cross-shareholdings in the
early 1990s. According to one estimate, non-fmancial fIrms in Japan sold a net 17.1 trillion
($84 billion) of stock between 1991 and 1994. In the fIrst quarter of 1995, they sold an
additional 1340 billion ($4 billion). It is too early to say whether these developments reflect a
long-term structural change or simply a response to adverse cyclical conditions which could be
reversed in the future; the fIgures cited above still represent only a fraction of the nearly 1300
trillion ($3.5 trillion) of total corporate shareholding among Japanese institutions. However,
they have given support to the view that a fundamental underpinning of the keiretsu structure
may be coming undone.

Increase in Derivative Lawsuits
More recently, another traditional assumption about Japanese corporate governance -- the
passivity of shareholders - has been challenged by the sharp rise in the number of derivative
lawsuits flied by shareholders against Japanese corporations. Prior to 1993, the Ministry of
Justice estimates that an average of about ten new derivative lawsuits were flIed annually. For
calendar year 1993, the Ministry puts the fIgure at 30, of which 23 were flied in the last quarter
of the year. In 1994, another 91 suits were flIed. The reason for this sudden increase is
presumably the revisions to the Commercial Code that took effect in October 1993, which
substantially lowered the costs of flling a derivative suit. In response to the increase in legal
actions, there is some evidence that corporations are taking steps to strengthen their legal
departments and internal auditing procedures.

Forces for Change
A number of factors may help to explain the two developments described above and
support the thesis that fundamental changes are underway in the Japanese system of corporate
governance:

Cyclical Conditions
A fIve-year bear market in equities and four years of declining corporate profIts have
called into question traditional business practices in Japan. The erosion of both dividends and
capital gains has raised the opportunity cost to all Japanese firms of locking up corporate assets

CORl"ORAm COVJi'llNANCE IN JAPAN

in cross-shareholding arrangements. With the average return on equity in Japanese fmns being
less than two percent, corporate investors are being forced to take a hard look at their crossshareholding arrangements and in some cases are beginning to loosen these ties.
At the same time, one of the main incentives for entering into stable long-term
relationships with business partners -- the ability in times of fmancial distress either to issue new
shares to friendly companies or to rely on main-bank credit -- has also been undermined by the
weak cyclical conditions in recent years. Sagging share prices and government restrictions on
new share issues in the wake of the collapse of the "bubble" in the early 1990s (see Chapter IV)
have all but eliminated the first option, while banks' own financial difficulties may have made
them less willing or able to extend support to ailing group companies.
Pressure also has grown on banks as institutional investors. Traditionally, banks have
relied on a substantial cushion of latent gains on their shareholdings to support their capital
positions and cover bad debts. This cushion has worn so thin in recent years -- the 11 city
banks' latent gains fell nearly 60 percent in the six months to March 1995 -- that some banks
are under pressure to sell their stakes in other companies in order to bolster capital or write off
losses.
Other traditional business practices have come under scrutiny as a result of sluggish
economic growth and declining corporate profitability. The bottom-up, consensus-oriented
decision-making process that has characterized Japanese corporate governance has in many cases
proved to be too rigid and costly in a slower-growth environment. Many larger fmns have taken
steps not only to streamline their production methods and labor practices but also to reexamine
the way they make decisions, which could signal more permanent changes in traditional patterns
of corporate governance.

Legal/Regulatory Reforms
Recent legal changes have had direct and indirect implications for corporate governance
in Japan. In general, these changes have supported enhanced transparency of corporate
performance, greater accountability of directors, and stronger rights for shareholders.
Commercial Code
As mentioned earlier, major revisions to the Commercial Code were implemented on
October 1, 1993. Two changes were of particular relevance to corporate governance:
•

The costs of filing derivative lawsuits were substantially reduced through a
lowering of the stamp duty to a uniform 18,200 ($96) and introduction of a
requirement that the company pay most legal fees if the shareholders win the suit.

•

The share ownership threshold at which shareholders are entitled to review the
company books was lowered from 10 percent to 3 percent.

In addition, the related Law on Special Exceptions to the Commercial Code was amended
in October 1992 to require large corporations to appoint a three-member audit committee,
including at least one outside auditor.

Judging from the sharp increase in the number of derivative lawsuits since October 1993,
the amendments in this area appear to have already had an impact on shareholders' exercise of
their rights. The practical impact of the other two changes remains to be seen.
Securities and Exchange Law Regulations
Largely in response to U. S. Government requests in the Structural Impediments Initiative
(see below), implementing regulations under the SEL have been amended in recent years to
increase the detail of financial statements issued by public corporations. This has helped to
enhance transparency of corporate performance and business dealings and made it easier for
shareholders to assess their existing and potential holdings.
Financial Deregulation
Over a decade of financial market liberalization and deregulation, described in Chapter
IT, has taken its toll on traditional patterns of corporate governance in Japan. The principal
effect of these changes has been to open up new channels of corporate finance other than bank
lending for larger Japanese corporations. Whereas equity issuance represented only 12 percent
of corporate financing in Japan in 1980, it reached as high as 30-40 percent before the collapse
of the "bubble." This process of disintermediation, combined with the pressures on banks from
cyclical economic conditions, has significantly eroded one of the underpinnings of the keiretsu
structure - the main bank system.
Another effect of deregulation has been to change the relationship between government
and business. While the Ministry of Finance's power remains formidable, the government no
longer directly allocates credit through the banking system. The government's control over
industry through administrative guidance has weakened accordingly. Some argue that recent
political reform has also checked the ability of the bureaucracy to wield its influence over
business, but this remains a matter of debate.

Demographic Pressures
Long-term demographic trends are also causing strains in the traditional system of
corporate governance. The rapid aging of the Japanese population has been widely noted; by
2020, roughly one-quarter of the population will be over the age of 65. The need for cash to

coJU'OllAm GOVERNANCE IN JAPAN

cover pension payments for these elderly citizens will force Japanese pension funds and other
individual investors to search for higher-yielding investments. These pressures should lead
investors, both individual and institutional, to demand more say in the running of the companies
they choose to hold domestically and bring about significant changes in the way Japanese
corporations are governed in the future.

Conclusion
As the preceding discussion has suggested, there is reason to believe that corporate
governance in Japan is undergoing fundamental changes. Companies are unwinding some of
their mutual shareholdings; shareholders are beginning to flex their muscles; and many other
traditional business practices are increasingly coming under scrutiny. Japanese Government
policy has generally supported these changes, by forcing more light to be shed on formerly
opaque relationships and encouraging greater balance of power among the various corporate
governance constituents, among other things.
The degree and significance of these developments should not be overstated. The
continuity in the way corporations are governed in Japan is as evident as the change. As
mentioned earlier, the unwinding of cross-shareholdings to date represents only a fraction of the
total number of shares mutually held by listed Japanese companies. Notwithstanding the sharp
increase in derivative lawsuits, this comes off a very low base; most shareholders remain largely
passive and unwilling to "rock the boat." And keiretsu relationships are likely to remain the
defining characteristic of Japanese industrial organization in the foreseeable future. Moreover,
two legal changes that are being actively debated at present - easing restrictions on share buybacks, or treasury shares, and eliminating the long-standing ban on holding companies - could
reinforce traditional modes of industrial organization and corporate governance by reducing the
percentage of outstanding shares of individual companies that are actually on Japan's stock
exchanges.
On balance, however, it appears likely that the combination of short- and long-term
economic pressures and accommodating government policy actions will continue to force the
Japanese system of corporate governance towards harmonization with the systems in other
industrialized countries. Among other benefits, this should improve the environment for foreign
investment in Japan, by facilitating mergers and acquisitions and further strengthening
shareholders' rights.

U.S.-JAPAN NEGOTIATIONS ON CORPORATE GOVERNANCE
The Structural Impediments Initiative
Following years of a case-by-case sectoral approach to trade negotiations with Japan, the
U.S. Government in 1989 proposed a broader initiative designed to root out the deeper

COIU'ORA'IE GOVERNANCKJN JAPAN

structural causes of chronic external imbalances in Japan and the United States. The so-called
"Structural Impediments Initiative," or SIT, was launched in July 1989. The objective of the
initiative was to "identify and solve structural barriers in both countries that stand as
impediments to trade and balance of payments adjustment, with the goal of contributing to the
reduction of payments imbalance. "
After thorough research, the U. S. Government identified a wide range of issues as
impediments in Japan, falling into half a dozen broad categories: saving and investment patterns,
land use, distribution, exclusionary business practices, pricing mechanisms, and keiretsu
relationships. It was in this last category that corporate governance issues were taken up.
The U.S. Government's basic contention in the keiretsu area was that the network of
formal and informal ties among Japanese companies promotes preferential group trade,
discourages foreign investment into Japan, and can give rise to anti-competitive business
practices. The U.S. Government argued that shedding light on, and ultimately loosening these
ties would facilitate the entry of foreign goods, services, and investment into the Japanese
market.
A number of legal and institutional features of the Japanese economy were identified as
reinforcing keiretsu relationships. These included cross-shareholding, interlocking directorships
and other personnel linkages, inadequate accounting and disclosure requirements, and relatively
weak shareholders' rights - in other words, many of the elements of corporate governance in
Japan. The U.S. Government made a number of specific proposals designed to address these
underlying features of the keiretsu structure.
For its part, the Japanese Government argued that keiretsu relationships represented a
rational form of industrial organization, were appropriate in the Japanese context, and did not
inherently foster exclusionary or anticompetitive practices. The Japanese Government resisted
remedies designed to attack the structure of keiretsu, but were generally willing to discuss
proposals to shed light on keiretsu ties and to address anticompetitive practices that might stem
from those ties.
In the initial year of SIT (1989-90), the two governments held more than a half-dozen
formal rounds of negotiations, culminating in agreement on an Interim Report and Assessment
in April 1990 and a Joint Report in June 1990. Over the next two years, the two sides met
regularly but less intensively, producing a First Annual Report in May 1991 and a Second
Annual Report in July 1992.

The Japanese Government's commitments in the Keiretsu Relationships chapter of each
of the four SIT reports fell into five different categories. The major commitments in each of
these categories are summarized below.

COIU'ORA'IE COVERNANCEIN JAPAN

Strengthening the Function of the Fair Trade Commission
•

Strengthening the Japan Fair Trade Commission's monitoring function with
respect to transactions among keiretsu fmns. If the JFfC determines that a
transaction restrained competition or constituted an unfair trade practice, it will
take appropriate measures, including restricting cross-shareholding between the
firms.

•

Publication by the JFTC of a biennial analysis of various aspects of keiretsu
groups, including buyer-supplier transactions, fmancing arrangements among
group firms, personal ties, and the role of general trading companies in keiretsu
groups. The JFfC published such reports in February 1992 and July 1994.

•

Issuance of a statement affirming that the Japanese Government would take steps
to ensure that keiretsu relationships do not hinder fair competition or transparency
and that the entry of foreign fmns into the Japanese market would thereby be
facilitated. The Chief Cabinet Secretary issued such a statement in August 1990.

•

Publication of guidelines clarifying the criteria for enforcement of the
Antimonopoly Act, in order to deter violations of the Act. The guidelines were
published in July 1991.

Foreign Direct Investment
•

Issuance of a clear policy statement affirming the Japanese Government's strong
commitment to an open foreign direct investment (FDI) policy, based on the
principle of national treatment. The statement was issued on June 28, 1990.

•

Amendment of the Foreign Exchange and Foreign Trade Control Law to ensure
that restrictions on inward FDI would be limited to cases raising national security
concerns or in four sectors reserved under the DECD Code of Liberalization of
Capital Movements (agriculture, leather, mining, and petroleum refining). The
Japanese Government also agreed to replace prior notification requirements for
inward FDI with ex post reporting requirements, except in the above-mentioned
restricted areas. These amendments were enacted in Apri11991 and implemented
in January 1992.

•

Expansion of low-interest loan facilities and promotional activities to encourage
FDI into Japan.

COIlIOIlA'IE GOVDNANCEIN JMAN

•

Publication of a guide on investing in Japan for the benefit of potential foreign
investors, including a description of the new FDI legal regime, a detailed list of
sectors in which only ex post reporting of FDI is required, and a description of
government incentive programs for FDI. The guide was published in February
1993.

Revision of the Takeover Bid System
•

Abolition of the prior notification requirement for takeover bids and lengthening
of the takeover period. The requirement was dropped in December 1990.

Enhancement of Disclosure Requirements
•

Enhancing transparency of keiretsu relationships through a number of legal
amendments to strengthen disclosure requirements, including:
disclosure of holdings of 5 percent or more of a company's outstanding
shares, and additional reporting by such large shareholders of acquisition
or disposal of one percent or more;
greater disclosure of related-party transactions;
disclosure of the consolidated fmancial statement in a company's primary
annual financial statement (rather than as an attachment);
segmented disclosure of sales by geographic region, and sales as well as
profits and losses by industry; and
enhanced disclosure of sales to major customers (those accounting for over
10 percent of total revenue).

All of these new disclosure requirements were enacted and implemented by April 1991.
The Japanese Government also enacted legislation in May 1992 increasing the penalties
for inadequate or fraudulent disclosure.

Reexamination of the Company Law
•

Commitment to have the Cabinet Legislative Council examine the Company Law
(Commercial Code) with a view to enhancing disclosure requirements and
shareholders' rights, and to simplifying procedures for mergers and acquisitions.

CORPOKATE GOVERNANCEIN' JAPAN

•

In the Second Annual Report, the Japanese Government clarified that the
Legislative Council was examining issues such as facilitating shareholders' access
to company records and derivative lawsuits. As noted above, the Commercial
Code was amended in 1993 to effect these changes.

•

The Japanese Government also confmned its expectation that shareholders'
meetings will be held "properly" according to the Commercial Code; confirmed
that shareholders are able to exercise their voting rights disunited1y" through
proxies; and urged companies to "avoid possible obstacles" to the exercise of
voting rights by foreign shareholders.
II

The Framework
The corporate governance issues raised in SIT continued to be discussed by the two
governments in the "U.S.-Japan Framework for a New Economic Partnership." As described
in Chapter IT, the Framework was launched by President Clinton and then Prime Minister
Miyazawa in July 1993 as a comprehensive forum for addressing macroeconomic, structural,
and sectoral issues between the two countries, and for strengthening bilateral economic
cooperation. Keiretsu issues were swept up into the economic harmonization basket of the
Framework, in a sub-group examining inward direct investment and buyer-supplier relationships
in Japan.
In the investment sub-group, the u.S. Government noted the relatively low level of FDI
in Japan in comparison with other OECD countries and argued that greater inward FDI will
make the Japanese economy more open and efficient, stimulate business activity, and widen
consumer choices. While recognizing the steps that have been taken by the Japanese
Government to enhance disclosure requirements, improve shareholders' rights, and strengthen
the role of company auditors, the U.S. Government noted the continued difficulty of M&A in
Japan for foreign firms and encouraged the Japanese Government to take additional steps in this
area.

Agreement was reached in the investment sub-group in June 1995. In the agreement, the
Japanese Government noted the numerous steps it had taken to strengthen shareholders' rights
and improve the transparency and disclosure of financial information. In addition, the Japanese
Government confirmed that foreign investors will be protected from any anti-competitive actions
or intimidation that may hinder or impair their ability to undertake M&A in Japan. The two
governments agreed to continue consultations on these issues within the Framework context.

IV. THE "BUBBLE ECONOMY" AND ITS AFfERMATH
INTRODUCTION
This chapter begins by presenting a brief overview of the "pre-bubble" international
economic environment and the policies employed by Japan to deal with the effects of the yen's
sharp appreciation in the mid-1980s. The chapter then describes in greater detail those policies
and the policies that eventually led to the early 1990s collapse in Japanese stock and land prices.
Examined next is the question concerning the connection between the fmancial bubble and the
structures and practices of the Japanese financial system. The chapter then turns to a discussion
of the aftennath of the collapse in asset prices: stagnating economic growth, the highly
publicized scandals in the securities and banking industries, and the emergence of sizeable
amounts of non-performing bank loans. The chapter concludes with a description of some of
the responses undertaken by the Japanese Government to deal with these problems.
By way of introduction, the two standard statistics typically used to describe Japan's
fmancial bubble of the 1980s are the near-tripling of equity and land prices between year-end
1985 and year-end 1989. At its peak on December 31, 1989, the capitalization of listed
Japanese shares represented 42 percent of the total capitalization of world stock markets (up
from 15 percent in 1980), and the capital value of stocks traded on Japanese stock exchanges
had appreciated from around 29 percent of GNP in 1980 to 151 percent of GNP in 1989. The
land-price bubble was not quite as large, peaked later, and was generally localized among
Japan's three largest cities: TOkyo, Osaka, and Nagoya. Nevertheless, by 1990, the market
value of privately-owned land in Japan, relative to GNP, had risen to 517 percent from 286
percent in 1985.
Japan was not the only country to experience asset price inflation in the mid-to-late
1980s. Other countries, including the United States, also experienced rising stock and real estate
prices during this period, as well as some economic dislocation when real estate prices
eventually corrected for the overshooting. In Japan, however, these price trends tended to be
considerably larger than elsewhere.
THE EMERGENCE OF THE FINANCIAL BUBBLE
The International Economic Environment
Following the 1979-80 oil shock, during which Japan posted its first current account
deficit in 4 years ($10.7 billion in 1980), Japan's current account returned to surplus in 1981
and increased substantially thereafter during the early and mid-1980s. Real economic growth
during this period averaged 3.5 percent, led by growth in private sector domestic demand of 2.0
percent and real net export growth equal to 1.3 percent of GNP. Public sector real demand
increased only 0.1 percent during this period, reflecting the Japanese government's policy of
fiscal consolidation that had the effect of reducing the general government balance from -3.8
percent of GNP in 1981 to -0.8 percent of GNP in 1985.

1BE "BUBBLE ECONOMY" AND ITS AFI'ERMATH

That the external sector was a major factor contributing to overall growth in Japan was
helped in part by the depreciating value of the yen from 1203 per dollar at year-end 1980 to
1251 per dollar by year-end 1984, and by strong economic growth among Japan's major trading
partners, including the United States, where growth of real GDPaveraged 4.4 percent (1983-85)
and growth of real domestic demand averaged 5.3 percent. As a result, Japan's global trade
surplus increased and its bilateral trade surplus with the United States ballooned from $10.4
billion in 1980 to $43.5 billion in 1985.
With concern growing about the differing positions in the economic cycle of the major
industrial countries and the emergence of historically high trade and current account imbalances,
the Finance Ministers and Central Bank: Governors of the G-51 nations convened a meeting at
the Plaza Hotel in New York in September 1985 to discuss ways to reverse global trade
imbalances and realign exchange rates among major currencies.
As a result of the ensuing agreement among the G-5 -- known as the Plaza Accord -Japan committed to undertake economic measures to expand domestic demand in order to boost
imports. The Finance Ministers also agreed to cooperate more closely to promote an orderly
realignment of foreign exchange rates. By 1986, the yen had appreciated 60 percent against the
dollar, moving from an average of 1244 per dollar in 1985 to an average of 1153 per dollar in
1986.
The loss in Japanese export competitiveness following the Japanese yen's appreciation,
and the inability of the Japanese economy to quickly pass through the income and price benefits
of a stronger yen to domestic consumers, reduced Japan's rate of economic growth in 1986 by
one-half: to 2.6 percent, its slowest rate of expansion in the 1980s.

Causal and Contributing Factors to the Bubble
Until 1986, asset prices in Japan had risen generally in line with the nominal growth rate
of the Japanese economy. As measured by the Nikkei-225 stock index, Japanese equity prices
l,"ose at an annual rate of 13.5 percent in the 1970s and 11.2 percent during the first half of the
1980s. Data on land prices indicate roughly similar growth trends: 10.3 percent in the 1970s
and 6.9 percent in the first half of the 1980s.

The Early Stage of Excess Liquidity: 1986-87
As with most "bubbles," monetary accommodation was a key ingredient in Japan's land
and equity price bubbles. But the run-up in asset prices, while wages and prices remained
stable, point to other factors as well. Classic characteristics of bubbles were present: claims

1 The G-5 consisted of the United States, Japan, West Germany, the United Kingdom, and
France.

THE "BUBBLE ECONOMY" AND ITS AFI'ERMATB

that Japan was unique in its capacity to sustain high asset values, increasing emphasis on trading
for profit rather than holding for long-term gain, and entry into the market of new players who
were not bound by traditional notions about how to value asset prices.
Concerned that the yen was appreciating too rapidly and that economic growth had
slowed too much, Japan's monetary authorities embarked on a policy of rapidly easing monetary
policy. In January 1986, the Bank of Japan reduced its official discount rate (ODR) from 5.0
percent to 4.5 percent. This reduction was followed by several more reductions throughout 1986
and early 1987, eventually leading the Bank of Japan to establish an historic low for the ODR
at the time of 2.5 percent, a level at which the ODR remained until May 1989. Concurrent with
the lowering of interest rates was an acceleration of the growth rate in Japan's monetary
aggregates: M2 + CDs, the standard measure used in Japan for the money supply, grew an
average of 9.6 percent between 1986/87 versus an average of 8.1 percent between 1984/85.
That these increases in liquidity growth did not spill over into consumer price inflation
is a critical point in understanding the Bank of Japan's behavior during this period. Helped by
an appreciating yen, which tended to keep consumer price inflation low, the Bank of Japan
ostensibly saw no immediate need to modify its policy of providing easy credit to the economy.
Even at the height of the bubble in 1989 and 1990, consumer price inflation was not a serious
problem. 2 Consequently, the Bank of Japan's low interest rate policy continued throughout
most of 1989 until the Bank's newly appointed Governor, Yasushi Mieno, reversed course in
December 1989 upon taking control of the Bank.
The acceleration in nominal monetary growth from 8.1 percent to 9.6 percent was one
factor behind the sharp rise in Japanese asset prices. However, an even more important factor
was the significant increase in borrowing, largely for speculative purposes, that the Bank of
Japan's low interest rate policy engendered.
With growth of real demand for goods and services temporarily stunted by the yen's
appreciation, Japanese corporations and individuals turned their sights on using the historically
low level of interest rates to borrow heavily and invest heavily in real estate and financial assets.
This practice became so widely practiced in Japan at the time that a new word was coined to
describe it, zaitech, which loosely defmed meant speculating in fmancial market transactions to
increase income. By 1987, both Japanese individuals and Japanese corporations were engaging
extensively in the practice.
As Japanese corporations began raising funds domestically and in the eurocurrency
markets substantially in excess of their real economic needs, they channeled these funds not into
purchases of goods and services (hence, the low rate of consumer price inflation), but into stock

Inflation averaged 0.5 percent 1986-88. Although inflation did accelerate to 2.3 percent
in 1989 and to 3.1 percent in 1990, these increases were due to the implementation of a
nationwide sales tax of 3 percent in April 1989. By 1991, consumer price inflation had receded
to 1.6 percent.
2

1BE "BUBBLE ECONOMY" AND ITS AFTERMATH

and real estate purchases. In 1986, Japanese non-fmancial corporations increased their holdings
of financial assets by 115.6 trillion; and in 1987 they increased their net holdings by another
156.1 trillion. In both of these years the increases were larger than increases of earlier years,
and by 1987 the annual increase was more than five times larger than the 1985 net increase
(i10.4 trillion) in financial assets by non-fmancial corporations. As evidence of the importance
of financial speculation to the bottom lines of Japanese corporations, pre-tax profits of Japan's
largest non-financial companies jumped by 32 percent in 1987, of which one-third of this gain
was due to increased profits from trading fmancial assets.
To support these increases in financial assets, Japanese corporations borrowed heavily
both domestically and offshore. As a percentage of GNP, Japanese non-fmancial corporate debt
rose from 5.8 percent of GNP in 1985 to 7.7 percent of GNP in 1986, and then to 20.5 percent
of GNP in 1987.
Within the household sector the net annual increase in Japanese household financial assets
also increased sharply, from 139 trillion annually in 1985 to ISS trillion annually by 1987. Most
of this increase was in the form of time deposits, but increases also were registered in life
insurance products and stocks. Trading volume in stocks by households increased from 281
million shares traded daily in 1985 to 494 million shares traded daily in 1987. Households also
took on sizable increases in personal debt, aided by the rising values of the stocks and real estate
they held, which served as collateral for personal loans. Between 1985 and 1987, household
debt more than doubled, rising from 3.2 percent of GNP to 7.2 percent.
With interest rates low, a building boom also got underway in Japan -- first in Tokyo,
later in Osaka, and then in Japan's other major cities. In 1986, new housing starts in the Tokyo
metropolitan area increased by 21.7 percent. In 1987, they increased another 23.8 percent.
Office space under construction in both 1986 and 1987 more than doubled what was under
construction in 1985. The building boom put a premium on Japan's scarce urban land on which
to build new office space and new apartment buildings. This in tum bid up real estate prices.
As shown in the table on the following page, between 1982 and 1985, stock and land
prices advanced 14.5 and 3.3 percent a year, respectively. During this same period, the
difference between nominal monetary growth and real economic growth averaged 4.2 percent;
the central bank's official discount rate averaged 5.2 percent; the annual net increase in financial
assets averaged 1117.6 trillion; and total borrowing by households and private non-fmancial
corporations averaged 13.6 percent of GNP.
Beginning in 1986, and continuing through 1987, virtually every category in the table
registered an increase -- with the principal exception of interest rates, which by 1987 were 240
basis points lower than in 1985. The gap between nominal monetary growth and real GNP
increased to 6.3 percent; the annual net increase in fmancial assets rose to 1217 trillion; and
borrowing by households and non-financial corporations increased to 28 percent of GNP. In
addition, trading volume on the Tokyo Stock Exchange increased by 129 percent, and increases
in new housing units and new office space under construction in Tokyo rose 51 percent and 151
percent, respectively.

THE "BUBBLE ECONOMY- AND ITS AFmRMAm

The net result of these financial transactions was a sharp rise in stock and land prices.
In 1986, stock prices increased by 42.6 percent (as measured by the Nikkei 225) and land prices

in the Tokyo metropolitan area increased by 23.8 percent -- versus a nationwide average of7.7
percent. In 1987, the stock market cooled somewhat, rising 15.3 percent, but this increase was
inclusive of a 15 percent drop in October during the 1987 ·slOck market break.· Land price
inflation accelerated to 65.3 percent in Tokyo and to 21.7 percent nationwide.
1982-85

1986

1987

1988

1989

1990

1991

117.6

202.1

217.7

227.9

260.5

113.7

92.6

90.5

39.4

59.5

61.1

60.1

64.2

30.7

20.2

19.3

40.1
13.6

40.5
11.9

98.7
27.7

109.4
28.8

130.7
32.2

97.1
22.3

42.1
9.2

17.2
3.7

Differency Between Nominal
Monetary Growth and
Real GNP Growth (%)

4.2

5.7

6.3

4.8

5.8

5.1

-1.0

-0.5

Average Official Discount
Rate (%)

5.2

3.2

2.5

3.6

5.7

5.3

3.3

344.0

693.0

946.0

1020.0

876.0

483.0

372.0

264.0

113.0

263.0

259.0

281.0

271.0

311.0

320.0

354.0

Rise in Stock Prices (%)

14.5

42.6

15.3

39.9

29.0

-38.7

-3.6

-26.4

Rise in Land Prices (%)
(Tokyo)
(Nationwide)

3.3
3.2

23.8
7.7

65.3
21.7

1.8
8.3

7.2
16.6

7.0
11.3

-8.4
-4.6

-14.9
-8.4

Fiscal Year
Net Increase in Financial
Assetsl (I Tril)
Percent of GNP (%)
Net Borrowing by Households and Non-Financial
Corporations (I Tril)
Percent of GNP (%)

TSE Daily Trading Volume
(Mils of Shares; CY)
New Office Construction in
Tokyo (Hectares)

1992

Source: Annual report on national accounts by the Economic Planning Agency
Economic Statistics Annual by the Bank of ] apan
Posted land price survey by the National Land Agency
Annual white paper on real estate conditions in Tokyo by the National Land Agency

Extension a/the Financial Bubble: 1987-89
By mid-1987, Japan's domestic economy was in a full-fledged recovery with the economy
expanding in the second half of the year at an annual rate of 6.4 percent and industrial production up

3 Financial assets consist of cash, bank and postal savings deposits; money and capital
market instruments; bank lending; and offshore borrowing.

THE "BUBBlE ECONOMY" AND ITS AFI'ERMAm

more than 6.3 percent over the previous year. Nevertheless, the Bank of Japan not only continued
its policy of keeping interest rates low, but accelerated the rate of monetary growth to near 12 percent
annually.
One explanation for why the Bank of Japan acted in the way that it did was the "stock market
break" in October 1987, which shaved 15 percent off the Nikkei 225 stock average and sent stock
markets around the world falling. Following the October 1987 "break" in stock prices, the Bank of
Japan moved quickly to provide additional liquidity to Japan's fmancial markets. The annual rate of
monetary growth accelerated from 10.8 percent during the flIst 9 months of the year to 11.2 percent
in October and to 15.6 percent in November. The Bank of Japan sustained these increases throughout
1988, during which the money stock expanded by another 11.2 percent.
Buttressing the Bank of Japan's decision to retain an accommodative credit policy was the fact
that consumer price inflation continued to remain subdued, at 0.1 percent in 1987. By year-end 1987,
not only had the Nikkei 225 regained what it had lost in October, but it ended the year up by more
than 15 percent over its 1986 close.
With stock prices up a cumulative 64 percent (1986-87) and land prices up over 100 percent
in Tokyo (1986-87), Japan's system of asset-based collateralized bank lending supported larger
increases in new bank lending. In 1988, new lending by banks increased by another 131 trillion,
bringing tota110ans outstanding in the Japanese banking system to 89 percent of GNP. In combination
with funds raised from other sources, including equity-related financing (discussed below), offshore
borrowing, and retained earnings - net financial assets in Japan expanded in 1988 by 1228 trillion.
As the economy gained momentum, Japan's blue-chip manufacturers began to shift to other
sources of finance to supplement, and in some cases replace, their borrowing from banks. It was
about this time that arguments began to appear about the significantly cheaper cost of capital enjoyed
by Japanese firms and the competitive cost advantage that this cheaper capital conferred to Japanese
manufacturers and exporters. In addition to the opportunities to generate additional income through
speculative investments, publicly-traded corporations also took advantage of the rapidly rising stock
market to raise inexpensive equity-linked financing (Le., bonds with warrants attached and convertible
bonds).
Equity-related financing represented an especially attractive source of fmancing because of its
virtually cost-free features at the time. In 1985, new issues of equity warrants and convertible bonds
totaled just 13,455 billion. However, in the four years that followed (1986-89) a total of 147,227
billion in new warrants and convertible bonds were issued. Among the external sources of funds used
by corporations (i.e., bank loans, fIXed-income issues, commercial paper, and equity-related paper),
equity-related fmance rose in importance from 6.8 percent of total funds raised in 1985 to 13.3 percent
of total funds raised in 1989. By 1989, the coupon rate of issuing an equity warrant was just 88 basis
points, and the coupon rate on convertible bonds was zero.
As larger Japanese companies opted for capital market instruments, Japan's banks gradually
shifted the focus of their lending toward households, smaller businesses, and real estate lending; and
from shorter to longer-term maturities in order to sustain their income growth. These trends were
especially prevalent among Japanese trust banks, which turned out to be the largest lenders to the real
estate market.
85

THE "BUBBLE ECONOMY" AND ITS AFmRMA11I

By the end of 1989, the proportion of total bank loans to GNP had increased to 103 percent,
up from 74 percent of GNP in 1985. Loans to the real estate sector had doubled from 117.2 trillion
in 1985 to 141.0 trillion in 1989 -- for an average annual increase of 24.6 percent. The annual
increase in loans to the business sector had increased from 117 trillion in 1985 to 148.6 trillion in
1989. And the annual increase in loans to individuals had increased from 11.5 trillion in 1985 to
117.8 trillion in 1989.
In addition, the loan composition of bank balance sheets also had changed. At the end of 1980,

30 percent of bank lending went to large, blue-chip manufacturing corporations. By 1989 this share
had dropped to 15 percent. Over the same interval, lending to the real estate sector had risen from
10 percent of total lending to 23 percent.

Land Prices
By 1990, land prices in Tokyo were 140 percent above 1985 prices. Prices in Osaka had
increased 172 percent. And prices in Nagoya were up 83 percent. Outside of the major cities, the
climb in land prices was much less steep, rising at an annual average rate of 6 percent between 1985
and 1990.
Many comparisons have been drawn with land values in other countries to highlight the
magnitude of land price inflation in Japan at the time. One of the most striking comparisons was that
made by Stone & Ziemba (1993) that the total stock of property in Japan in 1990 was worth five times
the total stock of property in the United States even though Japan's land area is only about 4 percent
that of the United States.

Equity Prices
By year-end 1989, Japanese stock prices, as measured by the Nikkei 225 stock average, had
risen to 138,915 from 113,113 at the end of 1985, an increase of 197 percent. Most of the increase
occurred in the 2 years 1988-89 when the Nikkei 225 stock average rose 80.5 percent. However,
stock prices also rose in 1986 (by 42.6 percent), despite the slump in Japan's domestic economy, and
again in 1987 (by 15.3 percent), despite the October "stock market break. ,.
Average daily turnover of stock on the Tokyo Stock Exchange totaled 415 million shares in
1985, but by May 1989, nearly 1,000 million shares were trading daily -- of which, individuals
accounted for 26 percent, trades by corporations accounted for 40 percent, foreigners 9 percent, and
securities companies the remaining 25 percent.
COLLAPSE OF THE BUBBLE
Monetary Policy
By 1989, the Japanese Government, and more specifically the Bank of Japan, saw the economy
as being overheated, the yen losing strength against the dollar (the yen depreciated in value by 7.7
percent in 1989), and the skyrocketing price of land becoming a major social problem.

TOE "BUBBLE ECONOMY" AND ITS AFI'ERMAlH

In May 1989, the Bank of Japan raised its official discount rate by 75 basis points to 3.25
percent. The ODR was raised again in October 1989, this time to 3.75 percent; and raised again on
December 30, 1989, to 4.25 percent.
As interest rates rose, bond prices collapsed. On March 2, 1990, the ODR was raised 100
basis points to 5.25 percent, and in August 1990, the ODR was raised to 6.0 percent. In a little more
than 16 months, the cumulative rise in the ODR was 3.5 percent, or 350 basis points.
Accompanying the hikes in the key lending rate of the Bank of Japan were increases in bank
short-term interest rates from 4.24 percent to 8.0 percent, and a rise in long-term interest rates from
5.7 percent to 8.9 perCent. With consumer price inflation essentially stable over this period (i.e., 2.3
percent in 1989 and 3.1 percent in 1990), real interest rates rose about 270 basis points.
The Collapse in Asset Prices
With interest rates rising, the higher credit costs began to strain leveraged equity and real estate
positions. The Nikkei-225 stock index was essentially in a free-fall during the first half of 1990,
falling from a high of 138,916 on the closing day of 1989 to 131,940 by June 30, 1990, a decline of
17.9 percent. The index fell even more rapidly in the second half of 1990 following Iraq's invasion
of Kuwait, losing an additional 25.3 percent to close the year at 123,849. For the year as a whole,
Japanese stock prices fell 38.7 percent in 1990.
Stock prices remained fairly stable throughout most of 1991,. finishing the year at 122,984.
However, trading volume, a critical factor driving securities flrms" profits in Japan, continued to
decline. From a peak of 1 ,537 million shares traded daily in February 1989, average daily volume
declined to 484 million shares in 1990, and to 445 million shares in 1991.
A number of financial market scandals in late 1991 and early 1992 coincided With a renewed
decline in Japanese equity prices. By mid-August 1992, the Nikkei 225 index reached its then postbubble low of 114,309: a cumulative 63 percent decline in the value of the market from peak to
trough. From the end of 1989 until the end of 1992, the Japanese stock market's capitalization,
relative to GNP, had fallen by more than one-half.
Land prices peaked in late 1990, but did not begin to fall precipitously until the fall of 1991.
The general pattern of real estate markets at a turning point is for a backlog of unsold properties to
build up for 6 months or longer before prices begin to adjust. However, restrictions imposed on
lending for real estate investment and tightened land taxation had the effect of accelerating the
deflation in land prices. In Apri11990, Japan's Ministry of Finance issued administrative guidance
in the form of an official notification that the growth of lending by Japanese financial institutions to
real estate businesses should be kept below the rate of growth of total bank loans. In May 1991, the
government strengthened restraints on nonbank lending for land-related purposes. By year-end 1992,
land prices had fallen 21.4 percent in the Tokyo area, 35.0 percent in Osaka, 12.6 percent in Nagoya,
and 12.6 percent nationwide. This downward trend in Japanese land prices has continued up through
the present day.

THE "BUBBlE ECONOMY" AND ITS AFI'ERMAm

OTHER FACTORS IN THE BUBBLE

Constraints on Fiscal Policy
Japanese fiscal policy was either neutral or restrictive throughout most of the 1980s. This
followed from the Japanese government's twin fiscal objectives at the time of reducing the central
government's budget deficit and eliminating the issuance of deficit financing bonds by the year 1990.
That the government steadfastly adhered to this policy is best seen in the sweep of the twelve years
1978-90 when net public sector savings swung from -8.7 percent of GNP to +2.7 percent of GNP.
With fiscal policy moving in a contractionary direction, monetary policy bore the brunt of the
burden to stimulate domestic demand, accelerate import growth, maintain price stability, and manage
the yen's appreciation in an orderly manner. Although fiscal stimulus packages were eventually
developed in the fall of 1986 and the spring of 1987, these fiscal measures only slowed the pace of
fiscal contraction. They did not generate any appreciable effects on the real growth of the economy
which might have enabled the monetary authorities to reassess their accommodative stance.
The Impact of the Structure and Practices of the Japanese Financial System
While the financial bubble in Japanese asset prices was primarily a monetary phenomenon,
there are certain features of the Japanese fmancial system, some of which continue to this day, that
amplified the severity of the price increases once the financial bubble got underway.
First, as noted in Chapter III, because of the keiretsu system of stable cross-shareholding, only
about one-half of Japanese equities are freely tradable. This meant that as funds were channeled into
Japan's equity market, equity prices tended to rise more rapidly than they would have had there been
a broader supply of tradable securities across which to diffuse price pressures.
Second, because bank lending in Japan is heavily skewed in favor of collateral-based lending,
with real estate being the preferred form of collateral, as real estate values rose so too did the
borrowing capacity of the Japanese general public. As noted previously, the balance sheets of
Japanese banks expanded sharply during the latter half of the 1980s.
Third, certain Japanese tax and land-zoning policies tended to keep significant amounts of
available, unused urban land off the Japanese real estate market. Among these policies are high
capital gains tax rates that tend to discourage sales of private land holdings, and special tax exemptions
for agricultural land, including agricultural land within urban areas, which tended to keep large tracts
of urban land essentially vacant. Consequently, during Tokyo's residential housing and commercial
construction boom of the late 1980s there was a serious shortage of available land on which to build
even though a significant amount of urban land was close at hand and left vacant and unused. As a
result of these policies, funds for real estate investment were channeled into a relatively narrow pool
of available urban land.
Fourth, as noted in Chapter ill, in Japan's system of corporate governance the vast majority
of outside directors come from current and retired company employees. Moreover, banks and other
financial institutions are the major shareholders of Japanese stocks. The combination of company-run
88

THE "BUBBLE ECONOMY" ANDITSAFTERMAm

boardrooms, weak shareholders' rights, and inaccessibility by small shareholders to company
information resulted in weak internal oversight of Japanese bank lending policies. This was especially
true during the late 1980s.
Lastly, market psychology plays a big role in virtually all fmancial bubbles, and in Japan it was
no different. Given a postwar history in which prices of assets tended to go in only one direction, up,
and given the view in Japan that land is an extremely scarce and safe resource in which to invest, once
the prices of assets began to rise it produced a bandwagon effect. As prices tended to go higher and
higher, the psychology of the time was to buy more, not less, and to incur larger amounts of personal
and corporate debt to buy at ever higher prices. Notably, even though price-earnings ratios on stocks
were at exceptionally high levels, 70.6, trading volume in the Tokyo stock market in 1989 was among
the world's most frenzied.
THE BUBBLE'S AFTERMATH
In the aftermath of the collapse of the financial bubble, the Japanese economy has experienced
a protracted economic slowdown, persistently weak asset prices, deflation, sharp downturns in
corPorate business profits, general deterioration in the quality of commercial bank balance sheets,
ballooning current account surpluses, and a series of financial market scandals that have cut across
several sectors of the Japanese financial services industry.
Economic Stagnation
Underlying the initial collapse in Japan's economic growth rate were the successive interest rate
hikes in 1989 and 1990, which generated a renewed rise in the international value of the yen and the
implosion of stock and land prices. Collectively, these events necessitated a major stock adjustment
process, particularly in the area of fixed business investment, which through the late 1980s had been
a major source of Japan's economic expansion -- accounting for 45 percent of Japan's economic
growth during the 1987-90 period.
This led to a marked slowdown in new real business investment and an over accumulation of
inventories that eventually led to a sharp reduction in industrial output. Real business investment,
which had expanded from 16.4 percent of GDP in 1986 to 21.5 percent of GDP by 1990, slowed to
6.6 percent growth in 1991, turned negative at -4.7 percent in 1992, and fell another 9.3 percent in
1992. The inventory/shipments ratio, which had fallen to a low of 96.9 in 1989 (1990 = 100), rose
steadily for the next 55 months to peak at 123.6 in 1993, roughly 18 percent above its average ratio
for the period 1985-89. Industrial production, which had kept pace until the spring of 1991, declined
0.4 percent in the second half of 1991 and another 6.1 percent in 1992. By year-end 1993, industrial
production had fallen 13 percent below its first quarter 1991 peak.
With the economy undergoing a period of structural readjustment, and pessimism about shortterm economic prospects at an all-time low, fmancial market transactions slowed markedly.
Borrowing by non-bank corporations fell 21 percent in 1991 and another 31 percent in 1992. The
household sector reduced its borrowing by 37 percent and 38 percent, respectively. The volume of
land transactions declined by 16 percent in 1991 and 13 percent in 1992. And the volume of stock
trading declined by 23 percent in 1991 and 29 percent in 1992.

THE "BUBBLE ECONOMY- AND ITS AFTERMATH

By the end of 1992, domestic private fmal demand in Japan had fallen 1.1 percent. In 1993
it fell another 1.7 percent. What was not consumed at home was sold abroad: Japan's current account
surplus rose from $36 billion in 1990 to $73 billion in 1991. By 1993 it had risen to $131 billion.

Weakened Industry Profits'
The weak economy produced sharp contractions in corporate business profits. Pre-tax income
in the non-bank business sector fell 12 percent in 1991, 23 percent in 1992, and 21 percent in 1993.
Commercial banks suffered declines in their net pre-tax incomes of 6 percent, 21 percent, and 9
percent, respectively. Securities frrms, dependent on brokerage commissions for income, suffered
declines in income of 37 percent and 26 percent before registering a gain of 22 percent in 1993.
Among the hardest hit by the recession and the decline in asset prices were Japan's real estate
companies. They suffered losses of 1512 billion in 1991, 11,009 billion in 1992, and 1873 billion in
1993. Bankruptcies among real estate companies climbed from 244 in 1989 to 1,121 in 1991; 1,136
in 1992, and 775 in 1993.

Problems in the Banking Sector

Non-Perjonning Loans of Japanese Banks
As asset prices plummeted and the economy stagnated, many of Japan's banks began
experiencing serious problems in managing their increasing exposure to non-performing loans. 5
Disclosure of the severity of the problem began only in March 1993 when Japan's 21 largest banks,
accounting for 70 percent of total banking system assets, were required for the first time to publicly
disclose their non-performing loans.
The initial report revealed that 113 trillion in loans were 6 months or longer overdue in
payment, or 3.2 percent of these banks' total credit assets. Not included in the figure at the time were
loans that these 21 banks had either restructured at lower interest rates to ensure their repayment, or
loans where additional credits had been extended to cover interest arrearages. In a move that raised
concerns at the time about the transparency of the system, banks making up the remaining 30 percent
of the banking system, (i.e., regional banks) were not required by the Finance Ministry to disclose
their non-performing assets.
As the underlying assets backing up the loans continued to lose value, the 21 banks reported
in March 1994 that the situation for the 21 largest banks had deteriorated further: to 114 trillion or
3.5 percent of their total credit assets. Individually, the degree of bad-loan exposure for the 21 banks
varied from 2 percent to 7 percent.

Business years refer to fiscal years, ending March 31.

S Defined in Japan as a loan to a bankrupt borrower or a loan on which interest is in arrears
for 6 months or longer. The U.S. definition is 3 months.

THE "BUBBLE ECONOMY" AND ITS AFTERMATH

By March 1995, the situation had improved only marginally -- the 21 banks reported nonperforming loans of 112.5 trillion. In addition, for the frrst time the Finance Ministry also disclosed
that these same 21 banks had about 110 trillion in restructured loans.
Because smaller banks making up the remaining 30 percent of the banking system were not
required to disclose their bad loan exposures, except those loans to banlaupt borrowers, this
discrepancy has led to increased public pressure in Japan for greater bank disclosure - particularly
in light of certain private sector estimates which place the bad loan problem nearer to 160-80 trillion
for the financial system as a whole.
Partly in response to these calls for greater disclosure, on June 6, 1995, the Japanese Finance
Ministry announced that its estimate of the total of all bad loans and all restructured loans is 140
trillion ($470 billion), or roughly 6 percent of total Japanese credit institutions' assets.

Bank Rescues
As noted in Chapter IT, the general deterioration of bank loan portfolios since the collapse of
the bubble has claimed a number of financial institutions, primarily small banks and credit cooperatives
that have subsequently been merged with larger financial institutions. Since the collapse of the
financial bubble, 2 banks, 7 credit cooperatives, and 2 securities fIrms have had to be absorbed by
other banks or securities firms.

Capital Adequacy of Japanese Banks
The collapse in equity prices in 1990 also raised concerns about the ability of Japanese banks
to meet the new Basle minimum capital adequacy rules that were due to come into effect in March
1993. Under the terms of the Basle rules, Japanese banks were permitted to include in their Tier IT
capital calculations 45 percent of the market value of their unrealized equity gains. As long as the
stock market held its value, then Japanese banks were in good position not to only meet, but to exceed
the 8 percent minimum. However, as stock prices plunged the value of these unrealized equity gains
evaporated rapidly.
To help cushion the losses on unrealized stock gains in Tier II capital calculations, in 1990 the
Finance Ministry began permitting Japanese banks to borrow term subordinated debt, of which
Japanese banks borrowed an estimated $7.3 billion in 1991 and $4 billion in 1992. However, as the
permissible limits on term subordinated debt were approached in September 1992, the Finance
Ministry took the additional step of permitting banks to begin borrowing perpetual subordinated debt,
on which there is no ceiling in terms of calculating Tier IT capital. In 1992, Japanese banks borrowed
$2.8 billion of perpetual subordinated debt; and in 1993 they borrowed an additional $4.9 billion. By
1995, 57 percent of the Tier II capital of Japan's largest 21 banks had been funded through
subordinated debt issues.
All 21 major Japanese banks required to meet the minimum risk-weighted capital ratios for Tier
I and Tier IT capital have done so since 1993 -- with an average margin of 150 basis points. As of
the latest reporting period, March 1995, the average capital ratio of these 21 banks was 9.1 percent.

TOE "BUBBIE ECONOMY" AND ITS AFmRMAm

Among smaller banks also subject to the same minimum 8 percent guideline, all met the minimum
ratio in March - with one exception, a regional bank.

Financial Industry Scandals
In the wake of the collapse of asset prices, a number of illegal practices and management

improprieties in the financial sector also came to light. These are collectively known in Japan as "the
scandals. "

The -Recruit- Scandal
The fIrst of these scandals came to light in 1988 during the height of the financial bubble in
what was known at the "Recruit" scandal. This scandal involved the sale of unlisted shares in 1986
to well-known politicians, including persons on the staff of then Prime Minister Noboru Takeshita,
Finance Minister Kiichi Miyazawa, and former Prime Minister Yasuhiro Nakasone. When the shares
were subsequently listed on the over-the-counter market in 1986, the price of the shares increased
fourfold. Most of the 76 investors who had purchased the stocks prior to their listing sold them
immediately thereafter for a substantial gain. When details of the stock transactions eventually became
public, Prime Minister Takeshita was forced to resign.
Subsequent investigations of these transactions by the Japanese Finance Ministry determined
that the initial sale of the securities had occurred at a fair market price. However, in response to
public criticism over the special treatment accorded certain investors, the Tokyo Stock Exchange and
the Japan Securities Dealers Association, with Finance Ministry prodding, issued new rules in 1989
limiting the amount of new share offerings that can be sold to anyone individual or corporate
purchaser.

Loss Compensation Scandal
The most widely-publicized scandal involving the securities industry centered on the provision
of compensation to certain clients of securities firms who had suffered losses in the stock market
collapse. This scandal, known as the "loss compensation" scandal, came to light in the fall of 1991
when it was discovered that a number of large securities firms, including all four of Japan's Big Four
securities firms (Nomura, Daiwa, Yamaichi, and Nikko), had been compensating certain clients for
losses incurred in stock market transactions. These loss compensation payments were made in
violation of an earlier issued notifIcation from the Finance Ministry that had forbidden the payment
of loss compensation. As the scandal unfolded, it was revealed that payments made to "select clients"
totaled 1230 billion (about $2 billion).
Although the "notifIcation was later determined to be not legally binding, Japan's Ministry
of Finance assessed fInes on the securities fmns totaling 153.2 billion. In addition, the Finance
Ministry temporarily forbade the firms involved from certain business activities. Certain offIces of
the securities companies had to be temporarily closed, and MOF temporarily suspended the firms from
participating in the sale and underwriting of certain government security issues (over 100 public
entities temporarily suspended some of their business dealings with the Big Four). In addition, the
Finance Ministry asked the Big Four to temporarily suspend, on a voluntary basis, all transactions with
It

THE "BUBBLE ECONOMY" AND ITS AFI'ERMAm

corporate customers, and asked investment advisory companies to temporarily suspend, again on a
voluntary basis, the placement of securities orders with the Big Four securities firms and their
affiliates.
Lastly, several prominent executives and Board Chairmen of securities firms were forced to
resign - as did then Finance Minister Ryutaro Hashimoto, who voluntarily resigned to accept
responsibility for the Finance Ministry's failure to have properly supervised the industry.
The Japan Fair Trade Commission later determined that the loss compensation payments were
in violation of the exclusive. business practices provisions of the Antimonopoly Act, but the JFTC
imposed no penalties against the firms for the violations.
Stock Ramping

The third major securities scandal occurred in the fall of 1991. It involved Nomura Securities,
Tokyu Railways stock, and an organized crime group known as the Inagawa-Kai, in a suspected stockramping case that the Japanese Finance Ministry estimated
netted Inagawa-Kai 1800 million in 1989.
.

Nomura acknowledged that it had concentrated trading of Tokyu shares in 1989 in violation
of Article 54 of the Securities Exchange Law that prohibits securities firms from excessively
recommending that investors purchase a specific stock within a specific period of time. However,
Nomura denied the allegation that it had "ramped" the stock.
Although the Finance Ministry said it could fInd no evidence to substantiate the suspected stock
price manipulation, which is banned under Article 125 of the Securities Exchange Law; in October
1991 the Finance Ministry ordered Nomura to suspend all equity transactions on behalf of customers
and for Nomura's own account - at its headquarters branch and at 86 other branches -- for up to six
weeks. Nomura also was suspended from participating in underwriting Japanese government bonds
for one month. In addition, Nomura announced the resignation of two executives (the Deputy
President and a Senior Managing Director) and a reduction in executives' salaries of 20 percent, for
up to one year, as a means of taking responsibility for the Tokyu case.
In December 1991, the Finance Ministry announced that its investigation showed Nomura had
not violated Article 125 prohibiting stock price manipulation.
-Tobashi-

The fourth scandal involving the securities industry focussed on a practice known as tobashi,
or the "parking" of certain securities in other customers' accounts through repurchase agreements in
order to overstate gains or mask losses on securities transactions. Typically, these transactions took
the form of verbal repurchase agreements in which a securities firm, acting on behalf of a corporate
client, would sell a security to another corporate client having a different accounting period. In this
way, the seller of the security could "window dress" its balance sheet and income statement. The
corporate client purchasing the security would typically agree to make the purchase, conditioned on
a commitment that it would benefit from the transaction. However, when several securities firms
failed to make good on their commitments, they were sued by their corporate clients for damages
incurred.
93

11IE "BUBBLE ECONOMY" AND ITS AFmRMATU

In testimony before the Japanese Diet on February 25, 1992, then Securities Bureau Director
General Nobuhiko Matsuno said that the Ministry of Finance would investigate the involvement of
securities firms in "tobashi" transactions and whether these transactions violated any legal or
administrative prohibition guaranteeing returns on securities investments. At the time it was noted
Japan's Securities Exchange Law did not stipulate guidelines on repurchase agreements.
In late April 1992, the Finance Ministry announced that it would take administrative penalty
action for "tobashi" against one second-tier securities firm, Yamatane, and two of its employees: for
the firm, a temporary suspension of business. In addition, the Finance Ministry issued an
administrative notice stipulating that bond repurchase agreements in the future must be concluded at
market prices.
The number of securities firms involved in "tobashi" was relatively limited, but the courtordered payments for damages were more substantial than in the case of the loss compensation
payments.

Falsified Deposit Receipts
Within the banking sector there were several scandals as well. The flrst involved several
instances of the use of falsifled bank receipts, with the cooperation of certain bank offlcials, to obtain
loans for clients for speculative purposes. One case involved forged deposit receipts signed by a bank
employee which were used as collateral to borrow 1261.4 billion (over $2 billion) from another
financial institution. A similar case involved a bank branch manager who was later arrested for
receiving kick-back money for arranging loans for stock market speculators.
The most notorious case involved the owner of an Osaka restaurant who, using forged deposit
receipts from an Osaka credit association as collateral, obtained loans totaling 1240 billion (over $2
billion at the time). The restaurant owner, Mrs. Nui Onoue, then invested the proceeds of these loans
in stocks and bonds, including stocks of the Industrial Bank of Japan, of which she became the largest
single shareholder. When stock prices crashed, Mrs. Onoue's highly leveraged position came crashing
down and she was ultimately driven into bankruptcy. The Osaka credit association eventually had to
be merged out of existence.

Historical Rate Rollovers
Although not technically a scandal, authorized foreign exchange banks contributed to certain
problems in transparency by allowing certain bank clients to hide losses on forward foreign exchange
transactions through a practice known as "historical rate rollovers." This practice involved banks
allowing certain customers to roll over forward foreign exchange contracts at the same rate they were
entered into when the settlement date arrived, rather than requiring their customers to settle the
contracts and incur losses if the exchange rate had moved unfavorably.
In February 1992, voluntary orders were issued through the Federation of Bankers Associations
prohibiting banks from allowing their corporate clients to rollover their forward foreign exchange
contracts. According to the new rules, beginning in June 1992, forward foreign exchange transactions

THE "BUBBLE ECONOMY" AND ITS AFI'ERMAm

would have to be settled when they came due and new contracts would have to be entered into using
current market rates in order to improve transparency. At the time of the announcement, the press
estimated that the losses on the contracts totaled about 12 trillion at Japan's 11 city banks.
To further buttress the actions taken in 1992, on March 1, 1994, the Finance Ministry issued
an additional ordinance requiring all listed firms to disclose in a footnote to their income statements
their unrealized losses (or gains) on forward foreign exchange contracts.

THE JAPANESE GOVERNMENT'S RESPONSE
Creation of the Securities Exchange Surveillance Commission
In response to these disclosures about improprieties in the Japanese stock market, public
criticism arose over the Finance Ministry's dual role as both regulator and advocate of the securities
industry. Although the Finance Ministry fought vigorously to retain its full authority over
supervision of the securities industry, in the end it was decided that certain functions, such as
supervising stock market trading practices and policing violations, should be broken off into a separate
regulatory agency: the Securities Surveillance and Exchange Commission.

Legislation authorizing the creation of the SESC to supervise securities transactions was passed
in May 1992. However, in a partial victory for the Finance Ministry, the SESC was empowered only
to investigate and file charges in the case of violations of insider trading, loss compensation, price
manipulation, and fraudulent profit reporting. The SESC was not empowered with prosecutory powers
(the latter still fall within the domain ofMOF and the public prosecutor's office). Moreover, staffing
of the SESC was to come from the Finance Ministry, with personnel seconded on a rotational rather
than a permanent basis. On the other hand, the three commissioners, at least initially, were to be
appointed from outside the ranks of former Finance Ministry personnel.
Since the creation of the SESC in 1992, the staff of the Commission has recommended
5 securities trading cases for prosecution.

Legal Reforms
Various legal reforms also were undertaken to strengthen the regulation and supervision of the
securities industry. In addition to the creation of the SESe, the Securities Exchange Law was
amended in July 1992 to increase fmes, prohibit the payment of loss compensation, and prohibit
securities firms from engaging in discretionary fund management.
From late 1991 through early 1992, the Finance Ministry reviewed its administrative notices
applicable to securities regulation to determine those notices that should be codified into law, those
notices that should be done away with, and those notices that should be delegated to the Tokyo Stock
Exchange and to the Japan Securities Dealers Association for enforcement.
In a move designed to improve transparency, the Finance Ministry also committed to refrain
from issuing verbal administrative guidance in the future with respect to securities market regulations
(but not banking regulations) and to establish transparent, legally-based procedures for future
administrative action.

THE "BUBBlE ECONOMY" AND ITS AFI'ERMATH

In October 1994, the Administrative Procedures Law was enacted, which established new
guidelines for transparent regulation and procedural protections for dispositions.

Lastly, the charter of the Japan Securities Dealers' Association was revised to make the JSDA
a more effective self-regulatory organization. In early 1992, the JSDA tightened the self regulatory
organization rules governing the allocation of new equity issues and the pricing of off-market securities
transactions.
Price-Keeping Operations ("PKO")
In the immediate aftermath of the collapse in equity prices, the government was initially content
to let market forces determine the level of stock prices. However, as the market continued to
deteriorate through 1992, the government began to assist stock prices through a variety of "informal"
tactics known in Japan as "price-keeping operations." These included reports of moral suasion of
financial institutions to support the stock market, a temporary informal ban on new equity financing,
and the use of public money to purchase assets: both land and equity.
Ban on New Equity Financing

In March 1990, an informal moratorium was imposed on new equity financing. This was done
primarily as a means of restricting the supply of new equities to the securities market. Initially, the
moratorium was imposed only on new equity financing by existing listed companies. However, as
stock prices continued to slide in 1990, the moratorium was extended to new equity issues of
companies going public for the first time, including new equity issues placed in the over-the-counter
market.

By the summer of 1990 the moratorium began to be gradually eased, first with the resumption
of the issuance of new convertible and equity-warrant bonds, and then with resumption of new equity
issues by firms going public for the fIrst time. In December 1993, the Finance Ministry announced
a limited resumption of new public equity issues by existing listed firms. And in 1994 the last
remaining elements of the moratorium were removed.
Use of Public Money

Use also was made of public sector funds to support purchases of Japanese equities. Primarily
this was done through funds secured through initial and supplemental budgets of the central
government that were then made available to the Ministry of Posts and Telecommunications (MPT),
which oversees the postal savings and postal life insurance systems, and the Ministry of Health and
Welfare (MHW), which oversees the Japanese public pension fund system. MPT and :MHW then used
these funds to invest in Japanese equities. As an added measure, the Finance Ministry-imposed
30 percent ceiling on equity investments (80 percent in the case of postal life insurance) was
selectively lifted for MPT and MHW investments only.
Since FY 1992, and continuing through FY 1995, a total of 111 trillion or slightly over $100
billion has been allocated to MPT and MHW for these special investment purposes. Although a
precise measure of the percentage of these funds that subsequently were invested in the stock market

1HE "BUBBLE ECONOMY" AND ITS AF.IERMA1lI

by MPT and MHW is not available, one private source estimates that purchases of roughly 12.7
trillion were made by MPT in FY 1992, and purchases of about 12.8 trillion were made in FY 1993.6
Analysis done by J.P. Morgan at the time suggests that most of these purchases were
concentrated at times when private sector investment activity was extremely low; and that as a result
of this buying the government was able to contribute significantly to the stock market's recovery in
the fall of 1992 and the spring of 1993.
The Cooperative Credit Purchasing Corporation
To help deal with the bad loan problems of Japanese commercial banks and overcome some
of the rigidities in Japanese tax law regarding the treatment of bad loans, the Cooperative Credit
Purchasing Corporation (the CCPC) was established in January 1993, with encouragement from the
Japanese government, as a joint venture of 162 Japanese financial institutions.
The purpose of the CCPC is to assist member banks in disposing of their non-performing loans.
Although the structure of the CCPC is somewhat awkward, and partly a creature of Japan's tax system
which does not allow Japanese banks to write-off bad loans at their own discretion, the CCPC has
been successful thus far in helping Japanese banks dispose of 18.6 trillion in non-performing loans as
of March 31, 1995.
A typical transaction works as follows: A participating bank first extends a credit to the cpec
(at interest), which the latter then uses to purchase the non-performing loan being offered. The
participating bank sustains a capital loss as a result of this transaction and records the amount of the
discount as an income loss for income tax purposes. If the CCPC is able to dispose of the collateral
(typically land) underlying the non-performing loan, it then uses the proceeds from the sale to repay
the loan from the participating bank, which books either a gain or a loss depending on the price
obtained at disposition. In the event the CCPC is unable to dispose of the collateral within ten years,
the participating bank: is obligated to reacquire the non-performing loan and the collateral.

Macroeconomic Policy Actions
To support economic recovery and bolster asset prices, for the last several years the Japanese
government has pursued more expansionary monetary and fiscal policies. In the area of monetary
policy, Japan's official discount rate has been reduced eight times over the last four years. The first
cut came in July 1, 1991, with a reduction in the ODR of 50 basis points to 5.5 percent. Two
addition reductions were made in 1991 totaling 100 basis points. In 1992, with the stock market still
falling and the economy showing continuing signs of stagnation, two additional cuts were made totaling
125 basis points, bringing the ODR by year's end to 3.25 percent. In 1994, the ODR was lowered
further to a new historic low of 1.75 percent. And in 1995, the ODR was lowered to 1 percent.
Notwithstanding these reductions, unlike the late 1980s, the lower interest rates have not produced
;ignificant accelerations in either monetary growth (M2 + CDs expanded just 2.1 percent in 1994)
Jr an acceleration in bank lending (banking lending is down -0.4 percent over the last 2 years).

Source: J.P. Morgan, Economic Research, "Japan's Public Funds in the Stock Market,"
July 30, 1993.
6

THE "BUBBLE ECONOMY~ AND ITS AFl'ERMATB

In the area of fiscal policy, the government's consolidated budget balance has once again
moved into deficit (inclusive of social security) and the share of public sector spending has risen from
15.8 percent of GDP in 1990 to 18.8 percent of GDP in 1994. Included among these fiscal actions
have been four economic stimulus packages between August 1992 and February 1994, several
deregulation packages, and two additional economic programs in 1995.
The first of these stimulus packages was developed in August 1992 following the stock market's
fall below the 115,000 level. That package included 110.7 trillion ($125 billion) in fiscal, monetary,
and other financial measures. In April 1993, the government announced a second stimulus package
consisting of 113.2 trillion of public works spending, loans and grants to private firms, and tax
incentives for residential investment. And in September 1993, a third economic stimulus package was
developed that included deregulation measures and 16.2 trillion in additional government spending and
lending.
By early 1994, the government's fiscal authorities recognized that a even more aggressive fiscal
response was needed to offset the negative effects of asset price deflation. In February of that year
a fourth economic stimulus package was developed, this time consisting of 115.3 trillion of income
tax cuts, increased government spending, and increased lending by Japan's public sector financial
institutions.
The stimulus packages have had some impact in offsetting what could have been an even deeper
recession in Japan. Although the economy contracted 0.2 percent in 1993 and expanded only 0.5
percent in 1994, real public sector demand expanded by 8.5 percent and 5.2 percent, respectively, thus
preventing a contraction in the real economy that would have measured an additional 2 percent in the
absence of fiscal stimulus.

THE ROLE OF JAPANESE FINANCE IN THE WORLD ECONOMY:
IMPLICATIONS FOR THE UNITED STATES

INTRODUCTION
This chapter discusses the last of the four major questions posed in Chapter I: What is
the role of Japanese finance in the world economy and how does it affect U.S. economic and
financial interests?
Five areas of inquiry are reviewed in this context: (1) Japan's role as a net provider of
capital to global financial markets; (2) Japan's bilateral financial assistance to developing
countries; (3) Japan's growing financial contributions to the international fmancial institutions;
(4) the impact of Japanese capital investment in the U.S. on the development and operation of
U.S. macroeconomic policies, and (5) U.S. financial exposure to Japan's fmancial markets,
including the role of Japanese capital in fmancing recent U.S. savings-investment gaps.
ROLE OF JAPANESE FINANCE
The counterpart of Japan's large current account surpluses since the mid-1980s has been
a substantial outflow of capital from Japan. For at least the last 15 years Japan has generated
high levels of both savings and investment, with the former generally exceeding the latter so as
to produce surplus savings that were then invested abroad in the form of foreign capital
outflows.

In the 1980s, Japan's fiscal consolidation program to reduce deficits in certain parts of
the government's overall budget (Le., eliminate deficits in central government spending), while
retaining substantial budget surpluses in social security, not only offset an ongoing decline in net
private sector savings but led to an increase in Japan's net surplus of excess savings. Until the
early 1990s, this increase in public sector savings sharply boosted Japan's net capital outflows.
Since the early 1990s, net private sector savings has been on the increase whereas net public
sector savings has been declining. The net effect of these opposing trends has been a small
decrease in Japan's combined net excess of domestic savings over domestic investment, and thus
only a small decrease in Japan's still sizable capital outflows.
Japan's Capital Contributions to Global Financial Markets
Between 1985 and 1994, net private capital outflows from Japan, inclusive of net shortand long-term outflows, totaled $745.0 billion, of which net long-term outflows were $748.0
billion while net short-term inflows were $3.0 billion.
Most of Japan's net additions of private claims on foreign fmancial assets were in the
form of private sector purchases of foreign currency bonds, especially U.S. dollar-denominated
bonds. Many of these bond purchases occurred during the period 1986-89 when Japan's current
account surplus was growing rapidly and potential losses on investments resulting from U.S.
dollar depreciation were only slowly beginning to be felt. According to OEeD statistics, Japan's
life insurance companies were particularly aggressive buyers, increasing their allocations of

JAPANESE FlNANCE: IMPUCA'UONS FOR 1BE UNl1ED STAlES

foreign securities by 6.7 percent during this period. By 1990, these insurers were bumping up
against the maximum permitted ceiling on foreign securities holdings of 30 percent (29.9 percent
in 1990).
As shown in the table below, smaller shares were invested in foreign equities and in
foreign direct investments (i.e., purchases of real estate or investment in companies other than
portfolio equity investments). On the other hand, Japanese banks were net foreign borrowers,
increasing their net short-term liabilities by $181 billion while extending net long-term loans of
only $39 billion.

Net International Private Capital Transactions by 1apan
1991-94

1985-90
$ Billions

Pet of Total

$ Billions

Pet of Total

LONG-TERM CAPITAL

596.3

179.3

151.8

36.8

Net Purchase of Foreign
Bonds

421.4

126.7

184.5

44.8

Net Purchase of Foreign
Equities

110.8

33.3

-94.5

-22.9

Net Foreign Direct
Investment

164.6

49.5

74.5

18.1

39.2

11.8

-12.1

-2.9

Other Long-Term Capital

-139.5

-42.0

-0.6

-0.1

SHORT-TERM CAPITAL

-263.7

-79.3

260.3

63.2

Banking Sector

-180.6

-54.3

204.2

49.6

Other Short-Term Capital

-83.1

-25.0

56.1

13.6

TOTAL

332.6

100.0

412.1

100.0

Net Cross-Border Bank
Lending

Beginning in 1991, net long-term private investment in foreign bonds slowed
dramatically. Partly this was in response to sizable losses on investments due to currency
changes, estimated by one source at $474 billion since 198()1, and partly it was in response to
developments in bond markets which produced a significant narrowing of interest rate spreads
between yen and U.S. dollar-<ienominated bonds. From 1984-89, the average interest rate

Richard Koo, Japan's International Capital Flows, Nomura Research Institute, April
1995, pages 27 and 32.
1

100

JAPANESE FINANCE: IMPLlCATIONS FOR. THE UNITED STATES

spread between Japanese government bonds and 30-year U.S. Treasuries favored Treasuries by
375 basis points. However, between 1992 and 1994 the average yield spread in favor of
Treasuries fell to 197 basis points.
While Japanese buying interest in foreign currency bonds has tended to vary over the last
several years, alternating between years of strong bond interest and years of weak: bond interest,
most of the recycling of Japan's excess savings (or current account surpluses) since 1991 has
been in the form of net short-term capital outflows by Japanese banks. This was accomplished
mainly through a reduction in short-term bank liabilities abroad of $220 billion that was
substantially larger than the fall in Japanese bank short-term assets abroad of $26 billion.
Operationally, this meant that as interest rates declined in Japan following the collapse of the
Japanese financial bubble, Japanese banks shifted the funding of their foreign assets from foreign
to domestic sources. Another significant source of recycling in recent years has been purchases
of foreign securities by the Bank of Japan.
Japan's sizable capital exports over the last 10 years have been a substantial factor in
financing the savings-investment gaps of deficit countries. Using the sum total of current account
deficits by deficit countries as a proxy for these financing gaps, Japan's net capital outflows are
estimated to have financed 31 percent of the world's net external savings requirements between
1985 and 1993 (the last year for which comprehensive current account data are available). Roughly
80 percent of this financing was placed with OECD countries and 20 percent was placed with nonOECD countries.
In addition to providing liquidity to finance other countries' savings-investment gaps,
Japanese international financial transactions also increased the depth and liquidity of global financial
markets. In this regard, Japan's provision of excess savings to global financial markets has
contributed to lower global interest rates. In fact, in some circles in Japan the export of capital is
widely viewed as being highly beneficial to the global economic environment and an appropriate
objective of policy because of savings shortages in other parts of the world.

Japan's excess savings also represent lost export opportunities for the rest of the world.
Greater domestic absorption of Japanese savings would produce many of the same benefits through
increased exports to Japan and thus stronger income growth internationally. To the extent Japan's
large external surpluses may at times contribute to increased pressure in foreign exchange markets,
a reduction in Japan's excess of savings over investment would have the added benefit of
contributing to more stable foreign exchange rates.

Japan's Capital Contributions to U.S. Financial Markets
With respect to the United States, Japanese net investments in U.S. securities and foreign
direct investment have filled about 30 percent of the U.S. savings-investment gap since 1985. Most
of these investments have been in the form of purchases of U.S. Treasury securities (to be
discussed later in the section on The Impact of Japan's Capital Outflows on U.S. Macroeconomic
Conditions). Only small amounts have been invested in u.s. corporate bonds and in U.S. equities.
With the exceptions of 1990 and 1992, when Japanese investors sold $2.9 and $3.6 billion of U.S.
equities, Japan has been a net investor in the U.S. stock market each year since 1985.

101

JAPANESE FINANCE: IMPUCA1l0NS FOR THE UNI1ED STAll'.S

In 1992, Japan overtook the United Kingdom as the largest foreign direct investor in the
U.S. with cumulative direct investment of $96.2 billion, of which $72.8 billion has been invested
since 1986. Of this total, $33.9 billion was invested in wholesale trade operations, $21.6 billion
was invested in finance and insurance, $17.7 billion was invested in manufacturing, and $9.5 billion
was invested in U.S. real estate. Collectively, these investments produced $45.9 billion in U.S.
GDP in 1994 (0.7 percent of total U.S. GDP), employed 723,000 persons (0.6 percent of total nonagricultural employment), paid $31.1 billion in employee compensation, and invested $15.6 billion
in new productive capacity (2.5 percent of total U.S. investment in 1994 in new plant and
equipment).

Japanese Net Investments in the U.S. (1986-94)

$ Billions

Percent of Total
Net Japanese
Investment

Japanese
Investment as
a Percent of
U.S. Market

243.7

162.9

62.5

4.0

Purchases of U.S. Equities

26.4

26.2

6.8

0.4

Purchases of Corporate
Bonds

23.8

18.9

6.1

1.3

Foreign Direct Investment

96.2

12.8

24.7

21.6

Total

390.1

280.8

Stock
(4/95)
$ Billions
Purchase of U. S.
Treasury Securities &
Agencies2

Flow

Japan's F1nancial Contributions to Bilateral Development Assistance
Japanese development assistance has typically taken two forms: direct development
assistance administered through Japan's budgetary process and increased access to Japan's
fmandaI markets by multilateral sovereign borrowers, such as the World Bank and the Asian
Development Bank which have issued bonds in Japan's samurai bond market (Le., the issuance
of yen securities in Japan by foreign issuers).
Since 1985, Japan has contributed $57 billion in direct bilateral development assistance
to developing countries - accounting for 18.4 percent of total bilateral aid flows by OECD
countries between 1988 and 1992. Excluding military debt forgiveness, Japan became the
world's largest donor of bilateral official development assistance in 1991-- overtaking the United
States.
Japan's emergence as the world's largest donor of ODA partly reflects a 40 percent
increase in yen terms in Japan's budget allocations to ODA since 1985, and partly it is due to
valuation effects resulting from the appreciation of the yen.

Includes purchases by the Bank of Japan.

102

JAPANESE FINANCE: IMPUCAnONS FOR THE UNITED STATES

Countries in Asia have been on the receiving end of 65 percent of Japan's ODA
commitments since 1985, of which the largest individual recipients have been Indonesia ($7.6
billion), China ($6.7 billion), the Philippines ($4.9 billion), Thailand ($3.5 billion) and India
($2.7 billion). During this same period, Japan's ODA commitments to Africa totaled $6.6
billion (11 percent of the total) and aid to Latin America totaled $4.8 billion (7 percent of the
total).
Japanese development assistance is generally distributed in the form of loans (32 percent
of the total), which carry repayment grace periods of 10 years and charge interest rates of 1-3
percent. Grants make up 23 percent of the total, funds to international organizations 29 percent
of the total, and technical assistance the remaining 16 percent.
With respect to access to the samurai bond market by multilateral organizations,
regulations governing the issuance of securities by these organizations has been progressively
eased through expansion of ceilings on maximum issue amounts and the elimination of previous
restrictions on the frequency of issue. The first large issue by a multilateral organization was
completed in 1986 by the World Bank. In subsequent years, the World Bank has completed a
total of 14 samurai bond issues in Japan totaling l765 billion ($8 billion) and the Asian
Development Bank has completed 7 bond issues totaling l324 billion ($3.8 billion).
The growth of Japanese official development assistance outflows provide some important
benefits for both the global and the U. S. economies. The most important benefit of increased
Japanese ODA is that it increases the funds available to finance investment and growth in
developing countries. To the extent that Japan's increased assistance contributes to stronger
growth in recipient countries, the United States benefits indirectly since stronger economies are
better markets for U.S. exports. On the other hand, to the extent that the lending component
is large relative to the grant component, this assistance is less valuable to recipients.

Japan's Contributions to the International Fmancial Institutions
As Japan's financial resources have increased, so too has Japan's stake in the regular and
special operations of the international fmancial institutions (Le., the International Monetary Fund
and the multilateral development banks).
International Monetary Fund
Japan is currently the second largest creditor to the IMP, behind the United States, and
the largest creditor country when scaled for relative economic size. With a current subscription
of SDRs 8,242 million ($12.8 billion), Japan is currently tied with Germany for the secondlargest quota share. This is nearly double Japan's SDR subscription prior to the 1992 quota
increase, when Japan placed fifth in terms of quota share.
Japan has been a ready lender to the Th1F to supplement the Fund's general resources and
special fmancing arrangements, such as the Enhanced Structural Adjustment Facility, to which
Japan has extended large amounts of loans and committed 550 million SDR ($900 million) for
interest rate subsidies. In addition, Japan has established two special accounts: one for assisting

103

JAPANESE FlNANCE: IMPUCAnONS FOR 1lIE UNl'mD STA'IES

member countries through technical assistance ($33 million as of January 1995), and the other
for supporting member countries to resolve overdue obligations to the IMP ($97 million as of
January 1995).
Multilateral Development Banks
Japan is the second largest shareholder in the multilateral development banks (MOBs).
Japan is also now the largest overall contributor to the concessionalloan windows of these
institutions. Japan's share of the most recent MDB concessionalloan window replenishments
compared to the agreed U.S. share are as follows:

International Development Association (IDA)
Global Environment Facility
Fund for Special Operations of the IADB
Asian Development Fund
African Development Fund

Japan

20.0%
20.5%
39.6%
37.7%
13.7%

20.9%
21.3%
8.2%
16.2%
11.8%

The substantial appreciation of the yen has dramatically increased the U. S. dollar value
of the contributions which Japan is providing to the concessionalloan windows and has bolstered
Japan's status as the largest donor. Japan also has compiled an excellent record of timely
payment on its agreed contributions to the MDBs.

Japan's Shares in the Multilateral Development Banks
Multilateral Develogment Banks

Japan

U.S.

1985

1994

1985

1994

Hard Loan Windows:
World Bank (IBRD)
Int'l Finance Corporation
Mult'l Inv. Guarantee Agency
Inter-American Development Bank:
Inter-American Investment Corp.
Asian Development Bank:
African Development Bank:
European Bank: (EBRD)

6.6%
4.5%

1.1%

13.7%
4.7%

6.5%
7.1%
4.5%
1.1%
3.1%
21.8%
4.9%
9.0%

19.7%
25.4%

10.2%
26.0%
1.1%
33.3%
37.8%
100.0%
7.4%

19.0%

35.1%

13.7%
5.7%

17.1%
22.7%
21.6%
34.7%
25.5%
11.1%
5.9%
8.3%

SofUConcessional Loan Windows:
Int'l Development Association
Global Environment Facility
IDB Fund for Special Operations
Multilateral Investment Fund
Asian Development Fund
Japan Special Fund
African Development Fund

8.0%

2.2%

47.1%

7.4%

104

55.6%

19.2%

15.4%
14.8%
41.1%
33.3%
17.6%

5.8%

6.8%

JAPANESE FlNANCE: IMPUCA1l0NS FOR THE UNITED STATES

While financial support is not the only factor which determines members' ability to shape
MDB policies and operations, it is a particularly important element of influence. Japan has
exercised its increased fmancialleverage cautiously and selectively. As was demonstrated at the
Halifax Economic Summit, Japan, the United States, and other G-7 countries share a broad
consensus both on the crucial importance of the MDBs and on the appropriate development
priorities that these institutions should address (i.e., sound economic management, open markets,
private sector development, poverty reduction, and safeguarding the environment. Japan also
works cooperatively with the United States in ongoing efforts to maintain the fmancial integrity
of the MDBs and to improve their operational effectiveness.
Japan attaches major importance to the lessons of the East Asian experience and how the
remarkable economic progress which Japan and other countries of this region can be replicated
effectively in the design of MDB programs for other countries and regions. While the United
States subscribes to the emphasis which East Asian countries have placed on such areas as
macroeconomic stability, human resource development, the establishment of a professional civil
service, and export growth, the United States has questioned the replicability of other policy
features - such as the interventionist approach to industrial development and subsidized target
credit policies. Other policy areas of major interest to the Japanese include expanding MDB cofinancing arrangements with private and public financial institutions and, in the case of IDA,
ensuring that a substantial share of funding is allocated to the borrowing member countries of
Asia. In this context, Japan has been a strong advocate of MDB lending to China.
Japan's financial support of the IMP reflects Japan's growing stake in the international
financial system. This increased stake has had two direct effects with respect to the United
States. First, it has reduced pressure on U.S. financial resources, and second, it has resulted
in an increased voice by Japan in the operations of the IMP relative to other member countries.
Indirectly, Japan's greater stake in the international financial system has had the benefit of
enhancing Japan's appreciation of the benefits of an environment of open trade and capital flows,
and of close cooperation with other principal creditor nations on a broad range of economic
issues. This development has in turn increased Japan's willingness to contemplate a more liberal
approach to its internal structures and policies.
The Impact of Japan's Capital Outflows on U.S. Macroeconomic Conditions
Japan's international capital flows do not bear directly on the formulation of U.S.
macroeconomic policies. Macroeconomic policies are developed primarily with domestic
objectives in mind, taking due consideration of the impact of macroeconomic conditions abroad,
whether in Japan or elsewhere.
In the area of fiscal policy, Japan's investments in the United States have indirectly
benefitted the implementation of U.S. budget policy by helping fmance the U.S. savingsinvestment gap, thus allowing a lower financing cost of U.S. budget deficits and slightly smaller
budget deficits.
In the area of monetary policy, the Federal Reserve conducts its policy as guided by its
legislated mandate that specifies "maximum employment, stable prices, and moderate long-term
interest rates." In this context, developments in Japan's financial markets and Japanese

105

JAPANESE FINANCE: IMPlICAnONS FOR 1lIE UNlTED STAn:s

investments in the United States bear only indirectly on Federal Reserve monetary policy
decisions insofar as they may influence the outlook for inflation or employment. For example,
a large rise in the U.S. dollar's value in terms of the Japanese yen owing to Japanese capital
outflows reduces inflationary pressures through lower prices of imported goods from Japan or
through reduced demand for U.S. exports.
Japanese purchases of U.S. Treasury securities behave in virtually the same way and have
the same properties as do purchases of U.S. Treasury securities by domestic investors or
investors from other foreign countries. Stronger bond demand by domestic or foreign sources
tends to boost bond prices·and lower interest rates; weaker demand (or sales of securities) tends
to reduce bond prices and increase interest rates.
Investors from Japan were not the only foreign purchasers of U.S. Treasury securities
over the last decade. Purchases of U.S. Treasuries by non-Japanese foreign buyers were nearly
three-times as large as were purchases by Japanese investors. Non-Japanese investors have
purchased $433.6 billion, or 24.8 percent of newly issued U.S. government debt, since 1985.
Japanese purchases, inclusive of purchases by the Bank of Japan, totaled $162.9 billion, or 9.3
percent.
Notwithstanding Japan's increased buying presence in recent years in the U.S. Treasury
market, Japanese investors (including the Bank of Japan) still own only a small amount of total
privately-held U.S. Treasury debt outstanding: 4.0 percent.

u.s. Exposure to Jllpanese Financial Markets
This section reviews three dimensions of U. S. exposure to Japanese finance and Japan's
fmanciai markets: U.S. equity investment in Japan, U.S. bank exposure to Japan, and Japanese
investment in the U.S. With regard to the latter, the focus is on liquid investments, such as
Japanese bank lending to U.S. enterprises and Japanese investments in U.S. securities
instruments.
U.S. Equity Investment in Japan

U. S. investors have not been averse to increasing their equity stakes in Japan in recent
years. Data collected by the U.S. Department of Commerce show that as of year-end 1994, the
net equity position of U.S. investors in Japan was $66.2 billion. This estimate of the stock
position of U.S. investors reflects adjustments for price and exchange rate changes. Flow data
developed by the U.S. Securities Industry Association (SIA) , which are probably a better
indicator of U.S. demand for Japanese equities, show that since 1985, U.S. residents have made
net investments in Japanese equities of $27.3 billion. These investments in Japan's equity
market represent about 7.2 percent of total U.S. equity investment abroad since 1985. Of the
$27.3 billion invested in Japan since 1985, $25.4 billion was invested after Japan's fmanciai
bubble collapsed in 1990-91.

106

JAPANESE FINANCE: IMPUCA110NS FOR 1m UNI1ED STATES

u.s. Bank Exposure to Japan
u.s. bank exposure to Japan is a relatively small component of overall U.S. bank
lending. As of year-end 1994, U.S. bank exposure to Japan was $45.3 billion, inclusive of $29
billion in bank guarantees. This figure is 45 percent smaller than in 1987 when total U.S. bank
exposure was $65.9 billion.
U.S. banks decreased their exposure during the "bubble years" of 1988-90; then
increased their exposure in 1991 (to $59.7 billion) when temporary curbs were imposed by
Japan's Ministry of Finance on real estate lending by Japanese banks. In 1992, U.S. banks once
again reduced their exposure (to $41.2 billion). Since 1992, U.S. bank exposure to Japan has
fluctuated around $45 billion, with guarantees making up around 60 percent of the total.
The majority of U.S. bank exposure to Japan is in the form of guarantees. Of the
roughly $17 billion in loans outstanding, most of this exposure involves short-term bank credits
with maturities of 1 year or less ($11.8 billion). Only $3.6 billion involves credits with
maturities of 5 years or longer.
While U.S. bank exposure to Japan is not insignificant, neither is it as large as it was
during the height of the Japanese financial bubble. Aside from guarantees, which make up
roughly 60 percent of U.S. bank exposure to Japan, U.s. banks have generally structured their
loans to Japanese borrowers primarily with credits that can be unwound relatively quickly.
Long-term lending (i.e., loans with maturities of 5 years or longer) to Japan has been kept to
a minimum, representing less than a 10 percent claim on U.S. reporting banks' exposure in
Japan.
Measured against U.S. reporting banks' total assets, exposure to Japanese borrowers,
inclusive of guarantees, accounts for only 1.8 percent of U.S. reporting banks' assets; 16.3
percent of total overseas U.S. bank assets; and 12.6 percent of U.S. reporting banks' capital.

Japanese Investment in the U.S.
Although Japanese portfolio investment in the U.S. has increased substantially over the
last decade, it still represents a relatively small fraction of total portfolio investment in the U.S.
As of April 1995, Japanese investment in U.S. equities totaled $26.3 billion; investment in U.S.
corporate bonds totaled $23.8 billion, and investment in U.S. government securities -- including
investments in government agency issues -- by both public and private Japanese sources, totaled
$243.7 billion.
Of these totals, Japanese investment in the U.S. equity market represents only 0.4 percent
of the total capitalization of U.S. equity markets, and only 0.7 percent of the combined annual
turnover of the New York, NASDAQ, and American stock exchanges. Japanese investment in
the U.S. corporate bond market totals only 1.3 percent of U.S. private fIXed-income instruments
outstanding. And. Japanese investment in the U.S. Treasury security market, inclusive of
purchases by the Bank of Japan, represents only 4.0 percent of total privately-held U.S.
Treasury debt outstanding.

107

JAPANESE FlNANCE: IMPUCAnONS FOR THE UNIn:D STAlES

As of year-end 1994, 66 Japanese banks operated 84 branches and 46 agencies in the
United States with total assets of $403 billion (9.4 percent of total U.S. banking system assets),
of which $107 billion were in the form business loans (17 percent of business sector loans) and
$26.5 billion were in the form of real estate loans. Japanese banking activities tend to be
concentrated in two markets: California, where Japanese banks have a 22.6 percent market
share; and New York, where Japanese banks have a 25.4 percent market share. Collectively,
these two markets account for 90.5 percent of Japanese banks' assets in the United States.
This is not a measure of Japan-sourced financing, however. Japanese banks now fund
about 40 percent of their assets in the U. S. with funds raised in the U. S. Moreover, in the
highly competitive U.S. market other banks could be expected to step in if there were any
curtailing of activities by Japanese banks. As the United States moves towards full interstate
banking, any possible localized effects will be reduced.

108

VI. CONCLUSIONS
This study concludes with a summary of the main conclusions in the form of four
questions central to the issues raised by Congress.
(1)

How did the structure and practices of the Japanese financial system contribute to the
"bubble economy" of the late 1980s and its subsequent collapse?

A key characteristic of Japan's fmancial bubble in the late 1980s was Japan's excessive
reliance on monetary accommodation to slow the yen's appreciation, and continued monetary
accommodation long after the economy had adjusted to the shock of the yen's appreciation and
the economy was in a recovery trajectory. Over-reliance on monetary policy to simultaneously
boost economic growth, increase imports, and mitigate the yen's rise was engendered in part by
Japan's policy at the time to pursue a restrictive fiscal policy to eliminate deficit financing
bonds. Reliance on monetary policy led to rising asset prices, most visibly in the equity and real
estate markets.

Japan was not the only country to experience asset price inflation in the mid-to-late
1980s. Other countries, including the United States, also experienced rising stock and real estate
prices during this period, as well as some economic dislocation when real estate prices
eventually corrected for overshooting. In Japan, however, these price trends were considerably
larger than elsewhere.
Once asset price inflation got underway, certain features of the Japanese economic and
financial systems amplified price increases across asset markets. These practices included the
keiretsu system of cross-shareholding, which narrowed the scope of equities available for sale;
certain land-zoning and land-taxation policies that limited the availability of urban land for sale
during Japan's late 1980s construction boom; asset-based bank lending practices that tended to
fuel ever larger increases in liquidity once asset prices rose; and a breakdown in internal
oversight of bank lending policies because Japan's system of corporate governance tends to
emphasize internal over external control. Eventually, a general psychology took hold in Japan
that meant few questioned the proposition that prices of land and equities move in only one
direction -- up.
An appreciation of prices eventually became a bubble as prices overshot sustainable

valuations. As part of this process, substantial borrowing was undertaken by fmancial
institutions, non-financial corporations, and households to speculate in the stock and land
markets. The annual increase in household debt increased more than ten-fold; the annual
increase in non-financial corporate debt increased nearly three-fold.
The fmancial bubble eventually collapsed following a tightening of monetary policy in
1989 and 1990 that included five increases in the central bank's key lending rate in little more
than a year and a substantial slowdown in the rate of monetary growth. Higher interest rates
and constraints on lending growth eventually meant highly-leveraged speculative positions could
not be sustained. As asset prices began to fall, fITst in the equity market and later in the real

109

CONCWSIONS

estate market, a substantial amount of the collateral supporting bank loans lost value. Averse
to realizing losses on their income statements, corporate investors tended to hold rather than sell
their investments.
Following the collapse of the "bubble" and continuing to this day, the Japanese economy
and Japanese asset prices have remained weak and under pressure. The non-performing loan
problems of Japanese banks have risen. Weak balance sheets of Japanese banks and other
financial institutions in Japan have contributed to weak credit growth in the 1990s. Associated
with the fmancial bubble and its collapse were a series of financial market scandals in the
banking and securities industries.

(2)

What has the Government of Japan done to liberalize and strengthen the Japanese
financial system?

Over the last decade the Japanese fmanciaI system has undergone substantial deregulation
and liberalization. While not all of these changes address specific financial market practices and
policies associated with the bubble, many do have the effect of strengthening transparency,
pricing, and c<. ;.~petition policies within the Japanese financial system.
For example, interest rates have been fully liberalized, with the result that bank credits
now more fully reflect true market conditions. Inter-bank money markets are now more
accessible to foreign financial institutions, with funds purchased in the inter-bank money market
now bearing market-determined rates of interest. Competition in the banking and securities
sectors has increased through the addition of new financial instruments and through crossover
entry into other lines of fmancial business (via subsidiaries). New risk-management techniques
are now permitted through the availability of exchange-traded derivatives products. Restrictions
on cross-border capital flows that previously had the effect of channelling investment funds
through certain institutions and into certain fmancial instruments have been eliminated in all but
a few areas. In addition, transparency has improved with the codification into law of a large
number of administrative notices. Additional progress is underway with the gradual substitution
of a market-value accounting approach to valuing assets for Japan's traditional book-value
accounting approach.
A variety of regulatory changes also have been adopted to address many of the problems
that surfaced in the aftermath of the bubble's collapse. A Securities Exchange Surveillance
Commission was created in 1992 to oversee trading market practices in the securities market and
to recommend criminal charges against those found to be engaged in unfair and fraudulent
practices. The practice of compensating customers for losses incurred in stock market
transactions was made illegal. Certain other practices are no longer permitted, such as shifting
securities from one client's account to another client's account (i.e., tobashi) to take advantage
of different accounting periods to hide losses and "historical rate rollovers" to hide losses in the
case of adverse forward foreign exchange rate movements. In addition, rules have been changed
with respect to pricing off-market transactions, and fmes have been increased for various
fmancial- market-related infractions.

110

CONCLUSIONS

There also have been improvements in the area of corporate governance. Transparency
was improved in 1993 when the minimum amount of shares that a shareholder needed to own
in order to gain unrestricted access to a company's fmancial records was reduced. Transparency
also got a boost from new segmented disclosure requirements, new rules governing disclosure
of related-party transactions, and revisions to the take-over bid system. To improve outside
oversight, provisions were made for independent auditors and outside directors in 1992. Finally,
individual shareholder's rights were improved by changes to Japan's Commercial Code that
substantially lowered the cost of filing derivative lawsuits by shareholders.

(3)

What impact will these regulatory changes have in terms of ensuring the safety and
soundness of the Japanese financial system, that it is open to foreign capital, and that
foreign investors will be provided with a level playing field?

Throughout the late 1980s and early 1990s, a variety of changes were made to the
Japanese fmancial system to improve market access for foreign financial services fIrms. These
included permission to establish trust banking companies in Japan, access to securities licenses
by commercial banks, access to seats on the Tokyo Stock Exchange, participation in Japan's
fmancial futures market, competitive-bid access to the Japanese government bond underwriting
syndicate, and banking licenses for securities fmns. In addition, limited access was permitted
investment advisory companies to participate in the management of private pension funds in
Japan, and full access was permitted to establish a domestic investment trust company.
There are no current controls on the inflows of foreign capital into Japan, either in
Japanese equities, Japanese corporate and government bonds, or foreign direct investment. l
With the exception of certain constraints that still exist on bond interest rate structures, the use
of commercial paper issued by non-bank banks and Japanese companies, and the need to clarify
whether new types of instruments qualify as securities under the SEL, there are no other
constraints or impediments on foreign companies issuing securities in Japan to raise funds.
As a result of the February 1995 fmancial services agreement between the United States
and Japan, U.S. fund managers are now permitted to operate both a mutual fund business and
an investment advisory business within one entity, at reduced entry costs. Virtually full access
is now permitted to U. S. investment advisory companies to compete for management mandates
in the $200 billion public pension fund market, and a commitment is in place to remove, in
stages, the current ceiling on market access to the $350 billion corporate pension fund market.
In addition, past restrictions prohibiting investment advisors from offering specialized fund
management services have been eliminated, and a commitment has been made to move to a fully
market-value actuarial accounting system by 1997. Collectively, these changes will enable U.S.
fund management companies to compete for virtually all of Japan's pension fund management
business on the basis of their relative performance.

Japan's foreign direct investment regime prohibits foreign investment only in the
following four sectors: agriculture, leather, mining, and petroleum refming.
1

111

CONCLUSIONS

In the securities area, new instruments that previously were not permitted have been
approved for sale and underwriting in Japan, and new procedures have been adopted to improve
the transparency regarding the process of clarifying whether an investment constitutes, or may
constitute, a "security" under the SEL.
In the cross-border area, past restrictions on Japanese residents' access to the offshore
securities markets, both as issuer and as investor, have been removed, subject to certain
prudential qualifications.

(4)

What is the role ofJapanese finance in the world economy, and how does this affect U.S.
economic and U. S. financial interests?

The counterpart to Japan's large current account surpluses are large outflows of capital.
Net private capital outflows since 1985 have totaled $745.0 billion, of which $239.1 billion was
placed in foreign direct investment, $605.9 billion was invested in foreign bonds, and $16.3
billion was invested in foreign equity markets. On the other hand, Japanese banks were net
foreign borrowers, increasing their net short-term liabilities by $181 billion while extending net
long-term loans of $39 billion.
Collectively, Japan's net private capital outflows filled 31 percent of the savingsinvestment gaps of deficit countries during the period 1985-94.
Japan also has been a major financial contributor to the international financial institutions,
the largest donor of MDB-related concessional financing, and in recent years the world's largest
donor of official development assistance. During the Gulf War in 1990/91, Japan contributed
$13 billion in economic and financial assistance.
A significant percentage of Japan's capital outflows have been placed in the United
States, mostly in the form of purchases of U.S. Treasury securities and in foreign direct
investment. Smaller amounts have been invested in the U.S. equity and corporate bond markets.
Japanese investments in U.S. Treasury securities have been an important source of
fmancing the gap between U.S. investment and U.S. savings, providing an estimated 30 percent
of the U. S. savings shortfall. These investments have added depth and liquidity to U. S.
financial markets and have lowered the overall cost of financing government expenditures and
corporate investment.
Although the share of Japan's holdings of U.S. Treasury securities has increased
significantly in recent years, Japanese holdings of privately-held U.S. government debt, inclusive
of holdings by Japan's central bank, totals just 4.0 percent.

112

TABLE 1 - GROSS DOMESTIC PRODUCT

TABLE 1
Gross Domestic Product
Year

In Billions of
Japanese Yen

1960
1961
1962
1963
1964
1965
1966
1967
1968
1969

I16,009.7
19,336.4
21,942.7
25,113.2
29,541.3
32,866.0
38,170.0
44,730.5
52,974.9
62,228.9

$44.5
53.7
61.0
69.8
82.1
91.3
106.0
124.3
147.2
172.9

%13.1
11.7
8.8
8.5
11.4
5.7
10.4
11.0
12.2
12.1

1970
1971
1972
1973
1974
1975
1976
1977
1978
1979

73,344.9
80,701.3
92,394.4
112,498.1
134,243.8
148,327.1
166,573.3
185,622.0
204,404.1
221,546.6

203.7
231.0
304.8
414.1
459.6
499.8
561.7
691.3
971.3
1,011.0

10.2
4.3
8.2
7.6
-0.6
2.9
4.2
4.7
4.9
5.5

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

240,175.9
257,962.9
270,600.7
281,767.1
300,543.0
320,418.7
334,608.6
348,425.0
371,429.0
396,197.0

1,059.3
1,169.6
1,086.4
1,186.3
1,265.3
1,343.2
1,985.5
2,408.9
2,898.3
2,871.5

3.6
3.6
3.2
2.7
4.3
5.0
2.6
4.1
6.2
4.7

1990
1991
1992
1993
1994

424,537.2
451,296.9
463,145.3
465,972.4
469,148.7

2,932.1
3,350.1
3,656.9
4,190.4
4,589.1

4.8
4.3
1.1
-0.2
0.5

Note: Figure for 1960 is real growth in Gross National Product.
Source: Organization for Economic Cooperation and Development

In Billions of
U.S. Dollars

Real Growth
(percent)

TABLE 2 - CONTRIBUTIONS TO TOTAL OUTPUT GROwm, 1985-'13

TABLE 2
Contributions to Total Output Growth, 1985-94
(as a percentage of GDP)

1994

1985

1986

1987

1988

1989

1990

1991

1992

1993

4.0

3.6

5.0

7.4

5.8

5.1

2.9

0.3

0.0

0.9

4.3
-0.3

2.9
0.7

4.6
0.4

7.0
0.5

5.7
0.1

4.6
0.5

2.6
0.4

-0.9
1.3

-1.4
1.3

0.1
0.9

Net Exports

0.9

-1.0

-0.9

-1.2

-1.1

-0.2

1.3

0.8

-0.2

-0.4

TOTAL

0.5

2.6

4.1

6.2

4.7

4.8

4.3

1.1

-0.2

0.5

Domestic Demand
Private Demand
Public Demand

Source: Economic Planning Agency
Note: Totals may not add due to rounding.

TABLE 3 • CONSUMER PRICE INDEX

TABLE 3
Consumer Price Index
(In Percent)

Year

1945

1946

1947

1948

1949

Percent

51.1

364.5

195.9

165.6

63.3

Year

1950

1951

1952

1953

1954

1955

1956

1957

1958

1959

Percent

18.2

38.8

2.0

5.0

6.5

-1.0

0.0

3.2

-0.6

1.3

Year

1960

1961

1962

1963

1964

1966

1967

1968

1969

Percent

3.6

5.3

6.8

7.6

3.9

6.6

5.1

4.0

5.3

5.2

Year

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

Percent

7.7

6.1

4.5

9.4

8.1

4.2

3.7

Year

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

Percent

7.7

4.9

2.8

1.9

2.3

2.0

0.6

0.1

0.7

2.2

Year

1990

1991

1992

1993

1994

Percent

3.1

3.3

1.6

1.3

0.8

Sources:

11.7

24.5

11.8

Economic Statistics Annual, 1945-59.
Organization for Economic Cooperation and Development, 1960-93, National Accounts, and Economic Outlook,
December 1994.

TABLE 4· UNEMPLOYMENT RAm

TABLE 4
Unemployment Rate
(Percent of Labor Force)

Year

1960

1961

1962

1963

1964

1966

1967

1968

1969

Percent

1.6

1.4

1.2

1.3

1.2

1.1

Year

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

Percent

1-2

1.2

1.4

1.3

1.4

1.9

2.0

2.2

2.1

Year

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

Percent

2.0

2.2

2.3

2.7

2.6

2.8

2.9

2.5

2.3

Year

1990

1991

1992

1993

1994

Percent

2.1

2.2

2.5

2.9

Source: Organization for Economic Cooperation and Development.

TABLE 5 - MONEY SUPPLY

TABLES
Money Supply, Nominal and Growth Rate
(M2 plus Certificates of Deposits, Average Outstanding)
Year

In Billions of
Yen

1970
1971
1972
1973
1974
1975
1976
1977
1978
1979

1477,718
575,437
728,125
893,369
999,819
1,130,832
1,301,738
1,449,872
1,620,195
1,812,232

18.3
20.5
26.5
22.7
11.9
13.1
15.1
11.4
11.7
11.9

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

1,978,716
2,155,266
2,353,359
2,526,400
2,723,600
2,951,827
3,207,323
3,540,364
3,936,668
4,326,709

9.2
8.9
9.2
7.4
7.8
8.4
8.7
10.4
11.2
9.9

1990
1991
1992
1993
1994

4,831,186
5,006,816
5,036,241
5,089,787
5,194,212

11.7
3.6
0.6
1.1
2.1

Percentage Change
from Previous Year

Source: Bank of Japan, Economic Statistics Monthly. various issues.

TABLE 6 - OFFlClALDlSCOUNTRATE

TABLE 6
Official Discount Rate(End of Period for Year Shown)
Year

Discount Rate

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

7.25

1990
1991
1992
1993
1994

5.5

5.5
5.0
5.0
5.0
3.0
2.5
2.5

4.25
6.0
4.5

3.25
1.75
1.75

• Bank of Japan's discount rate of commercial bills
and interest rates on loans secured by government
bond, specially designated securities and bills
corresponding to commercial bills.

Source: Bank of Japan, Economic Statistics
Monthly, No. 560, November 1993, p. 22

TABLE 7 - OFFlCIAL DISCOUNT RAm ADJUSTMENTS

TABLE 7
Official Discount Rate Adjustments
Effective Date

Increase (+ )lDecrease (-)
(in Basis Points)

November 2, 1979

Level
(percent)
6.25

February 19, 1980
March 19, 1980
August 20, 1980
November 6, 1980

+100
+175
-75
-100

7.25
9.0
8.25
7.25

March 18, 1981
December 11, 1981

-100
-75

6.25
5.5

October 22, 1983

-50

5.0

January 30, 1986
March 10, 1986
April 21, 1986
November 1, 1986

-50
-50
-50
-50

4.5
4.0
3.5
3.0

February 23, 1987

-50

2.5

May 31, 1989
October 11, 1989
December 25, 1989

+75
+50
+50

3.25
3.75
4.25

+100
+75

5.25
6.0

March 2, 1990
August 30, 1990
July 1, 1991
November 14, 1991
December 30, 1991

-50
-50
-50

5.5
5.0
4.5

April 1, 1992
July 27, 1992

-75
-50

3.75
3.25

February 4, 1993
September 21, 1993

-75
-75

2.5
1.75

April 14, 1995

-75

1.00

Source: Bank of Japan, Economic Statistic Monthly, No. 568, July 1994.

TABLE 8 - LONG TERM INTEREST RATES, JAPAN AND THE U.S.

TABLE 8
Long Term Interest Rates, Japan and the United States
Japan"

United Statesb

Differential

11.5

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

8.9
8.4
8.3
7.8
7.3
6.5
5.1
5.0
4.8
5.2

13.9
13.0
11.1
12.4
10.6
7.7
8.4
8.8
8.5

+2.6
+5.5
+4.7
+3.3
+5.1
+4.1
+2.6
+3.4
+4.0
+3.3

1990
1991
1992
1993
1994

7.0
6.4
5.3
4.3
-4.4

8.6
7.9
7.0
5.9
7.1

+1.6
+1.5
+1.7
+1.6
+2.6

• Interest rate on ten year Japanese Government Bond (JGB).
b Interest rate on ten year Treasury Bond.
Source: Organisation for Economic Co-operation and Development, OECD Economic Outlook, June 1994, Annex
Table 34, p. A37, and December 1994, Annex Table 35, p. A38.

TABLE 9 - SHORT TERM INTEREST RATES, JAPAN AND THE U.S.

TABLE 9

Short Term Interest Rates, Japan and the United States
Japan-

United Statesb

Differential

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

10.9
7.4
7.0
6.7
6.5
6.6
5.1
4.2
4.5
5.4

11.4
14.0
10.6
8.6
9.5
7.5
6.0
5.8
6.7
8.1

+0.5
+6.6
+3.6
+1.9
+3.0
+0.9
+0.9
+1.6
+2.2
+2.7

1990
1991
1992
1993
1994

7.7
7.2
4.3
2.9
2.2

7.5
5.4
3.4
3.0
4.2

-0.2
-1.8
-0.9
+0.1
+2.0

Interest rate on 3 to 6 month Certificates of Deposit.
Interest rate on three month Treasury Bills.

Source: Organisation for Economic Co-Operation and Development, OECD Economic Outlook, Iune 1994, Annex
Table 34, p. A37, and December 1994, Annex Table 35, p. A38.

TABLE 10 - CALL MONEY INTEREST RATES

TABLE 10
Call Money Interest Rates
(End of Period)
Year

1986
1987
1988
1989
1990
1991
1992
1993
1994

Uncollateralized
Overnight

4.6

Collateralized
Overnight

4.1

4.4
4.0

4.4
6.7

4.1
6.5

8.3
5.6
3.9
2.4
2.3

8.3
5.5
3.8
2.4
2.2

Source: Bank of Japan, Economic Statistics Monthly. various issues.

TABLE 11 • NEW]GB ISSUES IN THE INITIAL BUDGET

TABLE 11
New Japanese Government Bond Issues in the Initial Budget
(Billions of Yen)
Fiscal Year

1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
Source: The Ministry of Finance

Construction
bonds
0
730
800
640
490
430
430
1,950
2,340
2,160
2,000
3,325
4,430
6,050
7,215
6,785
6,785
6,516
6,365
6,225
5,950
5,700
5,520
5,690
5,780
5,593
5,343
7,280
8,130
10,509
9,747

Deficit Bonds
0
0
0
0
0
0
0
0
0
0
0
3,750
4,050
4,935
8,055
7,485
5,485
3,924
6,980
6,455
5,730
5,246
4,981
3,151
1,331
0
0
0
0
3,134
2,851

Total
0
730
800
640
490
430
430
1,950
2,340
2,160
2,000
7,275
8,480
10,985
15,270
14,270
12,270
10,440
13,345
12,680
11,680
10,946
10,501
8,841
7,111
5,593
5,343
7,280
8,130
13,643
12,598

TABLE U - GENERAL ACCOUNT BORROWING REQUIREMENT

TABLE 12
General Account Borrowing Requirement
Fiscal Year"

In Trillions of I

In % of GNP

1960
1961
1962
1963
1964
1965"
1966
1967
1968
1969

0.0
0.0
0.0
0.0
0.0
0.197
0.666
0.709
0.462
0.413

0.0
0.0
0.0
0.0
0.0
0.6
1.7
1.5
0.8
0.6

1970
1971
1972
1973
1974
1975
1976
1977
1978
1979

0.347
1.187
1.950
1.766
2.160
5.281
7.198
9.561
10.674
13.472

0.5
1.4
2.0
1.5
1.6
3.4
4.2
5.0
5.1
6.0

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

14.170
12.899
14.045
13.486
12.781
12.308
11.255
9.418
7.152
6.639

5.8
5.0
5.1
4.7
4.2
3.8
3.3
2.6
1.9
1.6

1990
1991
1992
1993
1994c
1995

7.312
6.730
9.536
16.174
16.490
15.424

1.7
1.5
2.0
3.4
3.5
3.1

• Fiscal Year runs from April 1 of year shown through March 31 of the following year.
The GOJ resumed the issuance of government bonds starting in FY 1965.
Figure is on a revised basis.

b
C

Source: Organization for Economic Cooperation and Development.

TABLE 13 - GENERAL GOVERNMENT BUDGET BALANCE

TABLE 13
General Government Budget Balances
Fiscal

In Percent of GNP

1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
• Negative sign indicates a budget deficit.
b Fiscal Year runs from April 1 of year shown
through March 31 of the following year.
Source: Economic Planning Agency

1.8

0.5
0.2
2.0
0.0
-3.7
-3.6
-4.2
-4.2
-4.4
-4.0
-3.7
-3.4
-2.9
-1.8
-D. 8
-D.3

0.7
2.2
2.6
3.5
3.5

0.1
-1.1

TABLE 14 - GENERAL GOVERNMENT FINANCIAL BALANCES, JAPAN AND THE U.S.

TABLE 14

General Government Financial Balances, Japan and the United States
(as a Percentage of Nominal GDP)
United States

Year

Japan

1970
1971
1972
1973
1974
1975
1976
1977
1978
1979

1.7
1.2
-0.1
0.5
0.4
-2.8
-3.7
-3.8
-5.5
-4.7

-1.1
-1.8
-0.4
0.5
-0.3
-4.1
-2.2
-0.9
0.1
0.4

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

-4.4
-3.8
-3.6
-3.6
-2.1
-0.8
-0.9
0.5
1.5
2.5

-1.3
-1.0
-3.4
-4.1
-2.9
-3.1
-3.4
-2.5
-2.0
-1.5

1990
1991
1992
1993
1994

2.9
3.0
1.5
-1.4
-3.5

-2.5
-3.2
-4.3
-3.4
-2.0

Note: Percentages for 1970 and 1971 are of Japan's nominal GNP.
Sources: Organisation for Economic Co-Operational and Development, OECD
Economic Outlook. June 1994, Annex Table 28, p. A31 (1978-93 data), and
December 1994, Annex Table 29, p. A32 (1994 estimates).
Organisation for Economic Co-Operational and Development, OECD Economic
Outlook, June 1992, Table R14, p. 188 (1972-77 data).
Organisation for Economic Co-Operational and Development, OECD Economic
Outlook, June 1990, Table R14, p. 194 (1970-71 data).

TABLE 15 • GOVERNMENT FISCAL POSmON

TABLE 15
Government Fiscal Position - All Levels
(As a Percentage of Nominal GDP)
1984-1994

General
Government

Central
Government

Local Government

Social Security
Fund

1984
1985
1986
1987
1988
1989

-1.8
-0.8
-0.3
0.7
-2.2
-2.7

-4.0
-3.6
-3.0
-1.9
-1.1
-1.2

-0.6
-0.3
-0.2
-0.1
0.1
0.6

2.8
3.2
3.0
2.7
3.2
3.3

1990
1991
1992
1993

3.5
3.5
0.1
-1.1

-0.3
-0.2
-2.2
-2.9

0.3
-0.1
-1.1
-1.7

3.6
3.8
3.4
3.5

Fiscal Year

Source: Annual Report on National Accounts by the Economic Planning Agency

TABlE 16 - GOVERNMENT DEBT

TABLE 16
Government Debt
(As a Percentage of Nominal GDP)
Calendar

Gross

1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994

41.9
47.0
52.0
56.8
60.9
66.6
67.9
68.7
72.3
74.9
72.9
70.6
69.8
67.7
71.2
75.1
81.70

Source: Organization for Economic Cooperation and Development
o

Estimate

Net
11.3
14.9
17.3
20.6
23.1
26.0
27.1
26.7
26.4
21.5
17.9
14.9
9.6
5.4
4.4
5.80
9.20

TABlE 17 - GOVERNMENT SAVING

TABLE 17
Government Saving
(In Billions of Japanese Yen)
Year

Current
Receipts

Current
Disbursements

Balance

1960
1961
1962
1963
1964
1965
1966
1967
1968
1969

13,005
3,734
4,261
4,933
5,691
6,401
7,280
8,648
10,360
12,240

12,087.7
2,453.1
2,850.8
3,442.8
4,002.6
4,674.0
5,430.3
6,182.3
7,371.2
8,532.5

1917.3
1,280.9
1,410.2
1,490.2
1,688.4
1,727.0
1,849.7
2,465.7
2,988.8
3,707.5

1971
1971
1972
1973
1974
1975
1976
1977
1978
1979

15,127
17,454
19,906
25,273
32,825
35,648
39,248
45,770
50,064
58,308

10,296.2
11,990.5
14,357.8
17,621.5
24,376.3
30,948.1
35,949.2
41,546.2
47,174.5
53,004.2

4,830.8
5,463.5
5,548.2
7,651.5
'8,448.7
4,699.9
3,298.8
4,223.8
2,889.5
5,303.8

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

66,214
74,795
79,455
83,505
90,709
98,765
103,861
113,722
122,773
132,240

59,998.6
66,926.7
71,884.3
76,990.2
81,018.8
85,109.3
90,142.0
93,875.5
97,353.4
10,124.9

6,215.4
7,868.3
7,570.7
6,514.8
9,690.2
13,655.7
13,719.0
19,846.5
25,419.6
31,025.1

1990
1991
1992
1993

147,023
155,024
157,915
160,616

111,332.5
114,573.9
120,109.0
125,818.3

35,690.5
40,450.1
37,806.0
34,797.7

Source: Organization for Economic Cooperation and Development.

TABLE 18· HOUSEHOLD AND NATIONAL SAVING RA1ES

TABLE 18
Household and National Saving Rates
1960-1993
(In Percent)
Calendar Year
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1
1

Net Household
Saving Rate1
14.5
15.9
15.6
15.0
15.4
15.8
15.0
14.1
16.9
17.1
17.7
17.8
18.2
20.4
23.2
22.8
23.2
21.8
20.8
18.2
17.9
18.4
16.7
16.1
15.8
15.6
16.1
14.7
14.3
14.6
14.1
15.1
15.0
14.7

Net household saving as a percentage of household disposable income.
Net national saving as a percentage of net national income.

Source: Organization for Economic Cooperation and Development, National Accounts

Net National
Saving Rate1
24.8
27.2
25.6
23.8
23.7
22.3
23.2
25.6
27.9
29.2
31.0
28.4
28.1
29.3
26.7
22.4
23.0
22.5
22.9
21.8
21.0
21.2
19.8
18.7
19.9
20.9
21.0
21.4
22.7
22.7
22.9
23.3
N.A.
N.A.

TABLE 19 • GROSS SAVING RATIO· INTERNATIONAL COMPARISONS· 1991

Gross Saving Ratio

Country
Australia
Austria
Belgium
Canada
Denmark
Finland
France
Germany
Greece
Iceland
Ireland
Italy

TABLE 19
International Comparisonsl - 1991

Percentage of GDP
17.2
25.6
21.4
14.4
17.9
14.7
20.7
23.1
15.3
14.4
23.7
18.6

Japan

35.1

Luxemboug
Netherlands
New Zealand
Norway
Portugal
Spain
Sweden
Switzerland
Turkey
United Kingdom
United States

59.4
24.7
15.0
23.6
25.4
21.0
16.0
31.6
21.2

Note:

13.5
15.0

1 Defined as gross national disposable income minus private and
'government consumption, as a percentage of gross domestic
product.

Member nations of the Organization for Economic Cooperation
and Development.
2

Source: Organization for Economic Cooperation and Development, OECD
Economic Surveys 1993-94, United States (paris: Organization for
Economic Cooperation and Development, 1994), pp. 198-199.

TABLE 20 _ HOUSEHOLD SAVING RATES, JAPAN AND 1BE U.S.

TABLE 20
Household Saving Rates, Japan and the United States
(as a Percentage of Disposable Household Income)
Japan

United States

1970
1971
1972
1973
1974
1975
1976
1977
1978
1979

17.9
17.8
18.2
20.4
23.2
22.8
23.2
21.8
20.8
18.2

9.8
10.4
9.2
11.2
11.1
11.0
7.6
6.5
7.1
7.2

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

17.9
18.4
16.7
16.1
15.8
15.6
16.1
14.7
14.3
14.6

8.1
9.1
8.9
6.9
8.3
6.6
6.2
4.5
4.5
4.1

1990
1991
1992
1993
1994

14.1
15.1
15.0
14.7
14.9

4.3
4.9
5.0
4.6
4.2

Sources: Organisation for Economic Co-Operation and Development, OECD Economic Outlook. June 1994,

Annex Table 24, p. A27 (1976-93 data).
Organisation for Economic Co-Operation and Development, OECD Economic Outlook. June 1987 table R4,
p. 159 (1970-75 data).

TABLE 21 - GROSS NATIONAL SAVING RAlES, JAPAN AND THE U.S.

TABLE 21
Gross National Saving Rates, Japan and the United States
(as a Percentage of GDP)
Japan

United States

1972
1973
1974
1975
1976
1977
1978
1979

38.3
39.2
36.4
32.3
32.6
32.0
32.3
31.5

19.3
21.1
19.8
17.9
18.7
19.6
21.2
21.3

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

31.1
31.5
30.6
29.8
30.8
31.7
32.0
32.6
33.9
34.3

19.8
20.8
18.5
17.1
19.0
17.6
16.1
16.1
16.6
16.6

1990
1991
1992
1993
1994

34.6
35.1
34.0

15.6
15.7
14.6
14.9
N.A.

Note:

32.5

N.A.
Percentage for 1972 through 1975 are of Japan's nominal GNP.

Sources: Organisation for Economic Co-Operation and Development, OECD Economic Outlook, June 1994,
Annex Table 25, p. A28 (1976-92 data).
Organisation for Economic Co-Operation and Development, OECD Economic Outlook. December 1990,
Table R13, p. 187 (1972-75 data)

TABLE 22· SAVING RATE BY AGE OF HEAD OF HOUSEIIOU>, 1988 and 1994

TABLE 22
Saving Rate by Age of Head of Household, 1988 and 1994
(Percent)
1988
Age Bracket
Average
All Employees

21.1
20.3

-24

25-29

30-34

35-39

40-44

45-49

50-54

55-59

60-64

65-

10.7
11.0

9.9
7.1

21.3
18.2

18.2
19.1

25.9
24.1

19.0
17.4

17.6
16.2

22.8
27.4

31.8
30.3

18.5
23.0

13.7
13.8

15.0
12.1

15.1
15.1

20.1
17.2

28.4
36.6

27.3
14.8

1994
All Employees

18.1
15.8

17.8
19.0

15.6
15.7

12.4
14.6

12.2
12.7

Sources: Family Saving Survey 1998 and Family Saving Survey 1994, Management and Coordination Agency.

TABLE 23 - BALANCE OF PAYMENTS, 1976-79

TABLE 23
Balance of Payments, 1970-79
(In Billions of U.S. Dollars)

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

19.0
-15.0

23.6
-15.8

28.0
-19.1

36.3
-32.6

54.5
-53.0

54.7
-49.7

66.0
-56.1

79.3
-62.0

95.6
-71.0

101.2
-99.4

4.0

7.8

9.0

3.7

1.4

5.0

10.0

17.3

24.6

1.8

-1.8
-0.2

-1.7
0.3

-1.9
-0.5

-3.5
-0.3

-5.8
-0.3

-5.4
-0.4

-5.9
-0.3

-6.0
-0.4

-7.4
-0.7

-9.5
-1.1

2.0

5.8

6.6

-0.1

-4.7

-0.7

3.7

10.9

16.5

8.8

Long Term Ca~ital
BASIC BALANCE

-1.6

-1.1

-4.5

-10.0

-3.9

-0.3

-10.0

-3.2

-12.4

-12.6

0.4

4.7

2.1

-10.0

-8.6

-1.0

2.7

7.7

4.1

-21.4

Short Term Capital

0.7

2.4

2.0

2.4

1.8

-1.1

0.1

-0.6

1.5

2.4

Official Reserves, net
Errors and Ommissions
OVERALL BALANCE

0.9
0.3

10.8
0.5

-3.1
-0.6

-6.1
-2.6

1.3
-0.04

-0.7
-0.6

3.8
0.1

6.2
0.7

10.2
0.3

-12.7
2.3

1.4

7.7

4.7

-10.1

-6.8

-2.7

2.9

7.7

6.0

-16.7

Merchandise Exports
Merchandise Im~orts
TRADE BALANCE
Services
Unr~uited

Transfers

CURRENT ACCOUNT BALANCE

Note:

Negative sign indicates outflows of capital (an increase in assets or a decrease in liabilities). Totals may not add due to rounding.

Source: Bank of Japan, Balance of Payments Monthly. No. 173, December 1980.

TABLE 14 - BALANCE OF PAYMENTS, 1980-89

TABLE 24
Balance of Payments, 1980-89
(In Billions of U.S. Dollars)

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

126.7
-124.6
2.1

149.5
-129.6
20.0

137.7
-119.6
18.1

145.5
-114.0
31.5

168.3
-124.0
44.3

174.0
-IIS.O
56.0

205.6
-112.8
92.8

224.6
-128.2
96.4

259.8
-164.S
95.0

269.6
-192.7
76.9

-11.3
-1.5
-10.7

-13.6
-1.6
4.8

-9.8
-1.4
6.9

-9.1
-1.5
20.8

-7.7
-1.5
35.0

-5.2
-1.7
49.2

-4.9
-2.1
85.8

-5.7
-3.7
87.0

-11.3
-4.1
79.6

-15.5
-4.2
57.2

Long Tenn CaQital
BASIC BALANCE

2.3
-8.4

-9.7
-4.9

-15.0
-8.1

-17.7
3.1

-49.7
-14.6

-64.5
15.4

-131.5
-45.6

-136.5
-49.5

-130.9
-51.3

-89.2
-32.1

Short Term Capital

3.1

2.3

-1.6

0.02

-4.3

-0.9

-1.6

23.9

19.5

20.8

4.9
-3.1
-8.4

3.2
0.5
-2.1

-5.1

1.2

4.7
-5.0

2.J.

I.S
3.7
-15.2

0.2
4.0
-12.3

15.7
2.5
44.8

39.2
-3.9
-29.5

16.2
2.8
-29.0

-12.S
-22.0
-33.3

Merchandise Exports
Merchandise ImQorts
TRADE BALANCE
Services
Unr~uited

Transfers
CURRENT ACCOUNT BALANCE

Official Reserves, net
Errors and Ommissions
OVERALL BALANCE
Note:

5.2

Negative sign indicates outflows of capital (an increse in assets or a decrease in liabilities). Totals may not add due to rounding.

Source: Bank of Japan, Balance of Payments Monthly, No. 293, December 1990.

TABLE 2S - BALANCE OF PAYMENTS, 1990-94

TABLE 25
Balance of Payments, 1990-1994
(In Billions of U.S. Dollars)
1990

1991

1992

1993

280.4
-216.8
63.5

306.6
-203.5
103.0

330.9
-198.5
132.3

351.3
-209.8
141.5

384.2
238.2
145.9

Services
Unreauited Transfers
CURRENT ACCOUNT BALANCE

-22.3
-5.5
35.8

-17.7
-12.5
72.9

-10.1
-4.7
117.6

-3.9
-6.1
131.4

-9.3
-7.5
U9.1

Long Term Ca~ital
BASIC BALANCE

-43.6
-7.8

37.1
110.0

-28.5
89.1

-78.3
53.1

-82.0
47.1

Short Term Capital

21.5

-25.8

-7.0

-14.4

-8.9

-7.8
-20.9
-7.2

-8.1
-7.8
76.4

-0.3
-10.5
71.6

26.9
-0.3
38.4

-27.3
-17.8
20.4

Merchandise Exports
Merchandise Im~orts
TRADE BALANCE

Official Reserves, net
Errors and Ommissions
OVERALL BALANCE
Note:

Negative sign indicates outflows of capital (an increase in assets or a decrease in liabilities). Totals
may not add due to rounding.

Source: Bank of Japan, Balance of Payments Monthly, No. 338, September 1994.

TABLE26-CURRENTACCOUNTBALANCE

TABLE 26
Current Account Balance
Year

Billions of
U.S. Dollars

As a Percentage of
Gross Domestic Product

%1.0
2.5
2.2

1970
1971
1972
1973
1974
1975
1976
1977
1978
1979

$2.0
5.8
6.6

1980
1981
1982
1983
1984
1985
1986

-10.7
4.8
6.9
20.8
35.0
49.2
85.8
87.0
79.6
57.2

-1.1

35.8
72.9
117.6

1.2
2.2

1987
1988
1989
1990
1991
1992
1993
1994

~.1

~.01

-4.7

-1.0

~.7

~.1

3.7
10.9
16.5
-8.8

0.7

1.6
1.7
~.9

0.4

0.6
1.8
2.8
3.6
4.3
3.6
2.7
2.0

131.4

3.2
3.1

129.1

2.8

Sources: International Monetary Fund, International Financial Statistics Yearbook. 1993.
International Monetary Fund, International Financial Statistics Yearbook.
December 1994.

TABLE 27 - U.S.-JAPANBll.ATERAL TRADE BALANCE

TABLE 27
U.S. -Japan Bilateral Trade Balance
(Balance of Payments Basis, In Billions of U.S. Dollars)

Year

In Dollars

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

-10.4
-15.8
-17.0
-21.6
-37.0
-43.5
-54.4
-56.9
-52.6
-49.7

1990
1991
1992
1993
1994

-42.6
-45.0
-50.5
-60.5
-67.3

Note:

Negative sign indicates U.S. deficit with
Japan.

Source: Department of Commerce, Survey. of
Current Business. June 1994.

TABLE 28 - YENIDOLLAR EXCHANGE RATE. ANNUAL 1970-PRESENT

TABLE 28
YenIDollar Exchange Rate, Annual
1970 - Present
(Market Rate, Period Average)
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979

360.00
349.33
303.17
271.70
292.08
296.79
296.55
268.51
210.44
219.14

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

226.74
220.54
249.08
237.51
237.52
238.54
168.52
144.64
128.15
137.96

1990
1991
1992
1993
1994

144.79
134.71
126.65
111.20
102.23

Sources: International Monetary Fund, International
Financial Statistics Yearbook, 1993.
International Monetary Fund, International Financial
Statistics Yearbook. 1994.

TABLE 29· QUARTERLY YENIDOLLAR EXCHANGE RATE,

198~'"

TABLE 29
Quarterly Yen/Dollar Exchange Rate, 1980-94
(Market Rate, End of Period)
1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

First Quarter

249.70

211.00

246.50

239.40

224.70

252.50

179.60

145.80

125.40

132.05

Second Quarter

217.60

225.80

254.00

239.70

237.50

248.95

165.00

147.00

132.40

' 144.10

Third Quarter

212.20

232.70

269.50

236.10

245.50

217.00

153.60

146.35

134.55

139.30

Fourth Quarter

203.00

219.90

235.00

232.20

251.10

200.50

159.10

123.50

125.85

143.45

1990

1991

1992

1993

1994

First Quarter

157.20

141.00

133.20

116.35

103.15

Second Quarter

152.90

137.90

125.50

106.75

99.05

Third Quarter

137.80

132.85

119.20

105.15

98.45

Fourth Quarter

134.40

125.20

124.75

111.85

99.74

Source: International Monetary Fund, International Financial Statistics. Monthly issues.

TABLE 30· THE JAPANESE BANKING SYSTEM

TABLE 30
The Japanese Banking System:
Participants and Total Assets
Type of Bank
Commercial Banks
City Banks
Regional Banks
First Tier
Second Tier
Foreign Banks
of which U.S.
Long-Term Credit Banks

Nwnber

11*
129
(64)
(65)
90
(20)

Total Assets
(trillions of yen)
326.9
263.8
192.3
71.6
17.8
4.0
73.6

Trust Banks
Japanese-Owned
Foreign-Owned
of which U.S.
Domestic Subsidiaries

241

Credit Associations

419

106.7

Credit Cooperatives

373

29.0

Labor Credit Associations

9.8

Agricultural Cooperatives

2,500

54.5

43.0

N orinchukin Bank
1

(7)
(9)

«6»
(7)

251.9
5.9
3.5
N.A.

Total number includes Daiwa, a commercial bank with a "grandfathered" trust department.
Number of city banks will become 10 in 1996 with the merger of Mitsubishi Bank and Bank of Tokyo.

Notes:

The number of banks is as of April 1, 1994, for Japanese banks and as of year-end 1993 for foreign
banks.
Total assets for foreign banks are as of end-March 1994, and for all other institutions, as of yearend - March 1995.

Source: Department of Treasury, National Treatment Study, 1994, p. 337.

TABLE 31 - WORLD'S TOP TEN BANKS

TABLE 31
World's Top Ten Banks
(Ranked by Assets)
Rank
1.

2.
3.

4.
5.
6.
7.
8.
9.
10.

1988

1994

Dai-lehi Kangyo Bank
Sumitomo Bank
Fuji Bank
Mitsubishi Bank
Sanwa Bank
Industrial Bank of Japan
Credit Agricole
Citibank
Norinchukin Bank
Banque Nationale de Paris

Fuji Bank
Dai-Ichi Kangyo Bank
Sumitomo Bank
Sakura bank
SanwaBank
Mitsubishi Bank
Industrial Bank of Japan
Credit Lyonnais
Industrial and Commercial Bank of China
Deutsche Bank

Sources: The Banker. July 1988 and July 1994.

TABLE 32 • ASSETS UNDER MANAGEMENT BY PRIVATE lNS'ITI1.JTION

TABLE 32
Assets Under Management by Type of Private Institution
Assets Under Management By:
End of
Year

Trust
Banks

Life
Insurers

Investment
Advisors

Investment
Trust Mgrs.

Total

(yen trillion)
1987
1988
1989
1990
1991
1992
1993
1994

65.8
77.1
92.6
92.6
93.3
96.8
102.9
107.7

77.6
94.9
113.6
127.7
138.9
151.7
164.6
173.5

10.7
13.8
18.5
17.4
15.9
15.2
16.1
15.7

43.8
51.5
54.3
52.8
46.8
51.0
56.5
48.2

197.9
237.3
279.0
290.5
294.9
314.7
340.1
345.1

22.1
21.7
19.5
18.2
15.9
16.2
16.6
14.0

100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0

(% of total)

1987
1988
1989
1990
1991
1992
1993
1994

33.2
32.5
33.2
31.9
31.6
30.8
30.3
31.2

39.2
40.0
40.7
44.0
47.1
48.2
48.4
50.3

5.4
5.8
6.6
6.0
5.4
4.8
4.7
4.5

Note: Data is on an end of calendar year basis, except for Investment Advisors,
which are on a fiscal yar basis. 1994 figure for Life Insurers was as of
end-February, 1995.
Source:

Bank of Japan, "Economic Statistics," various monthly and annual
reports; Investment Trust Association.

TABLE 33 - OUTSTANDING POSTAL SAVINGS DEPOSIT ACCOUNTS

. TABLE 33
Outstanding Postal Savings Deposit Accounts
End of Fiscal Year Shown
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY
FY

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994

Source: Bank of Japan, Economic Statistics Annual

Trillions of Yen
62.0
69.6
78.1
86.3
94.0
103.0
110.4
117.4
125.9
134.6
136.3
155.6
170.1
183.5
197.3

Growth of Depositing
in Percent
(19.3)
(12.3)
(12.2)
(10.5)
(8.9)
(9.6)
(7.2)
(6.3)
(7.2)
(6.9)
(1.3)
(14.2)
(9.3)
(7.8)
(7.5)

TABLE 34 - UNREALIZED GAINS ON BANK EQUI1Y HOLDINGS

TABLE 34
Unrealized Gains on Bank Equity Holdingsl
(as a percentage of book value)
Fiscal Year

1988
1989
1990
1991
1992
1993
1994
1

Also known as "hidden reserves"

Source: Salomon Brothers

Percent

81.7
54.2

40.6
22.3
22.1
25.3

21.3

TABLE 35 - NET INCOME OF THE 21 MAJOR BANKS

TABLE 3S
Net Income of the 21 Major Banks
Fiscal Year

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994

i Billion

369
477

508
643
670
792
1,062
1,354
1,774
1,572
1,271
941
506
448

-120

TABLE 36 - PERFORMANCE STAnmCS FOR THE MAJOR 21 BANKS

TABLE 36
Performance Statistics for the Major 21 Banks
(I Trillion)
Core Operating
Profits

March
March
March
March
March
March
March

1989
1990
1991
1992
1993
1994
1995

2.4
2.2
1.9
2.4
3.2
3.2
2.8

NonPerforming
Loans

12.8
13.6
12.5

Write-offs

0.6
1.4
4.0

5.5

Source:

mCA, Salomon Bros., Nikkel.

Notes:

Non-performing loans (NPL's) = disclosed NPL's only
Write-offs include losses on sales to the CCPC.

(Loss on
Sales to
CCPC)

0.2
2.1
2.4

TABLE 37 • CORl'ORAm BOND MARKET

TABLE 37
CORPORATE BOND MARKET
- - Convertible & Warrant Bonds ----

- - Straight Bonds - Fiscal Year

Bond
Issues

(% of GOP)

Bonds
Outstanding

(% of GNP)

Bond
Issues

1,010
1,315
1,081
716
770
1,001
1,103
1,163
1,082
1,096
2,925
4,081
4,666
3,426
3,582

(% of GOP)

(Yen billion or percent)

(Yen bill or percent)
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994

(& of GOP)

Bonds
Outstanding

0.4%
0.5%
0.4%
0.3%
0.3%
0.3%
0.3%
0.3%
0.3%
0.3%
0.7%
0.9%
1.0%
0.7%
0.8%

9,009
9,830
9,947
9,724
9,551
9,461
9,443
9,629
9,959
10,098
11,938
14,896
18,703
20,913
23,236

Source: Bank of Japan, "Economic Statistics Monthly," various issues

3.7%
3.8%
3.6%
3.4%
3.1%
2.9%
2.8%
2.7%
2.6%
2.5%
2.8%
3.3%
4.0%
4.5%
5.0%

97
546
465
878
1,615
1,641
3,572
5,055
6,995
8,555
1,306
1,661
575
2,028
2,553

0.0%
0.2%
0.2%
0.3%
0.5%
0.5%
1.1%
1.4%
1.9%
2.1%
0.3%
0.4%
0.1%
0.4%
0.5%

1,150
1,498
1,775
2,376
3,680
4,661
7,844
10,314
14,046
17,655
17,559
18,780
18,575
19,197
19,903

0.5%
0.6%
0.6%
0.8%
1.2%
1.4%
2.3%
2.9%
3.7%
4.4%
4.1 %
4.1%
4.0%
4.1 %
4.3%

TABLE 38 - TOKYO STOCK EXCHANGE, FIRST SECTION

TABLE 38
Tokyo Stock Exchange, First Section
Year

Nikkei 225 Stock Average

Volwne of Share Trading

Price Earnings Ratio

(End of the Period)

(Daily Average, In miIIions of

(Times, End of Period)

shares)

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

7,116.38
7,681.84
8,016.67
9,893.82
11,542.60
13,113.30
18,701.30
21,564.00
30,159.00
38,915.87

351
371
267
349
345
414
693
946
1,020
876

20.4
21.1
25.8
34.7
37.9
35.2
47.3
58.3
58.4
70.6

1990
1991
1992
1993
1994

23,848.71
22,983.77
16,924.95
17,417.24
19,723.06

483
372
264
343
328

39.8
37.8
36.7
64.9
79.5

Sources: Bank of Japan, Economic Statistics Monthly. (as reported by Nikon Keizai Shimbum).
Bank of Japan, Economic Statistics Monthly. (as provided by the Tokyo Stock Exchange).
Bank of Japan, Economic Statistics Monthly, (as provided by the Tokyo Stock Exchange).
Tokyo Stock Exchange, Fact Book, annual issues.

TABLE 39· TOKYO STOCK EXCHANGE, TOTAL MARKET VALUE

TABLE 39
Tokyo Stock Exchange, Total Market Value
(Sum of First and Second Sections, End of Period)
Year

In Billions of Yen

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

77,075
91,906
98,090
126,746
161,812
190,127
285,471
336,707
476,850
611,152

1990
1991
1992
1993
1994
1995 (April)

379,231
377,924
289,483
324,357
358,392
309,546

Source: Tokyo Stock Exchange, 1995 Fact Book. p. 101.

TABLE 40 - JAPANESE SECURITIES COMPANIES - PROFITS AND WSSES

TABLE 40
Japanese Securities Companies - Profits and Losses
In'f'

Fiscal Yeat'

1984

422 billion

1985

560 billion

1986

860 billion

1987

2.2 trillion

1988

1.7 trillion

1989

2.3 trillion

1990

2.2 trillion

1991

700 billion

1992

-300.7 billion

1993

-483 billion

1994

-405 billion

• Fiscal year runs from April 1 of year shown
through March 31 of the following year.
b Negative sign denotes loss.

Source: Ministry of Finance.

TABLE 41 - GEOGRAPHICAL D1STRIBUl10N OF JAPANESE NET SECURITIES PURCHASES, 1980-89

TABLE 41
Geographical Distribution of Japanese Net Securities Purchases, 1980-89
(Billions of U.8. Dollars, Percentage of Total in Parentheses)
1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

U.S.

I.S
(25.5)

0.4
(6.8)

5.0
(38.3)

11.4
(42.4)

31.3
(56.4)

49.6
(49.1)

37.4
(41.3)

36.2
(40.7)

26.5
(23.3)

Luxembourg

1.4
(23.4)

1.7
(26.6)

3.2
(24.4)

6.2
(23.3)

11.7
(21.1)

24.3
(24.1)

21.2
(30.0)

25.4
(28.6)

48.1
(42.3)

U.K.

1.4
(22.6)

2.0
(32.8)

2.2
(17.0)

3.8
(14.1)

6.2
(11.2)

12.8
(12.7)

8.7
(9.6)

10.7
(12.0)

ILl

0.6
(9.7)

(-1.5)

0.2
(1.3)

(-0.1)

0.4
(0.8)

3.2
{3.2)

5.6
(6.2)

6.0
(6.8)

4.5
(4.0)

0.2
(2.7)

(-1.7)

0.0
(0.4)

0.0
(0.2)

-0.1
(-0.1)

0.1
(0.1)

0.5
(0.6)

0.8
(0.9)

0.3
(0.2)

-0.0
(-0.1)

0.1
(1.4)

0.1
(0.5)

0.0
(0.1)

0.4
(0.4)

1.0
(1.2)

0.6
(0.6)

3.9
(3.4)

0.0
(0.5)

0.0
(0.7)

0.2
(1.4)

0.9
(3.5)

0.5
(1.0)

0.1
(0.1)

0.4
(0.4)

0.9
(1.0)

1.2
(1.1)

0.1
(1.9)

1.8

0.7
(5.5)

1.6
(5.9)

1.0
(1.7)

-0.3
(-0.3)

2.4
(2.7)

1.8

(28.4)

(2.0)

l.S
(1.4)

0.8
(12.4)

0.1
(1.5)

1.1
(8.0)

2.1
(1.7)

2.2
(4.1)

6.6
(6.6)

2.5
(2.8)

1.4
(1.5)

4.8
(4.2)

0.3
(4.9)

0.4
(3.2)

0.8
(3.1)

2.1
(3.8)

4.2
(4.2)

4.8
(5.3)

5.1
(5.8)

(10.3)

West Germany

Netherlands

France

Switzerland

Australia

Canada

Others

0.1
(1.5)

~.I

~.O

Note:

13.2
55.4
26.8
101.0
6.1
6.2
90.6
88.9
(100.0)
(100.0)
(100.0)
(100.0)
(100.0)
(l00.0)
(100.0)
(100.0)
Excludes yen-denominatea foreign bonds; inclUdes foreign exchange-denominatedbonds issued in Tokyo. Negative entries indicate sales exceed purchases.

Source:

Ministry of Finance, International Finance Bureau Yearbook, (KOkuBBi Kin'yu Kyoku Nenpo).

Total

(9.8)

11.8

113.7
(100.0)

TABLE 42 - GEOGRAl'HICAL DISTRIBtmON OF JAPANESE NET SECURITIES PURCHASES. 1996-94

TABLE 42
Geographical Distribution of Japanese Net Securities Purchases, 1990-94
(Billions of U.S. Dollars, Percentage of Total in Parentheses)

1990
U.S.

1991

1992

1993

1994

-16.1
(-40.8)

15.6
(21.3)

8.8
(26.9)

21.9
(50.3)

14.4
(19.0)

32.4
(82.3)

21.4
(29.2)

-2.81
(-8.7)

-18.0
(-41.4)

41.2
(54.6)

2.0
(5.0)

14.5
(19.9)

17.1
(52.5)

16.8
(38.6)

27.2
(36.0)

-2.0
(-5.1)

0.3
(0.4)

8.1
(25.0)

17.4
(40.0)

-9.2
(-12.2)

0.2
(0.5)

0.3
(0.3)

0.1
(0.3)

-0.2
(-0.5)

-0.1
(-0.1)

5.6
(14.1)

3.3
(4.5)

2.5
(7.8)

10.0
(23.0)

8.8
(-11.7)

1.9
(4.8)

1.2
(1.6)

0.7
(2.2)

2.0
(4.6)

1.5
(2.0)

-1.1
(-2.9)

2.6
(3.5)

-1.7
(-5.3)

-4.4
(-10.1)

-0.9
(-1.2)

Canada

0.9
(2.2)

1.1
(1.4)

1.6
(4.9)

-5.8
(-13.3)

-6.3
(-8.3)

Others

5.8
(40.1)

13.0
(17.8)

-1.9
(-5.7)

3.6
(8.3)

16.5
(21.9)

Luxembourg

U.K.

West Germany

Netherlands

France

Switzerland

Australia

75.5
39.5
43.5
73.18
32.5
(100.0)
(100.0)
Total
(100.0)
(100.0)
(100.0)
Note: Excludes yen=<Ienominated foreign bonds; includes foreign exchange-denominated bonds issued in
Tokyo. Negative entries indicate sales exceed purchases. Columns may not add due to rounding.
Source: Ministry of Finance. International Finance Bureau Yearbook. (Kokusai Kin'yu Kyoku Nenpo).

TABLE 43 - INTERNATIONAL TRANSACTIONS, 1970-7'

TABLE 43
International Transactions, 1970-79
(In Billions of U.S. Dollars)

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

Current Account Balance

2.0

5.8

6.6

-0.1

-4.7

-0.7

3.7

10.9

16.5

-8.8

Long Term Capital, Net
Securities
Direct Investment

-1.6

0.2
0.3

-1.1
0.8
0.2

-4.5
-0.5
0.6

-9.8
-2.4
1.9

-3.9
-1.0
1.8

-0.3
1.5
1.5

-1.0
1.4
1.9

-3.2
-0.5
1.6

-12.4
-3.6
2.4

-12.6
-3.4
2.7

Short Term Capital, Net
Authorized Foreign
Exchange BanksOther1'

0.3

4.9

0.0

6.4

9.9

0.8

0.7

-2.3

3.7

6.4

-0.4
0.7

+2.5
2.4

-2.0
2.0

+4.0
2.4

+8.2
1.7

+1.9

+0.6
0.1

-1.7
-0.6

+2.2
1.5

+4.0
2.4

Notes: Postive sign indicates net capital inflows, or current account surplus.
- Net position of the authorized foreign exchange banks.
II Excludes transactions belonging to monetary movements.
Source: Bank of Japan, Balance of Payments Monthly, No. 173, December 1980.

-1.1

TABLE 44 - INTERNATIONAL TRANSACTIONS,I98G-89

TABLE 44
International Transactions, 1980-89
(In Billions of U.S. Dollars)

1980

1981

1982

1983

1984

1985

1986

1987

1988

Current Account Balance

-10.7

4.8

6.9

20.8

35.0

49.2

85.8

87.0

79.6

57.2

Long Term Capital, Net
Securities
Direct Investment

+2.3
+9.4
2.1

-9.8
+4.4
4.7

-15.0
+2.1
4.1

-17.7
-1.9
3.2

-49.7
-23.6
6.0

-64.5

-43.0
5.8

-131.5
-101.4
14.3

-136.5
-93.8
18.4

-130.9
-66.7
34.7

-89.2
-28.0
45.2

Short Term Capital, Net
Authorized Foreign
Exchange Banks·
Other"

16.2

8.7

-1.5

-3.5

13.3

9.9

56.9

95.7

64.0

29.4

+ 13.1
3.1

+6.4
2.3

+0.04
-1.6

-3.6
0.02

+17.6
-4.3

+10.8
-0.9

+58.5
-1.6

+71.8
23.9

+44.5
19.5

+8.6
20.8

Note:

Positive sign indicates net capital inflows or current account surplus.
• Net position of the Authorized Foreign Banks.
b Excludes transaction belonging to monetary movements.

Source: Bank of Japan, Balance of Payments Monthly, No. 293, December 1990.

1989

TABLE 45 - INTERNATIONAL TRANSACTIONS, 1990-94

TABLE 45
International Transactions, 1990-94
(In Billions of U.s. Dollars)

1990

1991

1992

1993

1994

Current Account Balance

35.8

72.9

117.6

131.4

129.1

Long Term Capital, Net
Securities
Direct Investment

-43.6
-5.0
-46.3

37.1
41.0
-29.4

-28.5
-26.2
-14.5

-78.3
-62.7
-13.6

-82.0
-48.9
17.1

Short Term Capital, Net
Authorized Foreign
Exchange BanksOtherb

7.8

-119.3

-80.0

-29.4

-31.6

-13.6
21.5

-93.5
-25.8

-73.0
-7.0

-15.0
-14.4

-22.6
-8.9

Note:

Positive sign indicates net capital inflows or current account surplus.
- Net position of the Authorized Foreign Banks.
b Excludes transaction belonging to monetary movements.

Source: Bank of Japan, Balance of Payments Monthly, No. 338, September 1994.

TABLE 46 - DIRECT AND PORTFOUO INVESTMEl'IT

TABLE 46

Direct and Portfolio Investment
(In billions of U.S. Dollars)
Year

Direct Investment

1970
1971
1972
1973
1974
1975
1976
1977
1978
1979

-.26
-.15
-.56
-1.93
-1.67
-1.53
-1.87
-1.63
-2.36
-2.66

Portfolio Investment
.25
.80
.08
-1.72
-.87
2.59
2.77
.64
-2.81
-1.23

Note: Minus sign indicates capitol outflows.
Source: International Monetary Fund, International Financial
Statistics Yearbook. 1993.

Year

Direct Investment

Portfolio Investment

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989

-2.11
-4.71
-4.10
-3.20
-5.97
-5.81
-14.25
-18.35
-34.73
-45.22

9.43
7.67
.84
-2.90
-23.96
-41.75
-102.04
-91.33
-52.75
-32.53

Note: Minus sign indicates capitol outflows.
Source: International Monetary Fund, International Financial
Statistics Yearbook. 1993.

TABLE 46 - DIRECT AND PORTFOUO INVESTMENT

TABLE 46 (CONTINUED)

Direct and Portfolio Investment
(In billions of U.S. Dollars)

Year

Direct Investment

Portfolio Investment

1990
1991
1992
1993
1994

-46.29
-29.37
-14.52
-13.64
-5.21

-14.49
35.45
-28.41
-65.71
54.67

Note:

Minus sign indicates capitol outflow. Figures for 1994
are annualized from data for the first
months of the
year.
Sources International Monetary Fund, International Financial
Statistics Yearbook. 1993.
International Monetary Fund, International Financial
Statistics. December 1994.

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•

Sheard, Paul, "Interlocking Shareholdings and Corporate Governance, " in Aoki and Dore
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•

"Sheard, Paul, "Main Banks and the Governance of Finance Distress," in Aoki and
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•

"Sheard, Paul, "The Economics of Japanese Corporate Organization and the 'Structural
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•

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•

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II

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Takao, Yoshikazu; Kwan, Chi Hung; and Kichikawa, Masayuki. "Long Term Outlook:
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Yamanouchi, Nobutoshi, and Cohen, Samuel J. "Understanding the Incidence of
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•

Yoshitomi, Masaru. Japan's Savings and External Surplus in the World Economy. Group
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•

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Stock Market. New York: Kodansha International, 1991.

ACKNOWLEDGEMENTS
This report was prepared under the direction of John L. Weeks, Director, Office of International
Banking and Securities Markets, U.S. Treasury Department; with substantive input and drafting
by Matthew Goodman, Financial Attache, U.S. Embassy, Tokyo, Japan; Robert Reynolds and
Richard Johnston, also of the U.S. Embassy, Tokyo, Japan; and Kathleen Byrne of the Office
of International Banking and Securities Markets. The entire report was reviewed by the staff
of the Office of the Financial Attache, Tokyo; including Ms. Keiko Shibuya and Mr. Shuya
Sakurai, who in addition to reviewing the text of the report, were also responsible for developing
most of the data used in the report and checking factual points for accuracy.
In addition to the above, the report also benefitted from suggestions made by the staff of the
Federal Reserve.
Special thanks go to Paulette Durham, who typed the entire report.

DEPARTMENT OF THE TREASURY
WASHINGTON

ASSISTANT SECRETARY

August 25, 199-5

The Honorable Richard Shelby
Chairman
Subcommittee on Treasury, Postal
Service, and General Government
Committee on Appropriations
United States Senate
Washihgton, D.C. 20510
Dear Mr. Chairman:
Pursuant to the Conference Report on FY 1994 Treasury Appropriations, I am pleased to
submit on behalf of the Secretary of the Treasury the "Report to Congress on Japanese
Capital Markets and Global Finance." This Report outlines the structures, operations,
practices, trends and regulations of Japanese financial markets.
As directed, the Report considers the implications of developments in Japanese frnancial
markets for the U.S. economy, the role of Japanese finance internationally and in the United
States, and the impact of Japanese fmancial flows upon U.S. macroeconomic policies. In
addition, this Report discusses the "Measures by the Government of Japan and the
Government of the United States Regarding Financial Services" recently concluded with
Japan on financial market liberalization under the U.S.-Japan Framework for a New
Economic Partnership. The "Measures" include important commitments by Japan to
liberalize fund management, securities trading and underwriting, and cross-border capital
transactions in Japan.
This Report does not constitute, and should not be considered, a comprehensive evaluation of
the health of the Japanese financial system. Nor does the Report seek to evaluate the
adequacy of the Japanese Government's response to recent problems in Japan's financial
sector.
We will continue to consult with Japan regularly to seek to ensure that the commitments it
has made are effective in securing market access in Japan for foreign financial institutions.

-2-

A copy of this report has also been sent to the Honorable Jim Lightfoot of the House
Appropriations Committee.
Sincerely,

ctf!;,f~,d ?(Li'trbn

. Linda Robertson
Assistant Secretary
(Legislative Affairs and Public Liaison)
Enclosure
cc:

Mitch McConnell

DEPARTMENT OF THE TREASURY
WASHINGTON

ASSISTANT SECRETARY

August 25, 1995

The Honorable J. Robert Kerrey
Ranking Minority Member
Subcommittee on Treasury, Postal
Service, and General Government
Committee on Appropriations
United 'States Senate
Washington, D.C. 20510
Dear Senator Kerrey:
Pursuant to the Conference Report on FY 1994 Treasury Appropriations, I am pleased to
submit on behalf of the Secretary of the Treasury the "Report to Congress on Japanese
Capital Markets and Global Finance." This Report outlines the structures, operations,
practices, trends and regulations of Japanese financial markets.
As directed, the Report considers the implications of developments in Japanese financial
markets for the U.S. economy, the role of Japanese finance internationally and in the United
States, and the impact of Japanese financial flows upon u.S. macroeconomic policies. In
addition, this Report discusses the "Measures by the Government of Japan and the
Government of the United States Regarding Financial Services" recently concluded with
Japan on fmancial market liberalization under the U.S.-Japan Framework for a New
Economic Partnership. The "Measures" include important commitments by Japan to
liberalize fund management, securities trading and underwriting, and cross-border capital
transactions in Japan.
This Report does not constitute, and should not be considered, a comprehensive evaluation of
the health of the Japanese financial system. Nor does the Report seek to evaluate the
adequacy of the Japanese Government's response to recent problems in Japan's fmancial
sector.
We will continue to consult with Japan regularly to seek to ensure that the commitments it
has made are effective in securing market access in Japan for foreign fmancial institutions.

-2A copy of this report has also been sent to the Honorable Richard Shelby of the Senate
Appropriations Committee.
Sincerely,

~i'~
7?1',A:c& 11
a~Ja
R6l5ff1son
Assistant Secretary
(Legislative Affairs and Public Liaison)
Enclosure
cc: Patrick Leahy

DEPARTMENT OF THE TREASURY
WASHINGTON

ASSISTANT SECRETARY

August 25, 1995

The Honorable Jim Lightfoot
Chairman
Subcommittee on Treasury, Postal
Service, and General Government
Committee on Appropriations
U.S. House of Representatives
Washington, D.C. 20515
Dear Mr. Chairman:
Pursuant to the Conference Report on FY 1994 Treasury Appropriations, I am pleased to
submit on behalf of the Secretary of the Treasury the "Report to Congress on Japanese
Capital Markets and Global Finance." This Report outlines the structures, operations,
practices, trends and regulations of Japanese financial markets.
As directed, the Report considers the implications of developments in Japanese financial
markets for the U.S. economy, the role of Japanese fmance internationally and in the
United States, and the impact of Japanese fmancial flows upon U.S. macroeconomic
policies. In addition, this Report discusses the "Measures by the Government of Japan
and the Government of the United States Regarding Financial Services" recently
concluded with Japan on fmancial market liberalization under the U.S.-Japan Framework
for a New Economic Partnership. The "Measures" include important commitments by
Japan to liberalize fund management, securities trading and underwriting, and cross-border
capital transactions in Japan.
This Report does not constitute, and should not be considered, a comprehensive evaluation
of the health of the Japanese financial system. Nor does the Report seek to evaluate the
adequacy of the Japanese Government's response to recent problems in Japan's financial
sector.
We will continue to consult with Japan regularly to seek to ensure that the commitments it
has made are effective in securing market access in Japan for foreign financial institutions.

-2-

A copy of this report has also been sent to the Honorable Richard Shelby of the Senate
Appropriations Committee.
Sincerely,

~~~~b?t~1~fh/'t1

~ta Ro

ertson
Assistant Secretary
(Legislative Affairs and Public Liaison)

Enclosure
cc: Bob Livingston

DEPARTMENT OF THE TREASURY
WASHINGTON

ASSISTANT SECRETARY

August 25, 1995

The Honorable Steny H. Hoyer
Ranking Minority Member
Subcommittee on Treasury, Postal
Service, and General Government
Committee on Appropriations
U.S. House of Representatives
Washington, D.C. 20515
Dear Mr. Hoyer:
Pursuant to the Conference Report on FY 1994 Treasury Appropriations, I am pleased to
submit on behalf of the Secretary of the Treasury the "Report to Congress on Japanese
Capital Markets and Global Finance." This Report outlines the structures, operations,
practices, trends and regulations of Japanese financial markets.
As directed, the Report considers the implications of developments in Japanese financial
markets for the U.S. economy, the role of Japanese finance internationally and in the United
States, and the impact of Japanese financial flows upon U.S. macroeconomic policies. In
addition, this Report discusses the "Measures by the Government of Japan and the
Government of the United States Regarding Financial Services" recently concluded with
Japan on fmancial market liberalization under the U.S.-Japan Framework for a New
Economic Partnership. The "Measures" include important commitments by Japan to
liberalize fund management, securities trading and underwriting, and cross-border capital
transactions in Japan.
This Report does not constitute, and should not be considered, a comprehensive evaluation of
the health of the Japanese fmancial system. Nor does the Report seek to evaluate the
adequacy of the Japanese Government's response to recent problems in Japan's financial
sector.
We will continue to consult with Japan regularly to seek to ensure that the commitments it
has made are effective in securing market access in Japan for foreign fmancial institutions.

-2-

A copy of this report has also been sent to the Honorable Jim Lightfoot of the House
Appropriations Committee.
Sincerely,

~ilJcd 7(J<t.t!;/I}

~:a Robertson

Assistant Secretary
(Legislative Affairs and Public Liaison)
Enclosure
cc:

David Obey

DEPARTMENT

THE

TREASURY

NEWS
OFFICE OF PUBliC AFFAIRS • 1500 PENNSYLVANIA AVENUE, N.W .• WASHINGOON, D.C .• 20220 • (202) 622-2960

FOR IMMEDIATE RELEASE
August 25, 1995

Contact: Michelle Smith
(202) 622-2960

TREASURY RELEASES INTERIM FOREIGN EXCHANGE REPORT
The Treasury Department on Friday released an Interim Report to Congress on
International Economic and Exchange Rate Policy, which reviews developments in the major
industrial economies and the exchange markets, and analyses the foreign exchange systems
and policies of Korea, Taiwan and China.
This interim report, which is provided under the Omnibus Trade and Competitiveness
Act of 1988, covers the period between the seventh annual report to Congress of December
1994, and May 31, 1995.
The report notes that the dollar stabilized in late April and May, following the release
of the April 25 Communique of the G-7 Finance Ministers and Central Bank Governors,
which called for the "orderly reversal" of recent exchange rate movements and reaffirmed the
commitment of the G-7 to "continue to cooperate closely in exchange markets." Since the
end of the period covered by the report, the dollar has appreciated significantly against the
yen and the mark, and U.S. monetary authorities have intervened in the exchange markets on
three occasions in cooperation with other members of the G-7.
The report found that global expansion strengthened in 1994, as most of the major
industrial countries experienced strong growth, and inflation was reduced to rates not seen in
30 years in many cases. In 1995 the pace of growth has slowed, but expansion appears
sustainable in most countries.
In this interim report, Treasury has reexamined the systems and policies of Korea,
Taiwan and China, which have been identified in some previous reports as having
manipulated the exchange rate between their currency and the U. S. dollar in order to prevent
effective balance of payments adjustment or to gain an unfair advantage in international trade.
As in the December annual report, it is Treasury's judgment that, at the current time,
neither Korea nor Taiwan is manipulating the exchange rate between its currency and the
U. S. dollar. However, Treasury continues to monitor closely certain financial and foreign
exchange policies in both economies, particularly capital controls, which have the potential to
impede the operation of market forces in exchange rate determination.
RR-533
(Cont.)
For press releases, speeches, public schedules and official biographies, call our 24-hour fax line at (202) 622-2040

It is also Treasury's determination that China is not currently manipulating its
exchange system to prevent effective balance of payments adjustment and gain unfair
competitive advantage. As noted in the last report, major strides were made in reforming
China's foreign exchange system in 1994. China should take advantage of its strong balance
of payments situation to implement additional steps to liberalize its foreign exchange regime
and provide meaningful market access for goods and services.
-30-

UBRAP,( HOOM 5310

SEP

IS5000l85

DEPT OF THE TfiEASURY

DEPARTMENT OF THE TREASURY
INTERIM REPORT TO THE CONGRESS
ON
INTERNATIONAL ECONOMIC AND
EXCHANGE RATE POLICY
AUGUST 1995

Embargoed for Release until
5:00 p.m., August 25, 1995

TABLE OF CONTENTS

Summary and Conclusions

Global Economic Developments

Economic Situation in the G-7 Countries

Developments in Major Currency Markets

U.S. Balance of Payments Developments

Actions under Section 3004

Korea and Taiwan

China.

Appendix:

T ext of Sections 3004 - 3006 of the Omnibus Trade and Competitiveness Act
of 1988.

SUMMARY AND CONCLUSIONS
This interim report addresses recent developments in U.S. international economic policy,
including exchange rate policy, since the seventh annual report to Congress of December
1994. The Report primarily covers information available through May 31, 1995. This report
is required under Sections 3004 and 3005 of the Omnibus Trade and Competitiveness Act of
1988 (Trade Act). Developments in Mexico are not discussed in detail because they are
treated extensively in other reports.
The global expansion strengthened in 1994. Most of the major industrial countries
experienced strong growth, with inflation reduced to rates not seen in 30 years in many cases.
In 1995 the pace of growth has slowed, but expansion appears sustainable in most countries.
The consensus of private forecasters is that aggregate G-7 growth will moderate from just
above 3 percent in 1994 to about 2 112 percent this year and next, with weakness in Japan
standing out as an exception to a generally positive outlook. G-7 inflation should reach the 2112 to 3 percent range in 1995 and 1996, up from 2 114 percent in 1994.
Weak conditions in Japan cast a shadow over an otherwise favorable outlook. Real GDP
declined in the fourth quarter and was essentially flat in the first quarter of 1995. Market
commentary cites a confluence of factors, all working to dampen the outlook: asset and goods
price deflation contributing to high real interest rates, weak bank balance sheets, an overhang
of investment from the late 1980s and the appreciation of the yen. The consensus is for very
low growth in 1995-96.
The first half of 1995 was a period of significant movement in all the major currencies.
Measured on a real, trade-weighted basis, the dollar declined 4 112 percent between October
1994 and May 1995, while the real mark and yen moved up 6 percent and 10 percent
respectively. The aggregate movement in the dollar masked sharply divergent movements
against the currencies of our key trading partners, as the dollar declined by 13 percent against
the yen and 6 percent against the DM, while appreciating against the Canadian dollar and the
Mexican peso. The dollar reached all-time lows of DM1.345 on March 8th and ¥79.75 on
April 19th, before stabilizing above these lows after the April 25 G-7 meeting.
Market participants attributed the dollar's decline and the appreciation of the mark and
yen to several factors. In the United States, there was a shift in expectations about the
outlook for Federal Reserve policy, along with indications the economy was slowing, and
renewed concern about the U.S. current account deficit. The mark was affected by
expectations of firm Bundesbank monetary policy and by concerns about inflation and fiscal
developments in some European countries. InJapan, the yen was affected by deflation,
economic weakness, and continuing concern about reduction of the current account surplus.
The decline in the dollar during this period was a source of concern to the Administration
and to the Federal Reserve, who intervened in the exchange markets on several occasions. At
the April 25 G-7 meeting, Ministers and Central Bank Governors "expressed concern about
recent developments in exchange markets". Further, they agreed that "recent developments

have gone beyond the levels justified by underlying economic conditions in the major
countries... [and]..that an orderly reversal of those movements is desirable, would provide a
better basis for a continued expansion of international trade and investment, and would
contribute to our common objectives of sustained non-inflationary growth". They also agreed
to strengthen efforts to reduce internal and external imbalances and to continue to cooperate
closely in exchange markets.
The U.S. trade and current account deficits widened further in 1994, as growth in the
United States exceeded that in its major trading partners. The robust U.S. expansion
contributed to a strong increase in imports. Increases were particularly strong in capital goods
and autos and parts. Export growth also continues to be robust, with double digit growth to
the G-7 industrial countries and Latin America.
For 1995, we expect a modest further widening in the U.S. trade and current account
deficits. The 1995 current account deficit is expected to be on the order of 2 112 percent of
GDP, as suggested in the previous Report. Looking beyond 1995, the U.S. competitive
position remains exceptionally strong and, at a minimum, the external deficit should begin to
decline as a share of GDP. But the outlook for 1996 depends heavily on prospects for a
sustained and strengthened recovery in the other industrial countries. With continued
expansion abroad, the trade and current account deficits should decline in absolute terms.
In this interim Report, Treasury has reexamined the systems and policies of Korea,
Taiwan and China, which have been identified in some previous reports as having
manipulated the exchange rate between their currency and the U.S. dollar in order to prevent
effective balance of payments adjustment or to gain an unfair advantage in international trade.
As in the December annual report, it is Treasury's judgment that, at the current time,
neither Korea nor Taiwan is manipulating the exchange rate between its currency and the
U.S. dollar for such purposes. However, Treasury continues to monitor closely certain
financial and foreign exchange policies in both economies, particularly capital controls, which
have the potential to impede the operation of market forces in exchange rate determination:

Treasury continues to engage Korea on further liberalizing its financial sector, and on
easing foreign exchange and capital controls which inhibit market forces from fully
determining the exchange rate. Discussion of these issues has taken place in bilateral
Financial Policy Talks, and in the context of the WTO negotiations on trade in financial
services. The U.S. is also encouraging liberalization in the context of discussions of
Korea's proposed membership in the OECD.

Treasury is also negotiating with Taiwan on further liberalization of its financial sector,
principally in the context of Taiwan's WTO accession negotiations. Of note since the last
report, Taiwan authorities moved in January to liberalize the rules governing forward
foreign exchange contracts and swaps further, and are reportedly considering a plan to
raise the cap on foreign ownership of listed shares and to remove the prohibition on

3
individual investors participating in the Taipei Stock Exchange. However, Treasury
remains concerned about significant remaining controls, and will continue to press
Taiwan to remove foreign exchange and capital controls that may impede market forces
from fully determining the exchange rate.
China has registered large increases in its global trade surplus and its bilateral trade
surplus vis-a-vis the United States in the first half of this year. High savings and efforts to
restrict credit have bolstered an already strong external position. At the same time, recent
renminbi appreciation, especially in real terms, and relatively high economic growth in China
are factors that are contributing to strong growth in U.S. exports to China. Nonetheless,
China's growing current account surplus is a concern and bears continued close observation.
Since 1992, China has taken important steps toward opening its market to U.S.
companies, but multiple overlapping barriers to trade continue to frustrate market access for
U.S. goods. Through bilateral and multilateral channels the Administration is pressing China
to provide meaningful market access for goods and services. These include the 1992 U.S.Sino Memorandum of Understanding on Market Access and China's accession to the WTO.
It is Treasury's determination that China is not currently manipulating its exchange
system to prevent effective balance of payments adjustment and gain unfair competitive
advantage. This report reiterates the conclusion of the prior Treasury report. As noted in
that report, major strides were made in reforming China's foreign exchange system in 1994.
China should take advantage of its strong balance of payments situation to implement
additional steps to liberalize its foreign exchange regime. Such steps should include a
commitment to current account convertibility as soon as possible, eliminating restrictions on
access to China's foreign exchange markets, and eliminating foreign exchange balancing
requirements.

GLOBAL ECONO:MIC DEVELOP1\1ENTS
A. Economic Situarion in the G-7 Countries

Recovery Firms, Except in Japan
The global recovery continued in 1994, with the weakness in Japan standing out as an
exception to a generally positive outlook. Table 1 below shows projections by the
International Monetary Fund, the Organization for Economic Cooperation and Development
and Consensus Economics (an average of private sector forecasts) for 1995 and 1996.
Table 1
G-7: Real GDP Growth
rio change year/year)

United States
Japan
Germany*
France
Italy
United Kingdom
Canada

4.1%
0.5
2.9
2.8
2.2
3.8
4.5

1996F
1995F
IMF OECD Consensus IMF OECD Consensus
2.4%
1.9% 2.3%
3.2% 3.2% 3.0%
1.5
3.5
2.3
1.3
1.0
1.8
2.7
2.7
2.9
3.3
2.9
3.2
3.0
3.2
2.9
3.0
3.0
3.2
2.7
3.0
2.9
2.9
3.0
3.0
3,4
2.8
3.1
2.8
3.0
3.2
3.4
2.5
2.6
2.9
3.9
4.3

Total G-7

3.1

3.0

1994

* All

2.8

2.6

2.4

Germany; F=Forecast

Sources:

IMF, World Economic Outlook, May 1995; OECD Economic Outlook, June
1995; and Consensus Economics, Consensus Forecasts, June 1995

Where the recovery first took hold -- the United States, Canada and the United Kingdom
-- the expansion has matured, and growth slowed in the first half of 1995. These slowdowns
were generally more sharp than anticipated. Nonetheless, in each case, the outlook is for a
rebound in growth this year and next, but at a slower and more sustainable rate than in 1994.
In contrast, in Continental Europe, where the expansion began later, growth is expected
by most forecasters to be as strong as or stronger this year than in 1994. Growth in Germany
is expected in the 2 1/2-3 percent range, although delays in publishing data make the current
economic conditions in Germany difficult to gauge. Growth in France and Italy remained
solid in early 1995.

5
Japan's recovery has taken a disappointing tum. After a strong third quarter in 1994, real
GDP declined sharply in the fourth quarter and barely rose in the first quarter of this year.
Indicators still point to positive growth, but at a very low rate, in 1995. A number of factors
are at work:
o

Consumer and producer price deflation is contributing to slow growth in incomes and
means that interest rates -- while low in nominal terms -- are high in real terms for this
stage of the cycle.

Weak balance sheets of the financial institutions and a growing bad loan problem suggest
that banks will act cautiously in extending new credit.

The rise of the yen earlier this year against all major currencies -- not just the dollar - is
contributing to a weaker outlook by leading to a markdown in export prospects and
discouraging investment spending in Japan by industries focused on trade.

Between December 1994 andJune 1995 the yen rose in real trade-weighted terms (I.e.,
against the currencies of all Japan's trading partners and after allowance for differences in
national inflation rates) by 11 percent, bringing the rise since the end of 1992 to 27 percent.
The yen at this level has significant effects on Japan's exports and investment in export
industries, encouraging adjustment of Japan's large external surplus but leaving growth
prospects all the more dependent on a strong recovery in domestic demand.
Prospects for Continued Low Inflation
Industrial country inflation continues to be low, with aggregate rates of increase in
consumer prices among the lowest in 30 years. Last year G-7 inflation averaged 2 1/4
percent, and should reach only the 2 112 to 3 percent range in 1995 and 1996 (Table 2).
The outlook for inflation is well grounded. The decline in long-term interest rates in
most G- 7 countries in recent months is partial evidence of a decline in inflation expectations.
In addition, the gap between the levels of actual and potential output remains sizeable in most
countries. (See Table 3 for IMF estimates.) Hence, economies below potential can continue
to grow for some time above their long-run potential rate of growth without experiencing
inflation pressures. The moderate pace of the expansion and the shift in momentum from
countries recovering earlier to the Continental countries have helped to prevent undue
pressure on supply in anyone country, thereby containing inflation pressures. In the United
States, the slowing of growth will favor continued moderation of wage and price increases, in
line with recent data and private sector forecasts.

6
Table 2

G-7: Consumer Price Inflation
(>fa change year/year)
1994
United States
japan
Germany*
France
Italy
United Kingdom
Canada

2.6°/0
0.7
3.0
1.7
3.9
2.5
0.2

1995F
IMF
Consensus
3.1%
3.1%
0.3
0.2
2.0
2.2
2.0
2.1
5.2
5.1
2.9
3.5
2.0
2.4

Total G-7

2.2

2.5

* western Germany for Consensus;
Sources:

2.6

1996F
IMF
Consensus
3.5%
3.4°10
0.7
0.4
2.0
2.5
2.0
2.5
4.2
4.6
2.8
3.5
1.9
2.5
2.7

2.8

F=Forecast

IMF, World &onomic Outlook, May 1995; and Consensus &onomics,
Consensus Forecasts, june 1995.

Table 3

G-7: Out12ut Ga12s
rio of potential GDP)
1994

1995

1996

United States
japan
Germany
France
Italy
United Kingdom
Canada

0.5°/0
-6.0
-2.1
-3.4
-2.5
-3.0
-2.5

1.2%
-6.4
-1.8
-2.5
-1.6
-2.0
-1.0

0.8°/0
-5.3
-1.3
-1.8
-0.8
-1.4
-1.0

Total G-7

-1.8

-1.3

-l.1

Source:

IMF, World Economic Outlook, May 1995

7
Cautious Monetary and Fiscal Policies
Monetary policy in the G-7 has reflected the differing conditions in the major countries.
In the Uni ted States, monetary policy has been directed toward keeping inflation low while
sustaining recovery. The Federal Reserve increased both the Federal Funds target and the
discount rate on February 1. After that, with inflation measures indicating that inflation
remains under control, and with some signs of slowing in the economy, market sentiment
shifted toward an expectation of future interest rate cuts. [On Ju& 6, the Federal Reserve
lowered the Federal Funds target hy 1/4 percentage point, to 5 3/4 percent.]
In Germany, the Bundesbank cut the discount rate by half a point at end-March. The
Bundesbank move was seen as a response to the weakness in domestic demand, continued
declines in inflation, and below target money growth. French official interest rates have also
fallen this year. With some concern about higher inflation risks, the Bank of Italy has twice
raised interest rates this year, while the Bank of England increased the base rate in February.
Canadian market interest rates rose sharply in early 1995, but are now below their peaks.
In Japan, with various measures showing declining price levels and with output growth
weak, the Bank of Japan cut the discount rate to 1 percent and overnight call money rates to
about 1 1/4 percent. [Another cut in the call rate, to 0.85 percent, was made on July 7.]
But real interest rates remain fairly high, given the slack in the economy.
Fiscal poliq has become more restrictive in most G-7 countries. The restrictive
movement in fiscal policy is indicated by an improvement in estimated "structural" budget
balances (I.e., the fiscal position is estimated by abstracting from the normal cyclical
movements in revenues, expenditures, and GDP). Since the upturn is also reducing budget
deficits by the revenue-increasing action of cyclical forces, the shift in actual budget deficits
will be larger -- from 4.1 percent of G-7 GDP in 1993 to 3.2 percent this year and 2.9
percent by 1996, according to IMF estimates. The GEeD Secretariat's estimates yield a
similar conclusion. The tightening outside Japan will be even greater. In Japan, the
authorities approved an economic program on April 14 which involved modest additional
spending for public infrastructure. Another supplemental budget is expected in the fall.
In the United States, the Administration has made it clear that it is committed to further
deficit reduction, building on the major reductions in the budget deficit that were
accomplished in the first two years of the Administration. In early June, the President
submitted a economic plan that would balance the budget over 10 years.
External Account Developments
Japan's trade and current account surpluses have begun to decline, but they remain high.
The current account surplus measured in yen -- and as a share of GDP -- peaked in 1992.
Because of the yen's rise against the dollar, however, the surplus in dollar terms continued to
rise for some time, beginning its decline only in the latter part of 1994. For 1994 as a whole,
the surplus fell nearly 10 percent in yen terms, but less than 2 percent in dollar terms. The

first four months of 1995 showed further declines by both measures (fable 4). Volume
measures also have begun to adjust. While import volumes rose very little in 1993, the gain
was 10.6 percent in 1994. Export volumes were also up, though moderately: 3.5 percent in
1994, reflecting strong growth in Japan's trading partners.
Some further reduction in Japan's current account surpluses is expected in 1995 and
1996, although the pace and the extent of the adjustment will be affected by the pace of
domestic demand growth and the tendency for the price effects of exchange rate changes to
offset in the short-term the change in volumes. The substantial rise in the yen in tradeweighted terms will work through to lower surpluses with a lag. At first, lower import prices
will simply lower the yen costs of imports, given customary time lags in adjustment of imports
curve effects). In addition, even lower surpluses in yen terms could have a higher dollar
value, because each yen is worth more in dollars (translation effects).

Strong German growth and the continued rebuilding of eastern Germany will result in
somewhat higher German current account deficits in 1995-96. Declining net inflows of
investment income, stemming from cumulative deficits (since 1991), are also affecting the
current account. France and Italy will continue to register surpluses, sizeable in relation to
GDP in the latter case. Canada's deficits should be falling as growth slows, while the UK will
register essential balance.
The U.S. current account deficit is expected to continue to rise this year, but is projected
to level off in 1996 as U.S. growth slows relative to that in Europe. Exports to Mexico will be
weak this year, but should recover in 1996 as the Mexican economy turns around. (For a
more detailed discussion of U.S. current account prospects, see Section C.)

9
Table 4
G-7: Current Account Balances
($ billions; % of GDP in parentheses)
1994
United States
Japan
Germany
France
Italy
United Kingdom
Canada

-151
129
-21
10
15
-0
-18

(-2.2)
(2.8)
(-1.0)
(0.7)
(1.3)
(-0.1)
(-3.3)

Total G-7
F=Forecast

-36

(-0.3)

Sources:

1995F
IMF
Consensus
-178 (-2.5)
-169
130 (2.5)
117
-26 (-1.1)
-18
10 (0.7)
10
23 (2.2)
17
-3 (-0.2)
1
-11 (-2.0)
-14
-56 (-0.3)

-56

1996F
Consensus
IMF
-179 (-2.4)
-151
128 (2.3)
87
-33 (-1.3)
-17
6
11 (0.7)
28 (2.5)
21
-1
-2 (-0.2)
-13
-11 (-1.8)
-60 (-0.3)

-68

IMF, World Economic Outlook, May 1995; OEeD, Economic Outlook,June 1995;
and Consensus Economics, Consensus Forecasts,June 1995

10
B. DeveIopu:::ilts in ~or Cmrency Madets
The period from October 31, 1994 to May 31, 1995 was a time of significant movements in
virtually all currencies. The dollar declined 12.7 percent against the yen and 5.8 percent versus the
mark.

CHART 1

CHART 2

$IOM Exchange Rate

SlYen Exchange Rate

1.6

105

1.55

100

1.5

1.45

1.4

12-Dec

31.()d~

1.~-Oct-84

12-Oec: 23-Jan-96 O$-Mar

17-Apr

23-Jan~

CJ6.Mar

17. . .

29-May

1.35

29-May

On a trade-weighted basis, as shown in Chart 3 however, the dollar's decline was more moderate,
losing 4.4 percent over this time period. This decline brought the dollar to the lower end of the
ranges in which it has been trading over the past seven years on a trade weighted basis (Chart 4). In
contrast, the mark and especially the yen moved well above their historic trading ranges on a trade
weighted basis.

CHART 3

Real Broad Trade Weighted Exchange Rate Indices
January 1994 to May 1995
120
g 115
...II 110
~
~ 105
...~ 100
~ 95

-g 90
85

.,
..a.-

---..

... -.
.. - - . _. _.

.....-_............

-......- .... _..

Jan 94

Apr

Jul

~.'
-,;,;1""..... .- ...... .

-.........

..., ..__.....
I

Oct

Jan 95

Apr

120
115
110
105
100
95

90
85

Dollar DM Yen
-....

Source: JP Morgan; 1990 trade weights of 22 OECD and 23 Developing Countries.
Monthly Average

The yen rose 12.7 percent in nominal terms on the dollar and 7.3 percent against the mark, as
Japan faced deflationary forces in conjunction with a stubborn current account surplus. The yen rose
9.9 percent in real trade-weighted terms (Chart 3). The Deutsche mark appreciated by 7.8 percent
on a real trade-weighted basis, in large measure due to the weakness of other European currencies.

CHART 4

Real Broad Trade Weighted Exchange Rate Indices
January 1985 - May 1995

8 160
. 160
"; 140 t - - - - - - - - - - - - - - t : :..:-,.-:::-..T.~H.' 140
m120
•
120
..,; 100~~------~~-----------4100
...
..

...

" ..,..

)(

]

.'__""_.--."~---""""--~"_'"

Jan-85 Jan-87 Jan-89 Jan-91 Jan-93 Jan-95
Dollar OM

Yen

Source: .P Morgan; 1990 trade weights of 22 OECD and 23 Developing Countries.
Monthly Average.

Market participants attributed these developments in the major currencies to several specific
factors:
o In the United States, a shift in expectations regarding the outlook for Federal Reserve policy
followed the FOMC's rate hike on February 1st of 50 basis points. As indications of a slowing
economy began to develop, earlier expectations that the Fed would tighten further dissipated. The
market focus turned to narrowing interest rate differentials between the U.S. and Gennany.
o Concern about the sustainability of the U.S. current account deficit increased, in part because of
the adjustment required in the wake of the Mexican financial crisis.
o Outright price level declines in Japan meant a small trend appreciation of the yen was consistent
with an appreciated real exchange rate. Weakness in the Japanese financial sector resulted in
capital repatriation to bolster Japanese balance sheets. Moreover, as growth in domestic demand
weakened again, pessimism over the prospects for a reduction in japan's current account surplus
continued to put upward pressure on the yen.

12
o In Germany, early in the year, wage talks with a key labor union suggested some inflationary
pressure, which initially contributed to the market's expectation of a steady Bundesbank policy in
the near term. Meanwhile, fears over worsening fiscal deficits, increasing inflation, and political
uncertainty in various European nations caused what some journalists termed a "flight to quality"
out of those currencies and into the German mark. This factor, along with the initial outlook for
Bundesbank policy, contributed to the significant rise in the mark's value.
At times, exchange rate movements were accentuated by technical factors, and the dollar hit alltime lows of DM 1.3450 on March 8th and Y 79.75 on April 19th.

The doDar stabt1in-d at the end of Api!. Among the factors cited by market participants as
contributing to this development are the following:
o The prospect of deeper fiscal consolidation in the United States, building on significant progress at
deficit reduction already achieved in this Administration, contributed to increased investor
confidence in U.S. assets.
o As growth slowed in the United States more quickly than had been expected, confidence increased
that inflation would remain low and prospects improved for a more rapid improvement in our
current account imbalance.
o As the economic outlook deteriorated in Japan and concerns emerged about a possible slowdown
in the pace of growth in Europe, interest rates in those markets fell, widening the differentials in
favor of U.S. assets.
o Substantial rallies in the U.S. debt and equity markets during this period induced further demand
for dollars by foreigners.
On April 25, the G-7 Finance Ministers and Central Bank Governors issued the following
statement on exchange rates:
"The Ministers and Governors expressed concern about recent developments in exchange markets.
They agreed that recent movements have gone beyond the levels justified by underlying economic
conditions in the major countries. They also agreed that an orderly reversal of those movements
is desirable, would provide a better basis for a continued expansion of international trade and
investment, and would contribute to our common objectives of sustained non-inflationary growth.
They further agreed to strengthen their efforts in reducing internal and external imbalances and to
continue to cooperate closely in exchange markets."
Exchange Rate Policy
Between October 31, 1994 and May 31, 1995, the U.S. monetary authorities -- in concerted
intervention operations with the G-7 partners -- intervened in the exchange markets during four
different periods.

13
o On November 2nd and 3rd, the U.S. monetary authorities intervened, buying dollars against the
Japanese yen and German mark. Secretary Bentsen stated, "I believe that the recent movements
in the dollar are inconsistent with the fundamentals of a strong, investment-led recovery in the
United States ... Continuation of recent foreign exchange trends would be counterproductive for the
United States and the world economy."
o The next round of intervention was on March 2-3. On the second day of intervention, Treasury
Secretary Rubin stated, "A strong dollar is in our national interest. That is why we have acted in
the markets in concert with others. The Administration is continuing its work on strengthening
economic fundamentals including bringing down the budget deficit further."
o During the first week in April, the U.S. monetary authorities intervened early in the Asian session
on April 3rd, later in the New York trading session on the same day, and on April 5th. On April
3rd, Treasury Secretary Rubin noted that, "We acted in the exchange markets overnight out of
concern with recent movements in exchange rates." Following the last round of intervention, he
also added that the G-3 "expressed their view that a strong dollar is in the most general interest of
the economies of the world .... In effect, you have a shared commitment to a stronger dollar."
o The U.S. monetary authorities intervened to support the dollar on May 31st. These purchases of
dollars against the yen and mark were accompanied by Treasury Secretary Rubin's comments
that, "We acted in the exchange markets this morning consistent with the exchange rate objectives
expressed in the April 25 G-7 Communique. We are prepared to continue to cooperate in
exchange markets as appropriate.
II

By the end of May, the dollar had recovered to 2.4 percent and 3.9 percent above the recent lows
against the yen and the mark, respectively.

Recent Developments
The U.S. current account deficit widened further in 1994, to $151.2 billion (2.2 percent of GDP),
reflecting a continuation of the factors which have been at work since the deficits hit their recent low
point in 1991. The balance on merchandise trade -- the largest component of the current account -was importantly influenced by cyclical movements:
o The robust U.S. expansion continued to pull in imports, which grew by over 13 percent in both
value and volume terms. Increases were particularly strong in capital goods and autos and parts.
o Exports grew 10 percent in both value and volume, substantially above 1993 rates of growth,
despite a recovery in Europe that was only moderate and continued sluggish activity in Japan.
Strong growth in developing country markets and industrial countries outside Europe was an
important contributor, as was the continued strong U.S. competitive position.

14
o Reflecting these trends, the 1994 merchandise trade deficit widened to $166 billion, up from $133
billion in 1993 and a recent low point of $74 billion in the recession year of 1991.
The other components of the current account ("invisibles") netted a surplus of $15 billion for 1994,
down from $33 billion in 1993. The principal contributor to the lower invisibles surplus was
investment income, which recorded a negative swing of $18 billion, from a surplus of $9 billion in
1993 to a deficit of $9 billion in 1994, as the U.S. net foreign liabilities position continued to widen.
Income payments to foreign direct investors in the U.S. rose steadily during the year, to over $7
billion in Q4 compared with $5 billion for all of 1993; for 1994 as a whole they were up 4-fold at
$23 billion.
The surplus on services transactions, which has grown very rapidly since the latter 1980s, showed
only a modest ($2 billion) increase in 1994 which was nearly offset by an increase in unilateral
transfers.
Table 5

U.S. Trade and Current Account
(selected years; $ billion)
1992
440

Ag.
Non-Ag.

1987
250
30
220

396

1994
502
47
455

Imports
Oil
Non-oil

-410
-43
-367

-536
-52
-485

-669
-51
-617

Trade Balance

-160

-96

-166

Services, net
Investment
Income, net

-9

Transfers

-23

-32

-36

CU1TeI1t Account
(As % of GDP)

-166
(3.7)

-62
(1.0)

.151
(2.2)

Exports

SOURCE: Survey of Current Business

15
Data on goods and services trade for the first quarter of 1995 indicate that the deficit on goods
trade continued to widen (to $45.1 billion, from $43.5 billion for Q4 1994), albeit at a slower rate
than during 1994. The first-quarter services surplus was down $1 billion or so from Q4 1994.
The pattern of capital flows continued to show a high degree of variability in 1994. There was a
strong rebound in net private inflows via both direct investment and securities transactions -- both
generally considered "long-term". U.S. reserve assets rose while official inflows from foreign sources
declined sharply (albeit from an unusually high level for 1993), as did the combination of "other"
Oargely banking) flows and the statistical discrepancy.

Table 6
Financing the U.S. Current Account
($ billions)

1993

1994

1991

1992

-93

-7

-62

-100

-9

-25

-31

-30

-38

Other
(of which: banks)

28
( 9)

14
(3)

48
(36)

63
(51)

78
(115)

Stat discrepancy

-29

-26

-14

1990
Current Account

-151

Financing (net)
Direct Investment
Securities
Official

SOURCE: Survey of Current Business

Outlook for 1995 and 1996
The slowdown in the Mexican economy as adjustment occurs in response to the financial crisis
will have a significant, although temporary, impact on the U.S. trade balance in 1995. In addition,
as U.S. economic growth slows to a more sustainable pace as capacity limits are approached, the rise
in U.S. imports should moderate. U.S. exports should continue to thrive as the recovery in Europe is
expected to solidify, and most developing country markets remain strong. But the changing relative

U.S. and foreign demand growth in prospect is not expected to be enough this year to prevent some
further deterioration in the current account balance of the United States despite strong U.S. price
competitiveness.
In addition to a widening in the goods trade deficit, invisibles transactions are expected to make
a small negative contribution to the current account. Continued growth in the services surplus will
only partially offset growth in the deficit on net investment income, where the negative trend due to
rising U.S. indebtedness could be reinforced by the return to profitability of FDI in the U.S. The net
result should be a 1995 current account deficit on the order of 2.5 percent of GDP, as mentioned in
the previous Report.
The U.S. competitive position remains exceptionally strong -- at a minimum, the external deficit
should begin to decline as a share of GDP. But the outlook for 1996 depends heavily on prospects
for a sustained and strengthened recovery in the other industrial countries. With a reasonably robust
recovery abroad, shared by Japan, the current account and trade deficits should begin to decline in
absolute terms.
Over the medium term, the course of the current account deficit primarily will reflect
developments in the U.S. -- and foreign -- saving/investment balances. A reduction in our external
deficit with continued strong investment will require higher U.S. saving (Including lower government
sector dissaving).

17
ACTIONS UNDER SECTION 3004
Section 3004 of the Omnibus Trade and Competitiveness Act of 1988 requires the Secretary of
the Treasury to consider whether economies manipulate the rate of exchange between their
currencies and the U.S. dollar for the purposes of preventing effective balance of payments
adjustment or gaining competitive advantage in international trade. Section 3004 also requires the
Secretary to undertake negotiations with those manipulating economies that have material global
current account surpluses, and significant bilateral trade surpluses with the United States. This
section summarizes the current status of Korea, Taiwan and China, economies that have in past
reports been designated as manipulating the rates of exchange between their currencies and the U.S.
dollar.
A. Korea and Taiwan
It remains Treasury's judgment that neither Korea nor Taiwan is manipulating its exchange rate
within the meaning of Section 3004 of the Omnibus Trade Act of 1988. Nevertheless, Treasury
continues to seek liberalization of certain financial and foreign exchange policies in both economies,
particularly capital controls, which have the potential to discourage investment and impede the
operation of market forces in exchange rate determination.

Korea
The Korean won appreciated by 2.4 percent relative to the U.S. dollar between December 1993
and December 1994, and appreciated by 3.5 percent between end-1994 and May 31, 1995.
Consumer price inflation for 1994 was 6.2 percent, slightly above the 6 percent target and well above
the 1993 average of 4.8 percent. Korean officials expect consumer price inflation to remain around 6
percent in 1995. The Korean won has experienced a real appreciation against the U.S. dollar of 10
percent over the past 18 months. Korea registered a global trade deficit of $2.5 billion during the
first quarter of 1995, compared to a deficit of $1.5 billion for the same period in 1994. According to
official U.S. trade statistics, Korea registered a trade deficit of $920 million with the United States
during this period, compared to a trade surplus of $172 million during the same period in 1994.
Korea's current account deficit (balance-of-payments basis) climbed to $3.8 billion during JanuaryMarch 1995, compared to $2.1 billion in the first quarter of 1994. This is the largest first quarter
current account deficit since 1968. Dramatic import surges in consumer goods and machinery
contributed to the record first-quarter trade and current account deficits. U.S. exports to Korea, on a
first-quarter to first-quarter basis, grew by 52 percent.
Strong economic growth is one of the key engines behind Korea's expanding trade and current
account deficits. Real GDP growth for 1994 was roughly 8.4 percent, and preliminary indications
are that GDP growth in the first quarter of 1995 may have been as high as 9.9 percent. Exchange
rates are also playing a role in Korea's shifting trade and current account balances. The Korean won
appreciated a small amount against the U.S. dollar and fell by approximately 16 percent relative to
the yen between December 31, 1994 and May 30, 1995. Consequently, Korea's import bill vis-a-vis
Japan grew by 35 percent during the first quarter of 1995, increasing the bilateral trade deficit with
Japan by 40 percent compared to the same period in 1994.

18
At the same time, the wonts depreciation relative to the yen is making Korean exporters more
competitive relative to their Japanese counterparts. The value of Korean exports to China during
january-March 1995, for example, increased by 53 percent compared to the same period in 1994.
By the same measure, Korean exports to Hong Kong increased by 43 percent, and to ASEAN
countries by 39 percent. Korean exports to japan grew by 29 percent, while exports to the U.S.
grew by 16 percent.
Treasury continues to engage Korea on further liberalizing its financial sector, and on easing
foreign exchange and capital controls which inhibit market forces from fully determining the
exchange rate. Discussion of these issues has taken place in bilateral Financial Policy Talks, and in
the context of the wro negotiations on trade in financial services. An example of progress
stemming from these discussions is Korea's recent decision to raise the ceiling on aggregate foreign
ownership of a Korean company from 12 to 15 percent of listed shares. As noted in the last report,
the Korean government released in late 1994 its Foreign Exchange System Reform Plan - a package
of measures which will loosen some foreign exchange and capital controls in three stages extending to
year-end 1999. Treasury will continue to press Korea to accelerate implementation of this plan and
broaden the measures contained in it.
Another significant development since the last report is Korea's formal application to join the
Organization for Economic Cooperation and Development. A key element in attaining membership
in this organization will be liberalization of the financial sector and a commitment to liberalize the
flow of capital. Korea's desire to join the OECD by 1996 should help to accelerate the reform
process and eliminate those controls which inhibit a fully market-determined exchange rate.
Taiwan
The New Taiwan dollar appreciated by 1.5 percent relative to the U.S. dollar between December
1993 and December 1994, and appreciated by 2.9 percent from end-1994 to May 31, 1995.
Consumer price inflation was 4.1 percent for 1994, compared to 2.9 percent in 1993 and 4.5 percent
in 1992. The increase in the CPI during 1994 was caused primarily by an increase in food prices
due to typhoon damage, a relatively easy monetary policy, and a rise in gasoline prices. Taiwan's
overall balance of trade declined from a surplus of $8 billion in 1993 to a surplus of $7.7 billion in
1994, the lowest level since 1983. Taiwan's current account surplus also declined from $6.7 billion in
1993 to $6 billion in 1994. Official sources estimate the overall trade surplus for the first four
months of 1995 to be $1.5 billion, compared to $750 million for the same period in 1994, with the
current account surplus at $1.2 billion for the first quarter, compared to a surplus of $556 million in
january-March 1994.
Taiwan's real GDP growth was 6.5 percent in 1994, and indications are that growth rates may
climb higher in 1995. Unlike Korea, however, where rapid growth has translated into an import
surge and significant expansion of the trade and current account deficits, growth in Taiwan's imports
lagged behind exports in 1994 and the first quarter of 1995. Taiwan's export growth was led by
shipments to Hong Kong, Taiwan's largest overseas market and the conduit for trade with China. A
continued strong export performance is likely to boost overall economic growth for Taiwan in 1995.

19
Exchange rates may also have played a role in the expanding first-quarter surplus. The New
Taiwan dollar fell by roughly 18 percent relative to the yen between January 3 and May 30, 1995.
As with Korea, the appreciation of the yen has helped Taiwan's products compete overseas with
Japanese products. For example, compared to the first quarter of 1994, the value of Taiwan's exports
to developing Asian countries during January-March 1995 grew by 33 percent, and by 33 percent for
shipments to Japan. By comparison, Taiwan's exports to the U.S. during January-March 1995 grew
by 14 percent, and by 16 percent for Western Europe. On the other hand, yen appreciation has also
sharply increased prices for Taiwan's imports, especially key Japanese technology products that are
incorporated in locally produced export goods. As a result, Taiwan's bilateral trade deficit with Japan
increased by 7.2 percent during the first quarter of 1995, compared to the same period in 1994.
Taiwan's bilateral trade surplus with the United States increased from $8.9 billion in 1993 to
$9.6 billion in 1994. For the first three months of 1995, Taiwan registered a trade surplus of $1.9
billion with the United States, compared to a surplus of $1.8 billion in the first quarter of 1994.
Although Taiwan's bilateral trade surplus with the United States showed a modest increase in 1994
and the first quarter of 1995, the overall trend for the past few years has been in the opposite
direction. An important factor in this process has been the slowing of growth in Taiwan's exports to
the U.S. as Taiwan companies have switched production of some consumer goods, one of Taiwan's
biggest categories of exports to the U.S., to overseas factories in China and elsewhere.
Treasury remains closely engaged with Taiwan on further liberalization of its financial sector,
principally in the context of Taiwan's WTO accession negotiations. Since the last report, Taiwan
authorities moved in January to liberalize further the rules governing forward foreign exchange
contracts and swaps, and are reportedly considering a plan to raise the cap on foreign ownership of
listed shares and to remove the prohibition on individual investors participating in the Taipei Stock
Exchange. However, Treasury continues to press Taiwan to remove remaining foreign exchange and
capital controls that may impede market forces from fully determining the exchange rate.

B. China
China has registered large increases in its global trade surplus and its bilateral trade surplus vis-avis the United States in the first half of this year. (The extent of the increase is highly uncertain and
difficult to interpret due to weaknesses in the data.) High savings and efforts to restrict credit have
bolstered an already strong external position. At the same time, recent renminbi appreciation,
especially in real terms, and relatively high economic growth in China are factors that are
contributing to strong growth in U.S. exports to China. Nonetheless, China's growing current
account surplus is a concern and bears continued close observation. Critical for addressing this
would be significant progress on lowering the broad array of trade barriers which impede imports to
China's strongly growing market.
It is Treasury's determination that China is not currently manipulating its exchange system to
prevent effective balance of payments adjustment and gain unfair competitive advantage. This report
reiterates the conclusion of the previous Treasury report in this series. Nonetheless, Treasury remains
concerned that the Chinese authorities retain the capacity to tighten foreign exchange restrictions.
China can take advantage of the strong external situation to implement additional steps to liberalize

20
its foreign exchange regime. In order to eliminate distortions in foreign exchange allocation and
investor disincentives, China should commit to current account convertibility as soon as possible,
eliminating restrictions on access to China's foreign exchange markets, and eliminating foreign
exchange balancing requirements. China should also act to remove the multiple formal and informal
trade controls which impede and distort trade.
Trade and Economic Developments
According to Chinese customs data, China's overall trade balance rebounded from a deficit of
$12.2 billion in 1993 to a surplus of $5.3 billion in 1994. Exports rose 32 percent to $12l.0 billion
while imports rose 11 percent to $115.7 billion. For January.:June 1995, China reported an overall
trade surplus of nearly $13.2 billion, compared to a $730 million deficit in the first half of 1994. 1 A
large disparity between the growth of China's exports and imports has been evident in the first half of
this year. China's exports to all countries grew by 44.2 percent during the first six months of 1995,
while imports grew by only 15.2 percent. Chinese economic authorities have attributed the rapid
expansion in exports to expectations of an official decision to lower value-added-tax (VAT) refunds
provided to trading companies. Trading companies reportedly sought to maximize exports before the
VAT rebate was reduced. The reduction in the VAT rebate from 17 percent to 14 percent was
implemented on July 1, 1995, and Chinese officials predict that exports will fall during the second
half of 1995. The issue of the VAT rebate's effect on China's export performance bears continued
observation, although Treasury remains skeptical as to the significance of this single factor.
In 1994, China's trade surplus with the United States continued to grow rapidly. According to
U.S. Commerce Department data, Chinese exports to the United States grew 23 percent to $38.8
billion while Chinese imports from the United States grew 6 percent to $9.3 billion. This gave China
a trade surplus of $29.5 billion with the United States in 1994.

According to official U.S. trade data through May 1995, China's trade with the U.S. did not
closely mirror China's trade with the world as a whole. In contrast to the large disparity between
China's export and import growth with all trading partners, the growth of China's imports from and
exports to the U.S. was near equal in percentage terms. In the first five months of 1995, Chinese
exports to the U.S. rose 25.2 percent to $16.2 billion, while Chinese imports from the U.S. grew 25.3
percent to $4.6 billion. As a result, China's surplus with the United States measured $1l.6 billion in
January-May 1995, up from $9.2 billion in the same period in 1994. Particularly notable was the
high growth rate of U.S. exports during January-May 1995 (25.3 percent). By comparison, U.S.
exports to China during the first two quarters of 1994 grew by only 17 percent. U.S. exports
continue to be concentrated in capital intensive goods such as machinery, aircraft, chemicals, and
agricultural products such as cotton. U.S. imports are concentrated in toys, footwear, clothing and
other labor intensive products.

China's trade data do not agree with those of partner countries. In particular, China
reports lower exports than partner countries report as imports. China's surrender requirements
and restrictions on access to foreign exchange for non-trade related transactions encourage
exporters to under-report earnings and keep foreign exchange offshore.
1

According to figures from China's central bank, foreign exchange reserves increased $30.4 billion
in 1994, bringing China's total reserves to $51.6 billion (about 5 months of imports).2 China's
services balance is estimated at -$3.2 billion in 1994. Net transfers are estimated at $1.2 billion
giving China an overall current account surplus of $2.2 billion. In addition to China's current
account surplus, China registered a surplus of $36.0 billion on the capital account. Net foreign direct
investment increased from $23 billion in 1993 to $30 billion in 1994.
The large increase in China's reserves and the easing of credit to troubled state enterprises
contributed to rapid growth of China's money supply in 1994. M 1 grew 27 percent in 1994 while
M2 grew 36 percent. The Chinese authorities have taken some limited steps to control growth of the
money supply. On January 1, 1995 the People's Bank of China announced it was raising the rates it
charged on loans to financial institutions. Rates on three month loans were raised 0.18 percent to
10.62 percent while rates on one year loans were raised 0.27 percent to 10.89 percent. In the spring
of 1995, the authorities took additional steps, including allowing more rapid appreciation of the
renminbi in the interbank market for foreign exchange and recalling RMB 5 billion in loans which
the People's Bank of China had extended to the Bank of China.
Real economic growth was 11.8 percent in 1994. Industrial production rose 22 percent while
fixed investment by state enterprises rose 34 percent. In the first three months of 1995, China's
growth moderated somewhat. Real GDP growth slowed to 11.2 percent while the growth of
industrial production slowed to 20 percent.
Reflecting strong growth in the money supply and aggregate demand, as well as a runup in food
prices, China's inflation continued to rise in 1994. Retail prices rose 23 percent in the year to
December 1994 while the urban inflation rate rose to an estimated 29 percent. Year-on-year
inflation rates peaked in September-October 1994 and have moderated somewhat since then as the
effects of rising food prices receded. However, without significant tightening of monetary policy,
inflation is likely to remain in double digits.
Foreign Exchange System
There have been no major changes to China's foreign exchange system since Treasury's last
report. China's exchange rate operates as a managed float, with the daily exchange rate set
according to the median price for foreign exchange on the previous day. Intervention by the People's
Bank of China and restrictions that prevent the exchange rate from moving more than +0.25
percent act to stabilize the exchange rate. China's main foreign exchange market is the foreign
exchange trading center (FETC) in Shanghai. A number of other cities are connected to this market
via satellite links. In those areas where satellite-links are unavailable, foreign funded enterprises
(FFEs) needing foreign exchange must buy and sell foreign exchange in local swap centers at the rate
set in Shanghai.

2 China's foreign exchange figures exclude holdings of the Bank of China that until 1992
were counted as part of official reserves.

22
T~7

Chinese Balance of Payments Figures
($ billions)

Current Account
Of Which:
Trade Balance*
Capital Account
Net Errors and Omissions
Change in Reserves

1991

1992

1993

1994

13.3

6.4

-11.9

2.2

8.1
8.0
-6.8
14.5

4.4
-0.2
-8.3
-2.1

-12.2
23.5
-9.8
1.8

5.3
36.0
-7.8
30.4

Sources: Chinese and IMF Statistics
*Trade Figures on Customs Basis; Other Figures on Balance of Payments Basis

FFEs may buy and sell foreign exchange through designated financial institutions in the interbank
market. However, all transactions must be approved by the State Administration of Exchange
Control (SAEC). This approval can be withheld if the FFE does not fulfill requirements imposed by
its investment contract (e.g. paid-in capital; export performance and foreign exchange balancing
requirements).
Unlike FFEs, domestic enterprises may purchase foreign exchange directly from banks for trade
and trade-related transactions upon presentation of supporting documents, without SAEC approval.
However, domestic enterprises may not trade foreign exchange in the interbank market and are
required to sell their foreign exchange earnings to designated banks at the official exchange rate.
While the Chinese currency is convertible for trade transactions, it is not convertible for certain
services transactions (e.g. tourism, purchase of services abroad) or for capital account transactions.
Exchange Rate Developments
In 1994, the renminbi appreciated 2.8 percent from its end-1993 value. On May 31, 1995
China's exchange rate stood at 8.3 yuan/dollar, a nominal appreciation of 1.7 percent from its end1994 value. The People's Bank of China intervened in the Shanghai interbank market for foreign
exchange to buy U.S. dollars in early 1995. In May, the authorities began to allow the renminbi to
appreciate more rapidly while still maintaining a close link with the U.S. dollar. The recent
acceleration in appreciation appears to have resulted from the authorities' attempts to resist inflation.
China's relatively high inflation rate has caused China's currency to appreciate more rapidly in
real terms. In 1994, the renminbi appreciated 15.7 percent in real terms versus the U.S. dollar, 4.4
percent versus the Japanese yen, and 3.6 percent against the ECU (See Table 9). The renminbi is

23
estimated to have appreciated an additional 9.4 percent in real terms versus the U.S. dollar between
January 1 and May 15, 1995.
Exchange Rate Negotiations
In bilateral negotiations as well as negotiations on China's accession to the 'WTO, Treasury has
continued to press the Chinese government to reform its exchange system. In particular,
Treasury has urged the People's Bank of ChWa to: (1) give domestic and foreign firms equal access to
a unified foreign exchange market; (2) eliminate all requirements for government approval of foreign
exchange purchases for current account transactions; and (3) eliminate foreign exchange balancing
requirements. Chinese authorities have responded that they are considering further reforms of the
exchange system. In this regard, the People's Bank of China has indicated that it is evaluating steps
to eliminate discriminatory access requirements for FFEs and simplifying the SAEC approval process.
Assessment
Treasury has determined that China is not currently manipulating its foreign exchange system to
prevent effective balance of payments adjustment or gain unfair competitive advantage in
international trade. While China continues to maintain the capacity to impose significant restrictions
on foreign exchange transactions, we do not have evidence that imports are impeded by exchange
restrictions. Nevertheless, China's growing current account surplus remains a serious concern.
Since 1992, China has taken important steps toward opening its markets, but multiple
overlapping barriers to trade continue to frustrate market access for U.S. goods. China uses high
tariffs - in combination with restrictions on trading rights, discriminatory technical standards,
quantitative import barriers, industrial policies and subsidies -- to protect its domestic industry and
restrict imports. China's market for services is still largely closed. In addition, on agriculture,
pervasive state trading and unscientific phytosanitary restrictions also block market access. Through
bilateral and multilateral channels, the Administration is pressing China to provide meaningful
market access for goods and services. These include the 1992 U.S.-Sino Memorandum of
Understanding on Market Access and China's accession to the \\lTO.
There are no technical or economic obstacles to immediate current account convertibility. China
should eliminate restrictions on access to its exchange markets as soon as possible. The United States
continues to seek these commitments from China in bilateral negotiations and in multilateral
negotiations on China's accession to the WTO.
Treasury is concerned about China's ability to reimpose significant restrictions on foreign
exchange transactions, thereby preventing market forces from having their full effect on exchange rate
determination and external imbalance adjustment. Treasury remains committed to seeking an
elimination of these restrictions and the associated bureaucratic apparatus.

Table 8
China: Nominal Bilateral Exchange Rates Indices
(End of Period)

United States
Japan
EU

1990

1991

1992

100
100
100

96.4
88.7
98.9

80.2
73.7
9l.1

1993
68.9
56.7
84.8

1994
66.3
48.4
73.6

China: Real Bilateral Exchange Rates Indices
(End of Period)

United States
Japan
EU

1990

1991

1992

1993

1994

100
100
100

97.2
89.9
98.2

83.8
78.8
93.2

82.6
70.7
98.8

95.6
73.8
102.5

Sources: IMF and Treasury Department Data
Decline of Index = Depreciation of Chinese Currency

APPENDIX 1:

OMNIBUS TRADE AND COMPETITIVENESS ACT OF 1988
(B.R.3)

SEC.3004. INTERNATIONAL NEGOTIATIONS ON EXCHANGE RATE AND

ECONOMIC POUCIES.
(a) Multilateral Negotiations.-The President shall seek to confer and negotiate with other
countries(1) to achieve--

(2)

(A)

better coordination of macroeconomic policies of the major
industrialized nations; and

(B)

more appropriate and sustainable levels of trade and current account
balances, and exchange rates of the dollar and other currencies
consistent with such balances; and

to develop a program for improving existing mechanisms for coordination and
improving the functioning of the exchange rate system to provide for long-term
exchange rate stability consistent with more appropriate and sustainable current
account balances.

Bilateral Negotiations.-The Secretary of the Treasury shall analyze on an annual basis
the exchange rate policies of foreign countries, in consultation with the International
Monetary Fund, and consider whether countries manipulate the rate of exchange between
their currency and the United States dollar for purposes of preventing effective balance of
payments adjustments or gaining unfair competitive advantage in international trade. If the
Secretary considers that such manipulation is occurring with respect to countries that (1) have
material global current account surpluses; and (2) have significant bilateral trade surpluses
with the United States, the Secretary of the Treasury shall take action to initiate negotiations
with such foreign countries on an expedited basis, in the International Monetary Fund or
bilaterally, for the purpose of ensuring that such countries regularly and promptly adjust the
rate of exchange between their currencies and the United States dollar to permit effective
balance of payments adjustments and to eliminate the unfair advantage. The Secretary shall
not be required to initiate negotiations in cases where such negotiations would have a serious
detrimental impact on vital national economic and security interests; in such cases, the
Secretary shall inform the chairman and the ranking minority member of the Committee on
Banking, Housing, and Urban Affairs of the Senate and of the Committee on Banking,
Finance and Urban Affairs of Representatives of his detennination.
(b)

SEC. 3005. REPORTING REQUIREMENTS.
(a)
Reports Required.-In furtherance of the purpose of this title, the Secretary,
after consultation with the Chairman of the Board, shall submit to the Committee on
Banking, Finance and Urban Affairs of the House of Representatives and the Committee on
Banking, Housing, and Urban Affairs of the Senate, on or before October 15 of each year, a
written report on international economic policy, including exchange rate policy. The
Secretary shall provide a written update of developments six months after the initial report.
In addition, the Secretary shall appear, if requested, before both committees to provide
testimony on these reports.
(b) Contents of Report.- Each report submitted under subsection (a) shall contain(1)

an analysis of currency market developments and the relationship
between the United States dollar and the currencies of our major trade
competitors;

(2)

an evaluation of the factors in the United States and other economies
that underlie conditions in the currency markets, including
developments in bilateral trade and capital flows;

(3)

a description of currency intervention or other actions undertaken to
adjust the actual exchange rate of the dollar;

(4)

an assessment of the impact of the exchange rate of the United States
dollar on(A) the ability of the United States to maintain a more appropriate and
sustainable balance in its current account and merchandise trade
account;
(B) production, employment, and .noninflationary growth in the United
States;
(C) the international competitive perfonnance of United States
industries and the external indebtedness of the United States;

(5)

recommendations for any changes necessary in United States economic
policy to attain a more appropriate and sustainable balance in the
current account;

(6)

the results of negotiations conducted pursuant to section 3004;

(c)

(7)

key issues in United States policies arising from the most recent
consultation requested· by the International Monetary Fund under article
IV of the Fund's Articles of Agreement; and

(8)

a report on the size and composition of international capital flows, and
the factors contributing to such flows, including, where possible, an
assessment of the impact of such flows on exchange rates and trade
flows.

Report by Board of Governors.-Section 2A(1) of the Federal Reserve Act (12
U.S.C. 225a(1» is amended by inserting after "the Nation" the following: ",
including an analysis of the impact of the exchange rate of the dollar on those
trends.

SEC. 3006. DEFINITIONS.
As used in this subtitle:
(1) Secretary.-The term "Secretary" means the Secretary of the Treasury.
(2) Board.-The term "Board" means the Board of Governors of the Federal

Reserve System.

Removal Notice
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Citation Information
Document Type: Transcript

Number of Pages Removed: 53

Author(s):
Title:

Department of the Treasury Press Conference

Date:

1995-05-20

Journal:

Volume:
Page(s):
URL:

Federal Reserve Bank of St. Louis

https://fraser.stlouisfed.org

UBLIC DEBT NEWS
Department of the Treasury • Bureau of the Public Debt • Washington, DC 20239

FOR IMMEDIATE RELEASE
August 28, 1995

CONTACT: Office of Financing
202-219-3350

RESULTS OF TREASURY'S AUCTION OF 13-WEEK BILLS
Tenders for $12,059 million of 13-week bills to be issued
August 31, 1995 and to mature November 30, 1995 were
accepted today (CUSIP: 912794V84).
RANGE OF ACCEPTED
COMPETITIVE BIDS:
Low
High
Average

Discount
Rate
5.33%
5.34%
5.34%

Investment
Rate
5.49%
5.50%
5.50%

Price
98.653
98.650
98.650

Tenders at the high discount rate were allotted 83%.
The investment rate is the equivalent coupon-issue yield.
TENDERS RECEIVED AND ACCEPTED (in thousands)
TOTALS
Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

Acce~ted

Received
$48,487,917

$12,058,567

$42,944,901
1 1 402 1 572
$44,347,473

$6,515,551
1 1 402 1 572
$7,918,123

3,645,180

495 1 264
$48,487,917

495 1 264
$12,058,567

An additional $55,636 thousand of bills will be

issued to foreign official institutions for new cash.

RR-534

UBLIe DEBT NEWS
Department of the Treasury • Bureau of the Public.Debt • Washington, DC 20239

FOR IMMEDIATE RELEASE
August 28, 1995

CONTACT: Office of Financing
202-219-3350

RESULTS OF TREASURY'S AUCTION OF 26-WEEK BILLS
Tenders for $12,093 million of 26-week bills to be issued
August 31, 1995 and to mature February 29, 1996 were
accepted today (CUSIP: 912794X41).
RANGE OF ACCEPTED
COMPETITIVE BIDS:
Low
High
Average

Discount
Rate
5.33%
5.35%
5.34%

Investment
Rate
5.57%
5.59%
5.58%

Price
97.305
97.295
97.300

Tenders at the high discount rate were allotted 2%.
The investment rate is the equivalent coupon-issue yield.
TENDERS RECEIVED AND ACCEPTED (in thousands)
TOTALS

Received
$49,925,074

Accepted
$12,092,657

$42,477,542
1,295,166
$43,772,708

$4,645,125
1,295,166
$5,940,291

3,400,000

2,752,366
$49,925,074

2,752,366
$12,092,657

Type

Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

An additional $309,934 thousand of bills will be

issued to foreign official institutions for new cash.

RR.-535

DEPARTMENT

THE

TREASURY

NEWS

17K4~~""""""""""""1II

OFFlCE OF PUBLIC AFFAIRS • 1500 PENNSYLVANIA AVENUE, N.W.• WASHlNG1'ON,D.C .• 20220. (202) 622-2960

FOR RELEASE AT 2:30 P.M.
August 29, 1995

CONTACT:

Office of Financing
202/219-3350

TREASURY TO AUCTION CASH MANAGEMENT BILL
The Treasury will auction approximately $18,000
million of 20-day Treasury cash management bills to be
issued September 1, 1995.
Competitive and noncompetitive tenders will be
received at all Federal Reserve Banks and Branches.
Tenders will not be accepted for bills to be maintained on
the book-entry records of the Department of the Treasury
(TREASURY DIRECT). Tenders will not be received at the
Bureau of the Public Debt, Washington, D.C.
Additional amounts of the bills may be issued to
Federal Reserve Banks as agents for foreign and international monetary authorities at the average price of
accepted competitive tenders.
This offering of Treasury securities is governed by
the terms and conditions set forth in the Uniform Offering
Circular (31 CFR Part 356) for the sale and issue by the
Treasury to the public of marketable Treasury bills, notes,
and bonds.
Details about the new security are given In the
attached offering highlights.
The Treasury may need to announce early next week
additional cash management bills to cover the low point
in the September cash balance.
000

Attachment
RR-536

For press releases, speeches, public schedules and official biographies, call our 24-hollr fax line at (202) 622-2040

HIGHLIGHTS OF TREASURY OFFERING
OF 20-DAY CASH MANAGEMENT BILL

August 29, 1995
Offering Amount .

· $18,000 million

Description of Offering:
Term and type of security
CUSIP number
Auction date
Issue date
Maturity date .
Original issue date
Currently outstanding .
Minimum bid amount
Multiples .
Minimum to hold amount
Multiples to hold

· 20-day Cash Management Bill
· 912794 T3 8
· August 31, 1995
September 1, 1995
September 21, 1995
· September 22, 1994
· $43,712 million
· $10,000
· $1,000
· $10,000
· $1,000

Submission of Bids:
Noncompetitive bids .

· Accepted in full up to $1,000,000 at
the average discount rate of accepted
competitive bids
(1) Must be expressed as a discount rate
with two decimals, e.g., 7.10%.
(2) Net long position for each bidder must
be reported when the sum of the total
bid amount, at all discount rates, and
the net long position is $2 billion or
greater.
(3) Net long position must be determined
as of one half-hour prior to the
closing time for receipt of competitive tenders.

Competitive bids

Maximum Recognized Bid
at .a Single Yield

· 35% of public offering

Maximum Award .

· 35% of

Receipt of Tenders:
Noncompetitive tenders

Competitive tenders .
Payment Terms .

~ublic

offering

· Prior to 12:00 noon Eastern Daylight
Saving time on auction day
· Prior to 1:00 p.m. Eastern Daylight
Saving time on auction day
· Full payment with tender or by charge
to a funds account at a Federal
Reserve Bank on issue date

DEPARTMENT

THE

TREASURY

OFFICE OF PUBUC AFFAIRS • 1500 PENNSYLVANIA AVENUE, N.W .• WAS~INGTON, D.C.. 20220. (202) 622-2960

FOR RELEASE AT 2:30 P.M.

CONTACT:

August 29, 1995

Office of Financing
202/219-3350

TREASURY'S WEEKLY BILL OFFERING

The Treasury will auction two series of Treasury bills
totaling approximately $24,000 million, to be issued September 7,
1995. This offering will result in a paydown for the Treasury of
about $3,400 million, as the maturing weekly bills are
outstanding in the amount of $27,393 million.
Federal Reserve Banks hold $6,687 million of the maturing
bills for their own accounts, which may be refunded within the
offering amount at the weighted average discount rate of accepted
competitive tenders.
Federal Reserve Banks hold $2,264 million as agents for
foreign and international monetary authorities, which may be
refunded within the offering amount at the weighted average
discount rate of accepted competitive tenders. Additional
amounts may be issued for such accounts if the aggregate amount
of new bids exceeds the aggregate amount of maturing bills.
Tenders for the bills will be received at Federal
Reserve Banks and Branches and at the Bureau of the Public
Debt, Washington, D. C. This offering of Treasury securities
is governed by the terms and conditions set forth in the Uniform
Offering Circular (31 CFR Part 356) for the sale and issue by the
Treasury to the public of marketable Treasury bills, notes, and
bonds.
Details about each of the new securities are given in the
attached offering highlights.
000

Attachment

RR-537

For press releases, speeches, public schedules and official biographies, call our 24-hollr fax line at (202) 622-2040

HIGHLIGHTS OF TREASURY OFFERINGS OF WEEKLY BILLS
TO BE ISSUED SEPTEMBER 7, 1995

August 29, 1995
Offering Amount .

$12,000 million

Description of Offering:
Term and type of security
CUSIP number
Auction date
Issue date
Maturity date
Original issue date
Currently outstanding
Minimum bid amount
Multiples .

91-day bill
912794 V9 2
September 5, 1995
September 7, 1995
December 7, 1995
June 8, 1995
$14,261 million
$10,000
$ 1,000

182-day bill
912794 X5 8
September 5, 1995
September 7, 1995
March 7, 1996
March 9, 1995
$17,352 million
$10,000
$ 1,000

The following rules apply to all securities mentioned above:

Submission of Bids:
Noncompetitive bids
Competitive bids

Accepted in full up to $1{000,000 at the average
discount rate of accepted competitive bids
(1) Must be expressed as a discount rate with
two decimals, e.g.{ 7.10%.
(2) Net long position for each bidder must be
reported when the sum of the total bid
amount { at all discount rates{ and the net
long position is $2 billion or greater.
(3) Net long position must be determined as of
one half-hour prior to the closing time for
receipt of competitive tenders.

Maximum Recognized Bid
at a Single Yield

35% of public offering

Maximum Award .

35% of public offering

Receipt of Tenders:
Noncompetitive tenders
Competitive tenders
Payment Terms .

Prior to 12:00 noon Eastern Daylight Saving time
on auction day
Prior to 1:00 p.m. Eastern Daylight Saving time
on auction day
Full payment with tender or by charge to a funds
account at a Federal Reserve Bank on issue date

<0
(j)

federal financing
WASHINGTON, DC

20220

bonkNE

S
August 29, 1995

FEDERAL FINANCING BANK
Charles D. Haworth, Secretary, Federal Financing Bank (FFB) ,
announced the following activity for the month of July 1995.
FFB holdings of obligations issued, sold or guaranteed by
other Federal agencies totaled $88.9 billion on July 31, 1995,
posting a decrease of $1,745.8 million from the level on
June 30, 1995. This net change was the result of a decrease in
holdings of agency debt of $121.4 million, in holdings of agency
assets of $1,592.7 million, and in holdings of agency-guaranteed
loans of $31.8 million. FFB made 18 disbursements during the
month of July. FFB also received 214 prepayments in July.
Attached to this release are tables presenting FFB July loan
activity and FFB holdings as of July 31, 1995.

RR-538

U/
'<t
N

N
CD

Ul
Ul

~
0...

C\J

l.L
l.L

Page 2 of 3
FEDERAL FINANCING BANK
JULY 1995 ACTIVITY

BORROWER

AMOUNT
OF ADVANCE

DATE

FINAL
MATURITY

INTEREST
RATE

AGENCY DEBT
RESOLUTION TRUST CORPORATION
Note 27 /Advance #1

7/3

$15,777,153,122.32

10/2/95

5.728% S/A

$500,000,000.00
$500,000,000.00

5/16/05
8/15/95

6.274% S/A
5.721% S/A

U. S. POSTAL SERVICE
U.S. Postal Service
U.S. Postal Service

7/17
7/21

GOVERNMENT - GUARANTEED LOANS
GENERAL SERVICES ADMINISTRATION
Atlanta CDC Office Bldg.
Chamblee Office Building
Oakland Office Building
Foley Square Office Bldg.
Foley Services Contract
Chamblee Office Building
Foley Square Courthouse
Miami Law Enforcement
Foley Square Office Bldg.

S/A
S/A
S/A
S/A
S/A
S/A
S/A
S/A
S/A

7/3
7/3
7/3
7/10
7/12
7/21
7/24
7/27
7/31

$1,784,861.76
$704.98
$373,873.96
$1,836,610.00
$29,709.47
$705.08
$793,036.00
$165,617.96
$1,334,446.00

9/1/95
4/1/97
9/5/23
12/11/95
12/11/95
4/1/97
12/11/95
1/3/22
12/11/95

5.729%
5.889%
6.679%
5.637%
5.692%
5.988%
5.792%
6.929%
5.719%

7/13
7/17

$2,265,228.00
$7,039,464.88

11/2/26
11/2/26

6.615% S/A
6.666% S/A

7/3
7/3
7/25
7/28

$208,000.00
$1;200,000.00
$1,000,000.00
$8,000.00

12/31/14
12/31/25
3/31/05
12/31/13

6.490%
6.565%
6.506%
6.602%

GSA/PADC
ICTC Building
rCTC Building
RURAL UTILITIES SERVICE
Guam Telephone Auth. #371
Randolph Electric #359
Tex-La Electric #389
Panhandle Tele. #400

S/A is a semi-annual rate:

Qtr.

a Quarterly rate.

Qtr.
Qtr.
Qtr.
Qtr.

Page 3 of 3
FEDERAL FINANCING BANK
(in millions)
Program
Agency Debt:
Department of Transportation
Export-Import Bank
Resolution Trust corporation
Tennessee Valley Authority
U.S. Postal Service
sub-total*

July 31, 1995
$

0.0
2,646.1
14,655.8
3,200.0
8,614.7
29,116.5

June 30, 1995
$

0.0
2,646.1
15,777.2
3,200.0
7.614.7
29,237.9

Net Change

FY '95 Net Change

7/1/95-7/31/95

10/1/94-7/31/95

0.0
0.0
-1,121.4
0.0
L 000.0
-121. 4

-664.7
-1,280.4
-11,863.4
-200.0
-358.4
-14,366.8

Agency Assets:
FmHA-ACIF
FmHA-RDIF
FmHA-RHIF
DHHS-Health Maintenance org.
DHHS-Medical Facilities
Rural utilities Service-CBO
Small Business Administration
sub-total*

1,838.0
3,675.0
22,906.0
8.0
23.8
4,598.9
0.3
33,050.0

2,698.0
3,675.0
23,631.0
10.5
28.5
4,598.9
0.7
34,642.6

-860.0
0.0
-725.0
-2.5
-4.7
0.0
-0.5
-1,592.7

-4,225.0
0.0
-1,485.0
-17.3
-11.9
0.0
-0.8
-5,740.1

Government-Guaranteed Loans:
DOD-Foreign Military Sales
DHUD-Community Dev. Block Grant
DHUD-Public Housing Notes
General Services Administration +
DOl-virgin Islands
DON-Ship Lease Financing
Rural utilities Service
SBA-Small Business Investment Cos.
SBA-State/Local Development Cos.
DOT-Section 511
sub-total*

3,567.5
93.1
1,688.5
2,232.2
21. a
1,432.1
17,274.4
15.8
386.0
15.0
26,725.6

3,580.8
95.7
1,688.5
2,222.4
21.2
1,432.1
17,256.8
16.8
428.0
15.0
26,757.4

-13.3
-2.6
0.0
9.7
-0.3
0.0
17.6
-1. 0
-41. 9
0.0
-31. 8

-217.9
-16.8
-58.0
202.6
-1.0
-47.4
-42.2
-40.9
-137.0
0.4
-358.1

grand-total*
*figures may not total due to rounding
+does not include capitalized interest

=========

========

=========

$ 88,892.1

$ 90,637.9

$-1,745.8

$-20,465.0

DEPARTMENT

THE

TREASURY

omCE OF PUBLIC AFFAIRS .1500 PENNSYLVANIA AVENUE, N.W.• WASHINGTON, D.C.. 20220. (202) 622-2960

FOR IMMEDIATE RELEASE
August 31, 1995

Contact: Michelle Smith
(202) 622-2960

TREASURY SENDS MONTHLY MEXICO REPORT TO CONGRESS
Treasury Secretary Robert E. Rubin, in a monthly report to Congress, said that
Mexico continues to pursue strong adjustment policies to address the financial crisis which
threatened its economic stab ility and put vital U. S. interests at risk.
"Mexico is making strong financial progress," Secretary Rubin said, "and that is
largely due to reforms undertaken by the Mexicans. The conditions we supported with our
assistance package earlier this year are helping the Mexican economy return to growth. We
acted to help Mexico in America's interest. The message of our monthly report is that our
actions are beginning to bear fruit.
II

In providing assistance to Mexico under the February 21 agreements, the U.S.
government acted to protect American exports and jobs, the security of our common border
and the stability of other emerging market economies.
Default concerns associated with the Mexican government's tesobono obligations have
been virtually eliminated, according to the report. Since the beginning of the year, $26
billion of $29 billion in outstanding tesobonos have been retired and its international reserves
have risen to $13.4 billion as of August 18.
While Mexico has experienced a deep recession during the first half of 1995 as a
result of its financial crisis, several factors suggest that the adjustment will be less protracted
than that which followed the 1982 crisis. Among those factors are the strong economic
adjustment program it is now undertaking, the increased efficiency of the Mexican economy
following seven years of reforms, its successful return to international capital markets, and
the liquidity provided under the U.S. -led support program.
The August report notes that Mexico has substantially expanded its public disclosure
of financial data, and that this month the Mexican government and the Bank of Mexico began
to provide a wide set of historical and current data on the Internet.
RR-539
(More)
For press releases, speeches, public schedules and official biographies, call our 24-hour fax line at (202) 622-2040

This is the fourth monthly report to Congress regarding the U.S Government's
financial assistance program as required by Section 404 of the Mexican Debt Disclosure Act
of 1995. It provides an account of the current condition of the Mexican economy, all
outstanding disbursements of U.S. funds to Mexico, financial transactions involving funds
from the ESF and from the Federal Reserve System, the status of the oil facility and
compensation for credit risk to the U.S. Government.
-30-

Monthly Report
by the
Secretary of the Treasury

Pursuant to the
Mexican Debt Disclosure Act
0[1995

........
;;)
.:
.

:.:

~~
~

August 31, 1995

Treasury Secretary's Report to Congress
August 1995

Contents
I.

Overview

Current Condition of Mexico's Economy

a.
b.
c.
d.
e.
f.
g.
h.

page

Monetary Policy
Fiscal Policy
Structural Reform and Privatization
Information Disclosure
Economic Adjustment
Banking Sector Developments
Financial Market Trends
International Reserves

Disbursements, Swaps, Guarantees and Compensation
to the U.S. Treasury

IV.

Mexico's Financial Transactions

Status of the Oil Facility

Appendix
Tab:

Key Trends in Mexico's Economy and Financial Markets
1.
2.
3.
4.
5.
6.
7.
8
9.
10.
11.

Monetary Policy
Fiscal Policy
Tesobono Repayment and Debt Profile
Inflation and Interest Rates
FOBAPROA Dollar Lending to Banks
Bond Markets
Currency and Stock Markets
International Reserves
Real Exchange Rate and Trade Balance
GDP, Industrial Production and Retail Sales
Private Analysts' Forecasts for Growth

Treasury Secre/(1ry's Repon to Congress
August 1995

Overview

During 1995, Mexico has implemented and maintained the strong adjustment
policies necessary to address the financial crisis that threatened its economic
stability and long-term prospects for growth. In providing assistance to Mexico
under the February 21 Agreements, the U.S. government acted to protect vital
U.S. interests -- American exports and jobs, the security of our common border,
and the stability of other emerging market economies.
The deep recession in Mexico during the first half of 1995 was an inevitable
consequence of the economic adjustment. However, Mexico's strong stabilization
policies, the increased efficiency of its economy following seven years of reforms,
and the liquidity provided under the U. S. -led support program suggest that the
adjustment will be less protracted than that which followed the 1982 crisis.
Although there was a sharp drop in GDP of 10.5 % in the second quarter, there are
already some signs that the economy is on the path to recovery. With strong
export performance, sound financial policies, renewed access to the private capital
markets, and continued structural reforms, Mexico should return to economic
growth by next year.
During August, Mexico continued to implement economic adjustment policies
consistent with its commitments under the February 21 Agreements. The Bank of
Mexico continued to conduct monetary policy to contain inflation, stabilize the
peso, and encourage capital inflows. Despite the recession, the government's fiscal
policy remained tight in the second quarter, resulting in a surplus in the first half
of 1995 of 2.1 % of GDP, a substantial increase from the 0.5 % of GDP for the first
half of 1994. In August, the government continued to take steps to advance
structural reforms, including additional privatizations of ports. Public disclosure
of financial data by the Mexican government and the Bank of Mexico has increased
substantially. This month, the Mexican government and the Bank of Mexico began
to provide a wide set of historical and current data on the Internet.
Mexico's adjustment policies, reinforced by the U.S.-led multilateral support
package, are working. By the end of August, default concerns associated with the
government's tesobono obligations were virtually eliminated, with $26 billion of
the $29 billion in tesobonos outstanding at the end of 1994 retired. At the same
time, international reserves rose by $7.2 billion from the beginning of 1995 to
$13.4 billion to August 18. Inflation continued to decline to 2.04% in July and
0.9% in the first half of August, from a high of 8.0% in April. Interest rates on

Treasury Secretary's Report to Congress
August 1995

short-term government securities declined as well, from a 83 % peak in March to
34% in August.
Financial markets have continued to respond favorably to the stabilization program,
as investor confidence in Mexico's prospects for recovery continue to grow. The
peso is about 20% above its mid-March low. Mexico's stock market has risen to
pre-crisis levels, up nearly 70% since its low in late February, although it is still
down about 40% in dollar terms since mid-December. Assisted by rising U.S.
bond prices, Mexican Brady bonds are also trading near pre-crisis levels, and the
prices of Latin American Brady bonds that fell with those of Mexico earlier this
year have also risen, suggesting that the risk of contagion has diminished.
Importantly, bond issues by the Mexican government and its agencies have been
sold to private investors for longer maturities and on better terms than many market
participants had expected. Following the initial return of the VMS to the
international capital markets in July with a $1 billion Eurodollar issue, Mexico
raised approximately $1.1 billion in August with a second VMS offering in
international markets. By contrast, after the 1982 crisis, it took Mexico seven
years to return to international capital markets for normal borrowing.
Mexico's banking sector remains strained, but the government's measures to
mitigate the immediate impact, improve regulation and supervision, and encourage
capital inflows have lent important support. An increase in investment inflows has
enabled commercial banks to repay almost all the dollars they borrowed from
FOBAPROA, the central bank's insurance fund.
In August, the government
announced a new program designed to provide additional temporary relief to
consumer, credit card, small business, and mortgage debtors. In announcing the
program, the government emphasized its objective of providing targeted relief at
a manageable cost.
Outstanding U.S. disbursements under the February 21 agreements total $12.5
billion, all of which are backed by the full faith and credit of the Mexican
government. Interest rates on currency swaps between the United States and
Mexico are sufficient to cover the risks that the United States bears. In the
unlikely event of default, all of Mexico's obligations to the United States are
backed by proceeds from Mexico's crude oil and petrochemical product exports.
Payments for these exports flow through a special account at the Federal Reserve
Bank of New York. As of August 22, over $3.95 billion had passed through this
account since March 8, 1995.

Treasury Secretary's Report /0 Congress
August 1995

II.

Current Condition of Mexico's Economy

Monetary Policy

Mexico has maintained its tight monetary polic)'
The Bank of Mexico has continued to conduct monetary policy to contain inflation,
stabilize the peso, and encourage capital inflows. The Bank s chief policy
instrument is its control over the growth rate of the monetary base, which it
achieves through limits on the growth of net domestic credit (defined as the
monetary base less international reserves).
I

The Bank of Mexico has continued to maintain strict control over the money
supply.
•

The monetary base as of August 18 was 15.7% below its level at the end
of 1994, even though the price level was 35.5 % higher than at the end of
1994.

•

Looking forward, seasonal increases in the demand for money typically
cause the monetary base to rise toward the end of the year. To the extent
that increases in money supply meet increases in demand, they are not
inflationary .

Control of domestic credit is key to monetary policy
The Bank of Mexico controls the money supply through tight limits on the growth
of net domestic credit.
•

Net domestic credit has fallen by NP60.6 billion since the beginning of the
year through August 18.

Within the overall change in net domestic credit, credit growth to financial
intermediaries, including commercial banks, has remained low.

Treasury Secretary's Report to Congress
August 1995

•

Peso credits to financial intermediaries such as commercial banks and
development banks, including programs to support the banking system,
were held steady through July and dropped sharply in the four weeks
ending August 18, for a total decline of Nfl 18. 1 billion since the beginning
of the year.

Mexico's monthly inflation rate continues to fall
Tight monetary policy is continuing to restrain inflation.
•

Inflation fell from 3.2 % per month in June to 2.04 % in J ul y, after a peak
of 8.0% in April. In the first half of August, prices rose by 0.9%
compared to the last half of July (see "Economic Adjustment" section
below).

Nominal interest rates have also fallen
While real rates have remained high, nominal interest rates have continued to fall
with declining inflation and inflationary expectations.
•

The interest rate on 28-day cetes, the benchmark Mexican government
security, declined from 36.1 % on July 31 to 34.2 % on August 22, after
peaking at 82.7% in March.

•

The real rate (nominal rate adjusted for inflation) on 28-day cetes in July
was about 20%, roughly the same as in May and June.

•

Over time, as inflationary expectations decline and confidence continues to
grow, a drop in real interest rates can be expected.

Treasury Secretary's Report to Congress
August 1995

II.

FISCal Policy

Revenues were supported by higher oil prices and the April increase in the
rate

VAT

Preliminary data for the first half of 1995 demonstrate that Mexico has maintained
a tight fiscal policy. Declines in total public sector revenues, adjusted for
inflation, remain limited, as the increase in Federal taxes paid by PEMEX offsets
declines in other revenues.
•

PEMEX revenues and Federal taxes paid by PEMEX, which account for over

one-third of public sector revenues, rose by 34.8% in real terms during the
first quarter and by 30.5% in real terms during the second quarter,
compared to their levels a year earlier (see Table 1 below).
While the year-over-year increase in the peso price of oil was lower in the second
quarter than in the first, this increase remained significant.
•

The dollar price of oil increased 39 % and 18 % in the first and second
quarters of 1995 compared to the same periods in 1994, respectively.

•

The peso was 47% lower in the first quarter of 1995 compared to its level
in the same period of the previous year, and 46% lower in the second
quarter compared to the second quarter of 1994.

•

Largely as a result, the peso price of a barrel of oil increased 164% and
117% during the first two quarters of 1995, respectively, compared to the
same quarters of 1994.

The April 1 increase in the value-added tax (VAT) helped offset losses in VAT
revenues that have resulted from the decline in domestic consumption.
•

After falling 13.9% in real terms between the first quarters of 1994 and
1995, real VAT revenues increased by 10.3% in the second quarter,
compared to a year earlier.

As the economy weakened further during the second quarter, most other sources
of revenue continued to decline.

Treasury Secretary's Report to Congress
August 1995

•

After falling 10% to 30 % in real terms between the first quarters of 1994
and 1995, most other revenue sources fell between 20% to 50% in real
terms during the second quarter compared to the previous year.

•

Corporate income and excise taxes continued to fall due to declining
domestic sales.

•

Tariff revenues also fell as imports continued to· decline.

Discretionary spending has been reduced to offset higher interest costs
Further real cuts in discretionary spending during the second quarter helped offset
higher interest costs (see Table 1 below),
•

After increasing 44% in the first quarter compared to a year earlier, real
public sector interest payments increased by 68 % in the second quarter.

•

Real interest payments by the Mexican government on external debt
increased 93 % during the second quarter, compared to a year earlier, after
increasing 78 % during the first quarter, primarily due to currency
adjustments, and to a lesser extent, a higher debt stock. This increase also
included the external interest cost of refinancing domestic tesobono debt
into medium-term external obligations to the ESF.

•

After declining by 34 % during the first quarter compared to a year earlier,
real interest payments by the Federal Government on internal debt
increased 38 % during the second quarter. Several factors were responsible:

(1)

Higher interest rates. While interest rates on internal debt peaked
in March and April, the average yield on internal debt instruments
outstanding was higher during the second quarter compared to the
first. Because interest rates also increased during the second quarter
of 1994, however, the year-over-year increase in yields was only
slightly higher during the second quarter;

Treasury Secretary's Report 10 Congress
Augusl1995

(2)

Changing composition ofirue11U11 debt. During the second quarter,
the Mexican government reduced the outstanding stock of tesobonos
and increased the stock of cetes and bondes. The latter two
instruments generally have much higher yields because their
principal is not adj usted for exchange rate changes, as is the case
with tesobonos.

With interest expenses nsmg, the Mexican government cut real non-interest
spending further.
•

Real public sector spending, excluding interest payments, fell by 16%
during the second quarter, compared to the previous year, after falling by
12% during the first quarter.

Mexico's budget surplus has increased
Mexico's primary and overall budget surpluses have risen compared to their 1994
level due to the boost from oil revenues and the cuts in non-interest spending.
•

The overall non-financial public sector surplus was NP6.3 billion for the
second quarter (roughly 1.7% of GOP) compared to a surplus of NP9.0
billion for the first quarter (roughly 2.6% of GOP). In 1994, the public
sector had a first quarter surplus of NP4.3 billion (1.5 % of GOP) and a
second quarter deficit of NP1.3 billion (0.4% of GOP).

•

Mexico's primary surplus, which excludes interest payments, was NP25.5
billion (roughly 6.7% of GOP) for the second quarter, compared to a NP25.7
billion surplus (7.4 % of"GOP) for the first quarter.

•

Both quarterly primary surpluses in 1995 were significantly larger than the
primary surpluses for the first and second quarters of 1994, which were
NP11.4 billion (3.9% of GOP) and Np12.2 billion (3.8% of GDP) ,
respecti vel y .

Treasury Secretary's Report to Congress
August 1995

Quarterly surpluses may ease in the remainder of 1995
Mexico's quarterly budget surpluses may be lower in the third and fourth quarters,
and the increase in the surplus compared for the year may be less dramatic than for
the first half, for several reasons.

•

The difference in peso oil revenues in subsequent periods compared to a
year prior will likely continue to narrow. Mexican oil prices (in dollars)
increased during much of 1994 and the first half of 1995, but peaked in
April.

•

The recession has been deeper than the Mexican government forecast when
it prepared its revised budget in March.

•

Because of seasonal factors, discretionary spending tends to increase during
the second half during most years. For example, in 1994, 57% of public
sector discretionary spending occurred in the second half of the year.
Public sector discretionary spending during the first half of 1995 accounted
for only 38 % of total planned discretionary spending.

Mexico is on track to meet its 1995 fiscal targets
Mexico has targeted an annual public sector non-financial surplus of 0.5 % of GDP
and a primary surplus of 4.4 % of GDP for the year.
•

The overall and primary surpluses for the first half were well above targets
at 2.1 % and 7.0%, respectively.

Part A: Federlll Oovernment Budget

-3

tr'"

% ofGDP (3)
-161%
-20%
-369%
-309%
-242%

OJI

F...
Other
Other (Central Bank Profits, PnvatlZatlon)
Expenditures
% of GOP (3)
Discretionary
% ofGDP (3)
Operating Expenses
Salanes
Other
Public Investment
Transfers
Education
Other
Non-Discretionary
% of GOP (3)
Outlays From Past Year's Obligations
Revenue Shanng
Interest Payments
Internal
External
Transfers To State Enterprises, Errors & OmiSSions

Taxes
Income Tax
Value Added Tax
Excise Taxes (Oil, Alcohol, Tobacco, etc)
Import Duties
Other (Auto Registration, Tax Penalties, Export)
Non·Tax Income

974%
-40%
-37%
-82%

~:1~~:

.J1~,OOi
.;$,3~

96%
8,883
6,508
2,375
2,523
17,116
6,742
10,374
22,272
75%
3,963><
9,918 :::: :::l:tNll:f:
8,391::.':':
4,528
3,863:
3.017

103%:

1,531

...1:,977:
·.:1:954·
'. '.' 2:4)584
M19.
.: .... :J~,}~

..:': 2$;1'19:

<..iffh.

~i,~~:

:13,611

:1;~7.)

":.$.448
{73)

M,Ut

-169%

1~,~Q

-189%
-149%
-282%
-574%
-81%
-41%
-103%
51%

$,Q~:

19,383
13.635

14,422:

5.748

~.i27

7,114>3,187
36,570
'.41<198
13, 3531"5,~O:
23,218 :::2:5,886

4};~>~~:

21,937:<:~~;~t
14786 ';::::::24'989·:
8:422

"1JJ:M~

6,36414,3-1i:
1.142

117

-213%
-72 0%
-125%
-33%
-185%
-19% .:::::.':'::"':":"
-42

9%:.JIi~

-2 3% .:>ipJ~

17 9% .::}:M;6%
-338% . ::':$HI%'
784% ·:"00:,1%
-755%

>97;1%

(1) Based on a year-over-year increase In the CPI of 15'10 for the first quarter, 34'10 second quarter. and 24'10 for the first half
(2) Beginning in 1995, Mexico City budget no longer Included
(3) Second quarter nominal GOP estimated by adjusting the 105'10 decline In real GOP between the second quarters of 1994 and 1995 by the 34'10 Increase
during this period. This will, of course, differ from estimates using the GOP deflator, which has not yet been reported

-390%
-66%
360%
14%
81 7%
-453%

consumer prices

til

c::
c..

~~
I::

~ tl
I::
.....
..:::!

v,("')

S
S

",-

C
~

-g
C

;::::

'"'"

Part B: Stat..owned Enterprises

0-3

164%
231%
1530%
-1.1%
142%
96%
217 3%
02%
-129%
-120%
1510%
-126%
205%

......
a

1995

1994

8
::s

-s·

I::

~~
r")

.
'"~

~
~

::t
~

g
~

'"'"

1995

1st

.{562)

1.2'%

•· .• "O'2'!rc.

.i5-,S33.
41%

"·4.7%

t~(287)

8.990 .• /

. 6,30~·

•• --04%
12,152
39%·

38-%'

.·.iil%
3i,oo~

1~,~

;. 1ft%'

1994

26%· •• ··1.1%·
25.769 ""'25,462
74% •... t!7~'

4.4%

22%
3.058
05%'
23.537.

1~.293
.

'i;t%

51.t3f

·1.tl%

38%

1995

tr'

7,
213% ...21.8%

Interest Payments
% of GOP
Pemex Revenues + Pemex Taxes Paid to GOM
% of GOP
Non-Petroleum Revenues
% of GOP
Non-Petroleum Revenues. Excluding Value-Added Tax
% of GOP

t'!'

a..... f;

1994

Part C: Public Sector Balances
NP Millions (Nominal
Federal GOVernment BudoetBalance
% olGOP (3)
Federal Government Pnmary Balance
% ofGDP (3)
Public Sector Non-Financial Balance
% of GOP (3)
PubliC Sector Pnmary Balance
% of GOP (3)

Pemex. Balance
Revenues
Expenditures
Interest
Non-interest
CFE. Balance
Revenues
Expenditures
Interest
Non-interest
Other Enterpnses. Balance
Revenues
Expenditures
Interest
Non-interest
SubSidies From the Federal Government
Under Indirect Control 01 GOM. Balance (2)

::...~
I:: ~

~~II;Ri
i~~~n)¥j~:

204%

1!l4%

46%. >4~

.33.043
2 8% : "••>4!il$

nat

30.227 '·>3&'.M~'
8 7% >j01:~
58. 759"~t~t#
16 9% ';. "·)e.1;W'.

48. 804i.43.2~1

14 1% .....j}~%..

41.624 •..

.•

·l1a7W

l1f:,~.· ~~

18 2% ""je~K

~; 71~ ....:~J~~

.Q.m6-

444%

0541

~>~
-8 4%.··1tji~

-0135

·".~i

-0159

348% •••

-0 072

0329

Treasury &cretary's Report 10 Congress
Augusl1995

Structural Refonn and Privatization

Market-oriented refonns continue
Mexico's economic program includes a major privatization effort to increase
productivity, attract foreign investment, raise government revenue and infuse
private sector initiative.

•

The Mexican Congress amended the country's constitution this year to
allow private and foreign investment in railroads and satellite
communications. It has also passed legislation to open telecommunications
services and natural gas distribution and storage to private investment and
foreign competition.

•

The Mexican government is also drafting plans to privatize electricity
generation plants and airports, and to sell concessions to operate additional
toll roads.

•

On July 12, the government announced winning bidders for three port
facilities. Winning bids for the two largest ports were from joint ventures
between Mexican and foreign-owned companies.

Mexico completes second round of pori privatizations
On August 9, the Mexican government announced winning bidders for several
additional port facilities.
•

The winning bidders for facilities at the port of Lazaro Cardenas were an
Indian firm, and a joint venture between a Mexican firm and a U.S. firm.

•

The winning bidder for facilities at the port of Manzanillo was a joint
venture of several Mexican companies.

Government officials are planning another round of port privatizations that could
take place by the end of the year.

TrelMury Secretary's Report to Congress
August 1995

•

This third round of port privatizations will include additional facilities at
Lazaro Cardenas and Altamira, as well as facilities at Guaymas,
Topolobampo, Puerto Vallarta, and Acapulco.

•

Mexican officials have announced that they expect to raise
pesos from all the port privatizations.

NP 1. 1

billion

Government announces plans to privatize railroads
The government has announced that it will break up the state-owned railroad
company into regional subsidiaries, each with port access.
•

Bidding for Mexico's railroads is expected to begin by mid-1996.

•

The Mexican government has chosen CS First Boston and Grupo
Financiero Serfin as its advisors for the sale of the government-owned rail
system.

Petrochemical plant bidding to begin this year
PEMEX'S Director, Adrian Lajous Vargas, has announced that the bidding process

for the company's petrochemical plants will begin in October.
•

The first complex to be sold is likely to be the Cosoleacaque plant. After
that, bidding will open for some of PEMEX' S largest facilities including
those at La Cangrejera, Morelos and Pajaritos.

•

Director Lajous stated that there would be no restrictions on foreign
ownership of petrochemical facilities, even though NAFr A allows Mexico
to limit foreign ownership to 40% of the stock of voting capital.

•

PEMEX will continue to hold between 20% to 30% of the privatized

companies' voting shares during an unspecified transition period.
•

PEMEX has selected J.P. Morgan as financial advisor and Arthur D. Little
as the company's technical advisor. PEMEX officials expect to complete the

sale of all plants by mid-1996.

Treasury Secretary's Report to Congress
August 1995

GOM releases draft regulations to open natural gas distribution

The Mexican government has published draft regulations to open natural gas
distribution and storage to foreign and private investors.

•

Interested parties will be able to bid for concessions to build and operate
pipelines and storage facilities.

•

After receiving comments from interested parties, government officials plan
to publish final regulations this fall.

II.

Infonnation Disclosure

Mexico has significantly increased the breadth and frequency of its reporting

Public disclosure of financial data by the Mexican government and the Bank of
Mexico has increased substantially.
•

Mexico has improverl the coverage and timing of its reporting on both real
and financial indicators, including data on output, inflation, international
reserves, balance of payments, fiscal and monetary aggregates, and public
debt.

•

This month, the Mexican government and the Bank of Mexico began to
provide a wide set of historical and current data on the Internet. Much of
this data is being provided on a more timely basis than before.

•

The government and the central bank's efforts to improve the timeliness
and scope of its public disclosure encourages accurate private sector
monitoring of economic developments in Mexico. For example, weekly
infonnation regarding net domestic credit and its components (such as net
lending to commercial banks and net lending to development ban~) enables
private analysts to verify the direction of the central bank's credit policies.

Treasury Secretary's Report 10 Congress
August 1995

ll.

Economic Adjustment

Mexico's economic adjustment program has so far succeeded in its objectives of
containing the inflationary impact of the devaluation and improving the country's
external position. However, the economy experienced a deep recession in the first
half of the year, with high unemployment and losses in real income.
There are some signs, however, that the economy may be turning the comer.
Mexico's strong adjustment program, the increased efficiency of its economy
following seven years of reforms, and the liquidity provided under the U.S. -led
support program suggest that the adjustment will be less protracted than that which
followed the 1982 crisis.

Inflation is moderating
Following a sharp rise in inflation during the first four months of 1995, the
monthly inflation rate has fallen sharply.
•

In July, consumer prices rose 2.04%, the lowest monthly increase this year,
after rising 3.2% in June. The monthly rate of consumer price inflation
peaked at 8.0% in April primarily due to the peso depreciation and
increases in public sector prices and the value-added tax.

•

In the first half of August, prices rose by 0.9% compared to the last half
of July.

•

Many private analysts expect monthly inflation to continue its downward
trend, though with seasonal variations.

The sharp decrease in inflation is due to several factors.
•

The fiscal surplus, tight monetary stance, and relative stability of the peso
in recent months has limited pressure on prices in both the domestic and
international tradeable goods sectors.

Treasury SecreUlry's Report 10 Congress
August 1995

•

Wage increases have been substantially below the rate of inflation,
preventing a wage-price spiral.

Strong expons and restrained impons have shifted Mexico IS trade balance
Adjustment in Mexico's trade position has greatly reduced external financing
needs, and strong export growth has helped offset weak domestic demand.

•

Mexico registered a merchandise trade surplus of $609 million in June, a
$1 billion increase from last year's June deficit.

•

Mexico registered a merchandise trade surplus of $3.0 billion for the first
half of 1995, compared to a deficit of $8.9 billion in the first half of 1994.

Export performance was steady.
•

For the second quarter as a whole, exports were unchanged compared to the
first quarter, on a seasonally adjusted basis. This follows a 15.7% increase
between the fourth quarter of 1994 and the first quarter of 1995.

•

Manufacturing and petroleum export revenues grew vigorously in the
second quarter owing to the existence of competitive export-based
suppliers, as well as higher world oil prices.

Imports have continued to decline as a result of the increase in peso costs and weak
domestic demand.
•

Imports fell 11.3% from the first to the second quarter, on a seasonally
adjusted basis. This follows a 15.0% decline between the fourth quarter of
1994 and the first quarter of 1995.

Consumer and capital goods, which are sensitive to domestic demand, have largely
accounted for the drop in imports. Imports of intermediate goods, by contrast,
which are used as inputs in the production of export goods, have remained buoyant
in response to strong export demand.
•

Consumer good imports fell 29% in the first quarter and 49% in the second
quarter of 1995 compared to a year ago.

Treasury Secretary's Report 10 Congress
Augusrl995

•

Imports of capital goods were down 22 % and 37% in the first and second
quarters, respectively, compared to a year ago.

Mexico's economy contracted in the first half of the year
The large drop in capital inflows has been an important factor leading to a deep
recession, notwithstanding the tempering effects of the official support package.
Mexico's GOP fell 10.5% in the second quarter of the year after falling 0.6% in the
first quarter on a year-over-year basis.
•

Even after accounting for seasonal factors, the recession in the first half of
the year has proven to be deeper than official forecasts expected. On a
seasonally adjusted basis, GOP in thP first quarter of 1995 fell roughly 3.6%
compared to the previous quarter. In the second quarter, GOP fell an
estimated 7.2 % compared to the previous quarter.

Weak domestic demand, tight credit, and the transfer of resources to the export
sector have had a sharp impact on the non-tradeable goods sector.
•

Construction output declined 23.6% in the second quarter of 1995
compared to the same period last year, and fell 15.6% in the first half of
the year compared to the first half of 1994.

•

The service sector posted similar results, shrinking over 20% in the second
quarter. This resulted in a 13 % drop in the second half of 1995 compared
to the same period in 1994.

Modest growth in sectors sensitive to external demand (such as manufacturing) has
partially compensated for the contraction in output in the non-tradeable goods
sector.
•

Industrial production edged up an estimated 3.7% in May, on a seasonally
adjusted basis. This followed a decline of 8.3% in April and a fall of 5.3%
between the first quarter of 1995 and the fourth quarter of 1994.

Treasury Secretary's Report to Congress
August 1995

•

Output of mines, utilities, and steel have registered modest increases
compared to 1994. Despite the overall decline in GDP, the transport and
communications sectors also grew 0.4% in the first half of the year
compared to the first half of 1994.

•

The maquiladora sector has also increased output due to higher exports.
Value-added output in May was 34% above the level in December 1994
and was over 50% higher than in May 1994.

Labor markets weakened in the first half of the year
With the decline in output, unemployment grew in the first half of 1995, though
wage flexibility prevented even larger drops in employment. In addition, the
informal sector ~as absorbed some of the jobless from the formal sector and has
offset some of the loss in incomes.
•

After rising from 3.6% in the fourth quarter of 1994 to 5.2 % in the first
quarter of 1995, the open unemployment rate in the formal sector (a narrow
measure based on surveys of major urban areas) increased to 6.5 % in the
second quarter.

•

The Labor Ministry estimates that 2 million of the 35 million workers in
the tota1labor force were unemployed in the first half of the year, with an
additional 5 million working less than 35 hours per week.

•

Put another way, the number of unemployed or underemployed workers
grew from 4.5 million in the first half of 1994 to 7 million in the first half
of 1995.

The pattern of employment changes across sectors reflects the same economic
forces as those acting on output.
•

Employment in the construction sector contracted 26% in May compared
to the level in January, and was down almost 45% from May 1994.

•

By contrast, employment in the export-oriented maquiladora sector rose
5.4% in May compared to December and was almost 10% higher than the
May 1994 level.

Treruury Secretary's Report 10 Congress
August 1995

Underemployment rose from the effects of the recession.

•

One measure of underemployment is the rate of unemployed persons and
persons working less than 15 hours a week. This level rose from 7.4% of
the labor force in the fourth quarter of 1994 to 10.1 % in the first quarter
of 1995, and rose further to 11.2% in May.

The informal sector has absorbed some of the jobless, though generally at lower
rates of compensation.
•

As an indication of employment in the informal sector, the number of
workers who earn less than the Mexican minimum wage rose from 7.0%
to 8.0% of the labor force between the fourth quarter of 1994 and the first
quarter of 1995, and jumped to 10.8% in May 1995.

As a result of weak labor markets, real wages fell in many sectors.
•

Construction wages have fallen 7.6% and 2.2% in April and May,
respectively, on a month-to-month basis, and fell 5.4% between the first
quarter of 1995 and the fourth quarter of 1994.

•

In the manufacturing sector, real wages fell 1l.5 % and 1l.2 % in April and
May, respectively, after declining 4.5 % in the first quarter of 1995
compared to the first quarter in 1994.

Mexico's economy may be turning the comer
While monthly data must be interpreted carefully given the frequency of
fluctuations in the series, some data indicate that parts of the economy may have
bottomed out.
•

Industrial production in May increased compared to April, as mentioned
above. This was the first increase this year on a month to month basis.

•

The rate of open unemployment did not change in June compared to May,
after five consecutive monthly increases.

Treasury Secretary's Report to Congress
August 1995

The Bank of Mexico's July monthly manufacturing survey, which provides an early
reading on economic activity, also suggests that manufacturing output has begun
to strengthen.
•

According to the survey, the number of finns expecting an increase in sales
outnumbered those expecting a decline (one-third compared to one-fourth),
similar to June's results.

•

Although the pattern in earlier months of 1995 is somewhat erratic, there
has been a clear increase since April in the share of firms expecting higher
production and sales.

In an August survey by Consensus Economics, private analysts forecast that GDP
would rise 2.2 % in 1996. They further estimated that in 1996 manufacturing
production would increase 3.0%, private consumption would rise 1.0%, and gross
fixed investment would rise 3.5 %.

ll.

Banking Sector Developments

Mexico's banking system remains strained
The condition of the Mexican banking system is strained, as evidenced by the level
of nonperfonning loans, reported at 11.9% of total loans on June 30, 1995. There
are nonetheless some encouraging signs:
•

The rate of increase in non performing loans is reported to have slowed
since June for the system ·as a whole, though the situation varies by bank.

•

Loan restructuring efforts are gaining steam and should reduce the level of
nonperforming loans.

•

Banks' dependency on FOBAPROA, the central bank's insurance fund, for
dollar liquidity has declined to less than $100 million, from a peak of $3.8
billion in early April.

Treasury &cretary's Report to Congress
August 1995

Government initiatives provide support for banks

Earlier this year the Mexican authorities responded with a number of initiatives to
aid the banks by providing: liquidity (FOBAPROA), a temporary source of capital
(PROCAPTE), and a program to restructure loans (UDI).

•

In March, six banks joined PROCAPTE and issued approximately $1 billion
in subordinated debt to meet minimum capital requirements.

•

With its restructuring program (see below), Banca Serfin was able to
replenish its capital from other sources and withdraw from PROCAPTE.

•

The outstanding balance of PROCAPTE assistance is now approximately $600
million.

After a slow start, the pace of restructuring loans under the
accelerating.

UDI

program

•

The outstanding balance of loans restructured rose from NP3.5 billion on
July 7 to NP15.9 billion on August 11. The balance, however, remains far
below the program's NP156 billion ceiling.

•

Loans restructured under the banks' own programs, which include
variations of the UDI instrument, totaled NP39 billion as of August 11.

New program designed to encourage additional loan restructuring

In August, the Mexican government announced a new program targeted at
consumer, credit card, small business, and mortgage borrowers. The program is
intended to encourage additional loan restructuring, avoid the development of a
non-payment culture, and provide a transitional period for borrowers to restructure
in UDIs.
•

The program is designed to help holders of consumer/credit card loans,
small businesses, and small mortgage holders who continue to make all
required payments.

Treasury Secretary's Report to Congress
August 1995

•

It covers only loans outstanding as of August 31, 1995. All new lending
would be excluded from this program.

The program contains two components.
•

The first provides one year of interest rate relief for small credit card,
business, and consumer loans.

•

The second expands and modifies the current UDI program so that these
loans can be restructured into UDIS after the one-year support period. At
the same time, it expands and modifies the mortgage UDI program.

Borrowers who have been current in their payments will receive the lower rates as
of September 1, 1995. Delinquent borrowers need to sign a letter of agreement
with the bank and begin making minimum payments to qualify.
•

On credit card balances up to NP5,OOO, nominal interest rates will be
capped at 38.5% between September 1, 1995 and September 1, 1996.

•

For consumer loans up to NP30,OOO, nominal interest rates will be capped
at 34 % for the same period.

•

During this time, the Mexican government will pay the banks the difference
between this rate and the interbank rate plus 12.5 percentage points for
credit card debt and 8 percentage points for consumer loans.

•

On small business loans up to NP200,OOO, the borrower will pay 25 %. The
Mexican government will pay the banks the difference between 25 % and

the interbank rate plus 2 percentage points.
The cost of the interest rate relief program to the government thus depends on what
interbank rates are during the next 12 months. In mid-August, the interbank rate
was about 37%.

•

If interest rates remain unchanged from current levels, the interest rate
component paid by the government would be about 15 percentage points for
small business loans and about 10 percentage points for consumer and
credit card loans.

Treasury &cretary's Report to Congress
August 1995

•

However, many private analysts expect interest rates to fall during the next
12 months, which would reduce the cost of the program. In the August
Consensus £COMmies survey, respondents expected interest rates on 28-day
cetes to fall from 35% in August to 31 % by January 1996 and 26% by July
1996.

The ultimate cost of expanding the UDI program will depend on such factors as: (1)
real interest rates received and paid by the Mexican government, (2) the amount
of loans restructured, and (3) default rate.
In late August, the Mexican government estimated the fiscal cost of the interest
rates relief program and the expansion of the UDI program would be about NP7
billion.
•

The Mexican government estimated that this program will c( . 0.4 % of
1995 GDP, although they plan to amortize this cost over many years.

Government supports bank recapitalization efforts
To restore the solvency of the banking system, the Mexican government has
provided incentives for shareholders to inject additional capital.
•

Through FOBAPROA, the government has purchased loans from two banks
(Banca Serfin and Multibanco Mercantil Probursa) in relation to new capital
injected by shareholders in exchange for non-amortizing, long-term
government bonds.

II.

Financial Market Trends

Recent developments continue to suggest that financial markets are responding
positively to Mexico's adjustment program:
•

The peso remains about 20 % above its March 9 low.

Treasury Secutary's Reporr to Congress
August 1995

•

Volatility remains much lower than earlier this year. Buying and selling
spreads on the peso, a measure of volatility, have averaged 0.14% of peso
prices over the last month of trading as opposed to 3.64 % at the height of
the crisis.

•

The peso did see a slight uptick in volatility in late August in thin seasonal
trading. Concern regarding other Latin markets, market uncertainty before
the announcement of the debt restructuring program, and the reported
decline in second quarter GDP led to some cautiousness by market
participants.

Mexico's stock market is now trading about 5 % above the December 16, 1994
level, and about 70% above its low in late February, although it is still down about
40% in dollar terms since mid-December.
Interest rates have declined steadily as the exchange rate has stabilized, inflation
has declined, and the threat of default has dissipated.
•

Mexico's benchmark 28-day Treasury bill (cetes) rate has decreased from
a high of 83 % in late March to 34 % in the August 22 auction.

Improvements in the assessment of Mexican risk are also evident in the market for
Mexico's remaining dollar-denominated Treasury bills (tesobonos).
•

Secondary market tesobono rates have dipped to 8.5 % from highs above
30% in late March and early April.

The market for U.S.-backed Brady bonds also reflects a return of confidence in
Mexico and demonstrates that the risk of contagion in other Latin markets has
diminished.
•

Mexican Brady Bond interest rate spreads over U.S. Treasuries, adjusted
to remove the effect of U.S. collateral, have declined from 1937 basis
points in mid-March to 902 basis points on August 24, a decline of 10.37
percentage points.

Treasury Secretary's Report to Congress
Augusl1995

•

Yields of the stripped portion of Brady bonds in Argentina and Brazil have
recovered from the sharp declines earlier this year that had been sparked by
the Mexican crisis.

Mexico expanded funding from international capital markets in August
The Mexican government and agencies have raised over $3 billion in the private
capital markets thus far in 1995, matching levels in 1993 (see Table 2 below).
•

Following its successful $1 billion Eurodollar issue on July 11, Mexico
announced an issue of three-year, yen denominated bonds, which settled on
August 17. This offering - originally slated at ¥50 billion, and
subsequently increased to ¥100 billion (about $1.1 billion) in early August
- carries a 5 % fixed interest ratr equivalent to approximately a 425 basis
point spread over U.S. Treasuries in dollar terms.

•

Secondary market yields on the VMS I Eurodollar issue declined from an
initial 11.18% to approximately 10.4% by August 24.

•

National development bank Nafinsa IS 3-year Eurobond issue, denominated
in Deutsche Marks (DM 250 million, or about $170 million) with a 10%
interest rate (equivalent to approximately a 497 basis point spread over
U.S. Treasuries in dollar terms), was received enthusiastically by European
retail investors and the bonds quickly traded at a premium in the secondary
market after its offering in late J ul y.

Treasury Secretary's Report to Congress
August 1995

TABLE 2.

Mexican public-sector bond

issuan~

Issuer

Type

Date

Amount
(US$ M)

Tenor

Interest rate

Bancomext

Euro FRN 1

May 23

$30.0

1 year

LlBOR +5.80%

Euro FRN

May 31

$75.0

1 year

L1BOR + 5.44%

Euro FRN
144A

June 23

$300.0

2 years

UBOR + 5.51 %

Eum FRN

May 4

S11O.3

1 year

LlBOR + 3.50

Euro FRN

May 4

$73.7

7 months

LIBOR + 2.25%

Euro FRN

May 9

$50.0

1 year

LIBOR

Euro FRN

May 15

$28.0

1 year

UBOR + 8.00%

Euro FRN

May 24

$10.0

1 year

LlBOR + 5.60%

Eurobond

July 17
(issued
August 11)

DM 250
(approx.
$170.0)

3 years

10% coupon

Eurobond

August 23
(to be issued
September
29)

SwFr 150
(approx.
SI22.0)

3 years

7.50% coupon

Euto FRN
144A

July 11
(issued July
20)

$1000.0

2 years

Eum MTN 2

July 26
(issued
August 17)

¥ 100 billion

Nafinsa

United
Mexican
States

L1BOR

+ 6.00

5.375%

(approx.

$1.101),0)

1. Floating rate note.
2. Medium-term note.

3 years

5% coupon

Treasury Secretary's Report 10 Congress
August 1995

Mexican corporations and private financial institutions have re-entered the
international capital markets more slowly.
•

Several large corporations with export-oriented businesses have successfully
placed short-term dollar-denominated commercial paper. Other institutions
have found success in placing structured transactions in which investors
have recourse to assets or cash flows denominated in foreign currencies,
including dollars.

•

For example, Apasco, a Mexican cement producer, placed 12-year,
investment-grade rated debt with the assistance of the International Finance
Corporation (IFe) , the World Bank's private sector affiliate. This is the
longest-term financing obtained by any Mexican issuer since the December
devaluation. The $85 million in structured notes, yielding 9 %, were placed
with insurance companies and pension funds.

International Reserves

Mexico has repaid 89% of tesobonos maturing in 1995

At the start of 1995, $29.2 billion of dollar-denominated tesobonos were in
circulation.
•

With the onset of the crisis, many market participants began to doubt that
Mexico would have sufficient resources to meet these obligations.

The last remaining large concentration of tesobonos came due in the July-August
period, when $6.8 billion were redeemed.

•

By August 31, only $3.2 billion of the $29.2 billion in tesobonos maturing
this year will remain outstanding.

•

With its paydown of these tesobono obligations, Mexico has addressed one
of the primary drivers of its short-term liquidity crisis and eliminated a
substantial source of pressure on its international reserve position.

Tuasury Secretary IS R~port to Congress
August 1995

Mexico's reserves have risen substantially since the beginning of the year
Mexico's international reserves have risen by $7.2 billion in the year through
August 18 to $13.4 billion.
•

The increase in reserves includes official assistance of $22.3 billion less
direct dollar tesobono redemptions and other net outflows.

•

On August 28, the IMF disbursed a further

SDR 1.1 billion (approximately

$1.7 billion).
•

In the first quarter, severe liquidity problems, led by large tesobono
redemptions and other outflows of investment capital, allowed for only a
$702 million increase in international reserves despite official support
amounting to $12.7 billion.

•

In the second quarter, however, the reserve accumulation of $3.2 billion
amounted to 64 % of the $5 billion in official support despite dollar
outflows of $3.9 billion to redeem tesobonos.

•

In July, reserves grew by $3.8 billion, or 82 % of the $4.5 billion Mexico
received in official support, despite outflows of $3.1 billion to redeem
tesobonos.

•

Even with heavy tesobono redemption through August 18 of $1.3 billion
in dollars and no additional official support during the period, reserves fell
by only $548 million (a further IMF disbursement took place on August 28,
see above).

Treasury Secretary's Report 10 Congress
August 1995

TABLE 3.

Mexico's international reserves (US$ billions)

December 1994

$6.15 billion

J Mua!)' 1995

3.48

February

8.96

March

6.85

April

8.71

May

10.44

June

10.06

July

13.87

August 18

13.36

A mong the most important factors affecting reserve accumulation over the past
several months has been the government's return to international capital markets
and the paydown by Mexican banks of dollar loans from FOBAPROA.
•

The UMS'S $1 billion floating-rate note issue in July, was followed
August with a very successful $1.1 billion Euro-yen issue.

•

Mexican banks have been able to access dollar inflows to repay
approximately $3.7 billion in loans to FOBAPROA, largely eliminating these
obligations (see "Banking Sector Developments" above). These repayments
added to international reserves, reversing previous drains.

Treasury Secretary's Report to Congress
August 1995

Disbursements, Swaps, Guarantees and Compensation to the U.S.
Treasury

As of August 31, 1995, $13.5 billion in U.S. funds have been disbursed to Mexico
under the support program approved by the President on January 31, 1995. Of this
amount, a total of $12.5 billion remains outstanding - $2 billion in short-term
swaps, and $10.5 billion in medium-term swaps. To date, the United States has
not extended any guarantees to Mexico under the support program.
•

Under the swap agreements, Mexico purchases dollars and credits a
corresponding amount of pesos to the U.S. account at the Bank of Mexico.
On the maturity date, Mexico repurchases the pesos and pays back the
dollars.

•

Both the short-term and medium-term swap facilities require Mexico to
maintain the dollar value of peso credits to the United States, adjusting the
amount of pesos on a quarterly basis, in accordance with changes in the
dollar-peso exchange rate.

•

As provided for in the agreements, Mexico must pay the Treasury interest
on the swap balances outstanding. The interest charges applied to shortterm swaps are designed to cover the cost of funds to the Treasury and thus
are set at the inception of the swap based on the Treasury Bill rate. Interest
rates are reset at the time of any roll-overs of existing short-term swaps.

•

Interest charges applied to the medium-term swaps are designed to cover
the cost of funds to the Treasury plus a premium for the credit risk
associated with the extension of such funds, as assessed at the time of each
disbursement. Paragraph 6 (d) of the Medium-Term Exchange Stabilization
Agreement (the Medium-Term Agreement) provides that interest rates on
swaps with Mexico are "intended to be at least sufficient to cover the
current U. S. Government credit risk cost for Mexico. "

Trt!QSury Secretary's Report to Congress
August 1995

•

For each disbursement under the Medium-Term Agreement, the premium
is the greater of (1) a rate determined by the U.S. Government's interagency country risk assessment system (TeRAS) as adequate compensation
for sovereign risk of countries such as Mexico, or (2) a rate based on the
amount of U.S. funds outstanding to Mexico from short-term swaps,
medium-term swaps, and loan guarantees at the time of disbursement.

•

Mexico has not missed any interest payments or required principal
repayments under any of the swaps.

As of August 18, 1995, $12.0 billion has been disbursed through the
$11.5 billion remains outstanding.

ESF,

of which

The schedule of swaps under both ESF and Federal Reserve swap lines is as
follows:

ESF short-tenn swaps

•

On January 11 and January 13, 1995, Mexico made
two drawings of $250 million each under short-term
swaps through the ESF.
Mexico repaid these
drawings on March 14, 1995.

•

On February 2, 1995, the U.S. disbursed $1 billion
under a short-term swap through the ESF; this swap
was rolled over for an additional 90-day period on
May 3, 1995 and again on August 1, for a new
maturity date of October 30, 1995. The current
quarterly interest rate is 5.45 %.

Treasury Secretary's Report to
August 1995

ESF medium-tenn

Congr~ss

swaps

•

Mexico drew $3 billion under a medium-term swap
on March 14, 1995. The current quarterly interest
rate is 7.80%.
Repayment is to be made in seven installments as
follows: six equal installments of $375 million each,
payable on June 30, 1998 and each successive
calendar quarter date to and including September 30,
1999; and one installment of $750 million, payable
on December 31, 1999.

•

On April 19, 1995, Mexico made a second $3 billion
drawing through a medium-term swap. The current
quarterly interest rate is 10.16%.
Repayment is to be made in twelve installments as
follows: eleven equal installments of $245 million
each, payable on June 30, 1997 and on the last day
of each successive calendar quarter, to and including
December 31, 1999; and one installment of $305
million, payable on March 31, 2000.

•

On May 19, 1995, Mexico drew $2 billion under a
medium-term swap. The current quarterly interest
rate is 10.16%.
Repayment is to be made in twelve installments as
follows: eleven equal installments of $170 million
each, payable on June 30, 1997 and on the last day
of each successive calendar quarter, to and including
December 31,1999; and one installment of $130
million, payable on March 31, 2000.

Treasury Secretary's Repon 10 Congress
Augusl1995

•

Most recently, on July 5, 1995, Mexico drew $2.5
billion under a medium-term swap. The current
quarterly interest rate is 9.20%.
Repayment is to be made in twelve installments as
follows: eleven equal installments of $205 million
each, payable on September 30, 1997 and on the last
day of each successive calendar quarter, to and
including March 31, 2000; and one installment of
$245 million, payable on June 30, 2000.

Federal Reserve swaps
•

Disbursements to Mexico through the Federal
Reserve System total $1.5 billion, with $1 billion
outstandl ..g. All Federal Reserve disbursements are
in the form of short-term swaps.

•

On January 11 and January 13, 1995, Mexico made
two drawings of $250 million each under short-term
swaps. Mexico repaid these drawings on March 14,
1995.

•

A short-term swap of $1 billion was extended on
February 2, 1995; this swap was rolled over for an
additional 90-day period on May 3, 1995 and again
on August 1, 1995, for a new maturity date of
October 30, 1995. The quarterly interest rate is
5.45%.

Treasury Secretary's Report 10 Congress
Augusrl995

IV.

Mexico's Financial Transactions

Effecti ve upon the signing of the agreements on February 21, 1995, and prior to
each disbursement, Mexico must provide Treasury with information on the
intended use of U.S. funds, and Treasury must verify that such uses are consistent
with Mexico's Financial Plan.
•

To date, Mexico has requested and Treasury has authorized the use of funds
to redeem tesobonos and other short-term, dollar-denominated debt of the
Mexican government and its agencies.

•

As of August 17, 1995, Mexico has used $11.7 billion in U.S. funds to
redeem tesobonos and $0.8 billion to accumulate reserves for future
redemptions of tesobonos and other short-term dollar-denominated
obligations.

With U.S. and other official support, Mexico has reduced the amount of
outstanding tesobonos, or short-tenn, dollar-linked government debt, by about $26
billion since the beginning of 1995.
•

Since the beginning of 1995, the amount of tesobonos outstanding in public
hands has declined from $29.2 billion to $3.2 billion at the end of August.

Tr~asury

Secretary's Report to Congress
August 1995

Status of the Oil Facility

Payments through the Federal Reserve Bank of New York account
The payment mechanism, established under the Oil Proceeds Facility Agreement,
continues to function smoothly.
An independent review has confirmed that the Mexican oil proceeds financial
mechanism is working well. Petroleos Mexicanos' independent public auditors,
Coopers & Lybrand, analyzed the information utilized for the last two quarterly
export reports prepared by PEMEX and provided to the U. S. Treasury pursuant to
the Oil Proceeds Facility Agreement. Their review revealed that the reports "fairly
present" information related to both PEMEX's oil exports and the collection of
proceeds from such exports. Similar reviews will be performed every six months.
As of August 22, 1995, over $3.95 billion has flowed through Mexico's special
funds account at the Federal Reserve Bank of New York since the agreement went
into effect in early March. Approximately $25 to 30 million flows through the
account each day. To date, there have been no set-offs against the proceeds from
Mexico's crude oil, petrochemical. and refined product exports.

Mexico has pursued tight monetary policy_
• Money supply growth has been controlled.
Nominal M1. seasonally adjusted
30%

20%

10%

-10%

Jan 94 Mar 94 May 94 Jut 94 Sep 94 Nov 94 Jan 95 Mar 95 May 95 Jut 95
Feb 94 Apr 94 Jun 94 Aug 94 Oct 94 Dec 94 Feb 95 Apr 95 Jun 95

Change from previous year

Change from previous month

• Net domestic credit has been reduced.
100,000
90,000

80,000
70,000
60,000

50,000

40,000

30,000
20,000
101000

0
(10,000)
(20,000)
(30,000)
(40,000)

Nov 94 Dec 94 Jan 95 Feb 95 Mar 95Ap( 95 May 95 Jun 95

- ..

Monetary Gross International Net Domestic
Base
Reserves
Credit

Jul 95

Despite the recessionary effects of adjustment,
Mexico has maintained tight fiscal policy_
• Higher oil receipts and a
VAT increase helped
offset declines in other
public sector revenues
during the 1st half of

1995.

~ 40%

30%

~ 20%
£

!.E

10%
0%
-2%

t~10%
~ ~20%

-15.9%

"$
~-W%~----------------~-------------.Oil Revenuesi'NAT Taxes.Other Revenues

• Cuts in real non-interest
public sector spending,
particularly investment,
more than offset high real
interest payments.

g 80%
i 60%
L;.

40%
.9 20%
fii

0%1----

~ ~200/0
~-400/0

-60%

$ -80% '---______________---1.._ _ _ _ _ _ _ _ _-57.4%
cr:
_ _ _ _ _ _ _ __
_
_

• As a result, the public
sector non-financial
balance increased
compared to the first half
of 1994.

Interest IINon-lnterest
Payments
Spending

II Fed,

Wages fJi!1Federai
and Benefits - Investment

8
6

ou_2

First half 1994

I•

Firelhaf 1995

Overall Balance. Primary Balance

Second quarter nominal GOP estimated using reported increase
in Mexican CPl. Primary balance equals overall balance Jess
interest payments.

Mexico has effectively restructured its short-term
dollar debt ...
• The outstanding balance of tesobonos has been reduced by 89% this year.
• The July-August concentration in maturities has been successfully managed.
Weekly Amortizations in US$M

Outstaldng Balance in

ussa

1600

1500
1400
1300

1200
1100

1000
900
800
700
600
500
400
300
200

15
10

100

Jan-95

Feb-95

Mar-95

Apr-95

May-95

Jun-95

JuI-95

Aug..eS

Outstanding Balance Amortizations in Pesos Redeemed directly into US$

I'Ii!iII

... and has reconfigured its debt profile.
• Maturities of tesobonos and GOM external
debt· have been extended.
140
• Shcrt-term
• TesobOnos
• Long-term

• Domestic debt is now mostly
peso-denominated.
ClBordes
• cates
.Ajustabonos

.'esobonos

End 1994

End Q2 1995

... Includes only obligations of the Mexican government; does not include $11.5 billion in medium-term
assistance from the IMF and $2 billion in short-term swaps from the ESF and Federal Reserve,
accounted for as Bank of Mexico liabilities.

Mexico's stabilization policies have produced
strong results.
•

Inflation has moderated.
10010

.t.

CfI

60/0

,gE

ea.

~
.!2%
()

Mexican Consumer Price Index
(not seasonally adjusted)

Dec 94

•

Feb 95

Jan 95

Apr 95

Mat 95

May 95

....n95

..ktl95

Nominal interest rates have fallen since their March peak.

90%
28-day Getes
auction rate

80%

70%
60%
50%
40%

30%
20%

10%
0% 3/1

•

3115

3J29

4112

4126

519

5123

616

6120

714

7116

811

8115

High real interest rates reflect tight monetary policy.

10%

OOM.~----------~----------------------------~------~--10%

-20%

Real 28-day interest rates

~%UL----~~;-5----~~~1----41~;5---=4~II====~~15====~31~---~~5----&~ro----7~';5----7~~

While the banking system remains under strain, dollar
obligations by Mexican banks to the government insurance fund
have been almost completely repaid .
• Repayment of FOBAPROA loans reflects Mexico's improved access to private
international capital.
Net borrowing

Balances

Balances US$ billions

Net borrowing US$ millions

400

300
4

200
3

100

_ • • _.-

a
-100

-200

'·
I
5-Jan-95

- 'I 3 0-0

1D-Feb-95
16-Mar-95
24-Apr-9S
31-May-95
4-Jul-95
7-Aug...9S
25-Jan·95
29-Feb~g5
4-Apr-95
12-May-95
16.Jun·95
20..Jun-95
23-Aug-95

Bond markets have reacted favorably to
Mexico's stabilization program, suggesting
increased investor confidence .
• Stripped spreads on Mexican Brady Bonds have tightened
sign ificantly.
20%

15%

Stripped Spread
O%U--L-J--~~~~~--~~~~~--~~~~~~~

01105
02102
03102
03/31
04128
05126
06(26
07124
08f.21
12122
01119
02116
03116
04114
05112
06112
07/10
08107

• Yields on United Mexican States Yankee bonds have declined
since March.
24%

22%
20%
18%
16%

14%
12%

10%
u-~~~~~~~~~~~~~~~~~~~~~-L

8% 1211 12121 1113 2/2 2115 311

3/15 3129 4112 4125 5110 5124 617 6120 7112 811

Secondary market yields

8123

=100 ......

08/11

08101

07/20

07110

06128

06116

06106

05124

05112

05/02

04120

04/10

03129

03116

03/06

02122

02110

01131

01/19

01109

••

\
••

•I

,
,.•

,..

( ..

'-,

.,;

-".

•
I

,•
.':

,-.-

...,..',

•

.,.

• ..,
iii"

~~ ~g:~Cl~~8o
i tit, , i » ,
I
12128

IndeX: 12/2/94

06/14

05/17

04119

03122

02/22

c:::

"..,
CD
C"

(")

04118

08108

07/11

06/13

05/16

03121

02/21

01124

12127

11/29

11/01

10/04

09/06

uS/09

....

f\.)

(,,:l

•
<

:::l.

?fI!.

I
CD
C.

Q)
UJ

';3'

~
Q)

:::J

:::

!;P.

?f2.

01125

';3'
Q)

07/12

f\.)

"#.

12/28

....~

..,

6'
(")

UJ
UJ

(")

CD
~.

•

"tI

-g
~

•

08123

08114

08103

07125

';3'

"en
CD'"
C6
~
3:
Q)
07/14

o
07/05

::1
.....

~ CD

..... 3

.., s::::

0) ' - I

0)
_til-

(')

_.0

(')

::n3:
::1 CD
0)
::1 ><
_.

0.::1

CD CD

~o
..,
CD _.

o-::1
CD

C'"c.

-ft
_0

til ::1

:::r O

06/26

.....

3 ~

.., til

(QCD

-0:;-

06115

r\)

....

c:::

<t>

..,

00106

05125

05116

05/05

0026

~~
04/17

03/26

03/16

..,

s.n

Jf tt..

02124

02115

02100

01126

01/17

0'/06"

12128

:'"'I

~~~~o~~

Financial support and market inflows have
helped Mexico rebuild international reserves.
• In 01 1995, liquidity problems caused by large tesobono
redemptions and other capital outflows allowed for an increase in
international reserves of only $702 million despite $12.7 billion in
official assistance.
• In 02, however, reserve accumulation of $3.2 billion amounted to
64% of the $5 billion in official support, despite outflows of $3.9
billion to redeem tesobonos.
• In July, reserves grew by $3.8 billion, or 82% of the $4.5 billion
Mexico received in official support, despite outflows of $3.1 billion
to redeem tesobonos .

• USA. IMF • Reserves Fa Tesobonos 0 Other sources or uses, net *

14,000

12,000
fI)

:-:;
E 10000
,
fA

,:)
(Ii

~
c;:::

8,000

6,000

L:.

o
~

§, 4,000

·eo
u...

2,000

0195

Uses

Sources
(official and
other)

02 95
Uses
Sources
(official and
other)

Julv95
Uses
Sources
(official and
other)

* Current account balance, public sector external ~ebt issuances and amortizations, and private capital

flows.

Mexico's real exchange rate has reflected
stability of the peso and a moderating rate of
inflation.
• The real exchange rate has appreciated, but remains below
pre-crisis levels.
110

Dec. 19. 19~4=100

100
90
~

.--\

--~------

.s 70
60
50
40

19 Dec 94

23 Jan 95

28 Feb 95

09 May 95

04 Apr 95

13 Jun 95

18 JuI 95

Exports have exceeded imports for five
consecutive months, producing a trade surplus.

30%

20%
10".4

Imports Exports

-10%

-20%
$US millions

1,500

1,000

I•

Trade Balance

500
0
(500)

(1.()()0)
(1.500)
(2,000)
(2.500)

Lct"....l--~....J...--,-I~----::~..I..-_s.(-<J':-L--~-:-I-..~~~-~~<J'i..-/~_->;~~_-~,,~---.:ft'-.~-;:~:-~t:~:-~'~5bft;,t-A:~-t--~&>~!'-;!., ,<# # # ~- " ~ ~ rJi (J ~ 41 ~ « ~ ~ .$f ');:J

Mexico's economy experienced a sharp
recession in the first half of 1995.
• Industrial production declined.
15%
10%
5%

I--......J...~::=

-5%

-10%

Year over year change

-15%

Change from previous month (SA)

SA indicates seasonally adjusted.

• Retail sales fell.
20%
10%

OOk
-10%

-20%
-30%
-40%

Ctlange from.r earlier

Ctlange from pr.::ous month (SA)

• GOP contracted.
10%

-10%

• % Change from a year earlier

Most private analysts see Mexico return to growth
by 1996.
In an August poll by Consensus Economics, private analysts forecast:
• GOP would grow by 2.2% in 1996.
• Private consumption would rise 1.0% in 1996.
• Manufacturing production would increase 3.0% in 1996.
• Annual inflation would fall to 22.3% in 1996.
• Nominal interest rates would decline to 25.9% at the end of July 1996.

UBLIC DEBT NEWS
Department of the Treasury • Bureau of the Public Debt • Washington, DC 20239

FOR IMMEDIATE RELEASE
August 31, 1995

CONTACT: Office of Financing
202-219-3350

RESULTS OF TREASURY'S AUCTION OF 20-DAY BILLS
Tenders for $18,031 million of 20-day bills to be issued
September 1, 1995 and to mature September 21, 1995 were
accepted today (CUSIP: 912794T38).
RANGE OF ACCEPTED
COMPETITIVE BIDS:
Low
High
Average

Discount
Rate
5.57%
5.58%
5.58%

Investment
Rate
5.67%
5.69%
5.69%

Price
99.691
99.690
99.690

Tenders at the high discount rate were allotted 95%.
The investment rate is the equivalent coupon-issue yield.
TENDERS RECEIVED AND ACCEPTED (in thousands)
TOTALS
Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

RR-540

Received
$65,750,644

Accegted
$18,031,137

$65,750,144
500
$65,750,644

$18,030,637
500
$18,031,137

0
$65,750,644

0
$18 / 031,137

UBLIC DEBT NEWS
Department of the Treasury •

Bureau of the Public Debt • Washington, DC 20239

FOR IMMEDIATE RELEASE
September 5, 1995

CONTACT: Office of Financing
202-219-3350

RESULTS OF TREASURY'S AUCTION OF 13-WEEK BILLS
Tenders for $12,065 million of 13-week bills to be issued
September 7, 1995 and to mature December 7, 1995 were
accepted today (CUSIP: 912794V92).
RANGE OF ACCEPTED
COMPETITIVE BIDS:
Low
High
Average

Discount
Rate
5.28%
5.30%
5.30%

Investment
Rate
5.44%
5.46%
5.46%

Price
98.665
98.660
98.660

Tenders at the high discount rate were allotted 75%.
The investment rate is the equivalent coupon-issue yield.
TENDERS RECEIVED AND ACCEPTED (in thousands)
TOTALS
Type
Competitive
Noncompetitive
Subtotal, Public
Federal Reserve
Foreign Official
Institutions
TOTALS

Received
$48,337,651

AcceJ2ted
$12,065,120

$43,223,327
1,427,600
$44,650,927

$6,950,796
1,427,600
$8,378,396

3,287,155

399,569
$48,337,651

399,569
$12,065,120

An additional $73,631 thousand of bills will be
issued to foreign official institutions for new cash.
5.29 -- 98.663

RR-541

UBLIG DEBT NEWS
Department of the Treasury •

Bureau of the Public Debt

FOR IMMEDIATE RELEASE
September 5, 1995

Wa.shington, DC 20239

CONTACT

Office of Financing
202-219-3350

RESULTS OF TREASURY'S AUCTION OF 26-WEEK BILLS
Tenders for $12,003 million of 26-week bills to be issued
September 7, 1995 and to mature March 7, 1996 were
accepted today (CUSIP: 912794X58).
OF ACCEPTED
COMPETITIVE BIDS:

RF~GE

Low
High
Average

Discount
Rate
5.28%
5.30%
5.30%

Investment
Rate
5.51%
5.54%
5.54%"

Price
97.331
97.321
97.321

Tenders at the high discount rate were allotted 64%".
The investment rate is the equivalent coupon-issue yield.
TENDERS RECEIVED AND ACCEPTED (in thousands)
Received
$49,642,501

Accented
$12,003,243

Competitive
Noncompetitive
Subtotal, Public

$43,096,826
1,231,584
$44,328,410

$5,457,568
1,231.584
$6,689,152

Federal Reserve
Foreign Official
Institutions
TOTALS

1,914,091
$49,642,501

1,914,091
$12/003,243

TOTALS
Type

An additional $352,509 thousand of bills will be
issued to foreign official institutions for new cash.
5.29

RR-542

97.326

'IREASURY

omCE OF PUBUC AFFAIRS. 1500 PENNSYLVANIA AVENUE, N.W.• WASIllNGTON, D.C.· 20220 • (202) 622-2960

FOR RELEASE AT 2:30 P.M.
September 5, 1995

CONTACT:

Office of Financing
202/219-3350

TREASURY TO AUCTION CASH MANAGEMENT BILL
The Treasury will auction approximately $5,000
million of 8-day Treasury cash management bills to be
issued September 7, 1995.
Competitive and noncompetitive tenders will be
received at all Federal Reserve Banks and Branches.
Tenders will not be accepted for bills to be maintained on
the book-entry records of the Department of the Treasury
(TREASURY DIRECT). Tenders will not be received at the
Bureau of the Public Debt, Washington, D.C.
Additional amounts of the bills may be issued to
Federal Reserve Banks as agents for foreign and international monetary authorities at the average price of
accepted competitive tenders.
This offering of Treasury securities is governed by
the terms and conditions set forth in the Uniform Offering
Circular (31 CFR Part 356) for the sale and i&sue by the
Treasury to the public of marketable Treasury bills, notes,
and bonds.
Details about the new security are given in the
attached offering highlights.
000

Attachment

RR-543

For press releases, speeches, public schedules and official biographies, call our 24-hour fax line at (202) 622-2040

HIGHLIGHTS OF TREASURY OFFERING
OF a-DAY CASH MANAGEMENT BILL
September 5, 1995
Offering Amount .

· S5,000 million

Description of Offering:
Term and type of security.
CUSIP number
.
Auction date
.
Issue date
..
Maturity date.
. .
Original issue date.
Currently outstanding
Minimum bid amount
Multiples.
.
Minimum to hold amount
Multiples to hold
.
Submission of Bids:
Noncompetitive bids.
Competitive bids

a-day Cash Management Bill
912794 4P 6
September 6, 1995
September 7, 1995
September 15, 1995
September 7, 1995
- - S10,000
Sl,OOO
SlO,OOO
Sl,OOO

· Accepted in full up to Sl,OOO,OOO at
the average discount rate of accepted
competitive bids
. (1) Must be expressed as a discount rate
with two decimals, e.g., 7.10%.
(2) Net long position for each bidder must
be reported when the sum of the total
bid amount, at all discount rates, and
the net long position is S2 billion or
greater.
(3) Net long position must be determined
as of one half-hour prior to the
closing time for receipt of competitive tenders.

Maximum Recognized Bid
at a Single Yield

· 35% of public offering

Maximum Award .

· 35% of public offering

Receipt of Tenders:
Noncompetitive tenders
Competitive tenders .
Payment Terms .

DEPARTMENT

THE

TREASURY

TREASURY;
OFFICE OF PUBUC AFFAIRS. 1500 DUl'-'""',,,,,""

AVENiTE,N.W•• WASHINGTON, D.C. • 20220 • (202) 622-2960

FOR RELEASE AT 2:30 P.M.
September 5, 1995

CONTACT:

Office of Financing
202/219-3350

TREASURY'S WEEKLY BILL OFFERING
The Treasury will auction two series of Treasury bills
totaling approximately $24,000 million, to be issued September
14, 1995. This offering will result in a paydown for the
Treasury of about $2,800 million, as the maturing weekly bills
are outstanding in the amount of $26,801 million.
Federal Reserve Banks hold $6,408 million of the maturing
bills for their own accounts, which may be refunded within the
offering amount at the weighted average discount rate of accepted
competitive tenders.
.
Federal Reserve Banks hold $2,053 million as agents for
foreign and international monetary authorities, which may be
refunded within the offering amount at the weighted average
discount rate of accepted competitive tenders. Additional
amounts may be issued for such accounts if the aggregate amount
of new bids exceeds the aggregate amount of maturing bills.
Tenders for the bills will be received at Federal
Reserve Banks and Branches and at the Bureau of the Public
Debt, Washington, D. C. This offering of Treasury securities
is governed by the terms and conditions set forth in the Uniform
Offering Circular (31 CFR Part 356) for the sale and issue by the
Treasury to the public of marketable Treasury bills, notes, and
bonds.
Details about each of the new securities are given in the
attached offering highlights.
000

Attachment

RR-S44
For press releases, speeches, public schedules and official biographies, call our 24-hour fax line at (202) 622-2040

HIGHLIGHTS OF TREASURY OFFERINGS OF WEEKLY BILLS
TO BE ISSUED SEPTEMBER 14, 1995
September 5, 1995
Offering Amount .

$12,000 million

Description of Offering:
Term and type of security
CUSIP number
Auction date
Issue date
Maturity date
Original issue date
Currently outstanding
Minimum bid amount
Multiples .

91-day bill
912794 T6 1
September 11, 1995
September 14, 1995
December 14, 1995
December 15, 1994
$31,378 million
$10,000
$ 1,000

182-day bill
912794 X6 6
September II, 1995
September 14, 1995
March 14, 1996
September 14, 1995
$10,000
$ 1,000

The following rules apply to all securities mentioned above:
Submission of Bids:
Noncompetitive bids
Competitive bids

Accepted in full up to $1,000,000 at the average
discount rate of accepted competitive bids
(1) Must be expressed as a discount rate with
two decimals, e.g., 7.10%.
(2) Net long position for each bidder must be
reported when the sum of the total bid
amount, at all discount rates, and the net
long position is $2 billion or greater.
(3) Net long position must be determined as of
one half-hour prior to the closing time for
receipt of competitive tenders.

Maximum Recognized Bid
at a Single Yield

35% of public offering

Maximum Award .

35% of public offering

Receipt of Tenders:
Noncompetitive tenders
Competitive tenders
Payment Terms .

Prior to 12:00 noon Eastern Daylight Saving time
on auction day
,
Prior to 1:00 p.m. Eastern Daylight Saving time
on auction day
Full payment with tender or by charge to a funds
account at a Federal Reserve Bank on issue date

DEPARTMENT

'IREASURY
OFFICE OF PUBliC AFFAIRS. 1500 n"'''''''''''.TT

FOR IMMEDIATE RELEASE
September 6, 1995

THE

TREASURY

NEWS
GTON, D.C .• 20220. (202) 622-2960

Contact: Chris Peacock
(202) 622-2960

TREASURY NOTES BUREAU REGULATORY REFORM INITIATIVES
The Treasury Department and its bureaus have taken a number of steps to reduce
the regulatory burden on the American taxpayer.
The laws that Treasury's bureaus administer through regulations save lives, stop
illegal drugs from entering the United States and protect the American financial system.
In complying with the President's regulatory reform directive, Treasury Secretary Robert
Rubin asked Treasury bureaus to examine every page of their regulations in order to
eliminate unnecessary burdens while meeting their legal duty to save lives, protect our
citizens from crime, and ensure the safety and soundness of our financial institutions.
Examples of the initiatives undertaken by Treasury bureaus are listed below.
U.S. Customs Service:
Prior to the enactment of the Customs modernization provisions of the North American
Free Trade Agreement Act (NAFfA), Customs did not have the legal flexibility to
experiment with improving its operations. Under NAFfA, Customs can now publish
notices in the Federal Register informing the public of Customs test programs that permit
the agency to experiment with different methods of complying with the laws passed by
Congress, regardless of whether the methods are consistent with existing Customs
regulations. Customs can solicit volunteers to participate in the test programs and ask
for trade community input in designing the programs. This partnership with the trade
community gives Customs the flexibility to experiment with innovative procedures for
meeting statutory requirements, and provides the trade community with an opportunity
for much greater input into the design of the regulations that effect their industry.
Remote location filing will allow Customs to make more efficient use of its import
specialist work force by channeling work to remote locations, and will help importers by
allowing them to make an entry at locations other than where they are geographically
situated.
RR-545

For press releases, speeches, public schedules and official biographies, call our 24-hour fax line at (202) 622-2040

Office of the Comptroller of the Currency:
For the first time in its 132 year history, the OCC is conducting a top-to-bottom review
of all of its regulations and guidelines. With the focus of maintaining a safe and sound
national banking system, the OCC is adjusting how and what it regulates in order to
improve efficiency, eliminate unnecessary burdens on banks, and increase attention to
areas that pose the greatest risks to the stability and health of the banking industry.
An example of OCC's efforts is the reduction of a regulation from a convoluted and

legalistic 269 words to 65 words that are easy to understand. OCC also proposes to
eliminate a 30-step application process for ATM machines that are shared with other
entities. OCC's new procedure for conducting examinations of small, well-run banks is
drawing very favorable reviews, and the agency is taking the lessons it is learning from
this process to its other examinations. Steps such as these collectively reduce the burden
on banks, and provide OCC with the opportunity to concentrate its efforts on areas
where problems are apt to arise. Preliminary results indicate that the OCC is on the
right track, as bankers are commenting favorably on their experience with the new OCC
oversight procedures.
Office of Thrift Supervision:
OTS held a series of "Partnering Meetings" with thrift executives in each of its five
regions to receive input from the executives on the regulations they found to be most
burdensome, duplicative, and confusing.
OTS also created the Examination Outreach Program to identify shortcomings and
problems in its thrift examination process. Following on-site examinations of their
institutions, thrift managers are interviewed to determine the quality of the examination.
OTS incorporated feedback from the Partnering Meetings and Examination Outreach
Program into its regulatory burden reduction effort. As a result of the Examination
Outreach Program, OTS has improved the quality of its examinations and its
communications with thrifts. The agency also initiated a five-phase program designed to
delete obsolete and redundant regulations, to achieve commonality of regulations and
policies with banking regulators, and to identify legislative changes necessary to relieve
further the overall regulatory burden.
Internal Revenue Service:
The Internal Revenue Service review of the entire tax code found that most tax
regulations provide an important service to taxpayers by interpreting tax laws and
describing how to comply with them. Nevertheless, the IRS review identified over 1,200
pages of regulations and other tax guidance that either can be eliminated or reinvented.
A project to shed this regulatory dead weight is underway.

Also in response to the President's request for agency heads to get out of Washington to
talk directly with the regulated community, the Commissioner of Internal Revenue soon
will hold her seventh town meeting with small business owners to listen to their
comments about IRS regulations and administrative programs. The six sessions held so
far have led to numerous changes at the IRS to address small business concerns.
Financial Crimes Enforcement Network (FinCEN):
FinCEN is reviewing its regulatory policies regarding financial institutions subject to
counter- money laundering laws. To maximize input from the nation's financial
community, FinCEN sponsored five regulatory partnership meetings around the country
in April 1995 to elicit ideas from the financial sector on how the agency can best
implement its regulatory reform strategy. The partnership between Treasury and the
private sector to combat money laundering is an outgrowth of Treasury's Bank Secrecy
Act Advisory Group, which is comprised of 30 private sector and government entities.
Bureau of Alcohol Tobacco and Firearms:
ATF is making significant changes to streamline the approval process for alcoholic
beverage labels. The changes ease industry paperwork, set a timetable for processing
requests, and reduce review time by ATF. Customers seeking an ATF permit to
produce, import or wholesale alcoholic beverages can expect a 66 percent reduction in
processing requirements. ATF regulators report good progress in attaining that goal.
ATF is also moving to simplify the payment of federal firearms and ammunition excise
taxes. The new system will require fewer deposits and eliminate many forms.
Bureau of Public Debt
Public Debt reinvented its regulations governing the terms and conditions of Treasury
securities issued to finance the nation's $4.9 trillion public debt in order to improve
customer service.
Public Debt published new rules for Series EE savings bonds, effective May 1, 1995, to
assure the 15 million Americans who buy savings bonds each year a fair, market-based
return on the money they lend the government. The regulations governing signature
certifications were amended to improve customer service for investors in marketable
Treasury bills, notes and bonds. Public Debt amended its regulations to expand the
universe of certifying officers for security transactions in order to make it more
convenient for investors to complete transactions in Treasury securities.
After a thorough review of regulations governing State and Local Government Series
Securities, Public debt published in January 1995 regulations that streamline procedures
and improve customer service to state and local government entities that purchase these
special non-marketable securities.
-30-

DEPARTMENT OF THE TREASURY
SUMMARY REpORT
ON THE
PRESIDENT'S REGULATORY REFORM INITIATIVES

June 15, 1995

DEPARTMENT OF THE TREASURY
SUMMARY REpORT
ON THE
PRESIDENT'S REGULATORY REFORM INITIATIVES
TABLE OF CONTENTS

Part I - Missions,and Goals. • • • • • •

··

•

Internal Revenue Service • • • •
•
U.S. customs Service •
• •
• • •
Bureau of Alcohol, Tobacco
and Firearms
•
Office of the Comptroller
of the Currency •
•
Office of Thrift Supervision
Financial Management Service •
•
Bureau of the Public Debt •
•
Financial crimes Enforcement Network
Office of Foreign Assets Control

·
·
.. ·····
· · · · ·· ··
·
·

·
··
·
·

··

·
·

·
·
··
·
·

•

1
1
2
2

3
3
3
4

Part II - Eliminating and Improving Regulations
Internal Revenue Service • • • • • • •
u.S. customs Service • • • • • • • • •
vSureau of Alcohol, Tobacco
and Firearms
•• ~ • • • • • • • •
Office of the Comptroller
of the CUrrency • • • • • • • • • •
vOffice of Thrift Supervision
•••
• Financial Management Service •
• •
VBureau of the Public Debt • • • • • •
Financial crimes Enforcement Network •
yOffice of Foreign Assets Control • • •
Part III - Rewarding Results • • • • • • • •
overview

..............

9
12
14
16
19
25
26
27
28

..
30

Highlights of Bureau Plans
U.S. CUstoms Service • • • •
Bureau of Alcohol, Tobacco
and Firearms • • • • • • •
Office of the Comptroller
of the currency • • • • • •
Internal Revenue Service • •
))ffice of Thrift Supervision

•

• ••

• ••
.
• ••

34
34
35

Appendix A, Treasury Planning/
Budget/Evaluation Process

Appendix B, Number of Front-Line
Requlators
•

·····

.··· ·······

Appendix C, Implementation Plans

u.s.

customs service • • •
Bureau of Alcohol, Tobacco
and Firearms • •
• •
Office of the Comptroller
of the currency
•
• • •
Internal Revenue Service •
Office of Thrift supervision •

··
···

·
·

···
·· · ··
··

Part IV - creating Grassroots Partnerships

41
45
50
52
54

...

·· ·· 57
62
· · 63
71
·· ·· 74
· · 78
78
·
82
· · ·· 83
Part V - Consensual Rulemaking • . . . . . .
Internal Revenue Service •
84
·
·
·
·
·
·
U.S. CUstoms Service
85
···
Bureau of Alcohol, Tobacco
and Firearms
· · · · · · · · · · · 87
Office of the Comptroller
of the CUrrency
· · · · · · · · ·· · 91
Office of Thrift supervision
·· · · 91
Financial Management service
92
·
Bureau of the Public Debt
92
· · · · ·· 93
Financial Crimes Enforcement· Network
· ·
·
··
···

· ··
· ·· · ·
···
· · ·· ··
···

Internal Revenue Service
U.S. CUstoms Service
• •
Bureau of Alcohol, Tobacco
and Firearms
• •
•
Office of the comptroller
of the currency •
Office of Thrift Supervision •
Financial Management service
Bureau of the Public Debt
•
Financial Crimes Enforcement Network
Office of Foreiqn Assets Control

Part VI - Waiver of Requlatory Fines/Penalties
For Small Business Violators; CUtting
Frequency of Reports Required by the
Public

...............

Office of the Comptroller
of the CUrrency • • • • • • • •
Office of Thrift Supervision • • •
Financial Management Service • • •
Bureau of the Public Debt • • • •
Other Treasury Offices and Bureaus

• • 95
• • 97
•• 99
. • 100
• • 101

DEPARTMENT OF THE TREASURY
~UMMARY REpORT

ON THE
PRESIDENT'S REGULATORY REFORM INITIATIVES

PARI I - MISSIONS AND GOALS
The primary missions of the Department of the Treasury are:
Protecting and collecting the revenue under the Internal Revenue
Code and customs laws; supervising national banks and thrift
institutions; ma,naging the fiscal and public debt operations of
the Federal government; enforcing laws relating to counterfeiting, Federal 90vernment securities, firearms and explosives,
foreign commerce in goods and financial instruments, and smuggling and trafficking in contraband; protecting the President,
Vice President, and certain f~reign diplomatic personnel; training Federal, state and local law enforcement officers; and
producing coins and currency. Consistent with these missions,
most regulations of the Department and its constituent bureaus
are promulgated to interpret and implement the laws as enacted by
the Congress and signed by the President.
INTERNAL REVENUE SERVICE

The Internal Revenue Service (IRS), working with the Office of
the Assistant Secretary (Tax Policy), promulgates regulations
that interpret and implement the Internal Revenue Code and
related tax statutes. In developing these regulations, every
effort is made to carry out the tax policy determined by Congress
in a fair, impartial and reasonable manner, taking into account
the intent of Congress, the realities of relevant transactions,
the need for the Government to administer the rules and monitor
compliance, and the overall integrity of, the Federal tax system.
The goal is to provide useful guidance to taxpayers in as clear
and simple as possible.
UNITED STATES CUSTOMS SERVICE

The United States customs Service is responsible for administering laws concerning the importation of goods into the United
States. This includes inspecting imports, collecting applicable

-1-

duties, over-seeing the activities of persons and businesses
engaged in importing, and enforcing the laws concerning smuggling
and trafficking in contraband.
CUstoms is in the process of implementing actions to improve the
efficiency of CUstoms operations. Under authority granted by the
CUstoms Modernization provisions of NAFTA, a number of regulatory
actions will be undertaken enabling CUstoms to modernize the way
it does business with the trade community. The focus of many of
these regulations will be the development of a more automated
environment to expedite the entry, processing and release of
commercial importations. These regulations will benefit the
importing public by facilitating the work of CUstoms agents and
the trade community.
BUREAU OF ALcOHOL, TOBACCO AND FIREARMS

The Bureau of Alcohol, Tobacco and Firearms (ATF) issues regulations to fulfill its statutory m~ndate to enforce the Federal
laws relating to the manufacture ~nd commerce of alcohol products, tobacco products, firearms and explosives.
The primary ATF enforcement and regulatory missions are:
Preventing illegal traffic in, and criminal use of, firearms;
assisting state, local and other Federal law enforcement agencies
by tracing firearms and explosives, assisting in the investigation of crimes, and participating in law enforcement task forces;
investigating violations of Federal explosives laws and arsonfor-profit schemes; issuing licenses and permits applicable to
the alcohol, tobacco, firearms, and explosives industries; ensuring compliance with and the collection of taxes applicable to
alcohol, tobacco, firearms and ammunition; preventing commercial
bribery and unfair trade practices in the alcoholic beverage
industry, including consumer deception; preventing the illicit
manufacture and sale of alcoholic beverages; and assisting states
in efforts to eliminate interstate trafficking in, and the sale
and distribution of cigarettes in avoidance of State taxes.
OFFICE OF THE COMPTROLLER OF THE CURRENCY

The primary mission of the Office of the Comptroller of the
CUrrency (OCC) is to ensure a strong, safe and sound banking
system that supports economic qrowth. The OCC's other goals
include promoting bank competitiveness, increasing the efficiency
of bank supervision (including reducing regulatory burden), and
ensuring fair and equal access to credit. The oce achieves these
goals by regularly examining approximately 3100 national banks,
with about $2 trillion in assets representing approximately 56
percent of the total assets of commercial banks. In addition,
-2-

the OCC issues rules and requlations that implement Federal law
governing national banks as well as taking actions against
national banks that do not conform to laws and requlationb or
which engage in unsound banking practices. The OCC also a~proves
or denies applications for new national bank charters, branches,
capital or other changes in corporate or banking structure.
OFFICE OF THRIFT SUPERVISION
As the primary Federal requlator of the thrift industry, the

regulatory objective of the Office of Thrift Supervision (OTS) is
to effectively and efficiently supervise thrift institutions.
This objective includes promoting the safety and s0undness of the
thrift industry, providing support for the industry's efforts to
provide credit and other financial services to its communities,
particularly with respect to housing credit, and maintaining and
enhancing a risk-focused, differential and proactive approach to
the supervision of thrift institutions.
The OT& strives to
develop requlatory policies that provide flexibility to sufficiently capitalized, well-managed institutions while closely
supervising problem institutions. Savings associations are
encouraged to fulfill the housing needs of their co~~unities,
particularly the needs of lower to moderate-income.p~rsons.
FINANCIAL MANAGEMENT SERVICE

Requlations of the Financial Mana~ement Service (FMS) are developed to improve Government financ~al management by linking
program and financial management objectives, and by providing
financial services, information, advice, and assistance. The FMS
serves taxpayers, the Treasury Department and Federal program
agencies, and provides support to government policymakers on
financial management issues. Requlatory priorities of FMS
include integrating new technologies to process Federal payments
and collections more efficiently, and encouraging the use of
electronic funds transfers (EFT) to the maximum extent possible.
BUREAU OF THE

PUBUC

DEBT

The Bureau of the Public Debt (BPD) implements the borrowing
authority of the Federal Government and accounts for the public
debt. Pursuant to this authority, BPD prescribes requlations
governing the offering of marketable securities, savings-type
securities, and other special securities. BPD requlations also
establish the terms and conditions of u.S. securities, as well as
the requirements applicable to agents that assist in their sale
and redemption.
-3-

The Government securities Act of 1986 (GSA) authorizes the
Secretary of the Treasury to prescribe rules governing financial
responsibility, the protection of customer funds and securities,
and recordkeeping and reporting requirements for government
securities brokers and dealers, including financial institutions.
These rules are designed to prevent fraudulent and manipulative
acts and practices, and to preserve the integrity, efficiency and
liquidity of the government securities market. In developing
these regulations, the Department seeks to balance the benefits
of regulation with the compliance costs imposed on the governmp.nt
securities market and its participants.
The GSA regulations establish a consistent regulatory approach
for all government securities brokers and dealers, including
securities firms and financial institutions, in a manner intended
to minimize the creation of any competitive advantages for any
class of firm. consistent with the President's regulatory
priorities, regulations are only developed after considering the
cumUlative burdens of existing regulations applicable to various
broker/dealers, including financial institutions, and are designed to minimize duplication or overlap with existing regulations. To help meet this objective, the Treasury actively
consults with other regulatory organizations, including the
Securities and Exchange Commission and the bank regulators to
better coordinate its activities in securities regu"lation.
FINANCIAL CRIMES ENFORCEMENT NElWORK (FINCEN)

The Bank Secrecy Act (BSA) authorizes the Secretary of the
Treasury to issue regulations requiring financial institutions to
maintain records and file reports determined to have a high
degree of usefulness in criminal, tax, or regulatory proceedings.
These regulations are developed by FinCEN in the Office of the
Under Secretary for Enforcement. The purpose of these regulations is to combat financial crime, particularly money laundering. FinCEN oversees, and implements Treasury policies to
prevent and detect money laundering. FinCEN is also the nation's
central point for broad-based financial intelligence, analysis,
and information sharing, all to support the fight against
financial crime.
..
The regulatory objectives of FinCEN are to reduce the cost and
burden of compliance with BSA regulations and to enhance utility
of those regulations to law enforcement. FinCEN is committed to
accomplishing these objectives in conSUltation with financial
institutions and persons affected by BSA reporting and recordkeeping requirements. In 1993, the Department convened an
interagency Money Laundering Task Force staffed by experienced
agents and regulators from Treasury bureaus with BSA compliance
and money laundering responsibilities. This task force undertook
-4-

a comprehensive examination of Treasury's BSA regulatory programs, with a special focus on the manner in which Treasury
exercises its BSA authority. The Task Force has formulated
recommendations that have been presented to the Bank Secrecy Act
Advisory Group (Advisory Group) established by the Department
pursuant to section 1564 of Public Law 102-550. The Advisory
Group will consider alternative regulatory approaches and make
recommendations concerning the BSA to Treasury policy officials.
OFFICE OF FOREIGN AsSETS CONTROL (OFAC)

The Office of Foreign Assets Control (OFAC) issues regulations to
implement economic sanctions against foreign countries imposed
pursuant to Presidential order or mandated by legislation. OFAC
regulations currently implement unilateral or multilateral trade
and financial sanctions against CUba, Iran, Iraq, Libya, North
Korea, Serbia, UNITA (Angola) and terrorist groups threatening
the Middle East peace process.

-5-

PART U - ELIMINATING AND IMPROVING REGULATIONS
j

This par~ summarizes the Department's June 1, 1995, report to the
President concerning its page-by-page review of existing regulations to identify regulatory provisions that are obsolete,
unnecessary, or impose burdens that can be eliminated or reduced •
• ON-T~; REGULATIONS l

The vast majority of non-tax regulations administered by the
Department of the Treasury are issued by the following offices
and bureaus: the United states customs service (USCS); the
Bureau of Alcohol, Tobacco and Firearms (ATF); the Office of the
Comptroller of the CUrrency (Oce); the Office of Thrift supervision (OTS); the Bureau of the Public Debt (BPD); the Financial
Management Service (FMS); the Office of Foreign Assets Control
(OFAC); and the Financial crimes Enforcement Network (FinCEN).
Each of these offices and bureaus reviewed its existing regulations to identify regulatory provisions that are obsolete,
ltnnecessary, or impose burdens that can be eliminated or reduced.
ks detailed in the following table, these offices and bureaus
identified 789 regulations and regulatory provisions that have
been or will be eliminated or modified. These regulations and
provisions represent over 2,225 pages in the Code of Federal
Regulations (CFR). The result of this review is summarized in
the following table:

Althouqh Bome regulations of the Bureau of Alcohol, Tobacco and
Firearms concern the collection of excise taxes, they have been included in
this section because they affect industries regulated by the bureau.

-6-

DEPARTMENT OF THE TREASURY

Non-Tax Regulations
NUMBER OF
REGULATIOliS'

PERCENT OF,
REGULATIONS

NUMBER OF
CFR PAGES 4

PERCENT OF
CFR PAGES

Eliminate

Reinvent

575

Eliminate

Reinvent

6:'

606

Eliminate

Reinvent

2S8

Eliminate

Reinvent

448

333

Reinvent

Eliminate

Reinvent

Eliminate

135

Reinvent

Eliminate

255

692

1972

OFFICE/BUREAU;
REGULATORY ACTIONl

uses
ATF

OCC

OTS
BPD

Eliminate

l'HS

OFAC
FinCEN

Reinvent
TOTAL NQN-TAX
REGULATIONS
Eliminate
Reinvent

Include. action. taken after January 20, 1993.

3 Each CFR title generally consi.t. of chapter., .ubchapter., parts,
.ubpart., .ections and paragraphs. Depending on .ubject matter, the organization of a particular office'. or bureau'. regulations, and the method
.elected for review, one or more of these CFR component. can be con.idered a
-regulation.- Although the number of regulation. that will be eliminated or
reinvented i. indicative of the .cope of change. being made by individual
offices and bureau., the number of pages affected may be more indicative of
the magnitude of these changes. Moreover, the revi.ion of a very burdensome
paperwork requirement i. contained in on. paragraph of a lengthy regulation
may have more of an impact on the public than the elimination of an eneir.
ob.olete regulation that impo.ed minimal compliance burden.~

All pages in a regulation to be reinvented may not be changed.

-7-

TAX REGULATIONS
The Internal Revenue Service, in conjunctio with the Office of
the Assistant Secretary (Tax Policy), review~d CFR title 26 in
its entirety to identify regulatory provisions that can be
eliminated or simplified in a manner to reduce overall taxpayer
regulatory burden. Most tax regulations could not be eliminated
because they provide essential quidance to taxpayers by interpreting the tax laws. Indeed, one of the most frequent "criticisms" concerning tax regulations is that the IRS does not issue
enough guidance. Moreover, in recent yearb the IRS has been
developing regulations that are as simple and easy to comprehend
as possible given the often complex and technical nature of the
tax laws.
The IRS has identified 44 regulations (247 CFR pages) that have
been or will be eliminated and 35 (527 pages) that have or will
be reinvented.
In addition to these actions, the IRS has identified 197 revenue rulings and other guidance that have been or
will be eliminated (446 other pageb), as well as 8 (24 other
pages) that will be reinvented. Th~se actions are summarized in
the following table:

DEPARTMENT OF THE TREASURY
Tax Regulations, Revenue Rulings and Other Guidance

ACTION5
Eliminate
Reinvent
TOTAL ACTIONS

NUMBER OF REGULATIONS,
REVENUE RULINGS AND
OTHER GUIDANCE

NUMBER OF CFR PAGES
OR OTHER PAGES'

243

693

551

286

1244

Include. actions taken after January 20, 1993.
6

All pages in a document to be reinvented may not be changed.

-8-

HIGHLIGHTS
INTERNAL REVENUE SERVICE

All tax regulations are developed through a process involving
participation of the IRS Commissioner's Office, the Chief
Counsel's Office at the IRS, and the Treasury Office of Tax
Policy. Through the cooperative work of these three organizations, all tax regulations take into account administrative,
legal, and policy concerns.
Chief Counsel's Office at the IRS, working with the Office of Tax
Policy, undertook a page-by-page review of all tax requlations.
The reviewers determined that the elimination of many tax regulations would not relieve taxpayer burden because the regulations
provide essential guidance in interpreting the tax laws •. Moreover, the reviewers noted that efforts have been made in recent
years to ensure that tax regulations are as simple ~nd easy to
comprehend as possible. This approach to regulationo is a basic
component of two principal strategic objectives for tax administration: reducing taxpayer burden and enhancing compliance with
the tax laws. The current review of tax regulations is consistent with this basic regulatory approach.
Business Classification. Notice 95-14 sets forth a proposal that
the IRS and Treasury are considering that would greatly simplify
the current rules for classifying unincorporated business organizations either as partnerships or as associations taxable as
corporations. Under the proposal, a taxpayer would be allowed
simply to elect to treat an unincorporated business as either a
partnership or an association. This election would eliminate the
often difficult and cumbersome process of applying the existing
regulations and rulings.
Many states have revised their statutes to allow partnerships to
possess characteristics traditionally associated with corporations, such as limited liability. The flexibility provided by
these revised statutes allows taxpayers to achieve partnership
tax classification for non-publicly traded organizations that in
all meaningful respects are indistinguishable from corporations.
Nevertheless, the IRS and thousands of taxpayers spend considerable resources in determining the classification of unincorporated business organizations under the current rules. If adopted,
the proposal would save these resources. In addition, it would
aid numerous small unincorporated businesses that cannot afford
to commit significant time and resources to cope with the current
complexity. The IRS and Treasury are seeking to work cooperatively with taxpayers by soliciting views on this proposal before
any specific amendment to the current regulations.
-9-

Fiduciary Tax Returns. On June 29, 1994, final regulations were
issued amending the requirements imposed upon preparers of
fiduciary tax returns. Generally, bank trust departments and
other commercial organizations annually prepare hundreds of Form
1041, ·U.S. Fiduciary Income Tax Return." Multiplied by the
hundreds of banks nationwide offering trust services, tens of
thousands of returns are submitted.
A prior regulation required that an income tax preparer manually
sign a return in the appropriate space provided on the return.
The regulation further specified that a preparer may not satisfy.
this requirement by use of a facsimile signature stamp or signed
gummed label. Prior to 1987, trustees were able to choose fiscal
years for trust accounts at their discretion. ThUS, the annual
filing deadline could be spread throughout the year. In 1987,
however, Congress required that trusts adopt a calendar year.
The requirement of a calendar year, combined with the manual
signature requirement, made for a heavy burden each year on or
about April 15th.

The new regulation provides that the IRS will accept these trust
tax returns, with a mechanical, stamped, or other facsimile
signature under certain conditions. The preparer must attach
with the returns a letter, bearing an original signature, that
includes a list identifying the taxpayer names and-identification
numbers. The preparer also declares, under penalty of perjury,
that the returns have not been materially altered.
Under these conditions, banks and other commercial preparers can
direct their attention to the issue of preparing an accurate
return rather than manually signing hundreds of returns.
Passive Activity Losses. Final regulations were issued in
October 1994 relating to the definition of an "activity" for
purposes of the limitation on deducting losses from passive
activities under section 469 of the Code.
Under section 469, the Secretary of the Treasury was given
authority to define the term "activity," a term crucial to the
operation of the passive loss rules. Temporary regulations
defining "activity" were issued in May 1989. The temporary
regulations were lengthy and provided detailed, mechanical rules
for determining a taxpayer's activities. Many tax practitioners
complained that the regulations were overly long and complex, and
that the mechanical rules were too inflexible and burdensome on
small taxpayers. Revenue agents and government attorneys agreed.
There was widespread belief that taxpayers were not complying
with the rules due to their complexity.
In May.199~, new regulations were proposed. These regulations
were f1nal~zed in October 1994. Whereas the old regulations were
contained in about 40 pages in the CFR, the new regulations are
-10-

contained in less than 2 pages. The new regulations are easier
to understand and apply, and significantly more flexible. Over
100 rules 1n the temporary regulations were eliminated in the new
regulations, which now contain only about 15 rules. Many tax
practitioners and revenue agents believe there will be more
compliance with section 469 because taxpayers and revenue agents
will be able to understand and apply the rules with much less
effort.
Hedging Transactions. Temporary regulations were issued in
October 1993, and final regulations were issued in July 1994,
relating to the treatment of gains and losses recognized on
certain hedging transactions.
In general, a hedge is a transaction that a taxpayer enters into
in the normal course of its trade or business to reduce the risk
of interest rate or price changes or currency fluctuations. Most
large taxpayers and many smaller ones enter into a variety of
hedging transactions to protect against the risks inherent in
their businesses.
The Supreme Court's decision in Arkansas Best v. Commissioner
created uncertainty among taxpayers regarding the tax treatment
of their business hedges. As a result of that case, it was
unclear whether losses on business hedges could be deducted as
ordinary losses or were subject to the rules limiting the deduction of capital losses. The issue was raised in many cases under
examination and in litigation, and some taxpayers ceased their
normal hedging activity for fear of the adverse tax consequences.
Concern was expressed that the tax barrier to hedging would
damage the futures markets.
The new regulations resolved years of controversy. Treating gain
or loss from business hedges as ordinary, not capital, the
regulations allow taxpayers to hedge most common business risks
without fear of unintended and uneconomic tax treatment.
Because the new regulations provide guidance for all open tax
years, they resolve many issues in ongoing audits and avoid
costly litigation.
The regulations were widely praised by businesses for providing
sensible rules for most hedging transactions. In addition to
resolving most of the pending cases in examination and the
courts, the regulations enabled taxpayers to make hedging decisions on the basis of the economics of the transactions rather
than their tax treatment.

-11-

UNITED STATES CUSTOMS SERVICE

Each CUsto~s office responsible for interpreting or enforcing
regulations reviewed each regulation within its subject matter
expertise to ensure that the regulatory requirements are necessary and easy to understand. CUstoms offices were asked to'
determine whether each regulation is outdated or whether its goal
could be achieved in more efficient, less intrusive ways.
Responses were sent in by both legal and operational offices.
CUstoms also published a document in the Federal Register asking
the public to identify regulations that could be modified or
e\iminated. The document soliciting public input was also
puolished in the customs Bulletin and posted on the CUstoms Electronic Bulletin Board.
The review of the CUstoms regulations indicates that there will
be a SUbstantial reinvention of those regulations. The customs
.odernization provisions of the North American Free Trade Agreement Implementation Act repealed outdated statutes and provided
CU~toms with the statutory authority to modernize and streamline
many of its procedures.
Sinca early 1994, customs has been involved in business process
re-engineering, business process improvement, and process mapping
to develop how best to modernize and streamline its operations.
In addition, CUstoms is reorganizing its. internal structure. The
reorganization, in conjunction with the business process improvement and the flexibility provided by the CUstoms modernization
provisions of NAFTA, will result "in the modernization of CUstoms
operations and the rewriting of regulations to reflect CUstoms'
new procedures.
Accreditation of Commercial Testing Laboratories; Approval of
Commercial Gaugers for CUstoms Testing. This regulatory change
will allow the accreditation of commercial laboratories to
analyze a wide range of commercial products for CUstoms purposes.
By allowing commercial laboratories to perform more analyses,
importers should receive test results earlier. This will benefit
importers, commercial laboratories and CUstoms.
Test Programs. The change allows the Commissioner of customs to
conduct limited test programs -- with requirements different from
those specified in CUstoms regulations -- that have as their goal
the more efficient and effective processing of passengers, carriers and merchandise.
Prior to the enactment of the CUstoms modernization provisions of
NAFTA, CUstoms did not have the legal flexibility to experiment
with improving its operations. Under the new regulation, CUstoms
-12-

can publish noticec in the Federal Register informing the public
of a customs test that is i~~onsistent with certain provisions of
the CUstoms regulations, sol .. =it volunteers to participate, and
ask for trade community input. This gives CUstoms the flexibility to experiment with reinventing procedures before amending the
regulations. The regulation also provides the trade community
with an opportunity to comment before CUstoms undertakes a test
program or adopts a final regulation regarding a procedure.
Elimination of certain pocump.ntation Requirements for Articles
Entered Under Special Tarift Treatment Programs and Provisions.
This change removes documentation requirements relating to the
entry of articles claimed to be entitled to a partial dutyexemption or duty-fr~e treatment under various special tariff
provisions or programs.
The change, which reduces regulatory procedures and paperwork,
facilitates the entry process for both the public and CUstoms
without affecting ~~e ability of CUstoms to ensure compliance
with the basic legal requirements under these provisions and
programs.
Reconciliation of Entr.~. Reconciliation will allow undetermined elements of an entry to be provided to CUstoms after the
time an entry summary statement or an import activity summary is
otherwise required to be submitted.
Reconciliation·will permit CUstoms, importers, and brokers to
handle CUstoms transactions more efficiently by reducing paperwork and administrative costs.
Relaxation of Truck Cabotage Rules. certain foreign-based trucks
will be allowed to operate in unrestricted local traffic in the
U.S. to the extent that the country in which such vehicles are
based accords reciprocal treatment to U.S. trucks operating in
that country.
u.S. trucks and trucks of countries which accord U.S. trucks
reciprocal privileges will have expanded access to the domestic
markets of the respective countries. This will allow for more
efficient and economical use of vehicles in both the U.S. and the
countries that accord reciprocal privileges.
Remote Location Filing. An entry filer will be able to file
electronically an entry of merchandise with CUstoms from a
location within the United states other than at the port of
arrival or location of examination of the merchandise. CUrrently, an entry must be filed at the port of arrival or the examination location.

-13-

Remote location filing will take ,advantage of automated tech- .
nolegy to help both the trade community and customs in process1ng
entries. It will allow customs to make more e,·'ficient use of its
import specialist work force by channeling work to remote locations. It will help importers by allowing them to make an entry
at locations other than where they are geographically situated.
BUREAU OF ALcOHOL, TOBACCO AND

FIREARMs

The Bureau of Alcohol, Tobacco and Firearms (ATF) published
Notice No. 809 in the Federal Register on April 13, 1995,
requesting comments from the public concerning obsolete, unnecessary and burdensome regulations. ATF £1so mailed information
copies of this notice to 30 trade associations that serve the
alcohol, tobacco, firearms, ammunition and explosives industries.
ATF headquarters specialists conducted the page-by-page review;
ATF managers, specialists and inspectors nationwide also reviewed
ATF's regulations to identify areas wnere improvements were
needed.
Recycling waste Alcohol. Present law and regulations impede the
ability to recycle alcohol (spirits, win~, beer and other products containing alcohol). The law imposes requirements, such as
bonds and permits, and taxes upon unmarketable alcohol products,
such as spoiled wine or beer, and spent beer mash, before taxes
can be refunded when the alcohol products are destroyed or
recovered. In addition, the law often requires that such alcohol
products must be received and handled by an ATF authorized
operation'to receive and handle the products.
With the economic and environmental costs involved in disposing
of products containing alcohol, it makes sense to recover and
recycle the alcohol. ATF is reviewing the law and regulations to
identify and eliminate the obstacles to recovering and recycling
alcohol. Legislative action is needed to amend the Internal
Revenue Code to remove these obstacles. After the law has been
changed, ATF can move quickly to rewrite the regulations to
benefit many businesses (alcoholic beverage plants and industrial
alcohol users) through an easier and less burdensome program of
recycling alcohol.
Although there will probably be no change in the number of CFR
pages as a result of these changes, ATF estimates a 3,000 reduction in burden hours and industry savings of $3,000,000 annually.
Improve Alcoholic Beverage Label Approval Process. ATF is
considering a legislative change to the Federal Alcohol Administration (FAA) Act that would (1) eliminate the Certificate of
Label Approval (COLA) requirement and replace it with a label
registration system, or (2) make the criteria for ATF label
-14-

approval more objective and allow ATF to focus on mandatory
information such as the identity of the responsible person and
the nature and quantity of the product.
In addition, ATF is considering administrative changes to improve
the current system, such as revising the label approval form,
improving communication of our policies to the affected industry,
and working with state regulators to design a form which could be
used for both Federal and state approvals.
ATF customers (bottlers and importers) would benefit from the
improvement in the label approval process. Costs involved with
time and communication delays that are now needed to approve
labels could be eliminated. Businesses would be able to market
their products to domestic consumers quicker and realize the
economic benefits sooner.
If the statutory changes are adopted, ATF estimates it will be
able to reduce its existing regulations by 20 pages (30 percent)
and reduce more than 60,000 burden hours on its our customers at
a savings of more than $3,000,000.
Streamline Rules for Brewpubs'. CUrrently, ATF regulations treat
brewpubs (small breweries which serve their own beer in a tavern
on premises) exactly the same as large brewers. Most brewpubs
are operated by small businesses and have a limited impact on the
revenue collection or the national market. ATF plans to add
about two pages of regulations just for brewpubs that will
decrease the burdens now placed on them to qualify and operate.
Brewpubs will benefit from a less restrictive approach, and ATF
should not encounter significant difficulties in regulating
brewpub operations or losses to revenue.
Although the beer regulations will be increased by about two
pages to accomplish this initiative, ATF estimates reduced burden
of 1,250 hours and saving of $62,500 for brewpubs.
Simplify Firearms and Ammunition Excise Tax Deposit Rules.
Excise taxpayers who have an unpaid tax liability of more than
$100 during a calendar quarter are required to make deposits of
tax. Also, many taxpayers are required.to make semi-monthly
deposits for the entire calendar quarter and have several rules
to follow to correctly determine how much to deposit. This
occurs when a taxpayer has a tax liability of more than $2,000
for any month in the preceding calendar quarter.
ATF plans to increase the numbers of taxpayers exempt from making
deposits and simplify the rules for determining how much to
deposit. until an unpaid tax liability for a calendar quarter
exceeding $2,000 is reached, tax deposits will not be required.
A new deposit exemption will also be provided to persons who will
file one-time or occasional firearms and ammunition excise tax
-15-

returns. A one-time or occasional taxpayer does not engage in
any trade or business covered by the tax return. Taxpayers will
choose one of three rules to follow: the general rule (100
percent); a look-back quarter rule; and first-time filer rule.
This change will eliminate calculating, preparing and sending
checks and the forms required to deposit taxes for many taxpayers. In addition, the Federal government will save time and
money by no longer handling small dollar tax deposits.
ATF estimates that this change will reduce the burden on
customers by 500 hours and result in a savings of approximately
$25,000.
streamline and Clarify Alcoholic Beverage Permit Requirements.
ATF is currently reviewing the regulations, procedures, forms and
instructions for a permit to produce or wholesale alcoholic
beverages or to import alcoholic beverages for resale. This
review will eliminate or reduce existing requirements Dr burdens
on applicants. Requirements will be eliminated where it is
decided that they are no longer needed in the permit approval
process.
ATF estimates a 4,500 reduction in customer burden hours
resulting in savings of $225,000.
OFFICE OF THE COMPTROLLER OF THE CURRENCY

The Regulation Review Program at the Office of the Comptroller of
the currency comprises a top-to-bottom review of all OCC regulations. It is not an attempt at deregulation. Rather, the OCC is
adjusting how and what it regulates to improve efficiency,
eliminate unnecessary burdens on banks, and increase attention to
areas that pose the greatest risks to the stability and health of
the banking industry.
Risk Focus and Burden Reduction
The Regulation Review Program proceeds from the premiSe that bank
regulation should not eliminate all risk. Risk-taking is inherent in the business of banking. The goal is to ensure that
significant risk areas are recognized and managed through appropriate risk controls.
Accordingly, the Regulation Review Program seeks to focus those
OCC regulations designed to contain bank risk on the activities
and products that present the greatest risks to safety and
soundness, the payments system, or the general economic stability
of the Nation. The failure of regulations to focus on these
basics will lead in some instances to an overemphasis on
-16-

compliance with details of procedures rather than, and potentially at the expense of, attention to underlying conduct and
achievement of fundamental agency goals.
The Program looks beyond the sUbstantive requirements of the
current rules, recognizing that filing and paperwork requirements
also can be burdensome and over-broad. This is true of regulations that address bank risk and those regulations designed to
implement other statutory objectives, such as ensuring equal
access to credit. The total burden imposed by any regulation
must be measured against the risks or other goals it is intended.
to address.
Lending Limits. The OCC's new lending limit regulations are an
example of this approach. The regulations limit the amount of
funds a bank can advance to anyone borrower to avoid excessive
concentrations of risk. The final rule, published in February
1995, eliminates unduly burdensome regulatory requirements and
concentrates remaining requirements on areas of greatest safety
and soundness concerns. Specifically, the new lending limits
rule eliminates the need for banks to calculate lending limits as
often as every business day. Under the new rule, most banks
would only have to make lending limit calculations once every
quarter. The new rule also clarifies the scope and application
of the lending limits; updates provisions to address frequently
asked questions; incorporates significant OCC interpretations;
and restructures and simplifies loan combination rules.
Reduced Fees. In late 1994, the OCC revised its fee assessment
structure and amended the formula .for calculating fees for trust
and special examinations. As a result, the OCC reduced by 50
percent, on average, its trust examination and corporate application fees.
Improve Clarity
Too many bank regulations are unclear or confusing, wasting the
time and energy of managers, retarding innovation in the marketplace, and diverting resources to compliance officers and
attorneys. Thus, an important component of the Regulation Review
Program is to revise OCC regulations, where appropriate, to
improve clarity and better communicate the standards the rules
are intended to embody. Clear, concise, and well organized
regulations not only reduce banks' regulatory burdens, but also
improve the quality and consistency of bank supervision and the
level of bank customer service.
Differential Regulation
Any modification of bank regulations raises the issue of flexibility versus certainty in identifying acceptable risk. Bright
lines are simple to administer and can reduce uncertainty. On
-17-

the other hand, a bright line test may not recognize that different types of banks present different levels of risk, and that
some banks h ve a greater capacity to manage risks than others.
Some supervis~ry approaches try to tailor regulatory requirements
to the circumstances of each particular institution. But taken
to the extreme, these approaches may not sufficiently delineate
what is, and is not, acceptable risk management.
The Regulation Review Program tries to balance the need to
clearly define what constitutes acceptable risk management,
with the dalager of creating a system that imposes on many institutions regulatory burdens that are not commensurate with the
risks they present. The Program enhances regulatory flexibility
by .~knowledging that risk levels often are dependent upon
differences in banks' capital levels, size or other objective
factors. Thus, many of the new and revised OCC regulations
incorporate approaches that combine regulatory bright lines with
some degree of agency discretion. These regulations often
provide less intrusive regulation for banks that are healthy and
wel~-managed.

Corpo.ate Actiyities. A good example of differential regulation
is the OCC's proposal to revise the rules, policies and procedures that govern national banks' corporate activities and
corporate transactions. The proposed revisions wo~ld allow
strong and well-run banks to receive expedited review of their
applications for branches, affiliate mergers, operating subsidiaries, office relocations, and various other corporate actions.
Under the proposal, the OCC could deem many applications by these
banks to be approved 30 days after filing. The proposal also
recognizes the evolution of the "business of banking" and the
role of new technologies in banking by introducing new approaches
in areas such as the permissible activities of operating subsidiaries and the regulation of automated teller machines (ATKs) ,
giving healthy national banks additional flexibility. In the
case of the former, the proposal would replace the current
requirement that all operating subsidiary activities be approved
in advance with a simple, after-the-fact notice for many routine
activities. With the latter, the proposed rule would eliminate
branch applications for certain facilities, primarily ATMs, that
are equally accessible to customers of the owner bank and other
banks. The existing rule requires several steps to complete the
approval process, generating a large volume of paperwork and
requiring numerous exchanges between bank and OCC staff.
Public Input
since the inception of the Regulation Review Program in March
1993, the OCC has actively solicited input on how it could
improve its regulatory· process. Senior OCC managers, including
the Comptroller, have met with bankers and the public in meetings
across the country and have requested advice and comments. Many
-18-

banks and community groups have responded with detailed proposals
on how the oee could improve its regulations. The oee received
further input through the noti~~ and comment process. To ensure
that the oee hears from the broQ1est possible range of the
entities it regulates (and not just the large or Washington-based
firms), the oee sends copies of all proposed rules to all of the
banks under its supervision.
In addition to the input from the public, the oee also has sought
to engage a broac cross-section of the agency in its reform
efforts. The regulations are ~eviewed and revised by interdepartmental and interdisciplinary teams of employees. The oec's
other reform efforts -- aimed at improving the supervisory
process and the oec'S ~~ganizational structure -- are led by
teams of oee employees drawn from across the country, representing every oee district.
Overall Reinvention status. To date, the oee has published in
final or proposed fo~ 13 of the 29 parts of its regulations that
are under review. Fiv~ other proposed revisions are very near
publication. The oee intends to publish in final or proposed
form revisions to all oee regulations by the end of 1995.
OFFICE OF THRIFT SUPERVISION

OTS' review included input from front-line regulators and other
OTS personnel. In addition, input was solicited from industry
representatives. As a result of the review OTS has identified
five distinct phases of its regulatory review project.
Several separate rulemakings will be proposed to implement the
recommendations resulting from the review. A general regulatory
review proposal with deletions and technical changes will be
issued in Phase I. Additional interagency and SUbstantive
rulemakings on specific subject areas will need to be issued in
order to implement other recommendations of the review.
The various phases of OTS' regulatory review project will not
necessarily be sequential and there may be overlapping timeframes in some areas. Target dates were established based on
resources available and may be changed based on public and
industry comment.
Washington Staff Recommendations. Each regulation was reviewed
by a task force of Washington staff that made a preliminary
decision on the disposition of the regulation. These decisions
were made using the following criteria: Is the regulation
current? Could the regulation be eliminated without endangering
safety and soundness or violating statutory requirements? Would
the subject matter of the regulation be more suitable for a
-19-

policy statement? Is the requlation consistent with the other
federal banking agencies' requlations? Can the l~qulation be
understood without consulting an attorney? Is th~- regulation
written as a "stand alone" regulation, without corit~sing crossreferences? Is the requlation required by statute? Are the
requlations/parts/sections ordered in a logical fashion?
Front-line Regulators' Review. In addition to this comprehensive
review, input from front-line regulators was also obtained.
Front-line regulators provided input based on day· -to-day use of
regulations in the examination and supervision of thrift institutions.
Industry Input. OTS also obtained input irom OTS-regulated
entities. This feedback was gathered two ways. First, the OTS·
Examination Oversight Program (EOP) provides a vehicle to obtain
information from thrift executives after the completion of each
scheduled safety and soundness examination. Since 1993, OTS has
been using this outreach program to gain insight into its examination program. This feedback lets OTS ~ow how it is doing and
if there are areas where improvement is needed. OTS has been
soliciting specific comment from institutions on regulations that
should be eliminated or modified. For instance, the results of
recent EOP interviews indicate that thrift ~anagement finds the
constraints of the Qualified Thrift Lender (QTL) test and the
commercial lending limit burdensome. These two issues will
require statutory changes.
Second, input from thrift executives was obtained through a
series of town meetings held in cities throughout the country.
In these meetings, thrift executives were specifically asked for
comment on requlations they considered to be burdensome, duplicative, or confusing. OTS received specific comment on several
requlations such as the Interest-Rate-Risk Rule, the desire for a
simpler conversion process for smaller institutions, the aggregate requlatory burden imposed by consumer regulations, the
incongruity of the FIRREA and FDICIA capital standards, and the
QTL test.
PHASES OJ' '!'HE OTS REVIEW

Phase I - peletion of Obsolete or Redundant Regulations and
Technical Changes. OTS identified several regulations for
immediate elimination. These requlations will be eliminated
either because they are outdated or redundant. Many of these
recommendations will be implemented in Phase I along with certain
other technical amendments. Other regulations targeted .for
elimination will be addressed in the context of a Phase III
reinvention project.

-20-

Although these deletions and changes will significantly reduce
the number of OTS regulations, the reduction in regulatory burden
will be accomplished by streamlining and clarifying regulations
and reducing the total number of regulations, thereby making the
OTS regulations easier to use. Other more substantive changes to
specific subject areas will follow in Phase III. The OTS plans
to publish by August 31, 1995, a Federal Register proposal on
Phase I, to eliminate outdated and redundant regulations. A
final rule will be issued shortly thereafter, in time to be
included in the 1996 Code of Federal Regulations.
Phase II - Organizational and Policy Changes. In the course of
its review, OTS identified a number of issues as to how the
regulations should be drafted and organized to be as user friendly as possible. Rather than assuming that headquarters staff
knows the answer. to these questions, OTS believes that OTS
examiners and thrift executives should be consulted before an
initiative is launched. Accordingly, OTS plans to ask for public
comment in a Notice of Proposed Rulemaking on Phase I regar.ding
the issues identified for Phase II resolution. OTS anticipates
that a separate final rule will be issued to implement any
organizational and policy changes related to Phase II issues.
OTS also plans to solicit feedback in town meetings and EOP
interviews as well as from OTS examiners. OTS will ask for
general comments on organization of the OTS regulations and for
specific comments on the following issues:
• OTS feels that safety and soundness regulations should apply
consistently to both state and federal entities. As appropriate, should OTS consolidate safety and soundness regulations in Part 545 into Part 563 where regulations apply to all
savings associations?
• Should OTS consolidate common definitions of general applicability now in Parts 541, 561, 563 and 583 in a new Part SOl?
This would not preclude those definitipns that only apply to
one regulation such as capital or QTL from appearing in the
appropriate regulation.
• Should OTS delete regulations that only repeat statutory
authority or grant an implied power? Since regulations are
not the primary means of transmitting new developments in this
area, the store of knowledge is not completely codified in the
regulations.
• Should policy statements in Parts 556 and 571 be deleted?
These policy statements could either be recast as regulations
or deleted from the regulations and applicable guidance placed
in the appropriate regulatory Handbook.

-21-

• What method of communication is preferred for which types of
information? Different communication vehicles are available
other than regulations. OTS also communicates policy positions via Transmittals, Thrift and Regulatory Bulletins, Letters to Chief Executive Officers (CEO Letters) and legal
opinions.
• currently, various related regulatory subjects are addressed
in different places in the regulations. Should OTS make an
effort to group regulations relating to the same subject more
closely together for ease of reference?
As these questions suggest, OTS believes it has identified ways
to shorten and simplify its requlations. Any time regulations
are changed, however, the industry and regulators must invest
time and resources to learn the new regulations. OTS needs input
as to whether the changes suggested here would be worth the
resources they would require.

Phase III - Substantive Review of Subject Areas. Regulations to
be reinvented will be part of a SUbstantive review of a particular subject area in Phase III. In this phase, OTS plans to
involve staff, senior management, and industry representatives in
intensive discussions exploring creative alternatives to the
traditional regulatory approaches previously taken in this Phase.
As part of the initial review, OTS identified several categories
of regulations ripe for this type of review, which OTS plans to
reinvent over the next two years. OTS expects that these categories will be accorded priority in the following order:
• Lending powers and restrictions. Reinvent lending provisions
to eliminate duplication, delete unneeded provisions, and
consolidate.
• Subsidiaries. Review regulations that cover subsidiaries such
as service corporations, operating subsidiaries, and finance
subsidiaries and related regulations to eliminate overlap and
duplication. As part of this process, OTS will also resolve
issues regarding investments in investment companies and
special purpose corporations.
• Insurance and Fees. Revise, update and combine into section
563.44 six related, duplicative and conflicting regulations
concerning referral fees, insurance provisions and usurpation
of corporate opportunity as deemed necessary by substantive
review.
•
• Federal Pre-emption. Provide more specific guidance concerning Federal pre-emption than currently provided by Section
545.2, which is general and vague, and review Parts 590 and
591 for necessary updates. More specific guidance from OTS in
-22-

this area would reduce regulatory burden by reducing uncertainty and the need to do extensive legal research on
precedents.
• Corporate Governance, Update Model Charter and Bylaws for
Mutual and stock Institutions in Parts 544 and 552 and related
corporate governance regulations. CUrrent OTS regulations do
not reflect modern trends toward more flexible rules of corporate governance.
• Adjustable-rate mortgages. Revise, update and combine any
necessary provisions relating to adjustable-rate mortgages and
other restrictions contained in regulations.
• Recordkeeping. Remove regulations for specific recordkeeping
requirements such as transactions with affiliates and loan
documentation and rely on the general recordkeeping requirements in Part 562. Institutions would then be able to determine how to keep necessary records in the most efficient way.
Phase IV - Interagency Regulations and Common statutory
Provisions. For the past several years OTS has sought to more
closely conform its existing rules, policies, and procedures to
those of the other banking agencies to reduce regulatory burden
and maintain parity.
section 303 of the Community Development and Regulatory Improvement Act of 1994 requires the four federal banking agencies (the
OTS, OCC, the Federal Deposit Insurance Corporation and the Board
of Governors of the Federal Reserve System) to review their
regulations and written policies and to coordinate review of
interagency regulations and policies. The four federal banking
agencies have convened a steering committee, under the auspices
of the Federal Financial Institutions Examination council
(FFIEC), to oversee this project. The goal is to make uniform
all regulations and guidelines implementing common statutory or
supervisory policies.
interagency working group has met and compiled a list of
regulations and guidelines that implement common statutory or
supervisory policies. These common statutory or supervisory
policies generally fall into one of four categories:
An

• Rules or policies developed jointly that implement common
statutory provisions.
• Joint policy statements, often coordinated through the FFIEC.
• Common statutory provisions where a non-banking agency (such
as the Department of Housing and Urban Development) is given
authority to write the rule, but each banking agency enforces
the provisions of the rule.
-23-

• COmDon statutory provisions where only one agency is given
authority to write the rule, but the common rule is then
enforced by ~.~ four federal financial regulators.
Regulations that fall into one of these categories are identified
in the appendix as interagency projects. The interagency working
qroup plans to rank the regulations and give priority to those
regulations or supervisory policies that are not uniform or are
outdated.
In addition, the banking agencies will review all joint rules or·
supervisory policies that were designed to be uniform in order to
reduce regulatory burden because they overlap with the authority
of non-~anking agencies. An example would be the Interagency
Statement on the Retail Sale of Nondeposit Investment Products.
The four federal banking agencies not only consult and confer
with the National Association of security Dealers concerning the
sale of mutual funds, but have also signed an agreement to share
inform~tion and coordinate examinations to ensure that duplication of regulation is minimized.
Phase V - Legislative Changes. As a result of the review, the
statutory changes listed below are being considered. If these
changes are adopted, OTS could make further regulatory reforms to
reduce burden without compromising safety and soundness standards. In addition, there are many statutes that require other
agencies to write rules that OTS administers or enforces. These
rules are outside of the control or influence of OTS. OTS notes,
however, that there are many statutory and regulatory changes
that could be made to these statutes and rules; such as the Truth
In Lending Act, that would reduce regulatory burden on insured
depository institutions.
• Liquidity. Delete section 6 of the Home OWner's Loan Act
(HOLA) because it is obsolete •
• Federal Home Loan Bank Membership. As part of a comprehensive
reform of the Federal Home Loan Bank System, delete section
SCf) of the HOLA and related provisions in the Federal Home
Loan Bank Act to make Federal Home Loan Bank membership
voluntary for federal thrifts. This would provide parity
for federal savings associations with other depository
institutions.
• Anti-Tying Provisions. Authorize OTS to grant exemptions for
savings associations from section Seq) of the HOLA that track
exemptions authorized by the Federal Reserve Board for banks
under a similar provision in the Bank Holding Company Act.
• Qualified Thrift Lender Test. Revise section lO(m) of the
HOLA to allow savings associations to qualify as OTL lenders
by meeting either the OTL test or the IRS test.
-24-

• Small Business Loan Lending Authority. Amend section 5(c) of
the HOLA to allow savings associations to invest an additional
10 percent of their assets in s~all business loans. This
amount would be above the 10 per,-~nt now authoriz'ed for commercial loans •
• FIRREA Capital Requirements. Eliminate duplicative and inconsistent provisions between HOLA sections Set) and S(s) and
Prompt Corrective Action provisions in the Federal Deposit
Insurance Act that relate to capital standards, growth provisions an~ capital plan requirements.
• Dividend Notification Requirement. Delete the requirement in
section 10(f) of the HOLA that requires 30 days notice prior
to making a capital disttibution.
• Community Development Investments. Modify HOLA section
5(c)(3) (B) to permit thrifts to make community development
investments that are not linked to Title I of the Housing and
Community Development Act of 1974.
Administrative Changes.
• Reduction of InfOrmation Collected Through the Thrift Financial Report. OTS initiated a project to reduce by at least 30
percent the amount of information collected through the Thrift
Financial Report. Recommendations include converting to a
fully consolidated reporting format, eliminating items where
aggregate thrift industry investment is minimal, and combining
several items that need not be reported as discrete items.
This project also furthers OTS' goal to bring the regulation
of thrift institutions into greater conformity with the policies and procedures of the other banking agencies. OTS plans
to seek public comment on these changes, as well as on the
issue of OTS adopting the bank "call report" used by the other
Federal banking agencies.
FINANCIAL MANAGEMENT SERVICE

The Financial Management Service (FMS) page-by-page review was
accomplished by both staff charged with administering FMS programs and by other knowledgeable staff giving the regulations a
-fresh look." As a result, FMS identified portions of over
60 percent of its regulations that could be eliminated or reinvented. FMS also maintains frequent contact with its regulated
entities, providing a forum for suggested changes to regulations.
Federal Government Participation in the Automated Clearing House.
In a notice of proposed rulemaking published September 30, 1994,
FMS proposed to eliminate some of the differences between
-25-

Government and private sector rules governing transactions
through the Automated Clearing House eACH) system. Final rules
are expected in September 1995.
FMS regulations govern the rights and responsibilities of the
Federal Government, Federal Reserve banks, and financial institutions doing business with the Government through the ACH system.
The proposed change will bring the Government's regulations more
in line with financial industry rules. In addition, the proposal
will advance FMS' goal of increased use of electronic funds
transfers (EFT) by fostering the transition to full electronic
processing and the utilization of commercial ACH processes.
Financial institutions, Federal agencies and the Federal Reserve
all agree that greater use of private industrY rules will benefit
all parties in encouraging more efficient use of EFT.
Rules and Procedures for Funds Transfers. On June 1, 1994, FMS
amended its regulations implementing the Cash Management Improvement Act of 1990 (CMIA), which governs the ~ransfer of funds
between the Federal Government and the Statec under Federal
programs. The prior regulations defined the '::-.erm "State" to
include autonomous State-level entities that a~e legally or
fiscally independent of the Governor, Treasurer and Comptroller.
States opposed this definition because it made them responsible
for organizations over which they have no financial or legal
control. This definition was found to be untenable and could
have threatened the stability of the CMIA program by forcing
states into either default or noncompliance. By revising the
definition to exclude such entities, FMS responded to the concerns raised by States and strengthened the CMIA program.
BUREAU OF THE PUBUC DEBT

BPD's proposals to eliminate or reinvent portions of titles 17
and 31 of the CFR were based primarily on its long and ongoing
experience interacting with the public and regulated entities.
Public Debt staff involved in the review included individuals
with substantial career experience working with securities owners
and an extensive knowledge of the regulations being reviewed.
The Bureau reviewed those areas known to have been troublesome
for the public and others affected in the past. A review of the
list of actions already completed that meet the criteria for
reinvention demonstrates that Public Debt maintains a policy of
periodic review of regulations to ensure that they are not
obsolete or unduly burdensome.
Most regulations issued by Public Debt are better characterized
as matters of public contract, incorporating the agreements
between Treasury and investors in Treasury securities. These
-26-

public contracts are published in the Federal Register as regulations primarily to provide the most effective legal notice
possible.
Most of Public Debt's proposals involve revising the language of
various regulatory sections. Two sections in title 17 (sections
402.2 , 405.3) have been revised or reinvented. Parts 347, 348,
and 349 of title 31 of the CFR have been eliminated. Parts 306,
315, 316, 317, 321, 330, 332, 337, 342, 344, 351, 352, 353, and
357 in 31 CFR have been amended or revised to reflect pr~am
changes occurring after 1992. In addition, the Bureau is planning further improvements to six provisions in title 31, and to
eliminate part 390.
Proposed changes to parts 315 and 353 would simplify and streamline procedures established for processing transaction requests
and claims filed by owners of savings bonds or their representatives. Accordingly, the changes would reduce as much as possible
the burdens imposed by government regulation. Changes to title
17 have reduced reporting requirements for brokers and dealers in
government securities.
FINANCIAL CRIMEs ENFORCEMENT NmwORK

since mid-1994, FinCEN has been engaged in a thorough review of
its regulatory policies. As part of that review, FinCEN has
taken several major steps to simplify its regulations and to
reduce paperwork and compliance burdens on financial institutions
subject to the Bank Secrecy Act regulations.
Purchases of Monetary Instruments. FinCEN has fundamentally
modified and simplified its regulation requiring the maintenance
of logs of purchases of monetary instruments. A review of this
requirement indicated that the logs had not been used to any
significant degree by law enforcement officials. The new regulation limited required recordkeeping in most cases to information
maintained by financial institutions in the ordinary course of
business.
Magnetic Media Reporting. FinCEN withdrew, as costly and unnecessary, proposed rules requiring submission of all filings in a
single magnetic format, and imposing uniform rules for determining whether transactions should be aggregated for reporting
purposes.
currency Transaction Report. FinCEN published a new currency
transaction report (CTR) form that eliminates unnecessary and
duplicative information. The new form, which will come .into use
later this year in order to give financial institutions adequate
time to make the necessary adjustments in their automated
-27-

procedures, reduced the number of information fields by onethird, from 98 to 64 fields. FinCEN is also preparing a regulation, to be issued shortly, that will exempt banks ~rom filing
CTRs with respect to most transactions with government entities
and transactions with many businesses. This rule is expected to
reduce the volume of CTR filings by at least 30 percent, or 3.3
million forms annually.
Wire Transfers. FinCEN published long-delayed rules relating to
recordkeeping for wire transfer transactions, after fundamentally
modifying those rules to take account of the comments of regulated firms. The addition of a $3,000 threshold to the wire transfer rules excluded from'regulatory mandates 98 percent of all
transactions carried by non-bank money transmitters.
casinos. FinCEN withdrew a final rule that was due to become
effective on December 1, 1994, after determining that it would
have imposed significant additional recordkeeping burden on
casinos by requiring them to keep logs of certain customer
transactions. FinCEN also simplified the casino rules in response to industry comments.
Criminal Referral Reports. Later this year, FinCEN will complete
a project creating a single form for reporting possible crimes
and suspicious transactions at both banks and non-banks. This
rule will simplify reporting of an estimated 150,000 occurrences
each year; eliminate multiple filing of such forms; and make the
information available electronically for all relevant regulatory
and law enforcement officials within the federal government.
Qverall Simplification and Clarification. FinCEN is in the
process of issuing several regulatory proposals to implement
recent anti-money laundering legislation to reduce compliance
burdens. After these rules have been issued, FinCEN plans to
recodify and simplify the entire body of requlations implementing
the Bank Secrecy Act to make them easier to use and understand.
OFFICE OF FOREIGN AsSETS CONTROL

The requlations administered by the Office of Foreign Assets
Control (OFAC) were reviewed for possible elimination or improvement by members of OFAC's policy and legal staffs. It was determined that a number of whole parts of 31 CFR could be removed
inasmuch as the economic sanctions programs to which they relate
had been discontinued. The appendices to several other parts are
being eliminated in favor of a master appendix to be placed at
the end of Chapter V, 31 CFR, to set forth in an integrated,
alphabetized listing the Specially Designated Nationals (SONs)
for all current OFAC-administered programs. Such a listing
parallels the listing which is made available by OFAC to the
-28-

public as a printed handout and via electronic bulletin boards.
OFAC is also amending Part 505 to eliminate the requirement of
Treasury licensing of dual-use reexports and related
~~ansactions.

-29-

PART

REWARDING RESULTS
OVERVIEW

In accordance with the President's memorandum of March 4, 1995,
Treasury has completed a review of performance measures for
front-line requlators. The Department has determined that DO
front-line requlators are currently evaluated on performance
meas~es based on process and punishment.
The Department has
long been concerneu with ensuring that performance measures
support the mission of the organization ana, in some cases,
bureaus have been precluded by policy and contractual agreements
from devel~~ing measures that would tend to be punitive. For
example, a policy statement issued in June 1988 in the Internal
Revenue Service specifically states that: "Tax enforcement
results tabulations shall not (be) used to evaluate an enforcement officer or impose or suggest production quotas or goals."
LINEAGE TO OTHER INITIATIVES
Treasury and its bureaus are now working to ensure an integrated
strategic business systems alignment of vision, mission, customer
service goals, program performance plans and measures, budget,
organizational planning and results reporting including personnel/human resource systems. This includes a final link to
individual performance plans to ensure all employees are working
to further the goals of the organization.
All Treasury bureaus have developed customer service plans and
set standards in at least one of their major program areas.
These standards were forwarded to the Vice President in September
1994. As part of the Department's on-going commitment to improve
customer service, the bureaus developed comprehensive long-term
strategies that described how they are creating a customer
service orientation throughout the organization. They also
developed a customer Service Action Plan with Milestones, which
translates their long-term strategies into specific operational
tasks.
With respect to the Government Performance and Results Act of
1993, Treasury has four bureaus participating in the pilot
program: .the u.S. Mint,
. . the Internal Revenue Service , the Bureau
of Engrav~ng and Pr~nt~ng, and the Office of Investigations in
the u.s. customs Service. Each of these bureaus has already
submitted to OMB the following items:
•

FY 1994 Performance Plans

• FY 1995 Performance Plans

-30-

• FY 1996 Performance Plans
• FY 1994 Program Performance Report
• Nominations for managerial accountability and flexibility
waivers.
Treasury is beginning a process to involve all bureaus in GPRA
implementation before mandatory requirements begin in 1997. (The
draft strategic plannin~ process is attached at Appendix A.)
SUMMARY OP STEPS TAKEN TO COMPLY WITH PRESIDENT'S XEMORAHDOX
Although response to this initiative was coordinated at the
Department level, individual ~reasury bureaus were tasked to
review current performance measures and to ensure that overall
results are aimed at compliance rather than enforcement. Following a preliminary review of bureau operations, five bureaus were
identified as having employees that met the definition of.frontline regulators.
Attached ~t Appendix B is a matrix summarizing
the number of employees covered in these five bureaus, the job
series of these employees, and a brief description of the appraisal period for each bureau. The bureaus identified are:
Bureau of Alcohol , Tobacco and ·Firearms; Office of Comptroller
of the currency; u.s. customs Service; Internal Re~enue Service;
and Office of Thrift Supervision.
Briefings were provided to all bureaus, even those not identified
as employing front-line regulators. They are expected to include
the development of results-oriented performance measures in
future performance management programs using the following major
steps:
1.

Conduct strategic planning/goal setting

Communicate' coordinate
•

Involve unions

•

Involve employees

Identify characteristics of outcomes from employee/union
perspective

Conduct customer outreach
•

Identify/Survey customers

•

Analyze information to identify characteristics

-31-

Develop performance measures
•

Merge findings of employee/union involvement and
outreach

•
•

Develop performance measures based on inputs

c~stomer

Link with managerial goals
Develop data collection method

•

Identify data needed to measure outcomes

Implement new performance plans with new measures

Link results to reward program

Ensure follow-up

•
•
•

Resurvey employees/unions/customers at end of cycle
Revise performance plans as necessary
Feed new data into strategic planning/goal sGtting

Further, the five bureaus identified as employing front-line
regulators were required to prepare implementation plans to
describe how they have/will respond to the requirements of the
initiative. Highlights of these implementation plans are provided below with the complete plans attached at Appendix c.
BIGHLIGH'1'S OP BOREAU PLANS

United states CUstoms Service
customs identified 13 different positions as front-line regulators; principally CUstoms Inspectors and Import specialists.
These positions deal with regulated entities on a habitual basis
and their primary responsibility is to ensure compliance with
existing laws, regulations, and directives governing the trade
industry. A review of the performance plans of the identified
positions indicated that none focused on process or punishment.
Instead, as an example, they focused on the number of field
visits with the purpose of educating and providing clarification
to importers on both new and existing policies and procedures.
Despite having no performance plans that focus on process or
punishment, CUstoms has embarked on a major reengineering effort
of their performance management program. In April of 1995, a
joint union/management ·task force was instituted and charged with

-32-

designing a new program that will. be consistent with a process
management environment and one that more clearly meets the needs
of the primary customers.
They are working with their customers to change from a bureau
that focused on finding individual violations to one focused on
pursuing compliance with the laws they enforce. They are striving for 100 percent compliance and the preferred strategy for
doing this is to work with the trade and the traveling public to
provide them with the information to enable them to achieve
compliance voluntarily.
In terms of the reengineering of the performance management
program, several factors will impact the timetable for completing
this initiative. First, the Reengineering Task Force's findings
and recommendations are targeted for completion by late summer of
this year. The team recommendations must then be agreed to by
the respective management and union members of the National
Bargaining Team who are currently engaged in contract negotiations. Once final agreement by all parties is obtained, customs
will begin implementation of new result-oriented performance
measures throughout the organization.
Bureau of Alcohol. Tobacco and FirearmS
ATF identified Inspector positions and their first and second
line supervisors as front-line regulators. They primarily engage
in direct contact with the regulated firearms, explosives,
alcohol, and tobacco industries. ATF's review of the Inspector
performance plans indicated that.none focus on process or punishment but rather cite such activities as providing accurate
technical information to industry and the public and effectiveness in forging working relationships with the regulated industries.
Although no performance plans focus on process or punishment, ATF
is still undertaking a comprehensive review of the entire performance management program. They are conaucting a study that will
draw heavily from surveys of both supervisory and non-supervisory
employees. In developing the new program; survey results will be
considered; the union will be involved; strategic goals, GPRA,
customer service, and eFO requirements will be included; an
assessment tool will be developed; the existing performance cycle
will be examined; and the awards system will be accommodated.
The implementation is intended to begin at the top levels of ATF
and to cascade systematically down to the front-line employees.
A June 30 , 1995 deadline has been set for.
the development
of
.
revised performance contracts for the sen~or execut~ves. Recommendations for the remainder of the program are anticipated by
the end of FY 95 with implementation to follow soon.

-33-

However, certain issues may delay the final implementation of the
new program. These issues include court ordered mediation
involving'a class action lawsuit filed against ATF and required
negotiations with the exclusive representative of bargaining unit
employees.
Office of the Comptroller of the CUrrency
OCC identified those commissioned examiners who deal directly
with banks as front-line regulators since they have the authority
to prescribe remedies in an official capacity. They also include
certain corporate application examiners and selective attorney
positions that deal directly with banks on corrective actions.
However, none of the performance plans for these employees focus
on process or punishment. Rather, the OCC performance program is
structured around developing performance objectives in support of
the organization's priorities.
Since no performance plans focus on process or punishment, no
performance measures need be eliminated. Nonetheless, ace is
considering more results-oriented performance measures as part of
their strategic planning process. This process also will take
into consideration streamlining, performance measures required
for the budget and CFO report, the customer service requirements
and organizational performance plans. organizational measures
are targeted for incorporation in performance evaluations this
fall.
Internal Revenue Service
IRS identified those occupations in tax administration that by
their nature require regular, direct contact with taxpayers and
that are authorized routinely to make determinations regarding
individual and corporate tax liabilities. These occupations
include Revenue Agents, Tax Auditors, Revenue Officers, and Tax
Examiners. All are covered by a 1988 IRS policy statement
forbidding the use of statistics in performance management. This
policy precludes the development of any measures that would tend
to be punitive-oriented.
Although no performance plans focus on process or punishment,
since January 1995, IRS has had a full time reengineering effort
underway to reinvent completely the performance management
program, including objective setting, evaluations/appraisals and
rewards/recognition, for all employees. This effort is called
the Total Organizational Performance System (TOPS). In addition,
since october 1994, all IRS executives, managers and management
officials have been assigned to more results-oriented objectives.
These measures were derived directly from the following three
major business objectives:

-34-

•

Increase Voluntary Compliance

•

Maximize CUstomer satisfaction and Reduce Burden

•

Achieve Quality-Driven Productivity Through Systems
Improvement and Employee Development

The TOPS project charter includes a timetable with an ultimate
bureau-wide implementation of 10/1/96. However, the reliability
of this timetable is dependent upon how negotiations with NTEU
pr~ceed.

Office of Thrift Supervision
OTS identified all Examiners assigned to the regions and their
immediate supervisors as front-line regulators. These are the
employees who interact daily with their primary customer, the
thrift industry. OTS established a task force of front-line
regulators that determined that the current performance standards
were not process-oriented and do not contain punitive measurements.
Since no performance plans focus on process or punishment, no
performance measures need be eliminated. However, OTS formed a
task force that met during April/May of 1995. This task force
bas modified OTS' generic standards to include an evaluation of
individual employee contributions to the furtherance of goals,
and the customer service plan. The results-based measures
proposed by the task force are scheduled to be implemented by
January 1, 1996.

-35-

PART ill - APPENDICES

Appendix A:

Planning/Budget/Evaluation Process

Appendix B:

Number of "Front-line Regulators"

Appendix

Bureau Implementation Plans:

u.s.

customs Service

Bureau of Alcohol, Tobacco , Firearms
Comptroller of the currency
Internal Revenue Service
Office of Thrift Supervision

-36-

APPENDIX A
TREASURY PLANNING/BUDGET /EVALUATION PROC.~$S

• aeaffirm/Publish xis. ion statements
•

Bureaus/PASS' review and refine Mission statements for each
bureau, as needed

•

Treasury review/approval/publication as Treasury Directive

• Develop strategic Goals
•

Bureaus/PASs develop strategic Goals for each major budget
activity:
•

"Vision" goal: Goal describing the "desired" or "ideal" state for the program to achieve
"Vision" goals:
Are non-specific in terms of the time/resources
needed to reach goa1
Provide a benchmark against which other goals can
be measured
·Option" goals: Goal options beyond the budget year,
defined primarily by resource levels/ranges
Could be a single goal, if no options are practical/feasible
"Option" goals should:
state relative importance in terms of achieving
mission
Be time specific
Specify underlying resource assumptions
state one or more performance indicators (if goal
itself is not directly measurable)

•

PASs/Management propose cross-cutting goals impacting more
than one bureau

Program Assistant Secretary
-37-

• Conduct STRATEGIC PLANNING SUMMIT (April)
~.~als

•

Secretarial policy choices on which of the strategic
are most critical to pursue

•

PASs prioritize strategic goals under their purview

•

Secretary/Deputy Secretary makes final policy decisions on
which strategic goals to pursue in order of priority

• Bureau• • ubmit budget request. (June)
•

CUrrent performance is described for each budget activity in
terms of the performance indicators used in pJanning process

•

Ranking of base resources and initiatives is conducted to
reflect extent of support for strategic goals
•

Promotes review of base resources DQt directed at
strategic goals

• Budget analyses/recommendations/decisions made in context of
achieving highest priority·strategic goals
•

Initiative requests are analyzed as to whethet they will:
•

Significantly help to meet an important strategic goal

•

Result in exceeding an important strategic goal

•

Not significantly contribute to meeting a strategic
goal

• Conduct BUDGET SUMMIT (July/AUgust)
•

Management presents Secretary with recommendations on major
budget alternatives which best meet the recognized strategic
priorities.

•

Secretary makes decisions made on what to propose to OMB.

• Submit Budget to OHa (September) and Congress (February)
•

Budget presentation to OMB and the Congress expressed in
terms of specific budget year performance goals and performance indicators, and in context of strategic goals

•

Appeals to OMB pass-back and negotiations with Appropriations Subcommittees quided by Secretarial strategic
priorities

-38-

Budget
GPRA

proposed Annual Performance Plan as required under

• I'INAL PERFORMANCE PLAN, and SECRETARIAL PERFORMANCE AGREEHDlT
WITH THE PRESIDENT, are completed after final appropriation.
are enacted •
• Conduct PERFORMANCE REVIEW SUMMIT (January/February)
~

secretarial review of actual performance compared with
planned performance

Performance Report· to the President/Conqress (March)

Analysis/feedback results into next planning cycle

-39-

APPENDIX B

DEPARTMENT OF THE TREASURY
Number of "Front-line Regulators"

Bureau

I of
Covered
Employees

ATF

501

OCC

Job
Series

Description
of Appraisal
Period

I None

Ends 9/30 for supvs.
Ends 45 days prior
to WGI for others.

1,800

Examiners, Corporate I None
Application Examiners
& some Attorneys

Ends on anniversary
date for most
employees; ends
12/31 for attorneys.

8,282

Inspectors, Canine
I None
Enforcement Officers,
Import Specialists,
Reg. Auditors, et al;

Ends 5/31.

IRS

29,932

Revenue Agents
I None
& Officers, Tax
Auditors & Examiners

Ends monthly based
on SSN.

OTS

189

Examiners

Ends 12/31.

TOTAL

Inspectors

I of Performance
Measures Based on
Process/Punishment

I None

41,310
-40-

APPENDIX C

REGULATORY REFORM INITIATIVE
PERFORMANCE MEASURES
IMPLEMENTATION PLANS'
U.S. customs Service
Describe rational. used ip identifyipg fropt-lipe regulator.:
The following customs' positions have been identified as frontline regulators in accordance with the NPR definition:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.

Canine Enforcement Officer
compliance Analyst
customs Inspector
customs Liquidator
District Director
Drawback Specialist
Entry Specialist
Import Specialist
Lead CUstoms Aid
Port Director
Regulatory Auditor
Seized Property Specialist
Vessel Entry Control Officer

Specifically, these positions were deemed front-line regulators
for the following reasons:
•

They deal with regulated entities on a habitual basis.

•

Their primary responsibility is to ensure compliance with
existing laws, regulations, and directives governing the
trade industry.

•

In cases of non-compliance, they have the authority to order
a corrective action.

Number of performance measures based on process or punishment:
A review of the performance plans of the identified positions
indicated that the measures in the plans focused on results
rather than process or penalties and called for vigilance in the
area of enforcement of customs laws and regulations. None of the
plans directly measures successful performance by virtue of the
number of seizures, penalties or fraud cases initiated. For
• Attachments referenced in the implementation plans of the
various bureaus have not been included in Appendix c.
-41-

example, the I~port Specialist position has an element that
requires the Specialist to make "X" number of field visits to the
trade community each rat:~g cycle. The purpose of the visits is
not to find violations an~ issue fines and penalties, but to
educate and provide clarification to importers on both new and
existing policies and procedures. Still, CUstoms will fine tune
the existing standards to focus more on ensuring that the trade
community understands and is knowledgeable of the applicable
rules.

Describe the current peltormance appraisal cyclers):
The current 1994/95 Employee Performance Appraisal System (EPAS)
rating cycle end~ on May 31, 1995, and all £PAS employees will be
issued their 1994/95 annual performance rating during the month
of June 1995. The new 1995/96 rating cycle commences on June 1,
1995, and will end on May 31, 1996.

Describe the strategy to evaluate internal personnel performapc.
measures and eliminate those based on process or punishment:
As indicated abov~, CUstoms' performance standards are not based
on process or puninhment. In fact, over the last two years,
customs has taken ~~e initiative in shifting away from these
types of measures and moving toward a customer service orientation, with emphasis on informed compliance and measurement of
results. Nonetheless, they have embarked on a major reengineering effort of the performance management program. In
April of 1995, the Office of Human Resources Management instituted the Performance Management and Recognition Task Force. This
joint union/management task force has been charged with examining
the usefulness of the traditional system used to evaluate performance and to design a new system which will be consistent with a
process management environment and one which more clearly meets
the needs of the primary customer groups.

Among the many specific goals of the team is to develop a system
that more clearly identifies the relationship between agency
mission and goals, and the work of individuals or teams of
individual workers. The team has received training in the Juran
reengineering methodology which emphasizes an outward customer
driven focus for problem solving and involves extensive data
collection from internal and external customers.
This effort, along with the designation of CUstoms as the
first Reinvention Laboratory for Human Resource Management under
the NPR will provide a solid basis for continuing efforts to
exemplify the direction and spirit of the NPR.

-42-

Describe bow your organization will shift tbe emphasis from
punitive measures to overall results:
customs has described a compelling vision f~r. a wholesale change
of its culture in its report People. Processes. and Partnerships.
Having adopted the concepts embodied in business process improvement and problem-oriented policing, CUstoms is working with its
customers to change from a bureau that focused on finding individual violations to one focused on pursuing compliance with the
laws they enforce. Their stretch goal is to strive for 100
percent compliance and their preferred str~~eqy for doing this is,
to work with the trade and the travelling public to provide them
with the information to enable them to achieve compliance voluntarily. Some examples of actions tQ focus on results follow.
Fiscal year 1995 will represent the first time that customs will
have comprehensive baseline compliance rates for imports in major
industries. They will use this data to design strategies to
raise compliance levels, where appropriate. customs is already
sharing this information with inductry to enable them to initiate
corrective action. High compliance will translate into reduced
inspection activity.
customs is redirecting its import specialist and regulatory audit
resources toward working voluntarily with large importers to
assess their internal controls so that they can reduce the
inspection activity which is costly and obstructs the smooth flow
of commerce.
Responsive to the mandates for informed compliance embodied in
the CUstoms Modernization Act, they are redesigning the entire
cargo process in partnership with industry to enable a shift from
a transaction focus, which led to industry complaints of petty
violations, to a servicing accounts framework, which will provide
a more informed context for their relationships with the trade.
A principle of this effort is that they shift resources from
transaction verification efforts to working with industry prior
to importation to achieve compliance.
Problem oriented policing is focusing their efforts toward
reducing or eradicating problems rather than achieving higher
enforcement action totals. For example, confronted on the
Southwest border with a sharp rise in port runner incidents (cars
speeding away from ports of entry without clearing CUstoms),
CUstoms has initiated an integrated program of increased inspections and physical security enhancements to prevent and deter
such incidents.
They are designing a balanced measurement framework capturing the
dimensions of effectiveness (compliance), efficiency, andcustomer

-43-

service. These measures will provide for a comprehensive assessment of their field activities rather than a focus on punitive
actions.
Describe how you intend to shift resources from epforcement
activities to partnership activities aimed at compliapce:
Pursuit of the goal of informed compliance will lead to a shift
in resources to partnership activities. In reengineering the
cargo importation process, customs envisions that they will shift
resources to working with accounts to ensure that they have ~le
internal controls in place to provide the confidence that they
can reduce inspection activities. customs 'already is doing this
with early trade compliance data and with a shift of requlatory
audit resources to assessing major importer control s}stems. In
fiscal year 1996, SO percent of their audit resources will be
focused on priority industries in which they have identified
significant non-compliance. The auditors will direct their
efforts to working with the firms to correct problems that lead
to recurring non-compliance. Also, their reengineerjng plans
call for major importers to have customs account repr~sentatives
who will work with them to achieve informed compliance~ As a
result, they expect to reduce the number of enforcement actions,
such as penalties. Using business process improvement techniques, they are meeting with the trade to identify the~r needs'
and design a system responsive to those needs. CUrrently,
CUstoms is also investing significant efforts into working with
the trade in developing the regulations necessary for implementing the informed compliance aspects'of the CUstoms Modernization
Act. Finally, working with INS and Agriculture, customs is
instituting statistically based compliance measurement techniques
to assess the risk associated with air and land passengers. This
data will enable them to move away from a narrow focus on the
violations they detect and provide a better basis for assessing
the level of risk. This will enable them to make more informed
decisions about the effectiveness of their strategies to address
non-compliance problems and will enable them to make better
resource allocation decisions.
pescribe how you intend to recognize employees and reward employees for performance based on achieving results:
In addition to reengineering the appraisal process, the reengineering team described above will also be examining the
manner in which CUstoms' employees are currently rewarded through
incentive awards and other agency programs. However, at this
time, it would be premature to speculate on the expected results
of the team efforts in this area.

-44-

provide a timetable for putting new measures in place:
customs will have comprehensive baseline trade compliance data
for fiscal year 1995. Their new measurement framework will be
operational beginning october 1995. Their revamped regulatory
audit program will be operational in fiscal year 1996. More
detailed plans for reengineering the cargo importation process
and moving toward implementing an account-based approach will be
available in the fall of 1995.
In terms of the reengineering of the performance management
program, several factors will impact the timetable for completing
this initiative. First, the Reengineering Task Force's findings
and recommendations are targeted for completion by late summer of
this year. The team recommendations must then be agreed to by
the respective management and union members of the National
Bargaining Team who are currently engaged in contract negotiations. Once final agreement by all parties is obtained, customs
will begin implementation of new result-oriented performance
measures throughout the bureau. Identifying the exact date of
implementation is difficult since customs is re-examining the
entire issue of performance management cycles and the feasibility
and desirability of tying the· performance appraisal cycles to the
budget and planning cycles.
Bureau of Alcohol. Tobacco & FirearmS
Describe rationale used in identifying front-line regulators:
ATF considers its Inspector and their first and second line
supervisors as its front-line regulators. They: constitute the
front-line population of the ATF's Office of Regulatory Enforcement; are located in the ATF's field offices; and are charged
primarily with direct, person-to-person contact with the regulated firearms, explosives, alcohol, and tobacco industries. Their
work involves conducting on-site inspections of industry (including individual dealers) financial and other related records and
documentation to ensure compliance with laws and regulations
governing their industry practices.
We believe these are the ATF positions that specifically match
the types of positions targeted by the Administration for reform.
While there may be additional personnel (primarily in Headquarters positions) who have contact with the regulated industries,
these positions' duties do not entail the front-line responsibility to impose punitive measures.
We have specifically excluded the special agents (Criminal
Investigator) population. These positions are separated organizationally and functionally from the regulatory popUlation.
These agents do not conduct inspections to ensure compliance with
-45-

law, rather, they investigate suspected criminal activity, are
typically exposed to potentially violent and extremely dangerous
elements of the population, and are empowered to serve warrants
and make arrests. Much of their work is conducted in undercover
operations to establish the presence of criminal activity and to
gather evidence sufficient to develop criminal cases. They do
not issue citations or violations as defined in the Administration initiative or the NPR guidance. While much of their work
involves cooperative activities, its focus is on developing close
working relationships with state, local and other Federal law
enforcement agencies.
~!mber

of performance measures based on process or punishment:

A review of the Inspector critical elements and performance
standards showed that none of their performance plans focus on
process or penalties. In fact, their elements and standards do
not contain any measures involving process and punishment. ATF's
performance plans for its regulatory functions cite such areas as
providing accurate technical information to industry and the
public and their effectiveness in forging working relationships
with the regulated industries.
Describe tbe current perfOrmance appraisal cycle(s):
The performance cycle for non-supervisory employees ends ~5 days
prior to the anniversary date of their last within-grade ~n
crease. The performance cycle for supervisors and managers is
October 1 through September 30. Independent from this initiative, and, as described elsewhere in this report, ATF is about to
conduct a comprehensive study of its performance management
program. The performance cycles will be subject to possible
change at that time.
pescribe the strategy to evaluate internal personnel performance
measures and eliminate those based on process or punishment:
ATF has reviewed the current performance measures covering all
the front-line regulators, as identified above. These elements
did not and do not focus on or even contain references to process
or punishment (samples provided at Attachment 1). Therefore, no
performance measures need to be eliminated. However, as noted
above, the Director of ATF has requested that they undertake a
comprehensive review of the performance management program. In
his meetings with field organizations, numerous concerns with the
present system have been identified both by supervisors and by
the rank and file employees. The current plan is to conduct a
study which will draw heavily from surveys of both supervisory
and non-supervisory employees as to the type of system that would
be most appropriate for· ATF, and to incorporate appropriate
measures to accommodate the CFO Act, GPRA, customer service
standards and the internal strategic planning efforts. Any
-46-

resulting changes will also incorporate the requirements outlined
in the R~gulatory Reform Initiative. We anticipate this study to
commence ~~ithin this FY, subject to the following considera~ions.
Plans to conduct such a study have been under consideration for
several months, but have been delayed due to a separate, but
clearly related, legal issue. Court ordered mediation involving
a class action lawsuit filed against ATF by a group of Black
agents resulted in ATF agreeing to engage a consultant to study
the caree~ development and promotional practices for the special
agent (GS-1811) population. Since these practices involve the
performance evaluation system· as well, any recommendations to
develop a sound, fair, objective, and statistically valid and
r3liable career development/promotional system will directly
impact and influence any changes in the performance appraisal
system. While the consultant's work will focus on the specific
issues surrounding the lawsuit, his recommendations will be
reflected in any changes to the overall performance evaluation
system.
The exclusive representative of inspectors and other bargaining
unit employees is the National Treasury Employees union (NTEU).
The union was briefed on the Regulatory Reform Initiative at an
April 19-20 Partnership Council meeting. There will be union
participation in any surveys or studies impacting the bargaining
unit. However, the union has always reserved the right to
bargain over the impact and implementation of any plans resulting
from such studies, whether or not they directly participated in
those stUdies. Such negotiations are not subject to time limits,
and, considering the nature of the subject and the potential for
substantial change to the existing performance program, we
anticipate lengthy negotiations.
Describe how your organizatiop will shift the emphasis from
punitive measures to overall results;
It is ATF's position that the emphasis of its performance management program for front-line regulators already focuses on overall
results, and is in compliance with the Regulatory Reform Initiative requirements in this area.
However, the Bureau is currently engaged in implementing the
first stages of its strategic planning process which incorporates
eFO and GPRA mandates (Attachment 2). Four main strategies have
been developed, including one that specifically focuses on
development of partnerships and other cooperative relationships
with industry. The implementation is intended to begin at the
top levels and to systematically cascade down to the front-line
employees. At present, management level groups have been working
for the past two months to develop a series of tactics to accomplish the broad strategies. One of these groups has developed
recommendations for new performance contracts for ATF's executive
-47-

staff that will focus on specific activities leading to the
accomplishment of the strategic goals. On May 9, the Director
and the executive staff agr~~d to the recommendations for the new
contracts. The contracts will be finalized for the new SES
performance cycle which begins on July 1. Once this step is
complete, performance contracts, memos of expectation, and/or
revisions to existing critical elements and performance standards
will be developed to translate the broad executive level activities into more specific tasks at lower management, supervisory
and non-supervisory levels.
ATF is also involved in the systematic development of customer
service standards. Standards have been published for several
functions, accompanied by continual measurement and assessment of
the degree to which those standards are being met. Standards
covering additional functions are currently in various stages of
development, and will continue.
pescribe bow you inten~ to shift resources from enforcement
activities to partnorship activities aime~ at compliance:
As described previously, ATF's chief executives will, with the

commencement of their next SES performance cycle, be held accountable for activities leading to the accomplishment of the
strategic management plan qoals (which include the types of
specific partnership activities aimed at compliance mandated by
the Regulatory Reform Initiative). Consequently, budget requests
will reflect expenditures to establish, maintain and expand these
partnerships activities.
Describe bow you ipten~ to recognize employees an~ reward employees for performance base~ on achieving results;
ATF rewards employees for performance reflected in their performance appraisals (i.e., performance awards and quality step
increases), as well as awards for specific shorter term performance (special act awards). As the current performance elements
and standards include measures for providing assistance to the
public and the regulated industry, and for maintaining effective
relationships with industry, the current awards program provides
direct links between the regulatory reform initiatives, performance measurement, and the awards system.
Provi~e

a timetable for putting pew measures in place:

A June 30, 1995 deadline has been set for the development of
revised performance contracts for the senior executives •. These
contracts will reflect ATF's strategic goals (which specifically
include establishing and maintaining partnerships with industry).
These goals will cascade down through the organizational levels,
to eventually be reflected in every employee's performance
elements and standards. At present, no specific timetable has
-48-

been set beyond the SES level (which was approved on May 9).
However, as noted elsewhere in this report, the strategic goal
that coincides with the Initiative's requirem'nt to partner with
industry is already contained in the elements and standards for
front-line employees.
ATF's plan to review and revise the overall performance management program is still in the preliminary planning stages, and
specific milestones and target dates have not yet been set (this
effort has been delayed to accommodate the schedule of the
consultant engaged to develop recommendations tor performance
evaluation and career development as part of the settlement of
the Black agents' lawsuit). Once the overall review commences,
an action plan will be developed. Th~ union will be involved in
this effort as it impacts the bargainiug unit; both supervisors
and non-supervisory employees will be surveyed; strategic goals,
customer service standards, GPRA, eFO and Regulatory Reform
Initiative requirements will be included in any recommendations;
an assessment tool will be developed; the existing performance
cycle will be examined; and the awards program will be accommodated. It should be noted, however, t~at this review will entail
far more than rewriting critical elements and performance standards. It will involve consideration of different ways of
assessing the performance of our employees (e.g., 360 degree
feedback systems, check-off systems, pas~-fail, team assessment;
etc.). Any change to the existing system will require negotiations with NTEU, which, depending on the system chosen, could be
protracted.
Describe the link between organizational goals apd organizational
performance measures/indicators;
The organizational goals, as enunciated in the strategic management plan, include the following strategy: To establish cooperative working relationships with industries through a formal ATF
Program. The key elements of this strategy are to: 1) Strengthen
relationships by exploring new ways for ATF, industry members,
and others to work together to ensure public safety as well as
the fair and accurate collection of revenue; 2) Use the latest
technology to exchange critical information with our customers;
and 3) Establish ATF as the primary point of contact for jurisdictional industry issues relating to alcohol, tobacco, firearms
and explosives.
The performance contract for the highest level in ATF (SES heads
of directorates) will reflect specific goals related to the
strategic plan (deadline 6/30/95). Specific organizational
performance measures/indicators will cascade down through succeeding levels with specific goals, tasks, and measures appropriate for each level (no specific targets have been set for this
phase).
-49-

Front-line employees' individual performance plans currently
include language directly reflecting ATF strategy noted above,
(i.e., M • • • Is effective in dealing with industry members, th~
public, co-workers, and other agencies. .Actively seeks to
create, improve and maintain relationships with co-workers,
industry members and other government agencies or officials that
facilitate an excellent atmosphere for intelligence gathering and
cooperation. Diplomacy and good judgment are exercised at all
times • • • M and M • • • provides accurate technical information
and advice • • • prepares and delivers presentati~ns to ATF
personnel and the public • • • • M (from critical elementsl
performance standards for Inspector, GS-18?4-11».
Office of the Comptroller of the CUrrency
Describe rationale used in identifying front-line regulator.:
The OCC identified as front-line regulators those commissioned
examiners who deal directly with banks since they have the
authority to prescribe remedies in an official capacity. Frontline regulators also include some corporate application examiners
and selective attorney positions that could deal directly ~ith
banks on corrective actions.
Number of performance measures based on process or punishment:
The OCC has approximately 1800 employee who are considered frontline regulators. However, currently none of the performance
plans for these employees focus on process or penalties. The OCC
performance program is structured around developing performance
objectives in support of the organization's priorities.
Describe the current performance appraisal cycle:
The performance appraisal cycle consists of four basic pieces:
developing organizational priorities; establishing additional
assignments or objectives to one's position description; determining the elements and standards to be rated against; and
evaluating the employee on a five point scale. The appraisal
cycle is on a twelve month basis from the date of the last
performance appraisal. The cycle is based on an employee'S
anniversary date which is dependent upon their appointment,
reassignment or promotion date.
Describe the strategy to evaluate internal personnel performapce
measures and eliminate those based on process or puniShment:
The OCC is continuing to work on establishing bureau level
performance measures. Once a clearly defined set ·of bureau
performance measures are approved, personnel performance measures
will follow. During the intervening period, planning will
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continue to incorporate organizational measures into the appraisal system. As stated earlier, the OCC does not have a process or
punishment type system in place.
pescribe bow your orqanization will sbift tbe empbasis from
punitive measures to overall results:
No shift will be necessary since OCC does not have a punishment
type system in place. The performance program is structured
around developing performance objectives in support of the
organization's priorities. The OCC is considering resultsoriented performance measures as part of the strategic planning
process. The proposed planning process is attached since regulatory reform is an integral part of their overall approach to
improving bank supervision.
Describe bow you intend to sbift resources from enforcemept
activities to partnersbip activities aimed at compliapce:
The OCC fulfills its mission through examining and supervising
national banks. Issues and recommendations from these examination activities are presented to the management of the institution for management to take action as they deem appropriate to
the issue. The focus is to resolve issues and ensure compliance
cooperatively. Enforcement actions are used when the institu- .
tion's safety and soundness is threatened or there is a violation
of law and when moral suasion has been unsuccessful.
During 1993, OCC's Southeastern District formed a Quality Improvement team that consisted of both OCC examiners and the
bankers they regulate. The team recommended that the frustrations of both bankers and examiners could be alleviated by
clarifying and communicating supervisory priorities and responsibilities, thereby eliminating many of the so-called "surprises"
in the supervisory process. As a direct result of this team's
work, OCC issued its first customer service standard in 1994,
Which makes clear both the type and frequency of communications
the bankers can expect from examiners. Beginning in July 1995,
OCC will begin attaching a survey to all examination reports to
assess how well the customer service standard is being met. This
is an example of how input from bankers is being used to assist
OCC in accomplishing its mission more effectively.
Describe bow you intend to recognize employees and reward employees for performance based OD achievinq results:
The primary vehicle for assessing an employee's performance
continues to be the annual performance appraisal. This system is
designed to be a "pay for performance" system. Once the bureau
wide performance measures have been agreed to, the next step is
to incorporate them into the performance appraisal. In addition,
a formal awards program currently exists which includes special
-51-

act awards, a Comptroller's award, spot awards, and special
achievement awards. These programs provide formal recognition
and awards to employees for performing acts over and above ~eir
normal job requirements.
Provide a timetable for putting Dew measures ip plaee;
This initiative will be rolled into the strategic planning
process. By design, they will incorporate the regulatory reform
initiative, streamlining, performance measures required for the
budget and CFO report, the customer service requirements, and
others into this overall framework. Attachments 1 , 2 provide a
timetable for these and related actions.
Internal Reyenue Service
Deseribe rational. used in identifying front-lip. regulators;
IRS designated those occupations in tax administration which by
their nature require regular, direct contact with taxpayers and
which are authorized routinely to make determinations regarding
individual and corporate tax ·liabilities. These occupations
include Revenue Agents, Tax Auditors, Revenue Officers, and Tax
Examiners in Automated Collection sites.

NUmber of performance measures based on process or punishment:
These occupations are covered by IRS' 1988 policy statement
forbidding the use of statistics in performance management (P-120, "Managing Statistics"). P-1-20 has precluded the development
of any measures which would tend to be punitive oriented.
(Attachment 1 contains P-1-20i Attachment 2 is an excerpt from
the IRS contract with the National Treasury Employees Union
(NTEU) which reiterates P-1-20.)
Deseribe the eurrent performance appraisal eycle:
These occupations are in the Bargaining Unit and the cycles have
been negotiated as part of IRS' contract with the NTEU. The
cycles are annual and based upon individual Social Security
Numbers.
pescribe the strateqy to evaluate internal personnel performapee
measures and eliminate those based on process or punishment;
Since January 1995, IRS has had a full time re-engineering effort
underway to completely reinvent the performance management
program, including objective setting, evaluations/appraisals and
rewards/recognition, for all employees. This effort, called the
Total Organizational Performance System (TOPS), is full time with
-52-

30 percent of the active team members selected by NTEU. TOPS
grew out of IRS' experience with a pilot of a previous, less
ambitious s~.,tem which was launched in October, 1993.
TOPS is using a reengineering methodoloqy which calls for design
of a new system based upon management and Union interests
and then the prototyping of various -releases" before IRS-wide
roll-out. In this case, several options will be designed for
possible approval and prototyping, evaluation and implementation.
Benchmarking, which was an early and critical step, has already
steered them away from any objectives or measures that were
process or punitive oriented. (Attachment 3 is the TOPS project
charter which contains the IRS strateqy on this effort.)
Describe how your organization will shift the emphasis from
pupitive measures to overall results;
As mentioned, due to P-1-20 IRS does not currently have punitive
oriented measures. Under the TOPS approach they will prototype a
variety of options from September 1995 through March 1996,
evaluate these results and finalize system options for IRS-wide
implementation in October 1996.
In the meantime, all executives, managers and management officials were assigned to more results-oriented objectives on
10/1/94. These measures are derived directly from the major
business objectives contained in IRS' Business Master Plan (BMP):
•

Increase Voluntary Compliance,

•

Maximize customer Satisfaction and Reduce Burden and

•

Achieve Quality-Driven Productivity Through Systems Improvement and Employee Development.

(Attachment 4 contains a set of these objectives and Attachment 5
contains the IRS BMP.)
Describe how you intend to shift resources from enforcement
activities to partnership activities aimed at compliance:
The TOPS team is exploring various monetary and non-monetary
awards to prototype. The current awards program has been jointly
sponsored by IRS and NTEU since July 1989; .it has been outlined
in the contract and implemented through local negotiations.
Because NTEU is a day-to-day participant in TOPS, IRS hopes to
jointly sponsor numerous education, internal communications,
marketing and culture change activities when they implement a
final performance management program. They cannot estimate the
resource need at this time because it will be driven by the
complexity of the new system, as well as the degree to which it
may divert from traditional, historical systems.
-53-

Describe bow you in~p-nd to recognize employees and reward employees for performance based on achieving results;
In 1989, IRS initiated its "Man~qer's Award" program which
greatly streamlined the award initiating/approval process. The
concept underlying this program is to allow managers to give
awards ($50 to $250) for an accomplishment above and beyond the
normal course of an employee's duties as soon as possible to the
time of the accomplishment. This Award proqram was implemented
in addition to L~e traditional Special Act and Annual Performance
recognition programs. Simila1ly, they are currently in discussions with NTEU for implementing the "Time Off in Lieu of Cash
Awards" programs which will reward accomplishments and result in
the same manner as the Manager's Awards.
Meanwhile, the TOPS effort is focusing on three major components
of performance management; one of which is recognition/awards,
which will focus on results. As noted earlier, various approaches will be prototyped before March 1996, then evaluated in time
for an IRS-wide syste~ to be implemented in October 1996.
Provide a timetable for putting pew measures in place:
Along with their strategy, the TOPS project charter also includes
a timetable with an ultimate IRS-wide implementation of October
1, 1996 (attachment 3). However, this timetable could be altered
siqnificantly should negotiations with NTEU become lengthy.
Office of Thrift Supervision
Describe rationale used in identifying front-line regulators:
OT5 identified all Examiners assigned to OT5 regions and their
immediate supervisors as front-line requlators. These are the
employees who interact daily with the thrift industry, which is
their primary customer.
Number of performance measures based on process or punishment:
OT5 established a task force of front-line requlators and other
regional personnel to evaluate existing performance standards.
This task force reviewed the generic elements and standards for
examiners and their supervisors and concluded that none are based
on process or punishment.
Describe the current perfOrmance appraisal cycle:
The OT5 performance cycle begins in January 1 and ends
December 31 each year for all employees.

-54-

pescribe the strategy to evaluate internal personnel performance
measures and eliminate those based on process or punishment;
stated above, OTS established a task force of :ront-line
requlators and other regional personnel to evaluate existing
performance standards. This task force met during April/May of
1995 and reviewed the currently established generic elements and
standards for "Supervisors" and the established generic elements
and standards for "Examiners, Attorneys, Technicians , Other
Specialists." As a result, they d~termined that no performance
measures need be eliminated.

pescribe how your organizatiop will shift the emphasis from
punitive measures to overall results:
While the task force determined that current performance standards for front-line regulators were not process-oriented and did
not contain punitive measurements, they also concluded that they
could be modified to include an evaluation of individual employee
contributions to the furtherance of OTS goals and the OTS customer service plan. In addition, the OTS performance management
program could be changed to emphasize goal setting for individual
employees and each front-line requlator co\~ld receive a discussion of results in the performance appraisa.l. These changes and
a strategy for communicating these changes are further described
in Attachment 1.
pescribe how you intend to recognize employees and reward employees for performance based on achievipg results;
The OTS Compensation Program is a merit pay system that directly
rewards employees based on results. Employees with the highest
ratings are rewarded with the highest increases. Additionally,
employees at the two highest levels of performance are eligible
for lump sum bonuses. They have amended the Incentive Awards
program to include the furtherance of OTS goals and/or the
customer service program as an award criteria. OTS is also
encouraging the public recognition of all award recipients.
Provide a timetable for putting pew measures ip place;.
In addition to reviewing existing generic elements and standards,
the OTS task force drafted revised performance plans that address
OTS goals and customer service requirements. (See Attachment 2).
The revised generic elements and standards must be reviewed by
all interested parties and, once approved, are scheduled for
implementation January 1, 199.6. A timetable for implementation
is provided at Attachment 3.

-55-

Describe the link between organizational goals and organizational
performance measures/indicators;

Attachment 4 is a matrix that depicts the link between organizational goals, organizational performance 'measures and the individual performance measures drafted by the task force.
In addition, Attachments 5 , 6 outline OTS' key management
objectives for 1995 and their customer Service Plan.

-56-

PART IV -

CREATING GRASSROOTS PARTNERSHIPS
INTERNAL REVENUE SERVICE

The concept of creating grassroots partnerships with the regulated community is not new at the IRS. The IRS' mission is to
collect the proper amount of tax at the lowest possible cost.
Because relying on enforcement resources alone can be costly and
inefficient, the IRS has adopted a fundamental strategy to
achieve its mission, called -Compliance 2000,· which focuses on
assisting individuals and businesses to meet their tax obligations voluntarily. Compliance 2000 also means working to understand industries and market segments in order to better focus IRS
enforcement resources on those individuals and organizations who
do not comply with the laws voluntarily.
The IRS' Compliance 2000 strategy requires that the IRS:
• Provide sufficient information, education, and assistance to
give taxpayers the knowledge necessary to fulfill their tax
obligations;
• Work closely with industry, professional, and C1V1C groups,
and other governmental agencies to encourage compliance and
improve the efficiency of tax administration;
• Continually adapt to the changing cultural and language needs
of the public; and
• Provide the best possible service by making IRS employees and
processes more accessible and responsive to the public.
To attain each of these goals, IRS employees must reach out to
the communities they regulate - communities made up of American
taxpayers. It is only through partnerships with those communities designed to achieve a common understanding of how the tax
system can work most effectively that any of these goals can be
reached; and because these goals are central to the IRS' fundamental strategy to accomplish its mission, IRS employees are
continually striving to forge these partnerships.
National Federal Advisory committees and Liaison Groups
At the national level', the IRS holds regular meetings with its
two federal advisory committees (the Commissioner's Advisory
Group and the Information Reporting Program Advisory Committee),
with the Federation of Tax Administrators, and with a wide array
of liaison groups representing tax practitioner and professional
associations such as the American Bar Association, the American
Institute of Certified Public Accountants, the Tax Executives
-57-

Institute, the National Association of Enrolled Agents, the
National Society of Tax Practitioners, the National Society of
Public Accountants, the American Payroll Association, and the
American Society of Payroll Managers. These meetings provide an
important exchange of views between the IRS and the regulated
community regarding all matters of federal tax administration.
Representatives at these meetings are strongly encouraged to
raise concerns and then to work with the IRS to offer solutions
to these concerns that take into account the combined interests
of the government and the regulated community.
Local Liaison Group Meetings
Most IRS district offices hold regular meetings with local tax
practitioners. The purpose of these meetings is to share information and to strengthen relationships within the local community. Some IRS districts have special councils or committees that
meet quarterly to share information about key current developments within the IRS.
Meetings are also held at the district level with the Tax Executives Institute, local bar associations, and local public accounting associations. The purpose of these meetings is to raise
and discuss issues of local concern. These groups generally
participate in the preparation of the agenda to ensure that the
topics chosen are of interest to the members.
COmmunity Outreach Tax Education
The IRS maintains a formal program for community outreach and tax
education. The program offers seminars and video presentations
to professional associations, community organizations, and other
groups of individuals seeking information on federal tax issues.
Topics include business tax issues, line-by-line help in preparing tax returns, recent tax law developments, and group self-help
training. Volunteer-staffed income tax assistance and tax
counseling for the elderly are widely available. This education
is provided free of charge at times and locations convenient to
taxpayers. Each local IRS district office has a Taxpayer Education Coordinator and a Public Affairs Officer charged with
ensuring that Community outreach Tax Education is readily available in their districts.
Regulatory Notice and Comment
The IRS makes every effort to partner with the regulated community as regulations are being developed. The IRS voluntarily
submits each tax regulation to a formal process to provide notice
and solicit public comment. The IRS initially issues each
regulation in proposed form, asks for written comments, and holds
one or more public hearings on the regulation upon request.
Comments received in this process are taken into account in
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revising and finalizing the regulation and an explanation of how
each significant comment was addressed is set forth in the
preamble to th~ final regulation. In addition, this formal
process is supp~emented by extensive informal commenting on
regulatory projects at meetings and seminars held by tax associations and practitioner groups.
' 1 'lza t 'lon
Market Segment Specla

IRS maintains a Market Segment Specialization Program for
conducting tax audits with tax examiners who have specialized
knowledge about particular market segments. The program requires
that the examiner gather information about a market segment,
share that information with taxpayers in that segment through
educational efforts, and work with representatives of the segment
to address non-compliance from both a tax administration and
taxpayer perspective.

The program also stresses the development and use of an "Audit
Technique Guide" for each market segment with input from industry
repres~ntatives.
These guides set forth prevalent compliance
issues, accounting procedures, audit techniques, and tax law
related ~o the particular segment. The IRS makes these guides
availabl& to taxpayers, practitioners, and other interested
stakeholaers upon request. Public release of the guides is
intended to provide awareness of concerns IRS has regarding noncompliance with specific market segments and the IRS' approach to
addressing those concerns.
Examiners in the program may also. initiate outreach educational
training seminars for specific market segments, explaining proper
filing procedures and federal tax responsibilities. Examiners
also frequently address practitioner organizations in meetings
related to their area of expertise.
Market Segment Understandings
The IRS maintains a Market Segment Understanding Program for
cooperatively resolving long-standing disagreements with specific
industries on administrative or technical issues. The program
involves partnering with the regulated community through the
establishment of a working group of representatives from the IRS
and a particular market segment. The working group strives to
develop a guideline document, or a pro forma accord, that provides clarification of the issue and that can be used by examiners, as well as by taxpayers and their representatives.
Other Partnering Efforts
The IRS also continually seeks out special purpose partnerships
with local regulated communities to enhance voluntary compliance
-59-

generally unaware of the assistance the IRS can provide to them.'
In addition, in March of 1994 the IRS established an Office of
Small Business Affairs in Washington to serve as th.' national IRS
contact with small businesses and to recommend chang~s to IRS
practices and regulations that cause undue burden on small
businesses. The IRS used the April meetings as an opportunity
for the director of that office to evaluate the needs of small
business owners in local communities.
Results from the April meetings were p.xcellent. Small business
participants expressed concerns about the complexity of the
regulations imposed upon them and offered numerous thoughtful
suggestions for improvement. Evaluation forms used to rate the
sessions indicated that the participants found the meetings to be
valuable and appreciated that the IRS representatives listened to
their comments and suggestions. A majority of participants
expressed a desire to continue this type of forum as an ideal
basis for establishing a partnership with the IRS. In the
evaluation forms, the statement "This should be a continuing
process" received the highest score.
Likewise, the IRS found the meetings and .the prospect of a
partnership with small business owners to be ~xtremely important.
Several of the most significant problems raised by the participants were problems that can best be addressed through a cooperative effort with the IRS. For example, many participants were
not aware of the services the IRS offers. Thus, the IRS identified a need to open new lines of communication with these taxpayers. In addition, participants complained of not getting the
right type. of guidance on how to comply with their tax obligations. The IRS concluded that its educational programs need
SUbstantial modification to better suit the needs of small
business owners. Lastly, the IRS determined that having an
exchange of ideas with small business owners on simplifying tax
forms and notices is essential to relieve burden and facilitate
compliance for the small business community.
The IRS is now evaluating the specific comments received in the
town meetings and is formulating an action plan for addressing
those comments. In addition, the IRS has made commitments at the
national level, as well as in the front-line offices where the
meetings were held, to continue the dialogue initiated in these
meetings. Moreover, the Commissioner has encouraged the
The IRS recently participated in a government-wide forum
addressing the impact of federal regulation on small businesses,
jointly sponsored by the Small Business Administration and the
Office of Information and Regulatory Affairs at the Office of
Management and Budget. The feedback received from that forum was
important to the decision .to address small business concerns in
the context of the April meetings.
9

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directors of ~ local IRS district offices to pursue partnerships with small businesses to identify and address small business concerns nationwide.
UNITED STATES CUSTOMS SERVICE

CUstoms worked closely with all of its customers to draft and
enact the CUstoms Modernization Act (Title VI of the North
American Free Trade Agreement Implementation Act) (Mod Act). The
Mod Act reinvented the way customs deals with the trade, and its
implementation requires revisions to virtually all of CUstoms
existing regulations. 'Since the passage of the Mod Act in 1993,
CUstoms has worked and is continuing to work in partnership with
its private sector customers to develop the necessary regulatory
proposals to implement the Act.
Since passage of the Mod Act, CUstoms has held 79 partnership
meetings with trade groups and industry representatives. Those
discussions totalled 590 hours and focused on issues such as
drawback, cargo reporting, etc. During these meetings, the trade
was told that this was their opportunity to tell us how best to
develop and design regulations to achieve the legislated goals
while accommodating their needs as well.
PARTNERSHXP MEETINGS
Four meetings were held in response to the President's call for
regulatory partnership and reform •
• Dallas, Texas

(April 5, 1995)

This was part of CUstoms' continuing series briefings and
seminars on Mod Act implementation held in conjunction with
major trade groups to seek input as Customs drafts the necessary regulations. A briefing by the Assistant Commissioner
(Office of Regulations and Rulings) and the Director of the
Mod Act Task Force was followed by several panels with trade
participants that focused on specific areas of the legislation
and the trade impact.
The meeting was hosted by the American Association of Exporters , Importers (AAEI) Southwest Chapter; the North Texas
Customs Brokers , Foreign Freight Forwarders Association; and
the Texas-Mexico Bar Association, Customs Law Committee.
Invitees included members of the various associations and the
general importing public.
Dallas was chosen by AAEI consistent with CUstoms policy of
trying to conduct these briefings in locales that will insure
reaching as many interested trade participants as possible.
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• Los Angeles, California (April.lO, 1995)
customs periodically holds general trade meetings conducted by
senior officials to update the public on our Mod Act progress.
As part of this policy, the Director of the Mod Act Task
Force, conducted briefing in conjunction with the Los Angeles
customs Region and District offices. The topics covered will
include the status of various regulatory initiatives and seeks
trade input on our proposals. Invitees included CUstoms
brokers and the general trade community.
• San Diego, California (April 11, 1995)
The Director of Mod Act Task Force participated on a panel
discussion on the Mod Act at a national convention of the Toy
Manufacturers of America. The panel discussion included a
session on the status of customs regulatory initiatives.
• Minneapolis, Minnesota (May 18, 1995)
The Assistant Commissioner (Office of Regulations and Rulings)
participated on a panel focusing on "Reasonable Care and
Informed Compliance Under the Mod Act.- Various trade representatives also participated in discussing relevant CUstoms
regulations. The meeting was hosted by the Minnesota Trade
Office and the Mid-West Importers Trade Association. Invitees
included their members and the general public.
BUREAU OF ALcOHOL, TOBACCO AND FIREARMS

Partnership Efforts
ATF has been reaching out to establish communications with the
regulated industries, trade associations and other interested
parties. The Bureau has strived to achieve communications with
industry and other parties that result in a two-way flow of
information and ideas. ATF's goals have also been to achieve a
consensus between the industry, government and other interests to
the maximum extent possible.
The Bureau's annual operating plans for front-line regulators
have called for establishing and enhancing its relationships with
industry members and associations. specifically, ATF has conducted hundreds of seminars with industry to discuss our regulations and policies in an open forum. In addition to the seminars, the plans for our front-line regulators have required them
to contact industry associations and build communication avenues
and establish successful working relationships. There also are

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many instances in which the Bureau representatives participate at
industry functions and activities. ATF participation in these
events benefits both industry and the government.
The Bureau has been, and continues to be, open to the comments,
concerns and suggestions of the regulated industry and other
interested parties. The policy of the Bureau has been to analyze
these ideas from the premise that if it achieves the same goal or
performs the same function, then approve it unless it is contrary
to the law. This policy is stated in the regulations for each
industry segment which ATF regulates and is carried through our
day-to-day operations at all levels. It has allowed industry the
flexibility to vary from the written rules' and to experiment with
new methods and operations.
The Bureau trains and encourages its field personnel and its
leadership to recognize and develop opportunities for open and
two-way communications with industry and the public. This is
important since our field personnel deal everyday and on a faceto-face basis with businesses and the public.
These communications often result in ideas and suggestions to
improve the Bureau's operations and regulation of industry
operations. The Bureau evaluates its field personnel on dealing
successfully with industry, the public and their issues and as
critical elements in their written performance evaluations.
The information that is gathered from both the seminars and other
less informal meetings is sent in daily reports everyday to
Bureau policy makers so that they can be informed and aware of
what is actually going on in the industry and how policy makers'
actions impact upon the daily operations of regulated industries.
The following sections illustrate ATF's recent efforts in creating grassroots partnerships with major industry segments that the
Bureau deals with.
ALCOHOL

• On March 30, 1995, ATF officials addressed a conference at
which representatives of businesses involved with importing
alcoholic beverages were present. The meeting included representatives of the National Association of Beverage Importers
and from other trade organizations, such as the Distilled
spirits Council, and the Beer Institute, importing companies,
foreign producers, industry attorneys, and trade pUblications •
• On April 22, 1995, ATF sponsored a meeting and met with members of a national alcoholic beverage group, Wholesale Spirits
and Wine Association, in Boston, Massachusetts. This trade
qroup includes national and regional spirits and wine industry
-64-

components involved in beverage alcohol production and distribution. Over 300 participants were involved in an open discussion of issl.~s. Though many topics involving industry
regulation were ~rought up, the main focus of the meeting
dealt with how ATF would apply the new trade practices rules.
• On April 23, 1995, 350 individuals involved with the emerging
microbrewery industry were present at a meeting with ATF in
Austin, Texas. This industry is growing rapidly throughout
the country. ATF is attempting to keep pace with this industry and preven~ inhibiting its growth by eliminating regulations which are irrelevant to the size and impact on the
market of most microbrewery operations. An open forum about
these l'9gulatory and legal issues was the main focus of this
meeting between ATF and industry personnel.
•

On May 15, 1995, a meeting was held between ATF officials
and representatives·from the two major wine producers associations in the united States, the Wine Institute and the
American vintners Association. These two associations
toge~er represent about 1,000 members in the wine industry.
(Ther~ are about 1,780 wineries in the United states today.)
Major ~opics included discussion on foreign imports of
variet~ls, ATF label approvals and policies, and health
claims in advertising and labelling of wine.

• During fiscal year 1994 ATF sponsored 28 seminars across the
nation for hundreds of individuals involved with the alcohol
industry. At these seminars front-line regulators, their
supervisors and other ATF personnel, such as ATF chemists and
technicians, meet with their counterparts in private industry.
These individuals represent companies which are large, medium
and small. Also, ATF invites other interests involved in the
alcohol industry, such as lawyers, trade associations and
media organizations to attend the seminars.
These 28 seminars focused on both revenue and beverage alcohol
product issues and regulations. ATF has found these face-toface and off-site meetings with companies provide a forum in a
neutral atmosphere for both industry and ATF personnel to deal
with significant issues and discuss ideas facing the industry
and government.
~OBACCO

Though no seminars were held with the tobacco industry, ATF has
an active program to visit with industry members and to ensure
that their questions and problems are addressed. Front-line
regulators spent over 800 hours dealing with these concerns
during fiscal year 1994.

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FIREARMS
• On October 27, 1994, ATF hosted tl:~ first-time meeting be~ween
the major representatives in the fi~earms manufacturing and
importing industry and ATF. About 40 individuals were at the
meeting to discuss current topics and issues affecting their
industry.
Specific topics of discussion included, assault
weapons, Federal firearms licensing provisions in regulations
and the law, and Crime Bill provisions, including Brady bill
sections and assaul~ weapons ban.
• During the week of January 16, 1995, ATF went to the largest
annual qun show in the nation, the Shot Show. This is the
largest show of its kind t~r companies involved in firearms
and ammunition manufacture, importation and dealing. Over
3,000 individuals involved in this industry attend. ATF
participated through setting up an area staffed with frontline regulators to handle questions and concerns from the
industry participants. ATF also conducted two seminars and
held a meeting with a specialized industry organization (collectors). The seminars addressed important current law and
regulatory changes concerning firearms such as the handgun
waiting provisions of Brady bill and assault weapons ban.
Addressing concerns with illegal dealing and public safety
concerns during qun shows, of which hundreds are-held throughout the United States each year, were the focus of a meeting
with the Collector and Arms Dealers Association during the
Shot Show.
• ATF conducted over 200 seminars during fiscal year 1994 to
address regulation in the firearms industry. These seminars
are held allover the United States and have been a major
factor in keeping front-line regulators in touch with the
concerns and needs of the firearms industry. The thousands of
participants who come to these seminars represent the entire
spectrum of industry including dealers, wholesalers, importers
and manufacturers.
In addition to the front-line regulators,
these seminars bring in other government components involved
with the firearms industry, such as ATF's legal counsel,
special agents involved with street crimes involving firearms,
and State and local law enforcement of~icials .
• ATF has requested firearms and ammunition manufacturers and
importers to review a draft of the tax return which they use.
The draft return was made to clarify the tax requirements and
decrease the burden on the industry. To meet these objectives, ATF published a notice on the draft return in the
Federal Register and sent out press releases to industry
publications and organizations. In addition, ATF also selected 75 taxpayers representing a cross section of all firearms
and ammunition excise taxpayers and sent letters to them
seeking their ideas on how to improve the draft.
This out-66-

reach to the industry starts the process of a partnership for
cooperation in administering this tax which ATF recently took
over frbm the Internal Revenue Service. To date, ~~F has
received positive comments trom seven individuals' fz~~ large
and small businesses •
• On April 24, 1995, ATF representatives met with a number of
international, Federal, State and local law enforcement agencies in Phoenix, Arizona. ATF's focus for this meeting was to
enhance its existing partnerships bet~een these various agencies and focus on the prevention of violent crimes through the
misuse of firearms and explosives.
EXPLOSrvES
• On April 11, 1995, ATF met with explosives industry members in
Atlanta, Georgia. More than 100 industry members attended
along with officials of other Federal and State agencies
involved with explosives regulation. The agencies represented
included the National Guard, u.S. Army, De~artment of Transportation, Occupational Safety and Health Administration, Mine
Safety and Health Administration, and state fire marshall and
law enforcement offices.
Topics brought up as a result of this meeting were the conflicting requirements between government agencies regulating
explosives commerce, sale, distribution and use. Industry
felt that regulating agencies need to get together to eliminate inconsistencies and provide one set of standards and
definitions. Input was also gathered from industry members on
a number of other issues, such as application procedures,
black powder, explosives exports and safety. The meeting
generated enthusiasm for additional discussions and cooperation.
• In addition, 28 explosives seminars were held throughout the
entire country with explosives permittees and licensees. The
seminars are conducted with ATF front-line regulators and
other interested Federal and state explosives regulators.
These seminars are an important base from which ATF builds a
working relationship and partnership with the industry and to
improve public safety involving explosives. During the seminars, ATF opens discussions to a number of topics during which
ideas on improving and reinventing regulations are brought up
and discussed.
• On May 19, 1995, ATF officials met with representatives of the
Institute of Makers of Explosives to discuss issues of mutual
concern in Colorado. The institute's representatives raised
the issue of taggants· in explosives materials as one of their
major concerns that needed further study.
-67-

Partnership Successes
• Streamlining Alcoholic Beverage FOrmulas. ATF established
a partnership with industry to expedite the handling of
formula approvals. ATF officials from its Alcohol and Tobacco
laboratory and regulatory formula processing section and
industry officials representing various components of the
alcohol beverage industry comprised the membership of this
partnership.
The results from this effort to streamline the process were
very satisfying. The approval time for formulas dropped from
an average of six weeks to 2 weeks, a 67 percent reduction.
This was done by communicating general information about the
entire approval process and the particular beverage formula
inVOlved. A computer program was developed that identifies
formulation problems while a product is under development.
The program specifies parameters for ingredients that are
allowable in an alcoholic beverage product. The user of the
program can therefore identify ingredients in formulating a
product that would be unacceptable to ATF. This saves the
industry member and ATF the time involved in the process of
resubmitting a formula that will definitely be rejected.
An industry organization (Distilled Spirits Council of the

United states) in partnership with ATF has agreed to copy the
program and make it available to all attendees at the ATF
symposium at the Institute of Food Technologies meeting July
1995.

Additional successful results are coming from this partnership.
For example, ATF and the industry representatives are
establishing an electronic bulletin board that could answer
questions from industry about the status of their formula
submissions .
• Publicizing Tax InfOrmation. ATF has worked out a partnership
with major industry associations and trade publications to get
out the word on special occupational tax. Special occupational tax is a once-a-year tax that applies to retail dealers of
alcoholic beverages and other members involved with alcoholic
beverage production and distribution.
The problem with this tax is with the businesses who retail
alcoholic beverages, such as bars, restaurants and retail
stores. There are more than a half million retail establishments owing this tax and a great turnover in the number of
businesses occurs every year.
In addition, retailers do not
need ATF permit approval to sell alcoholic beverages and
consequently are often unaware that there is any Federal tax

-68-

for this business Coupled with the fact that this tax is only
paid once during the middle of the year, it is difficult
getting' the word to all these businesses.
ATF has established a successful partnership with major industry associations, wholesalers and trade publications to help
to get the word out about special tax. A special effort is
put in place just before the tax comes due. Flyers or invoices from industry members to retailers are sent out and alert
retailers of their tax liability. Trade publications for
businesses involved with retailing alcoholic beverages (for
example, restaurants) receive ATF press release articles about
special occupational· tax and print them for their readers.
Partnership Plans
ATF plans to continue and enhance the existing partnerships it
has built. Also, ATF will establish new partnerships to address
specific concerns or needs. Specific plans for each industry
segment are outlined below.
ALCOHOL

• ATF will create partnerships with Federal, State and local
agencies and private domestic and foreign businesses and
organizations that establish ATF as the information center
about the alcohol beverage industry. This electronic information center will allow governments to share information and
resources and decrease the government and private industry
costs in securing and passing out information.
For private
businesses, it will decrease the number of places and stops
made to find information about the rules and regulations at
each level of government and consequently make it easier to
comply and decrease their costs significantly.
• ATF will conduct over 35 seminars for the alcohol industry
during fiscal year 1995. Most of these seminars will focus on
liberalized trade practice regulations. Additional improvements on these and other regulations affecting the industry
members will be solicited during these seminars.
• ATF plans to initiate industry participation in the revision
of existing forms. Specifically, during this year, ATF will
be revising a number of application forms that producers,
bottlers, importers, and wholesalers of alcoholic beverages
submit to get or retain a permit. ATF will be requesting
their ideas and comments to the application forms and consequently, the application process. In partnership with the
industry ATF believes that it will decrease the time it takes
to apply for a permit and the time it takes to get a permit.

-69-

TOBACCO

•

~uring

flscal year 1995 ATF has planned to spend .over 1,000
with industry members ana other agencies, including
state tax enforcement agencies, discussing areas of common
concern ana solutions to problems involving taxes. This will
enhance the existing partnerships that ATF has within the
tobacco industry ana state enforcement agencies.

~ours

FIREARMS
• ATF will continue to enhance ana improve relationships with
the firearms industry· through 110 seminars across the United
States.
EXPLOSIVES
• ATF will continue to pursue the initiatives to revise and
simplify intergovernmental rules and regulations that were
discussed during our initial meeting with industry and other
government agencies in Atlanta, Georgia, during April of this
year.
• In addition, ATF will meet with industry members at about 25
other locations throughout the country during this fiscal
year.
Partnership Recognition and Rewards
ATF plans.to reward the participation in partnership in three
primary ways. First, ATF will acknowledge and thank those who
contribute their times and ideas to all partnership efforts. A
simple "thank you" in response to a contribution by letter or
voice can always be done and is more valued at times than other
rewards. Secondly, ATF will issue formal awards through certificates of appreciation to industry members to highlight those
outstanding contributions in partnership efforts. Third, the
resulting success of the partnerships in decreasing burdens and
strengthening programs will benefit the entire industry and ATF.
These partnership successes by themselves probably are the most
important reward and recognition to its participants.
Publicizing Partnerships
As standard practice, all seminars are announced aheaa of time by
the ATF Public Affairs office or by the efforts of the local
district offices to interested industry members and media representatives. since traae publication personnel are often involved
at ATF industry meetings and seminars, ATF will continue to have
the benefit of these trade industry publicizing our partnership
meetings and successes.
-70-

As successes from partnerships are realized, regulations in many
cases will have to ~e changed. ATF always issues press releases
to highlight the reg •. latory reforms. ATF will make a special
effort to point out u.~se changes as the results of the partnership initiatives.
OFFICE OF THE COMPTROLLER OF THE CURRENCY
An important cOmpOnp.l~t of the OCC' s outreach efforts are regular
meetings with bankers, community groups and the news media.
In addition to meeting with bankers and community groups, the
Comptroller ~nd senior policy officials regularly speak at
conferences, meet with key editorial boards and reporters, and
speak with a wide range of financial policy makers and opinion
makers. These outreach efforts provide a forum for interested
parties to express their views on issues related to bank supervision and bank regulation. This in turn helps the agency to be
more respon~ive to the needs of banks, community groups and
others. For instance, over 95 percent of the bankers who participated in our "Meet the Comptroller" meetings 1994 reported that
they found then valuable.

In April 1994, OCC announced that it will begin to survey bankers
at the conclusion of each examination to solicit feedback on how
well the agency is doing its job. The survey will help OCC rate
and monitor the effectiveness of its communication with bankers,
the reasonableness of agency requests for data and information,
the quality of examiners' decision-making during the examination
process, the professionalism of OCC examiners, and the responsiveness of examiners to bankers' concerns throughout the examination process.
During April 1994, the Comptroller and senior OCC officials
participated in numerous outreach meetings. The following is a
brief description of nine events:
Banking community outreach
Washington, D.C.

• Colorado Bankers Association
Audience: Colorado bankers

On April 4, the Comptroller and senior OCC officials met with
Colorado bankers to review major regulatory and supervisory
issues and discuss pending legislative issues affecting the
banking industry.

-71-

• Bank Director Responsibilities
Audience: Bank directors

Kansas City, MO

On April 7, OCC Deputy Comptroller f~r·the Midwestern District
Robert Klinzing and other panelists discussed a wide array of
banking subjects, including the changes in capital requirements. Also on the panel were the FDIC regional director,
the Senior Vice President for Supervision at the Kansas City
Federal Reserve Bank, and the Missouri State Banking
commissioner.
Naples, FL

• Bankers Roundtable
-Audience: Bankers

On April 8, the Comptroller ~poke to the Bankers Roundtable to
urge bankers to maintain vigilance over their loan standards
as the economy slows and the business cycle matures. He urged
bankers to avoid temptations to stretch credit standards to
strengthen profits. The speech was widely reported in national and local news media.
• America's Community Bankers
Audience: Community bankers
and local leaders

Wilkes-Barre, PA

On April 13, the Comptroller discussed the OCC's major initiatives and solicited input from community bankers and local
leaders from northeast Pennsylvania. The Comptroller also
held a news conference with local news media to discuss Community Reinvestment Act reform.
Boston, MA

• Community Bankers
Audience: Community bankers

On April 20, OCC Deputy Comptroller for the Northeastern District Karen Wilson discussed OCC supervision, safety and
soundness and compliance issues with local community bankers.
Front-line examiners made brief presentations on current
issues. Bankers had an opportunity to ask questions and
present their concerns.
• Administration Institute Auditing
Derivatives Conference
Audience: Risk and derivatives experts
from national banks

New York, NY

On April 21, Senior Deputy Comptroller for Capital Markets,
Doug E. Harris discussed managing and monitoring risk at
national banks. Mr. Harris noted five areas in which the OCC
had identified some deficiencies in derivatives risk management by some banks: oversight by senior management and the
board, market risk management, valuation systems, liquidity
-72-

risk management, and netting systems. Mr. Harris also discussed OCC concerns with respect to interest rate risy as
articulated in Advisory Letter 95-1, "Interest Rate Ri~.!~"
(issued on 2/8/95).
The OCC will follow up with banks in future examinations to
determine whether the above mentioned deficiencies in risk
management have been addressed.
COmmunity outreach
• National Council of Urban and
Economic Development
Audience: Community development
organizations, local agencies,
bankers

Dallas, TX

On April 24, OCC Deputy Comptroller for Consumer and Fiduciary
Compliance Stephen Cross discussed Community Reinvestment Act
reform and other consumer compliance issues. gr. cross and
the participants discussed the approach of the revised CRA
regulation, which seeks to focus on performance rather than
process. Participants also asked questions regal ding how and
when the rule will be implemented •
Washington, D.C.
• Consumer and Bank customer Groups
Audience: ACORN, Center for Community
Change, Enterprise Foundation,
Local Initiatives Support Corporation,
National Peoples Action, Navajo Nation,
Organization for a New Equality
On May 5, the Comptroller and senior OCC officials reviewed
how the OCC plans to implement the final CRA rule. A number
of participants requested that the OCC and the other banking
agencies conduct working sessions with customer organizations
to hammer out details on distinct implementation matters.
Participants expressed an interest in having experts from
community organizations and community development organizations participate in examiner training.
International outreach
• The European Institute
Audience: European and American bankers
and policymakers

New York, NY

The Institute is a Washington-based organization dedicated to
strengthening U.S.-European ties and making progress towards a
united Europe. On April 28, the Comptroller spoke about two
issues in the context of the collapse of Barings Bank
compensation for derivative traders and deterioration risk.
-73-

His comments on trader compensation schemes that can set the
interests of the trader against the interests of the institution received a favorable reaction.
OFFICE OF THRIFT SUPERVISION

EXAMINATION OUTREACH PROGRAM (EOP)
OTS ia actively engaged in an effort to improve the quality of
its operations. A key component of this effort is the Examination outreach Program. OTS initially established this program in
Auqust 1993 as the Examination Oversight Program, charged with
the mission to improve the examination process and its final
product, the Report of Examination. During 1994, the program
evolved into an Examination outreach Program (EOP). In addition
to its oversight effort, the EOP uses its interviews with thrift
managers to improve OTS' relations with the industry and create
the basis for the Examination CUstomer Service Plan for the
agency. Going forward, the program will continue to focus on
improving service, achieving greater inter-regional consistency
in the examination product, and identifying opportunities for
requlatory reform.
In recent years, thrift executives have sometimes conveyed
frustration and uncertainty with the regulatory process. As the
industry's financial condition improved, OTS realized the importance of having the agency's regulatory policies reflect such
improvement. OTS also realized that frequent interaction with
thrift executives was critical to the continuous change and
improvement necessary for OTS to provide value-added services.
Under the EOP, senior regional staff meet with thrift managers
after completion of examinations to obtain feedback. The program
targets approximately 20 percent of all thrifts for field visits
on an annual basis. Since 1993, OTS has interviewed over 650
thrift executives under the EOP. In addition to gathering
feedback on the conduct of the most recent examination, OTS
invites comment on a wide range of industry and market issues,
and receive suggestions for reducing regulatory burden. These
interviews begin with a series of standard questions, but also
allow thrift managers to comment more freely about their concerns.
Additionally, OTS developed a questionnaire that is mailed to all
thrifts following the completion of an examination. The questionnaire allows every thrift an opportunity to provide OTS with
feedback with respect to its processes and standards.
The EOP has been extremely well received and very successful.
OTS has solicited specific comment from savings associations on
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regulations that should be eliminated or modified. For instance,
the results of the most recent EOP interviews indicate that
thrift management finds the constraints of the Qualified Thrift
Lender (QTL) test and the commercial lending limit burdensome.
These two issues are included in the legislative changes identified previously in this report.
PARTNERING MEETINGS
Input from thrift executives was obtained through a series of
town meetings held in cities throughout the country. In these
meetings, thrift executives were specifically asked for comment
on regulations they considered to be burdensome, duplicative, or
confusing. OTS received specific comment on several regulations
such as the Interest-Rate-Risk Rule, the desire for a simpler
conversion process for smaller associations, the aggregate
regulatory burden imposed by consumer regulations, the incongruity of the FIRREA and FDICIA capital standards, and the QTL Test.
The Directors of OTS Regional Offices
Meetings with executives of thrifts.
participated in Town Meetings in each
during 1993 and 1994. Most recently,
included:

frequently hold Town
The Acting Director of OTS
of the OTS five regions
Town Meeting efforts have

• On April 18, the OTS Acting Director hosted a Town Meeting
with ten thrift executives and OTS field staff in Philadelphia
• On April 19, the OTS Acting Director hosted a Town Meeting
with fifteen thrift executives and OTS field staff in
Baltimore
• Since April 20, the OTS Northeast Region has conducted 13
outreach meetings involving 120 institutions
• On May 9 and 11, the OTS West Region participated in two
conferences sponsored by the Western League of Savings Institutions
• On May 11, the OTS Acting Director met with thrift executives
representing the Virginia Bankers' Association
• On May 22, the OTS Acting Director met with thrift executives
representing the Massachusetts League of Community Bankers
• On May 25, the OTS Acting Director met with thrift executives
representing the Kansas-Nebraska-Oklahoma League of Savings
Institutions
• During June and July, the OTS Acting Director has tentatively
scheduled Town Meetings in Cincinnati, New Orleans and Miami.
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For the most part, the Town Meeting approach used by OTS consists
of srall gro~ps of thrift executives and OTS staff, i~fo~al
sett~,~s,'and little, if any, formal agenda.
OTS has~ound this
struct~~e to be most conducive to meaningful, candid exchanges;
this view is shared by most industry participants in the meetings. The thrift participants represent a cross-section of the
industry, including both large and small, state and federal
charters, and mutual and stock institutions. OTS has consciously
promoted this mix to ensure it has the benefit of hearing the
someti.mes differing views held by each sector of the industry.
Not surprisingly, the two topics dominating the recent meetings
have been the new Community Reinvestment Act Regulations, and the
looming BIF/SAIF premium differential issue. The meetings have
provided OTS representatives with the opportunity to share its
views on these matters, and to hear directly from the thrifts as
to the effect of both on their operations and business
strategies.
In the recent meetings, OTS has solicited specific industry
comments on regulatory and administrative burdens. OTS spent
considerable time discussing the laws and regulations that the
executives believe to be the most burdensome and least beneficial
to their institutions and customers.
A common theme at most of the Town Meetings has been the regulatory burden imposed by consumer protection regulations. Thrift
executives have commented on the abundance of such regulations,
citing the time and effort required to complete disclosures.
They opined that regulatory disclosure requirements outweigh
benefits to consumers. Many of the consumer protection regulations are required by statute, and industry representatives were
skeptical that OTS and the other regulators could actually
influence Congress to spend the time needed to evaluate both the
true cost of consumer laws, and whether the intended benefits of
the laws were being achieved. While neither OTS nor the industry
believe the laws should be rescinded in their entirety, many of
the suggestions deserve further study.
Many other suggestions for specific regulatory reform have been
offered in the areas of: mutual to stock conversions; audit
requirements; loan documentation requirements; interest rate risk
assessment; liquidity reserves; and application fees. The Acting
Director has requested staff to follow-up on many of the specific
recommendations and to consider whether OTS might be able to
address the issues without compromising its regulatory objectives. In some cases, OTS will need to coordinate its efforts
with other regulatory agencies.
In total, OTS has found the industry's insights as to regulations, policies, and practices that would benefit from a second
review by OTS and/or the other regulators to be helpful. Their
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views on these matters have been useful to OTS in its efforts to
improve both the way it does business, as well as the regulatory
environment in which ~ thrifts operate.
XEDXA COVERAGE
OTS has been successful in its efforts to publicize its commitment to prudently reduce regulatory burden. There have been a
number of recent trade publication articles, including:

• American Banker (Apr!l 20, 1995)
The article reports on "OTS Holding 'Town Meetings' on Reg
Relief", and notes that the recent meetings in Philadelphia
and Baltimore began the second series of town meetings held by
the Acting Director, following five prior meetings in the
cities where OTS has regional offices. The article goes on to
say "Jonathan Fiechter • • • is starting a new round of town
meetings this week to solicit advice on regulatory relief
• • • The ag~ncy is particularly interested in suggestions on
how it might ~eview, line by line, all its rules."

• American Banker (May 9, 1995)
John Downey, Director of Supervision, was interviewed on OTS'
CUstomer Service Plan for Examinations. The article's headline, "OTS Asking Thrifts: How Are We Doing?" captures the
essence of the article, which goes on to say "The Office of
Thrift Supervision is turning the world around. Oversight,
evaluation, and criticism in the world of thrift regulation
have traditionally moved in one direction-from regulators to
savings and loans. NOW, the OTS is shining the spotlight of
scrutiny on itself. As part of its periodic examinations of
thrifts, the agency now asks them to fill out a survey form
evaluating the examiners and the exam procedures."
• National Mortgage News (May 15, 1995)
Excerpts were provided from the Acting Director's recent
congressional testimony on regulatory relief. Under the
headline HOTS Wants Fewer Regulations", the testimony noted:
Reducing regulatory burden is one of OTS' highest priorities
• • • • The OTS is actively pursuing a program of regulatory
burden reduction. This program has three key objectives:
revising rules to achieve greater uniformity with the other
banking agencies; incorporating principles of differential
regulation into our rules; and streamlining our rules,
reporting and examination requirements.

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In addition, the American Bank~r again interviewed John Downey on
May 12. This time, the thrust of the interview was OTS' Examination Outreach Program.
FINANCIAL MANAGEMENT SERVICE

FMS regularly participates in industry groups to receive information pertinent to FMS programs. In March, 1995, FMS' Commissioner spoke on FMS programs and regulations ~t the National Automated Clearing House Association (NACHA) conference. This Association is a group of financial institutions and others working
together to design and direct electronic payments using the
Automated Clearing House eACH) sy~tem. FMS regulates financial
institutions that receive Government ACH payments.
FMS participates in many of the NACHA committees and work groups
and this relationship has produced program successes. For
example, FMS developed the Automated Enrollment Entry pilot
program with NACHA's help. This program has been used to enroll
over 750,000 recipients in Direct Deposit. FMS currently is
following up with the Automated Enrollment Rules Work Group to
make this pilot permanent.
FMS also is creating a work group to pilot a new Direct Deposit
initiative. This work group will be made up of representatives
from small to medium sized financial institutions. It is anticipated that this work group will discuss the role of financial
institutions in the pilot, formulate marketing plans, and create
performance measures. FMS has not made plans to reward partners.
BUREAU OF THE PUBUC DEBT

BPD has been very active in creating grassroots partnerships with
the entities it regulates, participants and investors in the
government securities market, and other regulatory agencies.
Meetings with Regulated Entities and other Regulators
BPD is responsible for Treasury's on-going regulation of the
government securities market by administering the rules issued
pursuant to the Government Securities Act of 1986, as amended.
In response to a Congressionally-mandated study of specialized
government securities brokers and dealers, BPD staff conducted
interviews with representatives of 17 such firms during the
period February 28 through April 5. This represents approximately 64 percent of the firms that are registered as specialized
government securities brokers and dealers (which includes affiliated broker-dealers).
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The focus of the interviews was to discuss the business, products
and customer base of the firms; the reasons why they originally
registered as specialized government securities brokerD~anc
dealers and whether those reasons are still valid today; ana, the
impact on the firms if they were required to convert their
registration status to a general securities broker-dealer business, subject to greater Securities and Exchange Commission
regulation. For the remaining specialized government securities
brokers and dealers that were not selected to be interviewed,
they were advised by letter of the study that Treasury is conducting and were given the opportunity to arrange a confer~nce
call or interview to express their views on the current regulatory structure.
BPD also met with staff of the National Association of Securities
Dealers (NASD) on March 31 to discuss the consequences of continuing the separate regulatory system for specialized government
securities brokers and dealers. The NASD is a self-regulatory
organization and is responsible for examining the brokers and
dealers for compliance with Treasury regulations. As a frontline regulator, the NASD has direct contact with the brokerdealers, so it is important that BPD maintains frequ~nt and open
lines of communication with them.
On April 7, BPD staff discussed sales practice rules for the
government securities market and large position reporting rules
at a conference sponsored by the Financial Markets Association.
The conference, which was held in Washington, D.C., and attended
by financial institution broker-dealers and bankers, provided
participants an opportunity to discuss market regulation issues
with a panel of regulators.
Partnership Success stories
• TRADES Regulations
BPD is planning to issue proposed new rules that will govern
book-entry (paperless) Treasury securities held by investors
in accounts with financial institutions and brokers and dealers (TRADES regulations). After BPD initiated an effort to
revise existing regulations on book-entry Treasury securities
several years ago, private sector efforts developed to revise
State law (the Uniform Commercial Code) on all types of securities held through intermediaries. BPD deferred its own
rulemaking and participated in drafting committee sessions to
revise Article 8 of the Uniform Commercial Code on Investment
Securities. Now that the new U.C.C. Article 8 has been approved by its sponsors, Treasury intends to make use of its
provisions for Treasury securities, so that to the extent
possible, all securities will be governed by the same rules.

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BPD is planning to issue proposed TRADES rules by the end of
the year, and intends to continue the practice of consultation
with private sector representatives, market participants and
federal agencies in the development of the regulations. BPD
staff will also be meeting with the American Bar Association
Task Force on Book-Entry Regulations in developing the TRADES
regulations. This group includes representatives of the
private bar and the academic community who have an interest in
the development of the law affecting interests in securities
beld primarily through financial intermediaries, such that th~
law reflects modern securities practices.
Given the fiscal agency role that the Federal Reserve Banks
play in the commercial book-entry system, BPD has also been
meeting with staff of the Federal Reserve Bank of New York.
Finally, in an effort to ensure uniform regulations for bookentry securities issued by other government agencies and
government-sponsored enterprises, BPD staff met with representatives of FNMA, GNMA, Freddie Mac, Sallie Mae, the Farm
credit Administration and the Farm Credit Funding Corporation.
These agencies currently have regulations that mirror the
book-entry rules for Treasury securities. The purpose of the
meeting was to inform the agencies of Treasury's intention to
revise its book-entry securities regulations and to open a
dialogue with the ultimate goal that they would aaopt the same"
rules for their securities offerings.
• Large position Reporting Regulations
The Government Securities Act Amendments of 1993 authorized
Treasury to write rules requiring specified persons holding,
maintaining or controlling large positions in certain Treasury
securities to keep records and file reports regarding such
positions.
.
Treasury has adopted a partnership approach in developing
large position reporting rules. Due to the complexity of
issues involved in developing large position reporting rules,
Treasury believed it was important to involve market participants at the earliest stage of the rulemaking process. Rather
than issuing proposed rules for comment, Treasury decided that
it would be beneficial to solicit advice, recommendations and
suggestions from the securities industry and other interested
participants on how large positions rules should be structured. Accordingly, an Advance Notice of Proposed Rulemaking
(ANPRM) for large position reporting was published in the
Federal Register on January 24, 1995. The ANPRM requests
responses to specific questions regarding various aspects of
the rule.

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The involvement of market participants in assisting Treasury
to write these rules will result in regulations that do not
impair the liquidity and efficiency of the Treasury securities
market but protect it from possible manipulation.- Treasury
staff met with representatives of the Public Securities Association and various broker-dealers on April 4, staff of the
Federal Reserve Board of Governors on April 18, and with a
member of Granite Capital International, a hedge fund, on May
3, to discuss their views on how this rule should be adopted.
Treasury has also contacted a number of organizations and
industry groups representing banks, institutional investors,
'pension funds and mutual funds to solicit their views and
suggestions regarding large position rules. The organizations
contacted include the American Bankers Association, the Investment Company Institute, the Council of Institutional
Investors, the Financial Executive Institute, and the Institutional Investor Institute.
• Sayinas Bond Offset Regulations
There is another rulemaking initiative, involving u.s. Savings
Bonds, that constitutes a partnership approach in soliciting
comments from affected entities. Regulations offering and
governing savings bonds are matters of public contract for
u.S. securities, and they represent an exercise of the borrowing power and fiscal authority of the Federal government •.
Therefore, the notice and public procedures requirements of
the Administrative Procedure Act are inapplicable. BPD is,
however, interested in, and sensitive to, the concerns of the
public, both individuals and organizations, affected by its
regulations.
For this reason, BPD plans to publish a notice of proposed
rulemaking that is intended to improve the procedures used to
collect amounts due from savings bond issuing and paying
agents. In order to inform the agent community of this action, solicit their views and reactions, and afford them the
opportunity to shape the content of the final rules, BPD will
issue these regulations in proposed, rather than final form.
Other Programs and Plans to Build Partnerships
As part of its on-going effort to improve customer service to
investors in Treasury securities, BPD regularly communicates with
its customers. It has instituted a customer service survey
program for TREASURY DIRECT customers and for purchasers of U. S.
Savings Bonds, in which its solicits their views every 3 years on
the level of satisfaction with BPD services.

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The initial TREASURY DIRECT customer survey was done in 1992 and
a follow-up survey will be conducted in the August-September time
frame. The first survey of u.s. Savings Bond purchasers will be
undert~~en this Fall; the survey questions are currently being
finalized. These surveys are crucial to understanding the needs
of BPD customers, determining whether the quality of its services
is satisfactory and identifying improvements that BPD may need to
make in customer service standards.
FINANCIAL

CRIMES ENFORCEMENT NElWORK

Until recently, the Bank Secrecy Act (BSA) was administered in an
adversarial manner. BSA strategy is now being refashioned to
treat financial institutions as allies and partners in government
enforcement efforts. The strategy calls on institutions to
identify the information that really indicates potential crime
-- and that should be reported to law enforcement -- and will
abandon mechanical and costly reporting of all transactions above
a certain threshold.
The success of this program rests on constant communication and
conSUltation with the financial sector. Sharpening the focus and
effectiveness of that communication has been a major objective of
FinCEN's Director during the last year.
The communication begins with the quarterly meetings of the Bank
Secrecy Act Advisory Group, chaired by Under Secretary (Enforcement); the Advisory Group is a 30 member panel of experts (drawn
from banks, broker-dealers, and non-bank financial institutions
and from government agencies that administer or oversee compliance with the BSA), who or the conduct of institutions subject to
the BSA who offer advice to Treasury on reducing regulatory
burden and increasing the utility of anti money laundering
programs.
FinCEN is working to institutionalize the paths to better communication that the Advisory Group creates. During April 1995,
FinCEN held five "Regulatory Partnership Meetings," in New
Orleans, Portland, Maine, Charlotte, North Carolina, Atlanta, and
Phoenix, respectively. The meetings were arranged with the help
of members of the financial sector in each area, and were attended by over 400 participants from more than 40 states. The agency
held a sixth regulatory partnership meeting as part of the annual
conference of the Independent Bankers Association in Washington,
D.C. FinCEN intends to hold quarterly meetings in the future to
continue building on the start to real partnership created by the
April meetings.

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FinCEN has also sought to recognize the contributions of private
sector officials to the success of its work. At its Annual
Honorary Awards Ceremony, FinCEN presented the Director's Medal
for Exceptional Service" \Q the Senior Federal Counsel of the
American Bankers' Association. The presentation emphasized the
awardee's essential role in creating the environment for regulatory cooperation by energizing the banking industry's efforts to
explain its views about the BSA to the Treasury and, in turn,
explaining Treasury's enforcement concerns to the industry.
In"another effort to fos~er increased interchange and understanding between government regulators and the financial sector,
FinCEN initiated a "FinCEN Senior Fellows Program" to bring
experts from pri,ate industry or academic disciplines to FinCEN
for short periods to supply the agency with expertise that it
could not otherwise obtain; the first Senior Fellow, an experienced bank security official, completed her fellowship earlier
this year.
FinCEN has also created an electronic "BSA Bulletin Board" for
regulatory announ~ements and materials. The bulletin board
contains millions of bytes of information in 120 separate files
covering virtually,ll aspects of the BSA. Access by modem is
free for anyone dialing the Detroit Computing Center of the
Internal Revenue Service. Over 1,500 different users have signed
onto the bulletin board over a two year period; queries are
running approximately 250-300 per month.
OFFICE OF FOREIGN AsSETS CONTROL

During April, OFAC's Compliance Programs Division staff travelled
to New York City to discuss financial sanctions compliance
matters with the American Express Bank and to Key Largo to
address the International Bank Operations Association.
OFAC also participated in a "Meet the Regulator Workshop" conducted as part of a week-long compliance seminar in April sponsored by the Financial Markets Association. Representatives of
more than 35 U.S. banks attended the workshop.
Also during April, the Director of OFAC and members of the OFAC
Enforcement staff travelled to Miami, Florida, to work out final
details of the new OFAC office in that city. The new office,
Which opened on May 8, will permit OFAC to provide information
regarding the CUban sanctions program to the extensive CUbanAmerican community located in and around Miami and to address, on
an expedited basis, sanctions compliance and enforcement issues
involving the CUban program, arguably the most complex program
that OFAC administers.
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PART V - CONSENSUAL

RULEM&~G

This part of the report highlights the Depal-tment' s March :3 0,
1995, Report to OMBls Administrator for Infor.wation and
Regulatory Affairs.
INTERNAL REVENUE SERVICE

The IRS currently has a well-established p10cess for soliciting
advice and assistance from those interested in a requlatory
project. The IRS issues regulations in proposed form, requests
written comments, and holds one or ~ore public hearings upon
request. The comments received in this process are taken into
account in revising and finalizing the regulatory project. The
IRS believes this notice and comment process, as supplemented by
extensive informal commenting at meetings and seminars held by
tax associations and practitioner groups, is working very well.
At all times where possible times, the IRS and the Office of Tax
Policy use informal ·consensual" rul~making by working with
taxpayers and practitioners prior to (~afting a proposed' regulation. This process often involves a public notice soliciting
views on how a regulation should be structured, and meetings may
be held with groups interested in providing input on the project.
At the end of the process, the IRS issues a proposed regulation
that is then subject to the normal notice and comment process
described above.
The following are examples of guidance projects underway that are
essentially consensual rulemaking projects:
• Entity Classification. In March, the IRS issued a public
notice soliciting input on possible changes to the current
rules for classifying entities for tax purposes. In part
because of the broad ramifications of the proposed changes,
the IRS has asked for comments from a wide range of small
business groups, bar associations, and other interested
stakeholders. Comments will be considered before any changes
to the current classification rules are proposed •
• Corporate Tax Issues. Three complex corporate tax issues are
among the IRS' 1995 guidance priorities: (i) the treatment of
corporate inversion transactions, (ii) whether certain transactions qualifying as corporate reorganizations under section
368 circumvent General utilities repeal, and (iii) the treatment of contingent liabilities in selected transactions. Due
to the complex nature of these issues, these projects are particularly well-suited for development with the early input and
cooperation of practitioner groups and other interested
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stakeholders. In the coming months, IRS representatives plan
to meet with various taxpayer representatives to discuss th~se
projects •
• Withholding on Foreiqn Payments. Last fall, IRS representatives met extensively with representatives from the financial
community to discuss potential changes to the rules and procedures governing withholding taxes on payments made to non-U.S.
persons. Due to the complexity of this issue and the significant impact changes will have on the operatious of major
financial institutions, the IRS sought the input of those
institutions prior to proposing a regulatory change. The IRS
is currently drafting the proposed regulation with the benefit
of the information acquired in this process.
The IRS has determined that a formal negotiated rulemaking
process would be difficult for most tax regulations. The provisions of the Internal Revenue Code, and thus the regulations
issued thereunder, have a direct impact on more Americans than
any other set of rules administered by the Federal government.
In addition, the interests of the population affected by tax
regulations are extremely diverse. Unlike many other agencies,
the IRS is not responsible for regulating any particular industry
or type of activity. Accordingly, it would be difficult to
identify a representative group to engage in a negotiated rulemaking process. Nevertheless, the IRS will continue to look for
.regulations that, because of their nature, are suitable for
formal negotiated rulemaking.
UNITED STATES CUSTOMS SERVICE

Implementation of the CUstoms Modernization and Informed
Compliance Act.
CUstoms worked closely with all of its customers to draft and
enact the CUstoms modernization provisions of the North American
Free Trade Agreement Implementation Act). The customs Modernization provisions of NAFTA reinvented the way customs deals with
the trade, and its implementation requires revisions to virtually
all of CUstoms existing regulations.
Since the passage of the these provisions in late 1993, CUstoms
has worked and is continuing to work in partnership with its
private sector customers to develop the necessary regulatory
proposals to implement the Act. CUstoms has held 79 partnership
meetings with trade groups and industry representatives. Those
discussions totalled almost 600 hours and focused on issues such
as drawback, cargo reporting, etc. During these meetings, the

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trade was told that this was their opportunity to tell us how
best to develop and design regulations to achieve the legislated
goals while accommodating their needs as well.
CUstoms' approach to this process was to solicit ideas from our
customers and develop concept papers describing how a given
regulatory process would work. After running the concepts by its
private sector partners, customs developed "strawman w proposals,
which were made available for comment through posting on the
CUstoms Electronic Bulletin Board. Once CUstoms received general
consensus about our proposals, it formally issued proposed rules
for comment in the Federal Register. Many ~egulations are now
close to final publication, others are still at the concept
stage.
Process Improyement Teams
CUstoms' Regulatory reform efforts go beyond the customs modernization provisions of NAFTA. Recognizing that regulations must
be reviewed in the context of its business processes, CUstoms
established Process Improvement Teams (PITs) to work with the
import-export community to review its operational frameworks and
related regulations. Many of the PITs have concluded their
meetings, others are just beginning.
Recent Rulemakings
Recent efforts to develop-rulemakings consensually with the
public include:
• Test Programs. CUstoms has published a final regulation that
will allow the Commissioner of CUstoms to test programs or
procedures aimed at more efficient and effective processing of
passengers, carriers and merchandise. Flexibility will be
ensured that procedures benefitting both CUstoms and the trade
could be explored. The public would then have an opportunity
to comment on the tests. A test of the "remote entry filing"
program, a major provision of the Mod Act, will begin in June
1995.

• Trade Compliance Redesign. CUstoms is redesigning all aspects
of its cargo importation process. Five national redesign
teams are traveling throughout the u.s. gathering information
on
needs. From December 1994 to March 1995 , CUstoms
. customer
.
1nterv1ewed 500 external customers.
• In-Bond Cargo Process. A task force was created to review
CUstoms' in-bond cargo tracking system. The group conducted
more than SO public forums and met with more than 1 000 members of the importing community to incorporate thei~ views in
the "strawman" proposals to reform the in-bond system.
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• Drawback Program. In the past year, CUstoms has held at least
32 meetings with the trade community to discuss new drawback
regulations and the new automated drawback system. As a
result of the meetings held across the country, customs was
able to consider their needs and concerns in developing the
regulations and in designing the automated systems •
• Automated Commercial Environment. On February 7-9, 1995,
customs held the first ACE Trade Support Network Conference to
discuss customs goals, businesses needs, and to target core
issues. Briefings were presented, and breakout groups prioritized and discussed the most. important issues.
BUREAU OF ALcOHOL, TOBACCO AND FIREARMS

Recent Bulemakings
ATF uses informal consensual rulemaking procedures to develop
most of its proposed regulations that are then issued for formal
public comment. These procedures were applied in the development
of two recent regulations •
• Trade Practices (Final rule published April 26, ~995). In
1990, two trade associations representing distillers and
importers approached ATF requesting amendments to the alcoholic beverage trade practice rules under the Federal Alcohol
Administration (FAA) Act. ATF requested that they coordinate
their efforts with representatives of wholesalers and retailers of alcoholic beverages. They did so and in 1992 filed a
petition which they all supported. Many of the ideas contained in that petition were adopted in ATF's notice of proposed rulemaking. Those which were not proposed were discussed in the preamble of the notice, along with ATF's reasons
for not adopting them in the proposal. Some of the ideas
initially sidelined by ATF were adopted in the final rule
after consideration of the comments on the proposed rule.
Another aspect of this project which encouraged SUbstantial
involvement by regulated industry was a 1992 decision by the
U.S. Court of Appeals, D.C. Circuit, in Fedway Associates,
Inc., et ale v. united states Treasury, Bureau of Alcohol,
Tobacco and Firearms. The Fedway court ruled that ATF erred in
its interpretation of the term "exclusion" in the trade practice sections of the FAA Act, and suggested that ATF use
rulemaking to arrive at an appropriate interpretation of the
term. Therefore, ATF's 1994 notice of proposed rulemaKing
included a discussion of exclusion as a threat to retailer
independence and gave examples of practices which ATF believed
could threaten retailer independence. Over 1,300 commenters
wrote to express an opinion on one or more of the trade
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practices discussed. Industry members also expressed their
support for ATF's continued involvement in trade practice
regula"~ '\.on and suggested many other changes in their formal
commentL" and in conferences and other meetings with ATF and
Treasury Department representatives. This valuable contribution on the part of the stakeholders made the final trade
practices rule a much better product •
• Wineqrape varietal Designations (Final rule in progress). In
response to the increasing emphasis on use of varietal grape
names in labeling and marketing wines, ATF decided to establish standards for use of such names. For assistance in this
effort, ATF invited individuals who represented various aspects of the industry -- wine producers, grape growers, educators, regulators and consumers -- to serve as a Wine grape
Varietal Names Advisory committee. After two years of study,
the Committee completed its work and its findings were published in the Federal Register, including a list of recommended names and a procedure for adding new grape variety names to
the list. ATF proposed to incorporate the listing in 27 CFR
Part 4, the wine labeling regulations. A large number of
comments either opposed the idea of establishing such a list
cr disputed inclusion or omission of specific items on the
list; other comments supported the idea, saying that it would
make wine labels less confusing for consumers. Many
commenters noted the committee had carefully researched the
issue of grape variety names. In 1992, ATF published a second
notice, discussing the response to the first notice and proposing a revised list based on information presented in the
comments and subsequent research. ATF received about sixty
comments in response to the second notice. These comments
contained SUbstantive discussion and evidence concerning
specific items in the proposed rule, and were useful in preparing the draft final rule.
• Brew-on-Premises Rules (Notice of proposed rulemaking in
progress). ATF is developing rules to address an emerging
area of the beer industry. Consumer interest in craft-brewed
beers and in home brewing has fostered the growth of a new
business, a "home-brew warehouse,· "U-brew," or "Brew-onpremises" business which provides equipment, supplies and
advice to prospective brewers in exchange for a fee. Following informal guidelines from ATF, most of these businesses
are structured so the individual client is always the responsible brewer and the owner of the beer. Such businesses do
not need to qualify as breweries, file reports or pay taxes,
since the individual clients are allowed to produce up to 200
gallons of tax-exempt beer each year for personal use. A few
businesses have opted to qualify as commercial breweries and
pay tax so that they can provide more hands-on assistance to
clients or even provide finished beer.
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ATF plans to solicit comments on a proposed rule based on our
current guidelines, which were developed in cooperation with
the industry. Because th~~ business is so new and the participants are very actively "J.~tworking," ATF is in frequent
contact with brew-on-premises proprietors discussing ideas for
inclusion in the guidelines and ultimately in the proposed
rule. An ATF representative attended a seminar on this subject held as part of the 1994 Microbrewers' Conference, met
people involved in the business, and had a very useful exchange of iceas. Anyone who has requested a copy of the
informal guidelines or co~~acted us with suggestions is on our
mailing list for a copy of the proposed rule when it is published. Although this has been a very informal process, we
believe it embodi~s the principles of consensus-based
rulemaking.
• Materials and Processes for Treatment of Wine (Notice of
proposed rulemaking published September 1994). ATF maintains
a list of materi~ls and processes authorized for treatment of
wine in 27 CFR Pa~t 24, along with a procedure for getting
permission to use ~aterials and processes which are not listed. Periodically, ATF publishes a notice of proposed
rulemaking to update the list and incorporate innovative
materials and processes which have been approved for use by
individuals on a trial basis and to delete any materials or
processes which we believe are no longer used. The individual
requests for approval are in letter form, often supplemented
by telephone discussions or informal meetings with the wine
producer and consultations with our laboratory. In the notice, ATF describes the process. or material, the circumstances
of the trial approval, any limitations imposed, any laboratory
findings, and any FDA rules on the same subject. ATF then
solicits industry comment on whether the use of the proposed
material or process is consistent with good commercial practice. The regulated industry itself has the final say on the
listing or de-listing of a material or process.
Future Rulemaking
ATF plans to use informal consensual rulemaking to develop the
following regulations:
• Labeling issues. ATF representatives recently met with a
group of small brewers and brewing industry representatives to
discuss beer labeling issues. The recent court decision on
alcohol content labeling was discussed, along with other
labeling issues of concern to craft brewers. One area which
may lend itself to rulemaking with substantial input from the
brewing industry is the use of class designations on beer.
CUrrent regulations do not offer many choices for designating
beer ("beer, ale, porter, stout"), and the renaissance in the
brewing industry has resulted in use of such terms as "bock"
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and "bitter" to describe different styles of beer. The brewers wish to expand the listing of names which may be used
without'adding the class designation "beer M ~o the label.
They also want to clarify in the regulations that the term
Mbeer" can also be applied to these products in a more generic
sense. ATF has not yet set up a schedule or format for this
project, but industry involvement is assured.
Another area ATF has identified as needing the combined attention of both the industry and the regulators is the labeling
of coolers and other flavored alcoholic bev3rages. Although
the end products are substantially alike, differences in the
type of base (wine, beer or spirits) lead to differences in
the treatment of the product for pUl~oses of production,
taxation, and labeling. The industry seeks permission to use
marketable labeling terms, and ATF's interest is to make the
labeling of the products informative to the consumer.
Finally, ATF is working with industry members, the u.s. Department of Agriculture and the National Organic standards
Board to establish rules for appropr~ate labeling of alcoholic
beverages made from organically grown raw materials •
• Activities at Gun Shows. ATF needs the assistance of firearms
dealers in establishing appropriate rules for requlating
activities at qun shows. ATF is finding that the current
rules may unnecessarily restrict and burden legitimate dealers
and promoters at these events, while not providing adequate
protection against "straw" or Moff paperw sales by others.
• Interstate Shipment of Alcoholic Beverages. The growth of
consumer interest in trying new products and the success of
"book of the month" and other mail and online direct marketing
services has led businesses to move into marketing alcoholic
beverages directly to consumers by similar means. Wine and
beer clubs are particularly popular.
Because alcohol is so heavily regulated, these businesses are
encountering many unforeseen problems at the state level. ATF
is directly involved in retail sales only for purposes of
special (occupational) tax collection and enforcing the minimal recordkeeping requirements imposed on retail dealers by
the Internal Revenue Code. However, State alcohol regulators
are seeking ATF support and assistance in enforcing their own
rules, including 3-tier marketing, tax collection, price
listing, brand registration, and customer age limitations.
The basis for their requests is the Webb-Kenyon Act, which was
passed by Congress in 1913 to remove Constitutional protection
of interstate commerce in alcohol if such commerce violated
State liquor laws. The reenactment of the Webb-Kenyon Act

-90-

(27 U.S.C. 122) gives ATF verY.limited authority to take
administrative action against holders of FAA Act basic permits
who violate State liquor laws.
Industry groups have various interests in this new area:
small producers welcome the expanded market available through
these clubs, and some producers even conduct their own direct
marketing efforts; many wholesalers welcome the States' intervention on behalf of the 3-tier system and other requirements.
states wish to protect their ability to regulate alcoholic
beverages within their own borders and prevent revenue lost
where there is no tax collection point in the transaction.
ATF is studying the situation and working to identify the role
it will play in resolving these problems.
OFFICE OF THE COMPTROLLER OF THE CURRENCY

The current regulatory focus of OCC is an intensive "A to Z"
review of all of its regulations. When completed, this project
-- which involves the revision of 29 CFR parts -- will have
simplified dozens of regulatory and paperwork requirements
applicable to both large and small financial institutions. To
date, action has been completed on seven parts, and six parts are
the subject of published notices of proposed rulemaking. Virtually all of these projects were developed after an aggressive
public outreach program by OCC. Similar efforts will be made for
each of the remaining 16 parts.
OCC plans ·to use informal consensual rulemaking to develop the
revisions to the remaining 16 separate CFR parts of its regulations, including its rules governing capital requirements and
prompt corrective action.
OFFICE OF THRIFr SUPERVISION

In mid-1993 OTS established an Examination outreach Program under
which senior OTS personnel visit and interview Chief Executive
Officers of savings associations following completion of an
on-site examination. OTS' objective in these meetings is to
identify ways in which it can improve its policies and procedures. Over 600 meetings have been held since the program was
initiated.
In addition, OTS regional directors frequently host town meetings
with thrift executives around the country. These sessions
provide the opportunity for OTS management to meet informally
with a dozen or so executives to discuss OTS initiatives and
industry suggestions as to the regulatory process.
-91-

securities, and financial institutions which serve as issuing and
paying agents, certain of whose employees act as certifying
officers.
BPD also administers the regulations under the Government Securities Act of 1986 (GSA), as amended, which are intended to preserve the integrity, liquidity and efficiency of the government
securities market and to insure investor protection. In the case
of the GSA regulations, the regulated entities are comprised of
government securities brokers and dealers and financial institutions. The GSA authorizes the Secretary of the Treasury to
prescribe rules governing financial responsibility, the protection of customer funds and securities, and recordkeeping and
reporting requirements for government securities brokers and
dealers, including financial institutions. These rules are
designed to prevent fraudulent and manipulative acts and practices, and to preserve the integrity, efficiency and liquidity of
the government securities market. In developing these regulations, the Department seeks to balance the benefits of regulation
with the compliance costs imposed on the government securities
market and its participants.
The GSA regulations establish a consistent regulatory approach
for all government securities brokers and dealers, including
securities firms and financial institutions, in a manner intended
to minimize the creation of any competitive advantages for any
class of firm. These regulations are developed after considering
the cumulative burdens of existing regulations applicable to
various broker/dealers, including financial institutions and are
designed to minimize duplication or overlap with existing regulations. To help meet this objective, the Treasury actively
consults with other regulatory organizations, including the
Securities and Exchange Commission (SEC) and the bank regulators
to better coordinate its activities in securities regulation.
Both the TRADES and large position reporting rulemakings are
being developed consensually through an informal partnership with
the private sector (see PART IV, above for a discussion of these
rules) •
FINANCIAL CRIMES ENFORCEMENT NETWORK

FinCEN has demonstrated a commitment to informal consensual
rulemaking, that is, to a good faith effort to formulate regulatory proposals based on consultation with those groups, whether
in the private sector or in other parts of the public sector,
that will be affected by the rules involved. The effort involves
several steps:

-93-

• Formulation of the goals of each regulatory project.
•

Communica~:ng

the goals through discussions with interested

groups.
• Soliciting comments, both formally and informally, on:
•

The issues raised by the goals in light of the overall
regulatory program of the agency and of other agencies or
gover~ental units.

•

Alternative approaches to accomplishing the stated goals.

•

The costs and benefits of each potential alternative to
accomplish the goals.

• Drafting proposed rules that reflect the points raised in the
pre-drafting discussions to the greatest extent
possible.
• Continuing of the process of consultation during the postnotice process.
FinCEN is conducting each of its regulatory projects in this way~
Those projects are derived from the various compliance mandates
in the Annunzio-Wylie Anti-Money Laundering Act of 1992 and the
Money Laundering Suppression Act of 1994 and involve such matters
as BSA compliance programs, reporting of suspicious transactions,
regulatory exemptions from currency transaction report filing,
and definition and registration of non-bank financial
institutions.
The coordinating venue for FinCEN's efforts is the Bank Secrecy
Act Advisory Group. FinCEN's April regulatory partnership
meetings were used to discuss publicly with industry representatives the issues that have to be resolved by the regulations.
FinCEN intends to continue the consensus building process during
the formal comment period for each of its notices of proposed
rulemaking. It plans in several cases to request comments on
specific issues that are not resolved during pre-notice discussions, and to allow for an extended notice period if necessary to
make the opportunity for additional comment meaningful.
Finally, FinCEN is planning to hold a series of public hearings
later this year, at locations in various parts of the country, to
permit its package of proposed regulations to be discussed as a
unified set of ·compliance partnership" proposals. Because the
goals of the projects are necessarily linked, and their details
are often inter-dependent, FinCEN wants to give interested
parties a chance to comment on the package as a whole, and to
engage in a dialogue with commenters that only a face-to-face
forum can effectively provide.
-94-

PART V-

WAIVER OF REGULATORY FINESIPENALTIES FOR
FIRST TIME SMALL BUSINESS VIOLATORS;
eUITING THE <.EQUENCY OF REPORTS
REQUIRED BY THE PUBUC

r. .

OFFICE OF THE COMPTROLLER OF THE CURRENCY

AUTHORITY TO WAXVE PENALTIES
The OCC seldom assesses. penalties against institutions and is
even less likely to do so in situations where the institution has
promptly corrected the violation and made a good faith effort to
comply with the law. The OCC also rarely, if ever, assesses the
maximum penalty allowed by law.
The OCC's Civil Money Penalty Policy provides that the purposes
of a civil money penaJty (CMP) are to serve as a deterrent to
future violations of l~w and to encourage correction of existing
violations. The OCC us~s its CMP authority as it deems appropriate to achieve these obj~ctives. This action may be independent
or used in conjunction w~th other supervisory or enforcement
procedures.
In certain cases, the OCC issues a reprimand in lieu of a CMP. A
reprimand is a strongly worded document that is used in cases
that a warrant a CMP but where the agency chooses not to pursue
the action. For example, the Policy provides that the OCC may
issue a reprimand in cases where a violation has occurred, but
the institution has recognized the supervisory problem and taken
steps to correct it.
The OCC's CMP matrix is a tool that indicates the relative degree
of severity of violations. The matrix provides guidance in
determining whether to assess a CMP and, if so, the appropriate
amount of the CMP. The 13 assessment factors recommended in the
Federal Financial Institutions Examination Council's policy
statement on CMPs are incorporated into the matrix and provide
the basis for recommended actions or CMPs. However, the matrix
is offered only as guidance; it does not reduce the CMP process
to a mathematical equation and is not a substitute for sound
supervisory judgment.
The OCC's CMP Policy and matrix fully comply with the requirements of the White House Memorandum. The matrix takes into
account the circumstances identified in the White House Memorandum where CMPs should be waived in whole or in part. Among the
factors included in the.matrix are intent, duration of the
violation prior to notification, and continuation of the violation after notification. In addition, good faith and full
-95-

cooperation are built into the matrix as mitigating factors.
Thus, it is highly unlikely that the OCC would assess a CMP
against a bank under the circumstances described in the White
House Memorandum.
REDUCING THE FREQUENCY OF REPORTS
To comply with the President's directive, OCC has reviewed all of
its existing reporting requirements to determine the extent to
which OCC can minimize their frequency without undermining bank
safety and soundness, or otherwise impeding the ~ffective administration of OCC's program. Based on this review, OCC has
initiated a process to reduce the reporting frequency of the
following five reports:
• Monthly Consolidated Foreign CUrrency Report -- This report
provides, on a consolidated basis, monthly data on gross
assets, gross liabilities, and positions in foreign currencies
of banks in the United states. At present, national banks
must submit this report monthly. The OCC has proposed eliminating the requirement as it concerns ~~e OCC •
• Special Report on Fiduciary Activities -- The OCC has suspended the requirement that national banks file the Fiduciary
Activities Special Report. It formerly was required on an
annual basis.
• Foreign Branch Report of Condition -- This interagency report
must be filed annually by all foreign branches of U.S. banks.
Significant branches (i.e., with assets over $2 billion) must
file the report on a quarterly basis. The OCC is considering
eliminating the quarterly reporting requirement •
• Minimum security Devices and Record of Review
Procedures -- At present, national banks must
effectiveness of their security program on an
The OCC is considering reducing the frequency
to once every two years •

of Plan
report on the
annual basis.
of this report

• Community pevelopment Information Collection -- At present,
OCC can request national banks to submit this information on
an annual basis. The information is primarily a questionnaire
to gather survey data. The OCC is considering reducing the
frequency of the report to once every three years, if needed.
The OCC has other reporting requirements that are exempt from the
President's memorandum because their frequency is mandated by
law. In this regard, OCC's most significant reports, the Quarterly Reports of Condition and Income (the "Call Report"), are
statutorily required to'be filed by banks four times a year.
Banks are also required by statute to submit a variety of Securities Act Disclosures and Country Exposure Reports.
-96-

Other OCC reporting requirements are not suitable for reductions
in frequency because they are necessary to preserve bank safety
and soundness, or other critical OCC objectives, such as enhancing consumer protection and ensuring equal access to credit. For
example, the annual Financial Disclosure Statement requires banks
to make public certain financial information. The OCC has made
an effort to reduce the burden on banks by limiting the required
disclosure to data compiled for the Call Reports, and not requiring banks to compile new data for this report.
Similarly, OCC recently revised its Community Reinvestment Act
(CRA) reporting requirements. The interagency CRA reporting
requirements were issued subsequent to the President's memorandum
of April 21 and designed to meet the objectives of that me~oran
dum. Further, the reduction in the frequency of CRA report~
would impede the effective administration of OCC's program.
Finally, the OCC requires an annual Disclosure of Fund Finances
from banks that exercise trust powers. ~pe disclosure is_required to protect the interests of trust services customer~.
OFFICE OF THRIFT SUPERVISION

AUTHORITY TO WAIVE PENALTIES
OTS currently has in place a flexible policy to determine civil
money penalties. Several factors are taken into consideration by
OTS in deciding whether a civil money penalty should be imposed,
and if so, in what amount. It states that civil money penalties
and other enforcement actions would not normally be employed when
addressing occasional and inadvertent regulatory violations or
record-keeping errors, provided the errors or violations do not
pose a threat to the safety and soundness of an institution or
undermine the integrity of its books and records.
The policy does state that civil money penalties should be
imposed for significant regulatory violations and practices that
remain substantially uncorrected after management or the board of
directors of an institution has been placed on notice •. The
policy also outlines potential aggravating and mitigating factors
that are taken into account when determining the amount of the
civil money penalty.
REDUCING THE FREQUENCY OF REPORTS
Elimination of the Monthly Thrift Financial Report
In 1993 OTS eliminated the monthly data collection for the Thrift
Financial Report (TFR). This reduced regulatory burden hours by
-97-

546,320. It is estimated that the elimination of the monthly TFR
saved the industry in excess of $4,000,000 and significantly
reduced OTS expenses.
Reduction of Information Collected Through the Ouarterly Thrift
Financial Report
The major reporting requirement imposed on the thrift industry by
O'I'S is the quarterly TFR. The information submitted on the TFR
is verified during examinations and used between on-site examinations to identify weaknesses or deficiencies in associations and
to monitor the activities of the association.
For safety and soundness reasons (i.e., early detection of
developing problems) OTS believes it is inappropriate to extend
the frequency of the TFR. It is focusing instead on easing the
burden by reducing the amount of information collected quarterly
by approximately 40 percent. This would reduce by 325 (out of a
total of 818) the line items required to be filed by associations.
Recommendations currently being considered that would enable OTS
to reach this goal include converting to a fully consolidated
reporting format, eliminating items where aggregate thrift
industry investment is minimal, and combining several separate
items. Another recommendation is to reduce the frequency of the
information collected on service corporations from quarterly to
annually. This effort furthers the OTS goal to bring the regulation of savings associations into greater confor.mity with the
policies and procedures of the other banking agencies.
OTS plans to ask for public comment on this information collection reduction and on the issue of whether OTS should adopt the
bank call report used by the other banking agencies.
Holding Company Report
OTS is pursuing another regulatory reduction initiative related
to the annual Holding Company Report (H-(b)11). OTS is scrutinizing usage of this report, currently used for off-site monitoring. In many cases, public companies may be able to SUbstitute
securities and Exchange Act filings as the information is similar. If it is determined that it is necessary to continue to
require the report (substitutions may be possible as noted
above), the amount of information requested will be reduced to
the minimum necessary. OTS anticipates this project will be
completed by December, 1995.
other Initiatives
Some of the other initiatives that OTS has taken, or has underway, to reduce regulatory reporting burden are listed below:
-98-

• Many filings to the OTS are corporate applications based on
statutory requirements and are triggered when an association
wishes to engage in new activities. While it is not possible
for OTS to reduce the frequency of these filings, the four
federal banking agencies are working to produce common forms
that request only the necessary information for common statutory requirements.
• In January 1994, regulatory burden hours were reduced by 573
when savings associations began submitting annual branch
survey data electronically.
• -In June, 1994, regulatory burden hours were reduced by 74,080
when the appraisal threshold was raised to $250,000 from
$100,000 pursuant to a final rulemaking on appraisals.
• In November, 1994, OTS eliminated the mandatory annual audit
requirement for savings associations with less than $500
million in assets and composite CAMEL ratings of 1 or 2. This
action reduces regulatory burden and also promotes comparability and consistency among the federal banking agencies.
• In December, 1994, the OTS issued a legal opinion that concluded that affiliated federal savings associations must no
longer file a branch application to enter into inter-affiliate
banking arrangements.
• In January, 1995, the Director of OTS waived the requirement
for savings associations to publish an annual statement of
condition in a newspaper of general circulation. This action
was taken in response to a provision in the Riegle Community
Development and Regulatory Improvement Act of 1994 that repealed a statutory provision requiring banks to publish their
statements of condition in newspapers. The OTS acted under
its general authority to waive regulations when good cause
exists.
FINANCIAL MANAGEMENT SERVICE

FMS has formulated a plan for discretionary waiver of penalties
for small financial institutions on late payment of reclaimed
amounts. A reclamation is a demand by FMS to a financial institution for refund of the amount of a check payment. It is issued
when Treasury checks are improperly negotiated. FMS will announce this plan by including a descriptive letter to financial
institutions with the monthly billing statements. waiver applications will be reviewed to ensure that the applicant financial
institution has a valid reason for waiver, and that no waiver has
been granted to the financial institution previously.
-99-

FMS regulations require one regularly submitted report from the
public: surety bond companies are required to report the location
of their proces~ agents to FMS annually. This requirement is no
longer adhered t~, nor is it necessary, and FMS plans to eliminate it as part o~ the regulatory initiative.
BUREAU OF THE PUBUC DEBT
&~ORITY

TO WAIVE PENALTIES

The Presidential directive to modify or waive the imposition of
penalties on small businesses for certain rule violations is not
applicanle to BPO's regulatory programs. BPO regulatory responsibilities do not include supervisory or enforcement powers to
levy fines or penalties such as those contemplated by this
directive.
REDOCIWG THE FREQUENCY OF REPORTS

In reviewing its
regular reports,
Act regul:ltions,
the frequp.ncy of

regulations, BPD has identified the following
required pursuant to the Government Securities
that would be covered by the directive to reduce
reports.

Unaudited monthly and quarterly, and audited annual, financial and operational reports.

Semi-annual unaudited and annual audited statements of
financial condition (i.e., a balance sheet and a statement
concerning capital adequacy).

annual statement indicating the engagement of an independent public accountant to conduct and annual audit and, if
applicable, the termination of the engagement and replacement of auditors.

Risk Assessment reporting requirements.

All of these reports must be filed by specialized gove'rnment
securities brokers and dealers with the Securities and Exchange
Commission (SEC).
BPO intends to request an exemption with respect to each of the
four types of reports mentioned above from the reduced reporting
requirement. A reduction in the frequency of the reports required under the GSA regulations would "impede the ,effective
administration" of Treasury's government securities market
regulation program because these reports are fundamental to the
financial responsibility and customer protection objectives of
the GSA. The financial and operational reports, the statements
-100-

of financial condition and the report on the audit engagement are
used by the SEC, and i~ some cases the self-regulatory organizations (SRO), to determ~ne broker~dealer compliance with
Treasury'S capital adequacy requi: ements, to monitor the size and
risk of securities positions held Ly the firms, and to ensure the
adequacy and reliability of broker-dealer accounting systems and
internal controls. The information provided in these reports is
the only periodic source of detailed financial information and
any delay in obtaining it would greatly complicate the ongoing
oversight of these firms.
The risk assessment reports are needed to help identify risks to
broker-dealers and the. securities markets from certain business
activities conducted by affiliates within a holding company
structure. This informatIon will also enable the SEC to
strengthen its regulatory oversight responsibilities.
In addition, less frequent submission of these reports would
result in inconsistent regulatory treatment of registered government securities brokers and dealers. This is because the reports
mandated under the GSA are virtually identical to those required
by SEC rules applicable to registered brokers and dealers, but
the President's memorandum does not apply to independent agencies
like the SEC. Further, eve.l if Treasury were to relax the
frequency of reports, the N~tional Association of Securities
Dealers, acting in its capacity as an SRO, could still require
the reports to be filed pursuant to their current, more frequent
time frames.
OTHER TREASURY OFFICES AND BUREAUS

Because IRS, ATF, CUstoms, FinCEN and OFAC programs and regulations relate to law enforcement, foreign affairs, the importation
or exportation of prohibited or restricted items, or the collection of taxes, duties or other revenue, they are exempt from the
provisions of the President's memorandum of April 21, 1995.

-101-

Department of the Treasury
Financial Crimes Enforcement Networlt; B1-: / " '( r, 0 r· •

DmJ

~~'

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031(J

.~.

2070 Chain Bridge Road, Suite 200,yienna,.vATl?2'AA:.~~~6
.
1500 Pennsylvania Avenue, NW, Suite 3210, Treasury Annex, Washington DC 20220
FOR IMMEDIATE RELEASE
September 5, 1995

Joyce A. McDonald
FinCEN
(703) 905-3770

FINCEN ANNOUNCES SIMPLIFIED RULES
FOR REPORTING SUSPICIOUS ACTIVITY
The U.S. Department of the Treasury's Financial Crimes Enforcement Network (FinCEN)
today issued proposed rules to simplify the process requiring banks to report suspicious
transactions. The rules are issued under the authority of the Bank Secrecy Act (BSA), the core of
Treasury's anti-money laundering efforts. The financial regulatory agencies have also issued
notices under their authorities in order to establish a coordinated reporting system.
The proposed regulation is the centerpiece of Treasury's effort to change the focus of BSA
anti-money laundering measures from the mechanical reporting of millions of large currency
transactions to the judicious reporting of relatively fewer, but more significant, suspicious
transactions. The proposed regulation will create a single centralized system for the reporting of
suspicious transactions and information on known or suspected criminal violations involving
financial institutions.
"The new process is an outgrowth of a working group composed of financial regulators,
law enforcement and FinCEN personnel," said Stanley E. Morris, FinCEN's Director. "The end
result is a single, automated process and database which will not only reduce the regulatory
burden on the banking community, but also greatly increase the usefulness of information
provided to the government and industry."
Since the early 1980s, banks have been required to file reports to alert regulators and law
enforcement personnel of possible criminal activity affecting or conducted through those
institutions. The banks reported these activities by filing mUltiple copies of Criminal Referral
Fonns (CRFs) with their respective federal regulators and law enforcement agencies. Banks were
also encouraged to report suspicious transactions by marking a "suspicious" box on another form,
the Currency Transaction Report (CTR). This reporting amounted to more than 150,000 forms
filed by over 10,000 U.S. banks each year. Multiple filings imposed a considerable administrative
burden on banks -- and on law enforcement agencies, which struggled to correlate the mUltiple
filings and avoid overlap and confusion in their investigations.
more

RR-546

Under the proposed regulation. banks will be required to send only one fonn. the
Suspicious Activity Report (SAR). to a single government agency--FinCEN. Also, the SAR may
be filed in paper or magnetic fonnat. The information will be input into the database by the
Internal Revenue Service's Detroit Computing Center on behalf of FinCEN and the regulatory
agencies. FinCEN will coordinate the infonnation and make it available to law enforcement and
regulatory agencies.
The new suspicious transaction regulations relate to a number of other FinCEN regulatory
initiatives, including the development of "Know Your Customer" requirements, implementation of
the revised, shortened CTR and giving banks greater discretion in determining which businesses
they can exempt from filing CTRs.
"The new reporting procedures are the direct result of the government and the industry
working together in partnership to make an incredibly complex process sensible and simple,"
Morris said. "By placing our emphasis on working smarter, the financial, regulatory and law
enforcement communities will all benefit."
The final rules will be published with the Federal Register on Thursday, September 7. The
notice includes an opportunity for a 30-day comment period in order for the financial community
to express further its views on the proposed rules. FinCEN anticipates that the new suspicious
activity reporting system will go into effect on October 1, 1995. Even if the final rules are not in
place for all the affected agencies by October 1, the system will accept the SAR, and banks may
use the new form.
###

(Editors and reporters: please see two diagrams attached which describe the current and proposed
systems.)

Current Criminal Referral Reporting Process

uses

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Department of the Treasury • Bureau of the Public Debt • Washington, DC 20239
I'

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UU I 8 Lj 8

CONTACT: Office of Financing
202-219-3350

FOR IMMEDIATE RELEASE
September 6, 1995

RESULTS OF TREASURY'S AUCTION OF 8-DAY BILLS
Tenders for $5,000 million of 8-day bills to be issued
September 7, 1995 and to mature September 15, 1995 were
accepted today (CUSIP: 9127944P6).
RANGE OF ACCEPTED
COMPETITIVE BIDS:
Low
High
Average

Discount
Rate
5.61%
5.68%
5.65%

Investment
Rate
5.73%
5.77%
5.77%

Price
99.875
99.874
99.874

Tenders at the high discount rate were allotted 19%.
The investment rate is the equivalent coupon-issue yield.
TENDERS RECEIVED AND ACCEPTED (in thousands)
TOTALS

Received
$30,076,000

Accepted
$5,000,000

$30,076,000

$5,000,000

Type

Competitive
Noncompetitiv!=
TOTALS

$30,076,000

$5,000,000

In addition to the above, the following amounts were
received and accepted.
Federal Reserve
Foreign Official
Institutions

°
°

5.62 - 99.875, 5.64 - 99.875, 5.67 - 99.874

RR-S47

°
°

PUBLIC DEBT NEWS

Department of the Treasury •

Bureau of the Public Debt ;.' \ W'~'shingtoI)~,D9 20239
I'

) i ') I

L.,,~

FOR RELEASE AT 3:00 PM
September 7, 1995

: I .'

., '~~n~ct: °p~tM Hollenbach
(202) 219-3302

PUBLIC DEBT ANNOUNCES ACTIVITY FOR
SECURITIES IN THE STRIPS PROGRAM FOR AUGUST 1995

Treasury's Bureau of the Public Debt announced activity figures for the month of August 1995, of
securities within the Separate Trading of Registered Interest and Principal of Securities program
(STRIPS).
Dollar Amounts in Thousands
Principal Outstanding
(Eligible Securities)

$857,022,252

Held in Un stripped Form

$633,551,601

Held in Stripped Form

$223,470,651

Reconstituted in August

$11,125,460

The accompanying table gives a breakdown of STRIPS activity by individual loan description. The
balances in this table are subject to audit and subseqent revision. These monthly figures are
included in Table VI of the Monthly Statement of the Public Debt, entitled "Holdings of Treasury
Securities in Stripped Form."
Information about "Holdings of Treasury Securities in Stripped Form" is now available on the
Department of Commerce's Economic Bulletin Board (EBB). The EBB, which can be accessed
using personal computers, is an inexpensive service provided by the Department of Commerce.
For more information concerniIlg this service call 202-482-1986.

000

PA-192
(RR-548)

TABLE VI - HOLDINGS OF TREASURY SECURITIES IN STRIPPED FORM, i IGUST 31. 1995
(In thousands)
Principal Amount Outstanding
Loan DeSCription

9-1/2% Note 0-1995 ......
8-7/8°", Note A-1996 ...
7-3/8°", Note C-1996 ......
7-1/4°", Note 0-1996 ......
8-1/2% Note A-1997 ...
8-5/8°", Note 8-1997 ...
8-7/8°", Note C-1997 ......
8-1/8% Note A-1998 .....
9% Note 8-199S ..........
9-1/4% Note C-1998 ....
8-7/8% Note 0-1998 .....
8-7/8% Note A-1999 ......
9-1/8% Note B-1999 ......
S°A. Note C-1999 ...
7-7/S°;" Note 0-1999 .....
8-1/2% Note A-2000 ......
8-7/8% Note B-2000 ......
8-3/4% Note C-2OO0 ......
8-112% Note 0-2000 ......
7-3/4% Note A-2oo1.. ....
8°" Note 8-2001.. ........
7-7/8% Note C-2001 ......
7-1/2% Note 0-2001 ......
7-1/2% Note A-2002 .....
6-3/8% Note 8-2002 ......
6-1/4% Note A-2003 ......
5-3/4% Note 8-2003 ......
5-7/8% Note A-2004 ......
7-1/4% Note 6-2004 ......
7-114% Nole C-2004 ......
7-7/8% Note 0-2004 ......
7-1/2% Note A-200s ......
6-1/2% Note 6-2005 ......
6-1/2% Nole C-2005 ...
11-5/8% Bond 2004 .......
12% Bond 2005 ...........
10-3/4% Bond 2005 .......
9-3/8% Bond 2006 ........
11-3/4°", Bond 2009-14 ....
11-1/4% Bond 2015 .......
10-5/8% Bond 2015 .......
9-7/8% Bond 2015 ....
9-1/4% Bond 2016.......
7-1/4% Bond 2016 ........
7-1/2% Bond 2016 ........
8-3/4% Bond 2017 ........
8-7/8% Bond 2017 ........
9-1/8% Bond 2018 ........
9°A, Bond 2018 ............
8-7/8% 60nd 2019 ........
8-1/8% Bond 2019 ........
8-1/2% Bond 202O ........
8-3/4% Bond 2020 ........
8-314°", Bond 2020 ........
7-7/8% Bond 2021 ........
8-118% Bond 2021 ........
8-1/8% Bond 202; ........
8°A, Bond 2021
7-1/4% Bond 2022 ........
7-5/8% Sor.d 2022 ........
7-118°", Bond 202:: ........
6-114% Bond 202: ....
7-112% Bond 202.:: .......
7-5/8% Bond 202~ ........
6-7/8 cA, Bond 2025 ........

Total ...
==================~

Maturity Date

11/15/95 ......
02115/96 ......
05/15/96 ......
11/15/96 ......
05/15/97 ......
08115/97 ..
11115/97 ......
02115/98 ......
05/15/98 .....
08/15/98 ...
11/15/98 .... ..
02115/99 ......
OS/15/99 ......
08115/99 ..
11/15/99 ......
02115/00 ......
OS/15/00 ......
08/15/00 ...
11/15/00 .....
02115/01 ......
OS/15/01 ......
08115/01 ......
11/15/01.. ....
05/15/02 ......
08/15/02 ......
02115/03 ......
08115/03 ......
02115/04 ......
05115/04 ..
08115/04 ......
11/15/04 ......
02l15/OS ......
05/15/05 ......
08115/05 ..
11/15/04 ......
05/15/OS ......
08/15/OS ......
02115/06 ......
11/15/14 ......
02115/15 ......
08/15/15 ......
11/15/15 ......
02115/16 ......
OS/15/16 ......
11/15/16 ......
05/15/17 ......
08115/17 ......
05/15/18 ......
11/15/18 ......
02115/19 ......
08115/19 ......
02115/20 .. ,...
05115/20 ......
08115/20 ......
02115/21 ......
05/15121 ......
08/15/21 ......
11/15/21.. ....
08/15/22 ......
11/15/22 ......
02115/23 ......
08/15/23 ......
11/15/24 ......
02115/25 ......
08/15/25 ......

Portion Held in
Unstripped Form

Total

7,318,550
8,450,609
20,085,643
20,258,810
9,921,237
9,362,836
9,808,329
9,159,068
9,165,387
11,342,646
9,902,875
9,719,623
10,047,103
10,163,644
10,n3.960
10,673,033
10.496,230
11,080.646
11,519,682
11,312,802
12,398,083
12,339,185
24,226,102
11,714,397
23,859,015
23,562,691
28,011,028
12,955,On
14,440,372
13,346,467
14,373,760
13,834,754
14,739,504
15,002,605
8,301,806
4,260,758
9,269,713
4,755,916
6.005,584
12,667,799
7,149,916
6,899,859
7.266,854
18,823,551
18,864,448
18,194,169
14.016,858
8,708,639
9.032,870
19.250,798
20,213,832
10.228,868
10,158,883
21,418,606
11.113,373
11,958,888
12,163,482
32.798.394
10,352,790
10,699,626
18.374.361
22,909.044
11.469,662
11.725,170
12,601.982

..............
857.022.252
= = = = = = = ===============

Portion Held in
Stripped Form

3,290,950
6,521,009
16,988,043
17,358,810
8,7OS,237
7.521,236
6,982,729
7,878,428
6,833,187
8.538,646
7,OOS,275
7,886,023
6,695,103
7.9OS,294
7,370,760
8,243,033
5,915,430
6,599,846
7,492.482
8,974,402
9,447.908
9,849,585
22,090.262
10,751.597
22,nl.015
22,960,963
27,363,028
12,955,On
14,440,372
13,315,267
14,373,760
13,834,754
14,739,504
15,002.605
4,873,006
2,754,708
7.700.113
4,753.164
2,074.384
8,502.679
2,301.916
3.523.859
6,666,054
18,569,151
18,093,968
8,977,689
8,904,858
2,153,439
2,667,070
5,425,198
16.866,632
6,116,468
3,626,403
6,329.806
10.305,373
4.437,928
4.212,122
6.9n,294
7,123,190
2.827.626
13,892.761
22,451.028
8,404.542
10.835,570
12.601,982

I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I

633,551.601

::: =

II
II
II
II

4,027,600 I I
1.929,600 I I
3,097,600 I I
2,900,000 I I
1,216,000 II
1,841,600 I I
2,825,600 I I
1,280,640 I I
2,332,200 I I
2,804,000 I I
2,897,600 I I
1,833,600 I I
3,352,000 I I
2,258,350 II
3,403,200 II
2,430,000 I I
4,580,800 I I
4,480,800 I I
4,027,200 I I
2,338.400 I I
2.950.175 I
2.489,600 I
2,135,840 I
962,800 I
1.088,000 I
601,728 I
648.000 I
0 I
0 I
31,200 I
0 I
0 I
0 I
0 I
3,428,800 I
1,506,050 I
1.569.600 I
2,752 I
3,931.200 I I
4,165.120 I I
4,848.000 I I
3.376.000 I I
600,800 II
254.400 II
nO,480 II
9,216.480 II
5,112,000 II
6,555,200 I I
6,365,800 I I
13,825,600 I I
3,347,200 I I
4,112,400 II
6,532,480 I I
15,088.800 II
808,000 II
7,520.960 II
7,951.360 II
25,821,100 II
3,229,600 I I
7.872.000 I I
4,481.600 I I
458.016 II
3.065,120 II
889.600 II
011
223,470,651

Reconstituted
This Month "

40,000
65,600
200,000
36,000
0
366,400

36.800
33,600
85,600
49,600
30,400
124,800
11,200
37,175
0
0
0
117,920
58,000
333,600
29.600
28.800
153.040
103,600
744.000
171.936
16,800
0
0
0
0
0
0
0
249,600
199,100
68.800
0
184.800
468,480
195.200
304,000
141,600
0
214,960
827,680
379,200
315,200
262.200
3n.600

348,480
540,400
250.400
776,160
166,400
147,200
75,200
498,825
230,400
196,800
240,000
326,304
173,200
92,800

0
11,125,460

-===== ===-====-======

#1 Effective May 1, 1987, securities held in stripped form were eligible for reconstitution to their unstripped form.
Note: On the 4th workday of each month Table VI will be available after 3:00 p.m. eastem time on the Commerce Department's
Economic Bulletin Board (EBB). The telephone number for more information about EBB is (202) 482-1986, The balances
in this table are subject to audit and subsequent adjustments.

DEPART1VIENT

TREASURY

THE

TREASURY

NEWS

omCE OFPUBUCAFFAIRS -1500 PENNSYLVANIA AVENUE, N.W. - WASHINGTON, D.C. - 20220 - (202) 622-2960

FOR IMMEDIATE RELEASE
Text as Prepared for Delivery
September 7, 1995

STATEMENT OF JOHN W. MAGAW
DIRECTOR, BUREAU OF ALCOHOL, TOBACCO AND FIREARMS
BEFORE THE
SUBCOMMITTEE ON TERRORISM, TECHNOLOGY,
AND GOVERNMENT INFORMATION
OF THE SENATE COMMITTEE ON THE JUDICIARY

RR-549
Far press releases, speeches, public schedules and official biographies, call our 24-hour fax line at (202) 622-2040

STATEMENT OF JOHN W. MAGAW
DIRECTOR, BUREAU OF ALCOHOL, TOBACCO AND FIREARMS
BEFORE THE
SUBCOMMITTEE ON TERRORISM, TECHNOLOGY,
AND GOVERNMENT INFORMATION

OF THE SENATE COMMITTEE ON THE JUDICIARY
September 7, 1995

Chairman Spqcter and distinguished Subcommittee Members, I
am pleased to come before you today as the Director of the

Bureau of Alcohol, Tobacco and Firearms (ATF) representing
the outstanding women and men who comprise our Bureau to
discuss with you ATF's role in the Federal case against
Randall Weaver in Idaho.

Let me assure you that ATF shares

your desire to make known the facts of this case and to
ensure that Federal investigations are conducted in a fair
and lawful manner and with the utmost regard for the rights
of our citizens.

In light of the misunderstandings and

misrepresentations concerning ATF's role, L welcome the
opportunity to help set the record straight and candidly
answer all of your questions.

After reviewing the actions

of ATP special agents regarding Mr. Weaver, I am convinced
that our agents' conduct was lawful and proper in every
respect.

2
ATF's role in this matter was the investigation and
subsequent referral of Federal firear.ms charges to the
United States Attorney for prosecutorial consideration.

young boy is dead, his mother is dead, three young people
are without a mother.

A deputy

u.s. Marshal is dead,

Marshal Degan's family is without a husband and

fathe~.

Should any criminal case justify these consequences?
course not.
into play.
afte~

and

But it was Mr. Weaver's actions that set this
The investigation of Mr. Weaver was opened only

he offered to supply illegal firearms to our

informant.

He hadn't been offered money and wasn't evan the

target of any investigation until then.

He demonstrated his

knowledge that his offer to supply firearms was illegal by
suggesting he had a source for untraceable (off-book)
firearms, and by his use of code words such as Bchain

in taped telephone conversation.

saw~

He demonstrated bad motive

when he stated that he hoped the guns uere going to street

gangs.

He later stated that he had five more guns to sell.

This is the conduct by Mr. Weaver that led to gun charges
being filed against him.

Weaver's decision not to appear

for trial led to the next confrontation with Federal
autho:ities.

until M:. Weaver offered to sell illegal firear.ma to our
undercover infor.mer in Octobc= 1989, he was not the focus of

the ATP criminal investigation underway at that

t~e.

Rather, ATF was investigating, and had been investigating
since 1983, members of the Aryan Nation and members of
splinter groups called "Order In and "Order II" suspected of
numerous

cr~es,

cr~es.

In conducting these investigations, ATF was

including bombings and other violent

pursuing its highest order of business -- the investigation
of violent crimes involving the criminal misuse of firearms
and explosives.

During this time, ATF productively shared

information and worked in conjunction with other Federal,
Stat. and local law enforcement agencies.

Allow me to share

with you the nature and results of these investigations.

The "Order In investigation, which was conducted by the FBX,
with assistance provided by the Secret Service, ATF and
state and local agencies, led to the conviction of over 25
members of

~~~

organization.

Between March and October,

1986, members of the group known as 1I0rder I];" terrorized
the residents of Coeur d'Alene, Idaho with a series of 5
bombings and 2 attempted bombings.

In September, 1986,

these individuals bombed the Coeur d'Alene Federal Building,
a local business, and a restaurant parking lot.

A task

force comprised of ATF, FB];, :IRS, local police, and State

police was for.med to investigate these incidents.

A suspect

eventually confessed his involvement in the bombings and
implicated 2 associates.

In October 1986, based on information provided by the
suspect and other information corroborated by task force
investigators. search warrants were executed at the
residence of a chief of security for the Aryan Nation,
licensed Federal firear.ms dealer.

Investigators seized

materials for use in making bombs, counterfeit money, a
printing press, and 100 firearms not recorded in the
dealer's records.

The execution of a search warrant at

adjoining property turned up over $27,000 in counterfeit
bills.

The investigation also disclosed that several members of the

Aryan Nation group had conspired to rob banks and National
Guard ar.mories, commit murder, counterfeit money, and commit
more bombings to advance their white separatist cause.
Several convictions resulted.

In 1986, ATF began using an informer to gather information
regarding illegal activities of some members of the Aryan
Nation movement.

This informer provided information which

assisted in the investigation of some of the crimea I have

mentioned.

This was the same infor.mer to whom Mr. Weaver

sold illegal sawed-off shotguns in 1989.

Through their

contact at the Aryan Nation Congresses in 1986, 1987, and
1989, the infor.mer came to know Mr. Weaver.

At Mr. Weaver's trial, defense counsel belittled the sawedoff shotgun charge, however, these guns have been recognized
by the Congress since 1934 as weapons having no
purpose.

legit~te

They have no sporting or recreational utility, but

are highly lethal, concealable weapons designed only for use
in violent crime to maim, kill, or to intimidate.

While the

law imposes a tax on their transfer and requires their
registration through the filing of applications with the
Government, the possession and transfer of unregistered
sawed-off shotguns are serious
National Firearms Act by

cr~es

~risonment

punishable under the
for a maximum ter.m of

10 years.

Mr. Weaver was not entrapped.

At the trial of Mr. Weaver

the defense of entrapment was raised in relation to the gun
violations.

The court gave the jury an instruction on

entrapment.

This meant that the Government was required to

prove beyond a reasonable doubt that Mr. Weaver was not
entrapped.

do not know whather Mr. Weavar'. acquittal on

the gun charge was based on the jury's belief that the
Government had not sustained its burden of proof.

Entrapment occurs when a person is induced by the Government

to commit a crime that the person had no predisposition to
commdt.

He was not persuaded or coaxed by the Government to

sell illegal weapons.

The idea to supply the weapons

originated in Mr. Weaver's own mind.
infor.mer was engaged in the firearms

Learning that the
bus~ess,

Mr. Weaver

initiated the transaction by offering to supply the weapons
at a profit.

He offered to supply

a week in the future.

many as 5 such weapons

Mr. Weaver stated that he had a

supplier who would furnish

firearms ·off record.

Mr. Weaver asked for $450 for the two guns.

It is alao

significant that when Mr. Weaver offered to sell the guns,

he was not the target of any ATF investigation.
of the informer's meeting with Mr. Weaver at that

The purpose
t~e

was

to gain his assistance in introducing the informer to
another individual, not to buy guna.

In short, ATF did not entrap Mr. Weaver.

He was not induced

by the Government to commit the offense, but was predispos.d

to do so.

In fact, Mr. Weaver volunteered to violate the

law and his association with the infor.mer provided
opportunity.

the

7
The infor.mer in this case is exceptional because of a number
of attributes not always associated with infor.mers.
involved in civic affairs.
home.

He is a family man and

He is
OWDS

He holds a job and was not dependent upon the

Government for his livelihood.

He has no criminal record.

He had never been known to supply false information to the
Government.

In order to maintain an undercover role, an

infor.mer necessarily has to establish a false cover story.
These are the nlies· referred to by Mr. Weaver.

The

information the informer has furnished has been found to be
consistently reliable in the dozens of investigations he haa
worked on over the last ten years.

Questions have been raised about the manner in which the
infor.mer was compensated for his work on behalf of ATF.

has been suggested that he was to be paid a fee contingent
upon the content of his testimony agaiDst Mr. Weaver or upon

Mr. Weaver's conviction.

Let me assure you that it waa not

ATP's policy in this case, nor is it now, to require that an
award be contingent upon a conviction.

He was paid bis

expenses and a future reward was to b. based on valid
information supplied and his cooperation.
by the facts.
charge,

This is borne out

After Mr. Weaver'. acquittal of the gun

ATF paid the informer a reward of $5,000 for hi.

services which was not conr.ingent upon acoDviction.

At an

earlier

t~e,

the informer was paid a reward of $2,500 baaed

in part for information that an individual employed by a
private school was plotting to kidnap children from the
school.

As a result of this information,

the individual was

discharged from his job and the plot was frustrated.

Again,

this reward was paid to the infor.mer for services rendered
in the school case and in another unrelated case and was not
contingent on the outcome of either.

The testimony at

Mr. Weaver's trial on the matter of compensation was in
conflict because the informer erroneously indicated that his
reward would be based on a conviction.

He realized his

mistake as soon as it was made and expected the point to be
clarified later.

Unfortunately, it was not.

ATF's request of Mr. Weaver to become an ATP informer has
been questioned.

This offer occurred after ATF referred its

case to the nnited States Attorney
before the indictment.

fo~

prosecution but

It was made because the identity of

ATF's current informer had been compromised.

Mr. Weaver was

infor.med that his cooperation would be brought to the
attention of the United States Attorney.
declined.

Mr. Weaver

We see no reason to apologize for this

act~on.

Developing informers in this fashion 1. • cammon and
accepted law enforcament technique.

While aame may view the

acquisition and use of informers, or ".nitches,- to

9
apprehend violators of the law as Rdirty business,n these
are often necessary means to deal with the dirty business of
crime.

They are essential to gathering information from

small, closely knit, cell-like groups of individuals like
members of the Aryan Nation who operate in a clandestine
manner.

commend our ATF agents for the manner in which they

effected

t~e

arrest of Mr. Weaver on his indictment for

firearms violations.

Because he was known to be armed and

potentially dangerous, a ruse was develo:-ad to make a aafe
arrest away from his home and children.

The plan involved

stopping Mr. Weaver's vehicle by placing a "disabledvehicle on a bridge.

Although Mr. Weaver attempted to reach

for a gun in his pocket, as well as an agent's gun, he was
apprehended without violence.

would note as well that his

wife was prevented from returning to the Weaver's vehicle
where she had a gun in her purse.

Mr. Weaver stated that

the ruse was a "nice trick- that would never happen again.

When Mr. Weaver did not appear for his trial, he waa then
also subject to the juri.diction of the
Service.

u.s.

Marshal.

Pollowing the confrontation at Ruby Ridge, the

details of which I need not reiterate here, the aituatioD

came under the control of the Department of Juatic..

ATF

was assigned to maintain a roadblock approximately three
miles from the Weaver cabin.

ATF did not open an investigation of Mr. Weaver or propose
his prosecution because of his beliefs.

Although Mr. Weaver

talked of a violent confrontation with the Government, ATP
did not investigate him or refer cbarges against
that.

fer

ATF recommended Mr. Weaverls prosecution, purely and

s~ly,

because he chose to commit violations of Federal

firearms laws.

In addition, ATF's role in this entire

matter was independently reviewed, at tbe request of Senater
Larry Craig, by the Oepartment of Treasury's Inspector
General.

The review concluded that Mr. Weaver was not

entrapped and that ATF was not guilty of any of the other
allegations of wrongdoing that have been associated with
this case.

A copy of that investigation has been made

available to all members of this committee.

In preparing my testimony, I bave given considerable thought
to the systam by which decisions are made to prosecute ATP's
casea.

It reinforces more than ever the need we a11 have

for a system of "checks and balances.-

The requirement that

A":F and the U.S. Attorney make independent judgment. in

these cases means that two separate departments of

gover.nment must agree before an individual can be
prosecuted.

This system was in place when the decision was

made to prosecute Randall Weaver on the firearms charges.
Although the ultimate decision to prosecute is a judgment
call and reasonable minds may differ as to whether a
particular case should be pursued, I believe the system is a
good one that worked properly in this case.

As long as

these checks remain strong, everyone benefits because they
ensure against investigative or prosec"ltorial abuse.
essential that the public trust its law enforcers.

It is
Truat is

a matter of personal integrity and competency, and I pledge
to maintain the highest of these standards at ATF.

Thank you for the opportunity to make this statement.
pleased to answer your inquiries.

I am

REVIEW or THB BUREAU OF ALCOHOL,
TOBACCO AND FIREARM'S (BATF)
INVOLVEMENT IN THB INCIDENTS AT
RUBY RIDGB, IDAHO

OFFICB OF INSPECTOR GENERAL
OFPICB OP ASSISTANT INSPECTOR GENERAL FOR
OVERSIGHT AND QUALITY ASSURANCB
OFPICB or SPECIAL PROJBCTS

OIO-OOA-94-013

JONB 30. 1994

O€PAllTMEHT atr THE TR£ASlJ1n'

•

W ...... IHG'TON. D.c:. 3IOGaD

J..N 30

O-SP-93-508
MEMORANDUM TO:

FROM:

SUBJECT:

John Maqaw
Director
Bureau ot Alcohol, To

cco ,n~ ~~

:.r.1c...U:

Gary L. Whittinqton
Assistant Inspector Gene 1 tor
Oversight and Quality .surance

Report on the Review ot BATP Invol ~·. .ent at Ruby
Ridge

The attached tinal report presents the result. of our review

ot the Bureau ot Alcohol, Tobacco and Fireara'. (BATP)

involvement in the incident. at Ruby Ridqe, Idaho. Senator Larry
craig requested that we do this review. Our objective va. to
determine whether the BATF tollowed the proper procedure. in
investigating Randall Weaver.
This review va. coordinated vith
the Department ot Justice's ottice ot Prote •• ional Re.pon.ibility
which conducted a more comprehensive review.of the action. of all
agencies involved in the Ruby Ridge incident.
OUr review showed that BATF did not target Mr. Weaver tor
inve.tigation becau.e he ascribed to any particular religious
beliet.. Mr. Weaver wa. as.ociated with individual. believed to
be involved in violent criminal activity when he . .de an offer to
sell saved-ott shotgun. to a BATF intormant. He bec. .e the
subject ot an investigation when the gun. were sold to the
intormant.

BATP acted properly in the investigation and arre.t of
The arre.t va. planned and executed to enaure the
satety of Governaent agent. and all civilian.. After hi. arrest,
Mr. Weaver tailed to report to his trial and the United State.
Marsbal Service (OSMS) a.sumed jurisdiction for hi. apprebension.
The .booti.,., incident. occurred while the ca.e va. under the
jurisdiction of the OSMS and the rederal Bureau of Inve.tigation.
BATP agent. vere not directly involved in the .hootinq incidents.
Mr. Weaver.

on June 9, 1994, ve requested your co...nt. on the fact.
pre.entad in the report. On June 2l, 1994, you re.ponded that
you concurred with the report. As we did not u.k. any
reco_endation., no turther actions are required. W. bave
pre.entad the co. .ent. to the report in their entirety a. an
Appendix to this report.

2 -

If you have any questions concerning this report, please
contact me, or Mr. Donald P. Devane at (202) 273-3060. We
appreciate the cooperation and the courtesies extended to our
staff during this review.
Attachment

TABLE OF CONTENTS
PAGE

••••••••.•..•.....•.•.•.•.•••••.••.•.••.•.........•..•.•....•••..••••••

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AltYAN

1rAAG~TING

WEAVER FOR INVESTIGATI()N..............................

AlJTH()RIZ~1rI()N

S~~ ()~ G~~

~ATIO~

FOR INVESTIGATION.................... 2

1rAA(;~TIN(;

()F WEAVER

IJY

INVESTIGATI()~.........................

~AVER.......................................................

IJAW D~<:ISI()~ 1r() ASIC WEAVER 1r()

INF()RMANT............... 5

~ ~ ()~ WE~VER.........................................................

WEAVER.................................................

~~~(;~lrI()N ()~ ~~ItJ\J?~~................................................

J)~~~y ~ <:~(;ING

B~'fF ro~I<:Y

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I?~VING

INF()RMANTS..................................... 8

Al?I?ENDIX A - <:HR.()N()~()GY

()~ ~VENTS

Al?I?ENDIX B -IJ~TF ItESI?ONS~ 1r() DRAFT REI?OR1r

iNTRODUCTION
senator Larry E. Craig requested a review, concerning the
Bureau of Alcohol, Tobacco and Firearms (BATF) involvement in the
Rand~ll Weaver incident, in a letter to the Secretary of'the
Treasury, dated July 22, 1993. The Senator specifically asked us
to determine; why Weaver was targeted, who authorized it, on what
evidence was it based, how reliable was the evidence, does BATF
have a policy of targeting investigations at individuals
ascribing to particular religious beliefs, how does BATF select
targets, were usual procedures followed in this case and which
came first the decision to target Weaver in a sting operation, or
the decision to use him as an informant.
Our review showed that the BATF acted properly in the
investigation and arrest of Weaver. Weaver became the subject of
the investigation when he initiated an offer to supply illegal
weapons to a BATF informant. He sawed off the barrels of two
shotguns and sold the illegal weapons to the BATF informant.
BATF effectively executed an arrest of Weaver that avoided the
likelihood of a violent confrontation.

SCOPE
To perform this review, we interviewed BATF agents and the
BATF informant. We also interviewed attorneys of the United
states Attorney's (U.S. Attorney's) Office and Weaver's defense
attorney. Weaver's attorney declined our request to interview
Randall Weaver. We reviewed BATF case files and other
documentation at Spokane, and Seattle, Washingto~ and BATF
Headquarters. We also coordinated our efforts with and reviewed
documentation obtained by the Department of Justice Ruby Ridge
Task Force. We reviewed documentation from July 1986 through
February 16, 1994. Our review was from August 1993 through March
1994.

BACKGROUND
BATF had an informant infiltrate the Aryan Nation World
Congress (ANWC) meeting in 1986 because of suspected violations
of laws BATF enforces by participants of that meeting. The
informant provided reliable information used to apprehend
criminals and thwart crimes.
Weaver was never considered the target of a BATF
investigation until October 11, 1989. The BATF informant
attempted to arrange for Weaver to serve as an unwitting
introduction to a potential suspect. During a conversation,
Weaver initiated an offer to supply sawed-off shotguns to the
informant. The informant reported this to the BATF agent who
obtained the authorization of the u.s. Attorney's Office and BATF
Headquarters to conduct an electronic surveillance of

conversations with Weaver.
On October 24, 1989, Weaver sold the informant two illegal
sawed-off shotguns.
On December 13, 1990, a grand jury indicted
Weaver and on January 17, 1991, he was arrested by BATF agents.
After BATF arrested Weaver, he was released on a personal
recognizance bond, but then he failed to appear for trial in
February 1991. A bench warrant was issued, at which time the
case became the jurisdiction of the United states Marshal
service (USMS). The USMS initiated action to arrest Weaver. On
one of the marshals' reconnaissance missions, an unplanned
confrontation occurred and resulted in the death of a marshal and
Weaver's son. The Federal Bureau of Investigation (FBI)
responded to the shooting incident because a Federal officer was
killed.
During a siege situation, a FBI Hostage Response Team
(HRT) member killed Weaver's wife and wounded Weaver and Kevin
Harris.
Weaver surrendered to the FBI, with the assistance of an
independent negotiator, and went on trial. He was charged with
making and possessing unregistered firearms, conspiracy, failure
to appear, murder, and other charges. At the subsequent trial,
Weaver was acquitted of all but two charges dealing with his
failure to appear and commission of an offense while on release.

TARGETING ARYAN NATION FOR INVESTIGATION
Our review showed that BATF has no policy to target
religious groups. According to the Crime Impact Program
Objectives for Spokane, Washington, their plan was to target
individuals planning or involved in violent crimes using firearms
and explosives.
In pursuit of these objectives, the office
identified individuals associated with the Aryan Nation.
According to case files, the Aryan Nation had a history of
members involved in violent criminal activity. Many of these
members were Chiefs of Security of the Aryan Nation. For example,
four recent Chiefs of Security were arrested and convicted of
crimes such as murder, bank robbery, counterfeiting, bombing and
firearms violations.
The Aryan Nation had discontinued their Annual meetings but
were renewing them in 1986. Some of the groups planning to
attend the July 1986 meeting were the Klu Klux Klan, the Posse
Comitatus, American Nazi Party, and the Western Guard (Canadian
Neo-Nazi group).

These groups advocated white supremacy, were anti-semitic
and were actively recrui~i~g followers f:o~ prison. These groups
had also encouraged acqulrlng and stockplllng firearms,
ammunition and explosives for a perceived eventual war with the
Federal government.
According to the July 10, 1986, BATF Status Report that we
reviewed and interviews conducted with the case agent and
confidential informant, the initial BATF investigation was not
targeted at the Aryan Nation as a group but at a notorious
individual, who had a history of violent crime. This individual,
convicted in 1973 of bombing ten school buses in Michigan, was a
scheduled speaker at the meeting. He was believed to be in the
process of moving his group to a location in the Pacific
Northwest to form the last white nation. In addition, the Chief
of security of the Aryan Nation was also of interest to BATF
because of information received concerning recent bombings in
Idaho.
BATF planned to have an informant attend the conference ~
establish a relationship with the individual scheduled to speak
at the conference and to identify various violations of the
Federal firearms and explosives laws. The informant subsequently
provided information on the criminal activities of others who
became targets of BATF investigations.
The informant met Weaver at the 1986 ANWC but he did not
become closely involved with Weaver. The informant developed
contact with another individual who was planning to kidnap
children of wealthy celebrities and hold them for ransom. BATF
provided the information concerning this plot to the FBI and the
school the children attended. The school terminated the
individual's employment before he could execute his plot. The
same individual also sold an illegal gun to the informant in
1986. The U.S. Attorney's Office declined prosecution of this
gun violation at the request of BATF, to maintain the informant's
cover and effectiveness. Over a three year period, the informant
had numerous meetings with the individual who had planned to do
the kidnapping. Weaver was present at four of these meetings.
At the 1989 ANWC, Weaver invited the informant to visit his
home. The informant visited Weaver's home in Naples, Idaho in
August 1989. During this visit, Weaver said he had visited with
an individual in Noxon, Montana. The Noxon, Montana individual,
a convicted felon, was the leader of group allegedly involved in
criminal activity. BATF then planned for the informant to have
Weaver serve as an introduction and reference for the informant
to infiltrate the Noxon, Montana group. BATF, at this time, had
not opened a case or started an investigation of Weaver.

TARGETING WEAYER FOR INVESTIGATION
Our review showed there was no documentation in BATF files
or other evidence to show that Weaver was ever considered the
subject of an investigation before he offered to supply guns in
October 1989. The BATF informant was involved in four other
cases. We reviewed the files for these cases and they showed the
development of information of criminal activity about the
subjects or potential subjects of investigations. Weaver was
noted as present at various meetings, but was not mentioned as a
subject or potential subject until he offered to supply sawed-off
shotguns in October 1989. The case files at BATF show that the
case on Weaver was opened after he offered to supply guns to the
informant.
On October 11, 1989, the informant met with Weaver to
discuss the trip to Noxon, Montana.
During this meeting Weaver
initiated an offer to supply guns to the informant.
In the
ensuing conversation, Weaver said he could provide five sawed-off
shotguns a week.
The informant stated that he became concerned when Weaver
offered to supply guns. He felt this might divert him from his
objective of infiltrating the Noxon, Montana group, especially
since BATF had not expressed any interest in making a case
against Weaver.

AUWORIZATION OF WEAVER INVESTIGATION
Proper procedures were followed by the BATF case agent in
seeking authorization for the Weaver investigation. ATF Order
3270.10A requires that a report of investigation be used to
report investigative matters that are of interest to the
district. The BATF case agent's report on October 11, 1989,
showed that Weaver had access to illegal firearms.
This report
was reviewed by the Resident Agent in Charge (RAC) and approved
by the Special Agent in Charge (SAC).
Once the BATF case agent learned that Weaver wanted to
supply illegal guns to the informant on a regular basis, he
requested authorization to electronically monitor conversations
between Weaver and the informant. ATF Order 3210.7A requires
that all electronic interceptions be approved by the SAC,
appropriate division chief, and/or the Department of Justice. On
October 13, 1989, the U. S. Attorney's Office in Boise, Idaho,
provided the Department of Justice authorization for the
electronic surveillance of Weaver. The case agent also received
the authorization of the BATF RAC, Spokane, the SAC, Seattle, and
the Chief, Firearms Division, Washington D.C.

The basis for the authorization was the confidential
informant's inform~tion.con7erning the offer to sell illegal
weapons. The conf1dent1al 1nformant had provided reliable
information on other cases.

SATE OF GUNS BY WEAVER
After BATF obtained authorization to monitor the
conversations with Weaver, the informant made a recorded
telephone call to Weaver on October 13, 1989. The purpose of the
telephone call was to change the date of their next meeting to
October 24th. During the conversation, they agreed that Weaver
could supply guns.
On October 24, 1989, the informant met Weaver at a
restaurant in Sandpoint, Idaho. The informant was wearing a
recorder to tape the conversation. They drove to an isolated
area where Weaver sold the informant two sawed-off (barrels less
than 18 inches) shotguns. He was paid $3QO and he also said he
could provide four or five a week.

BATF DECISION TO ASK WEAYER TO BE AN INFORMANT
Our review showed that Weaver was asked to be an informant
because the BATF informant became ineffective. BATF had used the
confidential informant as a source of information concerning
criminal activity of individuals associated with the Aryan Nation
since 1986. On March 29, 1990, the informant was asked to leave
the Aryan Nation compound because they had checked his identity
against state automobile records and found a discrepancy. The
BATF case agent decided that the informant would not be safe and
effective any longer in working with individuals connected with
the Aryan Nation.
The BATF case agent then decided to confront Weaver in an
attempt to get him to assist in the continuing investigation of
individuals associated with the Aryan Nation. As such, the case
agent submitted the Weaver case report to the U. S. Attorney in
May 1990.
On June 12, 1990, the case agent and another BATF agent
informed Weaver that a criminal case report was submitted to the
United states Attorney.
They requested that he ~ooperate with
BATF by providing information on criminal activities.
In return,
they iiould inform the united states Attorney's office of his
cooperat~or.
Weaver refused to cooperate. On July 2, 1990, the
Assista,nt lnited states Attorney CAUSA) stated that he would
proceed for an indictment against Weaver.

THE ARREST OF WEA VER
Proper procedures were followed by BATF in the arrest of
Weaver. ATF Order 3210.7A states that special agents will use
whatever force is r~asonable and necessary to make an arrest.
unnecessa~ force ~lll not be exerted and, where possible, any
form of vlolence wlll be avoided.
On December 13, 1990, a BATF agent testified before a grand
jury concerning Weaver's illegal sawing off of the shotgun
barrels and possession of an unregistered National Firearms Act
firearm. The grand jury indicted Weaver.
The case agent developed a plan to arrest Weaver. He knew
that the Weaver children carried firearms. An attempted arrest
at the Weaver residence would be dangerous to all, including the
children and the agents. Therefore, he devised a ruse in which
BATF placed a camper vehicle on the bridge that Weaver would use
to exit from his mountain home. A male and female agent were
placed in the front of the vehicle giving the appearance that
they were working on a disabled vehicle. Agents were in the back
of the camper to assist in the arrest. BATF placed an agent away
from the site to be a lookout and to provide cover for those at
the vehicle.
Weaver and his wife drove to the camper, got out and
approached the front of the camper. The BATF agent identified
himself as a Federal agent and attempted to arrest Weaver.
Weaver resisted arrest. He tried to go for a gun in his pocket
and then the agent's gun. His wife tried to run to the truck
where she had a loaded gun in her purse. BATF restrained both
Weavers without anyone firing weapons. Weaver stated that the
ruse was a nice trick that would never happen again.
This was an effective arrest of a potentially very dangerous
suspect. Weaver had previously stated that he was preparing for
a violent confrontation with the government. The case agent had
expected a potentially violent confrontation and devised and
executed a plan that avoided injury to any of the participants.
After Weaver's arrest, he was taken to the county jail. The
next morning the case agent called the AUSA and advised him of
Weaver's arrest. He recommended that the AUSA act to assure
Weaver's detention. The AUSA did not believe that the judge
would have Weaver detained.
The case agent then called the probation officer and
recommended to her that the court detain Weaver. He noted the
probability that Weaver would not report for trial. He cited l't
Weaver's statement when arrested (that it was a nice tric~ but
would never happen again) and a United states Secret Servlce
6

report concerning Weaver making threats about the President of
the United states and the Governor of Idaho.
The next day the current Aryan Nation Chief of security
appeared on Weaver's behalf at the arraignment. He stated that
Weaver was a good, law abiding citizen and he would return for
subsequent court appearances. The Magistrate released Weaver on
a personal recognizance bond.
Weaver did not report to his trial and a bench warrant was
issued for his arrest. The USMS then took over jurisdiction of
the Weaver case.

DELAY IN CHARGING WEA VER
Concerns have been expressed by Weaver's defense attorney
about the delay in charging Weaver with the sale of illegal
firearms. Weaver sold the guns on october 24, 1989, but he was
not charged until December 13, 1990, over a year later. Our
interviews with the case agent and the AU SA provided explanations
that the time was lengthy because of concern for the safety of
the informant and the AU SA case load.
At the time of the sale of the guns by Weaver, the informant
was actively trying to develop information on the criminal
activities of others believed to be violent and dangerous. To
act on arresting Weaver during this time would have been
dangerous to the safety of the informant, blown his cover and
would have made him ineffective.
In March 1990, when individuals in the Aryan Nation actually
discovered the informant's true identity, they expelled him from
their compound. The informant then became ineffective for BATF's
purposes.
After this, BATF prepared the Weaver case report that was
submitted to the United states Attorney in May 1990. The AUSA
was occupied with the investigation and prosecution of a Seattle
bombing case during that time. Therefore, he scheduled the
Weaver case for grand jury presentation in December 1990. The
grand jury indicted Weaver on December 13, 1990. The arrest was
planned and executed on January 17, 1991.
The timing of the events leading to the arrest of Weaver was
lengthy. In our opinion, the explanation5 uf the BATF case agent
and AUSA were reasonable.

Al.ll?GAT/QN OF ENTRAPMENT
Proper procedures were followed by the informant in
purchasing the illegal firearms from Weaver. BATF policy states
that the proper use of informants requires that individ~al rights
not-be infringed and that the Bureau conduct itself within the
parameters of ethical and legal law enforcement behavior. Our
review showed that Weaver had indicated a willingness to become
involved in criminal activity.
The defense attorney's position was that the government
induced Weaver into committing a crime that he was not
predisposed to commit. He stated that the government policy was
faulty. The government policy motivated informants to induce
innocent citizens to commit crimes. He stated that BATF told the
informant that he would receive a rey"lrd after a successful case.
This created a tacit understanding that getting a conviction
would result in a financial bonus for the informant.
The Weaver defense contention was that the informant lured
an innocent citizen into committing a crime to secure some
monetary gain by obtaining a conviction. We contacted the
defense attorney for details. The attorney said that Weaver
reported that, over a period of two years, the informant
repeatedly prodded him to supply guns. He did not provide any
other details or dates of these conversations other than general
statements that his client remembered being pursued by the
informant.
During the trial the Weaver defense noted, as an indication
of entrapment, that in a November 30, 1989 taped conversation
Weaver told the informant that he (infc~~ant) approached him
(Weaver) and offered him a deal. The informant did not confront
Weaver and deny this statement.
The informant subsequently stated that Weaver's statements
were incorrect. He had never approached Weaver or offered him
any deal. Weaver initiated the offer to supply guns to the
informant. Our review of transcripts of recorded conversations,
reports of investigation, status reports, the confidential
informant's notes of unrecorded meetings and our interviews with
the case agent, the confidential informant and the AUSA, all
substantiate that, in our opinion, Weaver was not entrapped.

BATF POlleY OF PAYING INFORMANTS
During the trial, the defense attorney questioned the method
of compensation that the informant would receive. The
confidential informant stated that he misspoke at the trial. He
testified that he assumed that he would get a monetary settlement
8

if the case went to trial and a subject was convicted.

The
informant also stated that as soon as he said it, he realized he
had misspoke, but he did not know how to correct it.
The BATF policy on payments to informants is to provide a
reward to informants for information concerning violations within
the jurisdiction of BATF regardless of whether a case goes to
trial, or a conviction is obtained.
The payments are not to be
used to compensate informants for their testimony in court.
The
case agent planned to request a reward for the informant in the
Weaver case at its conclusion regardless of the outcome of the
trial. Reward payments are made at the end of a case to ensure
the informant's cooperation during a trial and the reliability of
the informati~n provided. Payments to cover ordinary expenses,
(gas, telephone calls, lodging and food) are made as the
informant incyrs them.
Our review showed that the BATF policy concerning
compensation to informants was followed in this case. A number
of unusual oversights and instances resulted in a breakdown in
communications rather than a systemic or procedural deficiency.
The defense discovery motion asked the U. S. Attorney for
information on the informant from the BATF case agent. He was
asked to provide informant background, arrest record, if the
informant was on a government salary, and the amount of monies
already paid to the informant for ordinary expenses.
The case agent did not see the defense request, but provided
his information based on a conversation with the AUSA. The BATF
case agent provided the AU SA with a handwritten r~sponse to his
questions concerning the informant. The agent stated that the
informant was not paid a salary and had received about $500 to
cover expenses. The case agent responded to what he understood
the request to be.
Several pre-trial meetings were held with the AUSA, the
informant and the case agent.
Some meetings were also held
between the informant and the AUSA without the case agent. The
case agent stated he assumed that the AUSA would have discussed
the informant's compensation during the meetings between the AUSA
and the informant. The informant stated that the AUSA never
asked any questions concerning his compe~'sation.
When the defense attorney questioned the informant about
compensation, the informant incorrectly stated that he assumed
that a case would have to go to trial and a subject would have to
be convicted or he would not get any monetary settlement from the

government.
He stated that he had been testifying for a long
time covering many subjects and he was tired and lost foc~s and
attention in giving this statement. He realized immediately his
statement was incorrect.
The informant expected the AUSA to correct the misstatement
upon re-direct questioning.
The AUSA did not primarily because
he had not dealt with BATF reward payments in the past. The AUSA
had only dealt with agencies that placed informants on salaries
and believed that all agencies followed the same procedure. As
such, the AU SA believed that the BATF procedure for compensation
was inappropriate.
During our review, we surveyed other law
enforcement bureaus within the Department of Treasury, and in
addition, contacted a representative of the Drug Enforcement
Administration (DEA). Our survey showed that the United States
customs Service, united States Secret Service and DEA all had the
same reward procedure that BATF followed.
The AU SA expected that the BATF case agent would have
provided the information on compensation to him.
He stated that
he discussed compensation with the informant when he was
preparing him for the trial and this would be in his notes.
He
believed that they discussed compensation, however, the AUSA was
unable to produce his notes that showed they discussed
compensation.
In our interview with the AUSA, he stated that he should
have pursued the compensation issue further.
He had not dealt
with an BATF informant type situation in the recent past. His
question to the BATF case agent was too narrowly crafted
regarding the informant's compensation and money he received in
this case.
He had just completed a case in which the FBI used an
informant who was paid a salary and he believed that this method
was the usual method used in law enforcement.
As a result, we believe that the problems caused by the
informant compensation procedures resulted more from a breakdown
in communication between the prosecuting attorney, informant and
case agent than a systemic defect in the procedure.

APPENDIX A
(Page 1 of

CHRONOLOGY OF EVENTS
Late 1970's

BATF became familiar with Aryan Nation (AN) as
result of bombing at AN church

1981-2

1984

recruiting in prisons. Confidential
Informant (CI) went into AN and obtained
information on several firearms violations

AN Member states that Randy Weaver was at 1984
ANWC

1985

Former AN Chief of Security convicted of multiple
violent crimes

1986

Information was developed that another AN Chief of
Security was involved in numerous bombings.
CI-22 infiltrated AN and provided information
used in prosecuting a former Chief of Security and
others. This CI was developed in 1980 and worked
on biker cases. He had demonstrated reliability
in previous cases.
CI-22 first met Weaver at ANWC in July 1986
Weaver was accompanying an individual who was
involved in illegal gun, explosive activity and
was planning on kidnapping students.

1987

CI-22 met Weaver at July ANWC

1989

CI-22 was developing information on criminal
activities of a KKK leader and another individual
who was a felon and leader of Montana White
Knights.

7/15-16/89

CI-22 met Weaver at the Annual ANWC.

8/30/89

CI-22 visited Weaver at his home

10/11/89

CI met Weaver to arrange trip to meet Montana
White Knights l~~der. Weaver initiated offer to
supply illegal guns to CI.

APPENDIX A
(Page 2 of 3)
10/~3/89

CI made a monitored phone call to Weaver 'who
discussed the gun buy using disguised term "chain
saw" as SUbstitute for gun.

10/24/89

Weaver sold two illegal guns to CI

11/30/89

CI and Weaver met for trip to Montana. Weaver
said he didn't really know the White Knights
leader that well and did not feel comfortable
going to Montana.
He also said he had 5 more guns
to sell CI but he was uncomfortable with CI and
wanted to meet his family. (case agent determined
that it was not likely to get to the White knights
leader through Weaver)

3/29/90

CI-22 confronted at AN compound by current
Chief of Security and asked to leave because his
identity was checked and discrepancies were found.

5/21/90

Weaver case report submitted to U.S. Attorney

6/12/90

BATF case agents confront Weaver with
violations and ask if he wanted to cooperate and
supply information on criminal activities of AN
members.

Summer 1990

BATF took aerial photographs of Weaver cabin in
anticipation of need for planning arrest.

12/13/90

BATF special agent testifies before grand jury
which indicts Weaver on gun charge

1/17/91

BATF arrest Weaver at bridge

1/18/91

BATF case agent calls AU SA and Probation Officer
to report information to support recommendation
that Weaver should not be released on bond.
Magistrate releases Weaver on personal
recognizance bond.

2/19/91

BATF case agent went to MoscoW, Idaho for trial.
Weaver did not report.

APPENDIX A
(Page 3 of 3)
3/19-20/91

BATF case agent went to Moscow, Idaho for trial.
Weaver did not report.
USMS was provided statement by BATF case agent
concerning Weaver

6/20/91

BATF case agent provided background to USMS team
concerning Weaver
BATF provided some technical assistance to USMS

8/21/92

BATF case agent informed by Deputy U.S. Marshal
that another U.S. Marshal was shot at Weaver
property.

8/22/92

FBI snipc~ shoots Weaver, Kevin Harris and kills
Vicki Weaver.

8/22-31/92

BATF provided assistance to USMS and FBI. BATF
manned perimeter of Weaver site.

8/31/92

Weaver surrendered

1992-93

BATF case agent was requested to;
1. assist in investigation of shooting scene
where U.S. Marshal was killed (3 to 4 days
after shooting)
2. assist in search of Weaver cabin after
surrender
3. be part of USA pre-trial investigation team
4. testify at second grand jury that Weaver
did not report for trial
5.

test~fy

at trial of Weaver

4/13-7/8/93

Trial of Weaver/Harris

7/8/93

Weaver was acquitted of all charges except the
failure to appear and commission of an offense
while on release

•

1 ot i t

O£PA"TM£~T 01' THE TR!A.5lJ"Y
.U"EAU Oil' AL.COHOI .• TO.ACCO Af04C F'"EA'''''
WASH:NQTOH. C.C. ZOUt

",UN 2 I 19M

MEMORANDUM TO:
FROM:
SUBJECT:

Director
ottice ot Special Projects
Director
Bureau ot Alcohol, Tobacco and rirea.raa
Review ot BATF Involvement at Ruby Rid;.

After careful review ot the Ruby Rid;e document, ATF
concur. with the draft report, and we appreciated th.
opportunity to review the report batore tinalization.

Magaw

TREASURY

NEWS

OFFICE OF PUBUC AFFAIRS -1500 PENNSYLVANIA AVENUE, N.W. - WASHINGTON, D.C. - 20220 - (202) 622-2960

FOR IMMEDIATE RELEASE
Text as Prepared for Delivery
September 8, 1995

TESTIMONY OF GEORGE MUNOZ
ASSISTANT SECRETARY FOR MANAGEMENT/
CHIEF FINANCIAL OFFICER
BEFORE THE HOUSE COMMITTEE ON GOVERNMENT REFORM AND
OVERSIGHT SUBCOMMITTEE ON GOVERNMENT MANAGEMENT,
INFORMATION AND TECHNOLOGY

RR-550

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Department of the Treasury
Statement of George Munoz
Assistant Secretary (Management)1
Chief Financial Officer
before the
House Committee on Government Reform and Ovenight
Subcommittee on Government Management,
Information and Technology
September 8,1995

Mr. Chairman and Distinguished Members of the Subcommittee:
Good morning. I am pleased to be here and have this opportunity to discuss the Administration's
program to improve debt collection within the Federal Government. I would like to discuss
some of the key points of the program and the anticipated benefits which would result from
enactment ofH.R. 2234, the "Debt Collection Improvement Act of 1995." We appreciate the
leadership you and the Ranking Minority Member have shown on this legislation.
Pro~

Purpose and Vision

The purpose and vision of our program is to protect the financial interests of the American
taxpayer, and to treat delinquent debtors fairly while collecting what is rightfully owed to the
Federal Government.
BackiWlund
Since September 1993, Department of the Treasury officials have talked to over 800 Federal
employees involved in collecting delinquent debt about the barriers they face in doing their jobs
effectively and about ways to remove those barriers. Overwhelmingly, they support initiatives
that will improve their ability to share information with each other, to standardize and centralize
debt management functions, and to strengthen debt collection regulations.

In January 1995, the Financial Management Service of the Treasury Department documented in
its "Breaking the Barriers to Improved Debt Collection" report that agency debt collection
specialists throughout the Federal Government believe that debt collection performance can be
substantially improved. Specifically, debt collection specialists asked for enhanced resource
support of debt collection, and improved information sharing and communication within and
among agencies. Treasury's plan to provide systems and cross-servicing support is in effect a
new governmentwide debt collection program.
1

We know that centralized debt collection systems can payoff. The success of the tax refund
offset program is one example. Another example is the Department of Justice's Central Intake
Facility for managing delinquent claims referred to Justice for litigation and enforcement. In
1993, the Department of Justice implemented a centralized debt collection program through a
central intake facility and a computer link up of 94 judicial districts. Its advantages are better
workload scheduling, accurate case tracking and reporting, and compliance with the Privacy Act.
In 1994, one year later, the Justice Department's total cash collection increased by more than
$850 million over collections of $948 from the preceding year. This represents a near doubling
of collections in one year. For the record, this system was financed out of a special authority,
which allows Justice to retain up to 3 percent of collections for re-investment in its debt
collection program.
Consequently, as a result of previous successes in centralized debt collection and the work of
Treasury Department and agency officials, an expanded program is being created to strengthen
and enhance debt collection within the Government. The legislation you are considering, H.R.
2234, the "Debt Collection Improvement Act of 1995," would greatly enhance the
Administration's ability to implement this program.
This bill creates the necessary administrative incentives for Treasury and other major debt
collection agencies to invest in systems that support improved electronic payments and collection
of tax and non-tax delinquent debt. The Department of the Treasury is a leader in modem
payment and collections technologies. Treasury's role in the new governmentwide debt
collection program will be to design and manage a debt collection systems network which links
debt collection information resources to improve collections, while maintaining and insuring
compliance with Privacy Act and tax information disclosure requirements.

Mr. Chairman, our goals in creating this program are simple:
1. we wish to treat our debtors fairly and consistently, with due regard to their due
process rights;
2. we wish to reduce the monetary losses resulting from inadequate collection of debts
owed to the Federal Government;
3. we wish to maximize the amount we collect and minimize our costs of collection',
4. we wish to ensure that the public knows what we are doing and of its obligation to
repay Government debts;
5. we wish to avoid needless litigation;
2

6. we wish to ensure that our employees are properly trained to do their jobs, and to
ensure that the task of collecting debt is assigned to those who are properly trained; and
7. we wish to avail ourselves of private sector resources.
Every Federal agency has the responsibility to: (1) implement effective debt collection programs;
(2) streamline the debt collection processes; (3) be able to share information where appropriate;
and (4) use modem business practices and technology. We strongly believe that our program
will enhance each agency's ability to meet these responsibilities.
Treasury's Pro~
Treasury has been working through partnerships established with the Chief Financial Officer's
Council, the Office of Management and Budget, the Federal Credit Policy Working Group and
the Inspector General community to develop its debt collection program and will continue to
work through these partnerships, as well as other inter-agency partnerships, to implement its
program. There exists a strong desire by the Federal agencies to improve Federal debt collection.
For example, the Chief Financial Officer's Council has listed improved debt collection as one of
its top seven priorities for this year. Our partnerships will help us implement an effective
governmentwide program to improve debt collection.
Through knowledge and experience, Treasury is in a unique position to lead this new effort
toward more efficient debt collection. The Department of the Treasury, under Memoranda of
Understanding with the Office of Management and Budget, is the lead agency in credit
management and debt collection in the Federal Government. Treasury has, among other things,
issued standards for managing Federal receivables, managed the govemmentwide debt collection
contract, and has implemented the Federal tax refund offset program, which has resulted in
collections of over $S billion to date in delinquent non-tax debt.
Over the years Treasury has provided staff support to agencies and OMB by:
1. establishing standards, guidelines and procedures on debt collection;
2. developing and facilitating the use of various debt collection tools;
3. providing training for Federal debt collectors;
4. sponsoring pilot projects, including systems redesign, within agencies to improve debt
collection; and
S. collecting quarterly financial data on agency receivables and debt collection practices.
Our new program, which has Treasury involved in operational debt collection tasks, represents
3

the most effective way Treasury can improve governmentwide debt collection in the current
envirorunent of limited resources.
Treasury's program intends to take advantage of existing debt collection tools by improving and
expanding their use, more effectively using the efficient debt collection centers existing in the
Federal Government, and establishing a centralized offset program at the disbursement level so
that the Government may effectively collect on its delinquent debts from Government payments
that would otherwise be disbursed to the debtor. None of these proposals require costly
investments to implement, and all of these proposals will result in savings to the Government.
The implementation of this program, and the passage of the legislation you are sponsoring, will
clearly help us to do more with less.
Cross-Servicin~

We believe that agencies can assist each other in applying adequate debt collection procedures to
delinquent Federal debts. Some agencies have developed sophisticated and efficient "debt
collection centers" while other agencies do not have sufficient resources to collect their
delinquent debts effectively. Cross-servicing provides a solution. Under cross-servicing,
agencies will have the option of utilizing the debt collection services of the more efficient debt
collecting agencies of the Federal Government. We envision a consortium of debt collection
centers within the Federal Government, efficiently providing services for agencies with limited
debt collection resources. The Department of the Treasury will act as the key coordinating point
in the consortium, and will provide collection services not otherwise available through other
agencies. This consortium will tap into the capabilities of private sector collection agencies to
enhance its debt collection operations.
Cross-servicing will result in more consistent treatment of debtors. Employees in debt collection
centers are trained and experienced in debt collection procedures and will assure that debts are
aggressively pursued while adequate due process rights are provided to debtors. The Federal
Government, our taxpayers and our debtors will be assured a more consistent debt collection
process which will be driven by the ability of the debtor to repay the amount owed, and not
whether a particular agency has the experience or resources to pursue the debt.
Treasury Offset Promm
Another centralized debt collection service which is a key component of Treasury's program is
centralized offset. Statistical matches have shown that the Federal Government routinely makes
payments to persons and other entities indebted to the Federal Government. Centralized offset
would take advantage of Treasury's role as the chief disbursing agent for the Federal
Government. By matching Treasury's payment certification records against delinquent debtor
records, we will be able to identify payments which are intended to be made to delinquent
debtors, and use those payments to reduce the outstanding indebtedness the debtor/payee owes to
the Federal Government, where appropriate.
4

The Treasury Offset Program (TOP) will provide numerous benefits for Federal debt collection.
First, TOP will consolidate several current programs which emphasize specific types of
payments, such as tax refund offset and salary offset, and will encompass payments which are
currently not part of a governmentwide offset program such as vendor payments. H.R. 2234,
would provide clear authority for Treasury to conduct this centralized program, and would
expand the types of payments available for offset, including certain Federal benefit payments
such as Social Security and Railroad Retirement payments.
Secondly, TOP will centralize the offset process for the various types of debts which the
Government collects by offsets. TOP will provide a mechanism for collecting (1) non-tax
Federal debts, and, through legislative changes contained in H.R, 2234, (2) tax debts subject to
continuous levy, and (3) debts administered by States in which the Federal Government has a
financial interest.
TOP will also serve as a method for locating delinquent debtors, since payment records generally
contain very current address information. This will enable creditor agencies to locate the debtors
and pursue debt collection, compromise the debt or cease debt collection activity, where
appropriate.
Finally, for those payments which are not disbursed by Treasury (such as payments of the
Department of Defense and the Postal Service), the Treasury Offset Program will provide for
matching of delinquent debtor records with the payment certifying records of those non-Treasury
disbursing agencies, and authority to offset those payments.
Thus, TOP will provide a basic process where all appropriate payments can be matched against
all appropriate debts for the purpose of offset.
Debtors will be protected from having payments offset where it would not be appropriate. For
example, benefit payments issued by the Department of Veterans Affairs would be exempt from
offset, and the first $10,000 of all benefit payments made during any twelve month period would
be statutorily exempt from offset. In addition, TOP, as administered by Treasury, will provide
for an exemption from offset where the debtor demonstrates that taking the payment by offset
would result in hardship. TOP will be administered in a manner which will provide debtors with
exemptions for cases of financial hardship, but at the same time will assure that those who can
pay their lawful debts do so.
Due Process Ri~hts of Debtors
We are very concerned that the due process rights of our debtors be protected under Treasury's
Debt Collection Program and we have assured that those rights will be protected. In providing
for cross-servicing arrangements between agencies, our program provides that servicing shall be
performed under the authorities of the original creditor agency, thus maintaining all the original
5

rights and protections of the debtor. The language in the proposed legislation clearly adopts this
position. No right or privilege will be eliminated solely because the debt will be collected by an
agency other than the original creditor agency.

In consolidating offset within the Government, Treasury will provide extensive due process
protections. At a minimum, prior to initiating offset, creditor agencies will be required to
provide:
1. written notice to the debtor of the debt and that the debt is delinquent and that the
agency intends to collect the debt through the offset;
2. an opportunity to inspect agency records concerning the debt;
3. an opportunity to review the debt with agency officials; and
4. an opportunity to enter into a written agreement with the creditor agency to repay the
debt.
These rights concerning offset are currently contained in title 31, United States Code, section
3716, and the Federal Claims Collection Standards adopted by the Department of Justice and the
Government Accounting Office. The proposed legislation, H.R. 2234, does not change any of
these existing due process rights.
Computer MatchinK
The legislation does provide an exemption from the requirements of the Computer Matching and
Privacy Protection Act of 1988 (the "Act"). We support this exemption, not because it eliminates
any due process rights or protections, but because the Computer Matching and Privacy Protection
Act of 1988 contains provisions that would prohibit conducting a disbursing official offset
program. For example, the Act would require that the debtor be sent a written notice subsequent
to the match of debtor and payment records indicating that the agency intends to collect the debt
through offset. While this notice is substantially similar to the notice which will be sent by the
creditor agency prior to initiating TOP, the Act would both prohibit conducting offset for thirty
days after the notice is sent and, simultaneously, prohibit holding up the payment while the thirty
day period expires. As a result, no offset would be possible, and the money would be paid to the
debtor leaving the Federal debt unpaid.
By comparison, the tax refund offset program which is exempt from the Computer Matching and
Privacy Protection Act of 1988 and has resulted in over $5 billion in collections to date, provides
due process rights virtually equivalent to the rights provided under TOP.

In weighing the additional due process protections provided by the Act, which are minimal,
against the administrative burden of the Act, which is substantial, we believe that the exemption
6

provided under the proposed legislation is clearly necessary and warranted.
The Le~islative Proposal
We strongly support H.R. 2234, the "Debt Collection Improvement Act of 1995," because it will
assist us in implementing improvements to governmentwide debt collection. This legislative
proposal:
1.

protects the rights of the debtor, and provides notice and due process, before the
debt is collected;

enhances the Federal Government's ability to collect from those people who owe
money to the Government;

provides a mechanism for the Government to apply payments intended to be made
to people who are past due on amounts owed the Government to pay back their
Government debts;

expands the authority for Federal agencies to service and collect debts for each
other, so that agencies do not duplicate collection programs;

allows more Federal agencies to use private debt collectors;

prohibits the extension of Federal credit to delinquent debtors;

provides financial incentives for agencies to do a better job collecting the
Government's debts;

expands the use of private attorneys to help collect Federal debts; and

authorizes non-judicial foreclosure of federally held mortgages.

Anticipated Benefits - One Year From Now
This proposed legislation will provide the following benefits:
1.

increased receipts of an estimated $1.05 billion over five years, and additional
deficit reduction of $284 million over five years;

reduced delinquencies;

increased use of debt collection tools already in existence, including the use of
private collection contractors;
7

consistent and fair treatment of delinquent debtors; and

increased public perception that the Federal Government performs its functions in
an effective and efficient manner.

Thank you, Mr. Chainnan. This concludes my remarks this morning. I would be pleased to
address any questions regarding this legislation or our debt collection efforts that you or other
Members of the Subcommittee may have.

DEPARTMENT

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OFFICE OF PUBUC AFFAIRS • 1500 PENNSYLVANIA AVENUE, N.W. • WASHINGTON, D.C. • 20220. (202) 622-2960

FOR IMMEDIATE RELEASE
Text as Prepared for Delivery
September 8, 1995

TESTIMONY OF J. MARK IWRY
BENEFITS TAX COUNSEL
BEFORE THE HOUSE COMMITTEE ON SMALL BUSINESS

RR 551
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For Release Upon Delivery
Expected at 10:00 a.m.
september 8, 1995
STATEMENT OF
J. MARK IWRY

BENEFITS TAX COUNSEL
DEPARTMENT OF THE TREASURY
BEFORE THE
COMMITTEE ON SMALL BUSINESS
UNITED STATES HOUSE OF REPRESENTATIVES
Madam Chair and distinguished Members of the Committee:
I am pleased to be here today to present the views of the
Administration on pension reform and simplification as it
pertains to small business. We believe this is an extremely
important issue, and we hope Congress will act on it this year.
My testimony today will focus on the Administration's pension
simplification proposal, as it relates to small business.
In
addition, at the Committee's request, my testimony will address a
number of the more significant proposals that relate to small
business in H.R. 2037 and S. 1006 (the "Pension Simplification
Act of 1995"), and in miscellaneous tax proposals on which the
Committee on Ways and Means held hearings in July.
On June 12, 1995, the President announced the
Administration's pension simplification proposal at the White
House Conference on Small Business. The Administration's package
contains significant elements that will simplify pensions for
businesses of all sizes, as well as for tax-exempt organizations,
governmental plan sponsors, multiemployer plans, and employees.
However, much of the proposal is focused directly on small
business.
In advancing this proposal, the Administration's principal
goal was to initiate a bipartisan effort this year to enact
legislation that both simplifies the pension system and expands
coverage, with special emphasis on the needs of small business.
Therefore, we were pleased when Senators Pryor and Hatch
introduced S. 1006, the "Pension Simplification Act of 1995," on
June 30. This legislation moves the process forward in a very
constructive manner and includes many provisions that are similar
to those proposed by the Administration. On July 13, this
legislation was introduced in the House of Representatives, as
H.R. 2037, by Representatives Portman and Cardin.
In addition, a
number of miscellaneous proposals that relate to pension
simplification have been introduced and, on July 11 and 12, the
Ways and Means Committee held hearings on these and other tax
proposals.
Accordingly, we now have an opportunity to simplify
pensions and to expand significantly the number of workers in

small businesses who are covered by retirement plans.
The
Committee's focus on this issue is therefore most timely.
Pension simplification is an issue for which there has long
been consensus and broad-based, bipartisan support.
In 1992, for
example, pension simplification legislation sponsored by thenSenator Bentsen, Senator Pryor, and numerous others was passed
twice by Congress as part of broader tax legislation in H.R. 11
and H.R. 4210 that was vetoed twice by President Bush.
In 1994,
the House of Representatives passed H.R. 3419 (the "Tax
Simplification and Technical Corrections Act"), which contained
many pension simplification provisions that were similar to those
included in H.R. 11 and H.R. 4210. The Committee on Ways and
Means' recent hearings considered various modifications to the
pension simplificatlon provisions of H.R. 3419.
The Administration's proposal, H.R. 2037, and H.R. 3419 have
many provisions in common.
Indeed, the majority of their
provisions are very similar. Of the differences, most are minor
or technical, although a few are more substantive. My testimony
will first review the key provisions of the Administration's
proposal that relate to small business and will then address
significant differences between the Administration'S and the
other proposals.
ADMINISTRATION'S PROPOSAL
In the 21 years since Congress enacted the Employee
Retirement Income Security Act of 1974 (ERISA) to protect pension
promises made to employees, the pension laws have become
extremely complicated. There are many reasons for this: the
desire of employers to have a high degree of flexibility in
designing plans that best suit their work force; the policy
objective of ensuring that most employees receive tax and savings
benefits from retire~ent plans that are comparable to those
provided to highly compensated employees and business owners; the
need to prevent specific tax-shelter abuses; the need to limit
tax-favored retirement accumulations in light of revenue
implications; and the desire to "grandfather" past options when
changing the law.
While each of these is an important objective, and while the
private pension system has been greatly strengthened as a result
of ERISA and its amendments, the cumulative effect -- together
with almost annual legislative changes -- has been to raise
compliance and administrative costs. This is one reason many
small employers, in particular, believe they cannot offer
retirement plans to their employees and one reason the
Administration has put forward its pension simplification
proposal.

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The law currently includes a number of complex rules that
are outmo~ed, ,r7dun~ant, or no longer necessary to achieve policy
goals. Slmpllflcatl0n of current law will encourage more
employers, both small and large, to contribute to their
employees' retirement and to pr~vide employees with simpler, taxadv~n~aged ~ays to save for retlrement.
In addition, by reducing
ad~lnl~tratlv7 expenses, more of the ~o~ey spent by employers to
malntaln penslon plans can go to provldlng benefits to employees
rather , than to paying lawyers, accountants, consultants , and
'
actuarles.
In developing the Administration's proposal, our goal was
not only to simplify the pension system so that more dollars
could be spent on benefits and less on administrative and
compliance costs, but also to expand pension coverage -particularly in small businesses and among average and lower-paid
employees who might not otherwise save for retirement. The taxfavored treatment accorded to employer-provided retirement plans
under current law is designed to encourage those who own and
manage businesses to extend retirement benefits to these rankand-file employees. Simplification -- with its attendant revenue
loss -- must be consistent with -- and indeed enhance -- this
fundamental pension policy.
The Administration's proposal, particularly the proposal for
a new, simple retirement plan for small business (the NEST), was
also designed to further the broader objective of continuing the
healthy growth of our economy by promoting savings generally.
This is a very important goal. The Nation's rate of saving has
declined dramatically since the 1970s, and the Administration
believes that increasing the rate of saving is essential if the
united states is to improve living standards in the future.
The Administration also strongly believes that pension
simplification should be "paid for", i.e., that appropriate
revenue offsets must be provided for simplification proposals to
the extent that they lose revenue. Accordingly, the
Administration's proposal has been designed to achieve pension
simplification and expanded coverage in a,manner that will be,
"affordable" and cost effective -- to achleve as much as posslble
while minimizing revenue loss.
The Administration's proposal is the product of an
interagency process initiated at the dir 7 ction of Vice President
Gore as part of National Performance ReVlew II. staff,from the,
Treasury Department, the Department,of Labor~ ~he pe~s10n Beneflt
Guaranty Corporation, the Small Busl~ess Admlnls~ratl0~, the
National Economic Council, the Councll o~ ~conoml~ A~vlsers, and
the Office of Management and Budget partlclpated ~n lts
development.
The Administration also,consulted wlth n~merous
outside groups, including representatlves of ~m~ll bU~lness. The
Administration's proposal, which includes admlnlstratlve
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initiatives in addition to legislative components, is described
in the National Performance Review booklet, "Simplifying
Pensions," a copy of which is Attachment A to this testimony. 1
More detailed specifications for the legislative proposals will
be transmitted to Congress shortly.
The Administration's proposal includes a number of
provisions that would contribute substantially to simplifying the
pension system and expanding coverage for small business. The
key provisions are summarized below.
The Administration will work with Congress to fully offset
the cost of the Administration's pension simplification proposal.
1.

Establish the National Employee savings Trust (NEST)

The Administration has proposed a new, optional, simple
retirement plan for employers (including tax-exempt organizations
and state or local governments) with 100 or fewer employees. The
new plan would be known as the National Employee Savings Trust,
or "NEST."
The tax-favored employer retirement plans currently
available under the Internal Revenue Code have not been
sufficiently successful in inducing small employers to provide
retirement benefits for their employees.
For example, according
to Department of Labor Analysis of the April, 1993 Current
Population Survey, it is estimated that, in 1993, only 24% of
full-time workers in private firms with fewer than 100 employees
were covered by employer-sponsored retirement plans.
In
contrast, 73% of full-time workers in firms with 1,000 or more
workers were covered.
The administrative cost and complexity associated with
traditional qualified retirement plans often discourage small
employers from sponsoring these plans.
Especially for employers
with few employees, the cost of maintaining the plan may be large
relative to the benefits provided to employees.
In addition,
many small businesses are simply discouraged by the complexity of
existing law and by the fact that establishing a plan requires
additional interactions with the government.
Efforts have been made in past years to design a simplified
plan for small business, including, for example, the simplified

I Attachment A also includes one item that was not
incorporated in the National Performance Review booklet but that
is part of the Administration's proposal: a statutory
modification of the leased employee rules similar to that
proposed in H.R. 3419 and H.R. 2037.

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employee pension (SEP) that exists under current law, or the
PRIME proposal.
Development of the NEST has benefited from these
past efforts.
The NEST is designed to reduce dramatically the cost and
complexity that small businesses face under existing employer
retirement plans and, by doing so, to expand the number of
employees covered by plans.
It is structured to stimulate broad
coverage while operating in a simple manner and avoiding
burdensome testing, reporting, and correction requirements. A
company operating a NEST will have no continuing interaction with
either the IRS or the Department of Labor.
The NEST is a balanced package designed as a first pension
plan, an extremely simple starter plan that sUbstitutes simple
coverage rules and dollar limitations for virtually the entire
panoply of complex testing and reporting requirements designed to
ensure coverage and compliance in larger plans that permit
greater contributions. The NEST is a new alternative plan.
It
provides a vehicle for businesses who have not found existing
plans simple enough.
It offers a choice -- businesses could
still choose more complex and flexible plans if those suited
their needs.
The key features of the NEST are described below:
No top-heavy or nondiscrimination testing. NESTs would
not be subject to the top-heavy rules, the nondiscrimination
rules that apply to elective contributions under a section
401(k) plan, the nondiscrimination rules that apply to
matching contributions, or the nondiscrimination rules
applicable to SEPs and salary reduction SEPS (SARSEPs).
Instead, every NEST would simply be required to satisfy one
of two design-based safe harbors.
Under the first safe harbor, the employer would make a
3% nonelective contribution for each eligible employee, and
the employer could allow employees to make elective
contributions of up to $5,000 per year. Under the second
safe harbor the employer also would make a 1% nonelective
contribution for each eligible employee. The employer would
allow employees to make elective contributions of up to
$5,000 per year and would provide a 100% matching
contribution on those elective contributions up to 3% of pay
and a matching contribution of at least 50% (and no greater
than 100%) on the next 2% of employees' elective
contributions. The matching formula and 1% contribution
under the NEST are the same as the contributions under the
Federal Thrift Savings Plan. Because NESTs would not be
subject to the top-heavy rules, no top-heavy minimum
contributions (generally 3% of pay) would have to be made
for nonkey employees.
-5-

The NEST is designed to provide small businesses both
simplicity and flexibility.
A NEST could provide for
discretionary nonelective employer contributions in excess
of the safe harbor minimums (3% or 1% respectively), as long
as these additional contributions represented an equal
percentage of pay for all eligible employees.
Total
nonelective contributions (including both the safe harbor
minimums and discretionary contributions) would be limited
to 5% of pay.
consistent with the goal of the Administration's
proposal to simplify the pension system and expand coverage,
these safe harbors are designed to ensure that all eligible
employees actually receive some level of coverage under the
plan and that average and lower-paid employees have an
incentive to contribute. These safe harbors also allow
business owners to make significant contributions for
themselves.
For example, an owner whose annual compensation
was $150,000 and who wished to make the maximum
contributions permissible under the NEST could make an
elective contribution of $5,000, receive a matching
contribution of another $5,000, and receive an employer
nonelective contribution of $7,500 (5% of pay), for a total
contribution of $17,500 for the year.
No need for highly compensated employee determination.
Under the ~eneral nondiscrimination rules applicable to
qualified 2lans, it is necessary to determine who is a
"highly compensated employee" in order to compare the level
of benefits provided to highly compensated employees with
the level of benefits provided to employees who are not
highly compensated. Because NESTs would not be subject to
the nondiscrimination tests, an employer that offered a NEST
would not be required to determine which employees are
"highly compensated employees."
Simplified employee eligibility rules.
The employee
eligibility rules for NESTs would also be significantly
simpler than the eligibility rules that apply to traditional
employer retirement plans, SEPs, or SARSEPs. An employee
who reached age 21 would be eligible to participate in a
NEST only if the employee received at least $5,000 of Form
W-2 compensation from the employer for two consecutive
years.
Under this rule, employers would not be required to
count hours of service; they could simply look to the
compensation reported on employees' prior years' W-2's.
In
addition, under this rule, employers would not be required
to cover most short-term and many part-time workers.
In
contrast, a SEP or SARSEP must cover any employee who is
paid at least $400 from the employer for the year and who
worked as little as an hour per year in any three of the
preceding five years.
It appears that this SEP eligibility
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rule would not be changed by any of the other proposed
simplification legislation that is the subject of this
hearing
this simplification, then, is an important
feature of the NEST.
IRA based. The NEST would operate through individual
retirement accounts or annuities (IRAs) for employees. The
employer would have no responsibility for deciding how funds
would be invested or for selecting investment options to
offer employees. Yet, because the NEST would be a
workplace-based plan, it would have the significant
advantage of allowing employees to contribute on a pre-tax
basis through salary reduction.
In the context of section
401(k) plans, this method of contribution has proven to be a
very effective and relatively "painless" technique for
encouraging individuals to save for retirement.
contributions to NEST IRAs, like contributions to other
IRAs, would be 100% vested immediately and would be
completely portable; an employee could make a direct
transfer of his or her account balance to another IRA at any
time.
Distributions from NESTs generally would be subject to
the same rules as other IRA distributions. Thus, for
example, a 10% penalty tax generally would apply to
distributions before age 59 1/2.
Two-year holding period. Many small businesses
reportedly do not contribute to SEPs and SARSEPs because
employees may withdraw the funds from their accounts at any
time.
These employers are frustrated when they make
retirement plan contributions that employees immediately
withdraw for current use.
Imposing strict withdrawal restrictions (such as
completely prohibiting distributions prior to age 59),
however, could unduly discourage employees, especially those
who are lower-paid, from making contributions. These
employees may be reluctant to set aside money for retirement
if they cannot access the funds to meet unanticipated future
hardships.
In order to permit access to funds in such
circumstances, 401(k) plans can be written to permit
hardship distributions. Administration of plan hardship
provisions, however, involves the employer or plan
administrator in assessing whether a hardship exists and
whether other resources are available to meet the
participant's immediate and heavy financial need. These
provisions would require greater employer involvement in
continuing administration of the plan -- contrary to the
goal of minimizing employer burdens under the NEST.

-7-

To balance the policy of limiting immediate access to
retirement savings against the need to retain adequate
access to deal with hardships -- while still promoting
simple plan administration -- NEST contributions would be
available to employees only after they had been in the IRA
for two years. The two-year holding period is intended to
be an ~~sy to administer rule that is long enough to
allev~
e the problems associated with short-term
withdrawals but short enough to avoid discouraging lowerpaid employees from contributing. The holding period would
not limit employees' ability to transfer their account
balances to other IRAs.
Administrative simplicity for employers. To simplify
plan administration for employers, an employer could require
all employer and employee NEST contributions to be initially
deposited in the IRAs of a single designated financial
organization.
Participants would be notified in writing
that they could have the contributions transferred without
penalty to another IRA at any time, but employers could
continue to make contributions to only one financial
organization. Under SEPs and SARSEPs, the employer may have
to send each employee's contributions to a different
financial institution. This not only can be an
administrative burden for employers, but it also can
discourage financial institutions from marketing SEPs or
SARSEPs to employers.
An employer maintaining a NEST would not be subject to
any reporting requirements (e.g., Form 5500 filing).
The
NEST trustee or custodian would be required only to report
NEST contributions on the much simpler Form 5498, the same
form used to report IRA contributions.
A more detailed draft description of the NEST proposal is
contained in Attachment B to this testimony.
2.

Repeal the Family Aggregation Rules

The Administration has proposed repeal of the family
aggregation rules. Under these rules, if an employee is a family
member of either a more-than-5% owner of the employer or one of
the employer's ten highest-paid highly compensated employees, any
compensation paid to the family member and any contribution or
benefit under the plan on behalf of the family member is
aggregated with the compensation paid and contributions or
benefits on behalf of the highly compensated employee.
Therefore, the highly compensated employee and the family member
are treated as a single highly compensated employee.

-8-

A similar family aggregation rule applies with respect to
the $150,000 annual limit on the amount of compensation that may
be taken into account under a qualified plan.
The family aggregation rules greatly complicate the
application of the nondiscrimination tests, particularly for
small businesses, which are often family-owned or operated.
These rules also may unfairly reduce retirement benefits for
family members who are not highly compensated employees.
3.

Simplify the Definition of Highly Compensated Employee

A qualified employer retirement plan must satisfy
nondiscrimination tests to ensure that it does not discriminate
in favor of "highly compensated employees". The Administration
has proposed replacing the current seven-part definition of
"highly compensated employee" with a simple two-part test.
In
addition to being complex, the current-law test classifies many
middle-income workers as "highly compensated employees" who are
then prohibited from receiving better retirement benefits than
other employees.
(Employers offering the NEST would of course
not have to deal with even this revised definition because the
nondiscrimination and top heavy rules do not apply to NESTs.)
Under the current test, an employee is treated as a highly
compensated employee for the current year, if, at any time during
the current year or the preceding year, the employee:
(1)

owned more than 5% of the employer;

(2)

received more than $100,000 (as indexed for 1995). in
annual compensation from the employer;

(3)

received more than $66,000 (as indexed for 1995) in
annual compensation from the employer and was one of
the top-paid 20% of employees during the same year; or

(4)

was an officer of the employer who received
compensation greater than $60,000 (as indexed for
1995) .

These four rules are modified by three additional rules.
(5)

An employee described in any of the last three
categories for the current year but not the preceding
year is treated as a highly compensated employee for
the current year only if he or she was among the 100
highest paid employees for that year.

(6)

No more than 50 employees or, if fewer, the greater of
three employees or 10% of employees are treated as
officers.
-9-

(7)

If no officer has compensation in excess of $60,000
(for 1995) for a year, then the highest paid officer of
the employer for the year is treated as a highly
compensated employee.

Under the Administration's proposal, an employee would be a
"highly compensated employee" for the current year only if the
employee owned more than 5% of the employer during the current or
preceding year or had compensation from the employer of more than
$80,000 during the preceding year.
This definition, including
the elimination of the officer category, is dramatically simpler
than the current test.
In addition, the $80,000 threshold, which
would be indexed annually for cost of living, would mean that
many middle-income workers no longer would be subject to
nondiscrimination restrictions.
4.

Simplify Nondiscrimination Testing for 401(k) Plans

The Administration has proposed design-based safe harbors
that would allow an employer to avoid all nondiscrimination
testing under a 401(k) plan. These simpler 401(k) plans should
appeal to some small businesses who may wish to have a more
generous or flexible plan than the NEST.
Employees' elective contributions under a 401(k) plan are
subject to nondiscrimination tests known as the actual deferral
percentage (ADP) and the actual contribution percentage (ACP)
tests. The ADP test requires the calculation of each eligible
employee's elective contributions as a percentage of the
employee's pay. The ADP test is satisfied if the plan passes
either of the following two tests:
(1) the average percentage of
elective contributions for highly compensated employees does not
exceed 125% of the average percentage of elective contributions
for nonhighly compensated employees; or (2) the average
percentage of elective contributions for highly compensated
employees does not exceed 200% of the average percentage of
elective contributions for nonhighly compensated employees, and
does not exceed the percentage for nonhighly compensated
employees by more than two percentage points. The ACP test is
almost identical to the ADP test, but generally applies to
employer matching contributions and after-tax employee
contributions under any qualified employer retirement plan.
Performing these tests each year, and making corrective
distributions to remedy violations, can be complicated and
costly, particularly for small businesses. Therefore, the
Administration proposal would provide two alternative "designbased" safe harbors.
If a plan were designed in accordance with
one of these safe harbors, the employer would avoid all ADP
testing and all ACP testing of matching contributions. Under the
first safe harbor, the employer would have to make nonelective
contributions of at least 3% of compensation for each nonhighly
-10-

compensated employee eligible to participate in the plan.
Alternatively, under the second safe harbor, the employer would
have to provide a 100% matching contribution on an employee's
elective contributions up to the first 3% of compensation, and a
matching contribution of at least 50% on the employee's elective
contributions up to the next 2% of compensation.
(The employer
could not match elective contributions in excess of 6% of
compensation.)
The second safe harbor also would require the
employer to make a nonelective contribution of at least 1% of
compensation for each eligible nonhighly compensated employee.
These safe harbors are generally similar to the safe harbors
proposed for the NEST.
In addition, for employers that do not wish to use the
design-based safe harbors, the Administration has proposed
improving the operation of the current nondiscrimination tests in
two ways.
First, under current law, both the ADP test and the ACP test
generally compare the average contributions for highly
compensated employees for the year to the average contributions
for nonhighly compensated employees for the same year.
Because
the average for nonhighly compensated employees is not known
until the end of the year, contributions for highly compensated
employees must be monitored over the course of the year or must
be corrected after year end. The Administration's proposal would
simplify the operation of the ADP and ACP tests by requiring the
average contributions for highly compensated employees for the
current year to be compared to the average contributions for
nonhighly compensated employees for the preceding year.
Second, under current law, when the ADP or ACP test is
violated, correction is made by reducing the excess contributions
of highly compensated employees beginning with employees who have
deferred the greatest percentage of pay. This method usually
does not affect the most highly paid of the highly compensated
employees: their contributions, as a percentage of pay, are
likely to be lower than the percentage contributions of lowerpaid highly compensated employees, even if the dollar amount of
contributions by the most highly paid is higher. The
Administration's proposal would require excess contributions to
be distributed first to those highly compensated employees who
deferred the highest dollar amount (as opposed to the highest
percentage of pay) for the year. Under this approach, the lowerpaid highly compensated employees would no longer tend to bear
the brunt of the correction method.
5.

Repeal the Minimum Participation Rule for Defined
contribution Plans

The Administration has proposed repeal of the minimum
participation rule for defined contribution plans. This rule
-11-

currently requires every qualified defined benefit plan and
defined contribution plan to cover at least 50 employees or, in
smaller companies, 40% of all employees of the employer. This
rule was intended primarily to prevent an employer from
establishing individual defined benefit plans for highly
compensated employees in order to provide those employees with
more favorable benefits than those provided to lower-paid
employees under a separate plan. The rule also prevents an
employer from favoring one small group of participants over
another by covering them under two separate plans and funding one
plan better than the other.
The abuses intended to be remedied by the minimum
participation requirement are unlikely to arise under defined
contribution plans. These plans are generally fully funded and,
therefore, there is no risk that the employer will favor
participants in one plan over participants in another plan by
providing more favorable funding.
For defined contribution
plans, the minimum participation requirement adds unnecessary
administrative burdens and complexity without delivering
commensurate benefits to the system.
6.

Repeal the Special Plan Aggregation Rules that Apply to
Plans covering Self-Employed Individuals

The Administration's proposal would repeal the special plan
aggregation rules that apply only to qualified retirement plans
that cover an owner-employee -- that is, a sole proprietor of an
unincorporated trade or business or a more-than-10% partner of a
partnership. These special rules apply in addition to the plan
aggregation rules that apply to all tax-qualified employer
retirement plans. Therefore, plans covering owner-employees are
currently subject to an additional, and largely duplicative,
layer of rules.
Under the Administration's proposal, plans that
cover owner-employees would simply be subject to the general
aggregation rules that apply to all tax-qualified employer
retirement plans.
7.

simplify the SUbstantial Owner Rules Relating to Plan
Terminations

The Administration's proposal would greatly simplify the
"substantial owner" rules that apply to phase in PBGC-guaranteed
benefits when a defined benefit plan is terminated.
Under current law, the PBGC-guaranteed benefit for a
SUbstantial (i.e., more-than-10%) owner is generally phased in
over 30 years from the date the SUbstantial owner begins
participation in the plan. The owner's benefit under each
amendment within the 30 years before plan termination is
phased in separately. Guaranteed benefits are generally phased
in over five years for other plan participants.
-12-

Under the Administration's proposal, a sUbstantial owner
with less than a 50% ownership interest would be subject to the
same five-year phase-in as all other employees. Thirty-year
recordkeeping would no longer be required. The guaranteed
benefit for a sUbstantial owner with a 50% or more interest would
depend on how long the plan had been in effect rather than on the
owner's participation. The guaranteeable benefit for such a
majority owner generally would be 1/30 for each year that the
plan was in effect.
8.

Repeal the Combined Plan Limit on contributions and Benefits

The Administration has proposed repeal of the combined plan
limit (Code section 415(e» that applies to an employee who
participates in a qualified defined benefit plan and a qualified
defined contribution plan of the same employer.
The combined plan limit was designed to safeguard against an
individual accruing excessive retirement benefits on a taxfavored basis through the use of multiple plans. However,
computation of this limit is extremely cumbersome and requires
the retention of data relating to an employee's entire career
with the employer.
In addition, there are other Internal Revenue
Code provisions, such as the 15% "excess distribution" penalty,
that were designed to achieve essentially the same goal.
The Administration believes that, because the excess
distribution penalty and other provisions of the Code go far
toward ensuring that an individual cannot accrue excessive
retirement benefits on a tax-favored basis, the complexity of the
combined plan limit is not justified and the limit should be
repealed.
9.

Other Proposals

The Administration's pension proposal includes a number of
other elements that are not explicitly targeted to small business
but that lessen the administrative burdens on plans generally,
including plans sponsored by small businesses. These include,
for example, proposals relating to the filing of summary plan
descriptions and the preservation of benefits of missing
participants, and a non-legislative procedural change simplifying
the process of obtaining prohibited transaction exemptions. All
of these changes would lessen the administrative burdens on
plans.
The Administration's pension simplification proposal also is
designed to integrate legislative and purely administrative
changes.
The Administration has proposed to modify the summary
plan description (SPD) requirement by providing that SPDs would
no longer need to be filed with the Department of ~abor (DOL) ~n
a routine basis.
Instead, the DOL would be authorlzed to obtaln
-13-

SPDs from plan administrators on request of a plan participant or
beneficiary.
Without requiring legislation, the Administration will also
shorten the Form 5500 report that most pension plans (but not the
NEST) complete.
The Administration will pursue methods for
simplifying and expediting the receipt and processing of Form
5500 information and data through the use of advanced computer
technologies.
The Administration also has proposed legislation to expand
the Pension Benefit Guaranty Corporation's (PBGC's) missing
participant program, to permit employers terminating their
defined contribution plans to transfer benefits to the PBGC for
missing participants who cannot be located. This will enable
these participants to receive benefits when they reach retirement
age.
It will also ease the burden on businesses that wish to
terminate plans.
Currently, plans are placed in a difficult
position because they cannot terminate until plan assets are
distributed to participants, and it is sometimes difficult to
locate certain participants.
To further ease plan burdens, the Administration will take
administrative action to simplify the prohibited transaction
rules, by providing expeditious treatment of prohibited
transaction exemption requests that are similar to those for
which individual exemptions have previously been granted.
A
"prohibited transaction" is generally any transaction between a
plan and a person who is considered a "party in interest" or
"disqualified person" with respect to the plan.
Unless exempt by
statute or by an administrative "individual" or "class"
exemption, a prohibited transaction may trigger an excise tax
under the Code, and may give rise to liability under ERISA.
The
DOL generally has authority to exempt transactions from the
prohibited transaction rules.
Some employers have indicated that delays in securing
exemptions from prohibited transaction rules have prevented them
from entering into transactions that would in fact benefit the
p~an.
To expedite the process, the DOL will develop a class
exemption for all transactions that the DOL determines to be
substantially similar to previously granted individual
exemptions.
For transactions within its scope, the class
exemption would guarantee a DOL response within 45 days.
THE PORTMAN/CARDIN BILL (H.R. 2037)
As I have already indicated, the Administration was pleased
by the introduction of H.R. 2037 in the House and its earlier
introduction in the Senate (as S. 1006). Introduction of this
legislation is an important and positive step toward the
enactment of pension simplification in 1995.
-14-

As noted, many of the provisions of H.R. 2037 are
substantially similar or identical to the Administration's
proposal.
However, to respond to the Committee's request, this
section of our testimony will address the differences between the
proposals with respect to the definition of "highly compensated
employee" and the design-based safe harbors for 401(k) plans. As
previously discussed, our principal objective in developing the
Administration's proposal was twofold: to simplify the pension
system and to expand coverage, particularly in small business and
among average and lower-paid employees who might not otherwise
save for retirement. We also wanted to accomplish these goals in
the most cost-effective way. We believe these are appropriate
criteria to apply in assessing other proposals as well.
I want to emphasize that while there are some differences
between the Administration's proposals and H.R. 2037, our goals
are the same. We are eager to continue to work with
Representatives Portman and Cardin, and other interested members,
as well as this Committee and the Ways and Means Committee to
achieve our common goals.
1.

Definition of "Highly Compensated Employee"

Under the Administration's proposal, a "highly compensated
employee" would simply be an employee who owned more than 5% of
the employer during the current or preceding year or who had
compensation from the employer of more than $80,000 during the
preceding year. Under H.R. 2037, "highly compensated employee"
generally would be defined to include these two categories of
employees, plus the highest-paid officer of the employer for the
preceding year. However, a special rule would apply to a plan if
no participant in that plan had compensation for the preceding
year in excess of $80,000.
In this case, the plan would be
exempt from the top-heavy rules and would be considered to have
no highly compensated employees for any purpose, provided that
the plan met the requirements of section 401(a) (4)
(nondiscrimination as to benefits or contributions) and section
410(b) (nondiscrimination as to coverage) with respect to the
availability of contributions, benefits, and other plan features.
For purposes of performing this availability test, the more-than5% owners and the highest-paid officer would still be treated as
highly compensated employees.
In addition, the special rule
would not apply to a plan to the extent provided in regulations
that are prescribed by the Secretary to prevent the evasion of
the purposes of the special rule.
The elimination of all business owners earning less than
$80,000 from the class of highly compensated employees raises
significant policy concerns.
First, the owners of a business
(especially a small business) are the individuals who are
responsible for establishing any retirement plan, and they have
the power, within the law, to determine the terms of the plan.
-15-

By eliminating the rules relating to highly compensated employees
and the top-heavy rules, owners could establish plans that in
fact benefit only themselves. This is contrary to long-standing
pension policy and would undermine the goal of promoting coverage
of lower-paid employees.
Second, many owners potentially earning
more than $80,000 have the ability to reduce their compensation
below $80,000. For example, owners can determine how much of
their business profits are reinvested rather than distributed to
the owners and have some ability to determine what portion of the
amounts distributed will take the form of taxable compensation.
A rule that turns on these decisions would inevitably lead to
more government intrusion with business decisions as the IRS
attempted to determine whether an owner in fact received more
than $80,000 of compensation, although in non-wage form.
H.R. 2037 attempts to address these concerns in two ways:
adopting a nondiscriminatory availability test and providing
authority for anti-abuse regulations. However, neither of these
provisions adequately addresses the policy concerns.
The availability standard is vague, difficult to administer,
and potentially an inadequate mechanism for promoting broader
coverage.
It is not clear what is meant by the availability
requirement: whether it is intended that availability will be
measured using the analytical methods currently provided in the
section 401(a) (4) regulations or through some new standard.
In
addition, a mere availability standard may be insufficient to
promote broad coverage if the plan provides significant
contributions or benefits only to participants who make a
substantial threshold contribution (e.g., 5% of compensation).
Experience suggests that low-inco~e employees are more likely to
participate if employers match contributions.
It is important to craft changes in the nondiscrimination
rules in a manner that carefully balances the encouragement of
new plans with the maintenance of strong incentives to cover
middle and lower wage employees. The Administration's proposal - in both the NEST and the 401(k) safe harbor -- seeks to achieve
this balance by limiting the elimination of the nondiscrimination
and the top-heavy rules to employers who provide a minimum level
of benefits to a broad class of employees.
If, under the special $80,000 rule, a business were treated
as having no highly compensated employees, the business could
establish a 401(k) plan and, if all employees were given the
opportunity to make elective contributions, no employer
contribution or match would be required and no nondiscrimination
testing would apply. This would mean that the owner or owners of
the eligible business could each contribute $9,240 (the elective
contribution limit for 1995) to the plan on a tax-favored basis,
even if no actual coverage were provided to any other employees.
In addition, the top-heavy protections that are present under
-16-

current law to assure minimum contributions to nonkey employees
would not apply.
For example, an employer could establish a
defined benefit plan that provided generous benefits to those
employees who made a contribution of 5% of pay. Although the
plan would nominally be available to all employees, in operation
it is possible that only the highly compensated employees would
benefit.
Finally, any regulation issued to preclude evasion of these
nondiscrimination requirements would be inherently subjective and
difficult to implement without clear guidance from Congress.
providing administrative guidance that distinguishes legitimate
business decisions that have the secondary impact of reducing an
owner's current compensation from outright evasion of the
nondiscrimination rules would be extremely complex and risks
unwarranted intrusion into business matters. This would likely
cause problems. Among the problems would be the difficulty many
small business owners would experience in planning and
determining how far they could properly go to reduce their
reported taxable compensation without running afoul of these
rules.
Those responsible for writing and enforcing the rules
would be forced into the difficult and undesirable position of
second-guessing business decisions, and doing so in an inherently
subjective context in which businesses transfer value to owners
and employees by a wide variety of means.
As noted previously, the Administration's proposal retains
the 5% owner rule for determining who is a highly compensated
employee, but eliminates the highest-paid officer rule.
Eliminating the highest-paid officer rule is less likely to
create the potential for abuse.
If an individual has no
significant ownership interest, there will usually be a different
party with an adverse economic interest or broader institutional
goals that will have the authority to decide whether or not to
provide a retirement plan and to determine compensation levels.
Moreover, where an officer does not have a significant ownership
interest in an entity, there are fewer means available for the
shifting of compensation in order to take advantage of special
pension rules.
One of the miscellaneous tax proposals, which was included
in the proposals on which the Ways and Means Committee held
hearings in July, would also eliminate the highest-paid officer
rule.
However, the highly compensated employee definition
proposed would follow H.R. 3419 in setting the dollar thresholds.
H.R. 3419 used a $50,000 threshold (adjusted to $66,000 in 1995)
instead of the $80,000 threshold. As noted, raising the dollar
threshold to $80,000, as we have proposed, would prevent many
middle-income taxpayers from being classified as highly
compensated employees.

-17-

401(k) Design-Based Safe Harbors

The design-based safe harbors proposed in H.R. 2037 for
401(k) plans are identical to the design-based safe harbors
proposed by the Administration, with one difference. As noted
previously, under the second alternative safe harbor proposed by
the Administration, the employer would have to provide a 100%
matching contribution on an employee's elective contributions up
to the first 3% of pay, and a matching contribution of at least
50% on the employee's elective contributions up to the next 2% of
pay.
In addition, under this matching contribution safe harbor,
the employer would be required to make a nonelective contribution
of at least 1% of pay for each eligible nonhighly compensated
employee. H.R. 2037 does not require a 1% nonelective
contribution as part of the matching contribution safe harbor.
Our proposal for a 1% nonelective contribution as part of
the matching contribution safe harbor is consistent with the
twofold objective of pension simplification and expansion of
coverage. The current-law ADP and ACP nondiscrimination tests
provide a clear incentive for employers to design a plan that is
attractive to middle and lower wage employees and to make every
effort to communicate the plan to those employees and encourage
them to contribute. This is because the actual level of
participation by those employees directly affects the permitted
level of deferrals by highly compensated employees. The
Administration favors simple, design-based alternatives to ADP
and ACP nondiscrimination testing as a means of reducing
administrative cost and complexity and encouraging employers to
provide retirement plan coverage for their employees. At the
same time, safe harbors should not create an undue risk that
middle and lower wage workers will fail to receive meaningful
benefits and that the tax expenditure associated with 401(k)
plans will be used to provide disproportionately high benefits to
highly compensated employees.
Some have questioned whether communication of the plan and
the opportunity to obtain matching contributions would be
sufficient, by themselves, to encourage middle and lower wage
employees to make elective contributions.
In addition, some have
raised a concern that, under a matching contribution safe harbor,
an employer would have an incentive to purposely not communicate
the plan effectively to employees, since more effective
communication would require the employer to make greater matching
contributions for middle and lower wage employees.
A nonelective employer contribution could be a means of
alleviating these concerns by ensuring that all eligible
employees receive some retirement benefit.
In addition, the 1%
nonelective contribution could encourage eligible middle and
lower wage employees to make elective contributions and,
consequently, maximize the number of middle and lower wage
-18-

employees who actually benefit from the matching contribution
formula.
The receipt of regular statements showing a retirement
account balance and the effect of tax-free accumulation, together
with the marketing materials that financial institutions could be
expected to enclose with those statements to promote further
contributions (and larger account balances), should encourage
middle and lower wage employees to contribute.
3.

$1,000 Credit for Cost of Establishing a Plan

A major reason that some small business owners have been
reluctant to establish retirement plans for their employees is
the administrative cost and time burden associated with the
establishment and maintenance of the plans. They believe that
the resources -- both time and money -- required to administer
these plans could be better spent in other ways.
H.R. 2037 would provide a $1,000 tax credit to offset part
or all of the costs of establishing a pension plan. While
offsetting the employer's cost burden for up to $1,000 of startup expenses, the tax credit does not reduce administrative
expenses (for example by simplifying the steps involved in
administering the plan).
Instead, it shifts the burden of these
expenses from employers to taxpayers generally. Moreover, the
proposed tax credit addresses only the administrative expenses of
establishing the plan and not the demands on a business owner's
time.
A more effective approach to encouraging the formation of
retirement plans is to provide for actual simplification that
reduces all burdens, financial and administrative, including the
demands on the time and attention of the small business owner.
Moreover, structuring tax incentives to make retirement plans
more attractive to employers and employees is a more efficient
and effective use of tax expenditure dollars than subsidizing the
compensation paid to those who provide services to these plans.
We also believe that it is important to minimize ongoing plan
administrative expenses as well as to reduce start-up costs. The
Administration's simplification proposal, including in particular
the NEST and the 401(k) safe harbor, and other elements of H.R.
2037, promote these ends.

Special Regulatory Provisions Relating to Small Employers

H.R. 2037 also requires the Secretary of the Treasury to
include provisions to address any sP7cial nee~s of small, ,
employers in issuing any tax regulatlon relatlng to quallfled
pension plans. We oppose this explicit requirement.
In 1988 Congress specifically balanced the special concerns
relevant to the tax regulatory process against the need to
-19-

consider the impact of tax regulations on small business. At
that time, Congress concluded that it was appropriate to enact
section 7805(f) of the Internal Revenue Code, which requires the
IRS to submit all proposed regulations to the Small Business
Administration's Chief Counsel for Advocacy for review and
comment.
since the adoption of section 7805(f), Treasury and the IRS
have been particularly sensitive to the needs of small business.
We spend a considerable amount of time addressing their needs in
developing our regulations. While the Code is generally based on
an even-handed application of the pension rules, Treasury and the
IRS, where approp~ iate, have provided safe harbors and other
special rules for small business to assist them in addressing the
complexities in the Code. To the extent that Congress wishes to
provide special rules for small business, this should be done
direct:y and no~ -hrough mandatory modifications of the
regula_ons tha~ ,erely interpret the Code, so that owners of
small businesses may better rely upon the special rules.
Moreover, the addition of a requirement that pension
regulations include provisions addressing any special needs of
small employers could be counterproductive.
It could lead to
delays in issuing guidance and could undermine taxpayers' ability
to rely on published guidance by creating an avenue for anyone to
contest a regulation interpreting the Code on the procedural
ground that the regulation does not satisfy the new requirement.
MISCELLANEOUS PROPOSALS
A number of proposals relating to pension simplification
were among the many miscellaneous tax proposals that were the
subject of hearings held by the ways and Means Committee on July
11 and 12. The Administration submitted written testimony to
Ways and Means on these and other proposals relating to employee
benefits and other tax issues. Because that testimony already
covered the matters this Committee has requested us to address,
we will generally not repeat that testimony here.
Instead, to
respond to the Committee's request, we are attaching an extract
of that testimony that contains the portions that related to
pensions and employee benefits (Attachment C). We have also
discussed above the proposal to delete the highest-paid-officer
rule from the definition of highly compensated employee.
In
addition, it may be helpful to the Committee for us to elaborate
here on one other proposal, the proposed repeal of the 15% excise
tax on excess distributions.
Repeal of the 15% Excise Tax on Excess Distributions
Under a provision enacted in 1986, so-called "excess
distributions" are subject to a 15% excise tax. A distribution
-20-

is generally considered an "excess distribution" to the extent
that all distributions to an individual from all of the
individual's qualified employer plans and lRAs exceed $150,000
during a calendar year. The limit is $750,000 for a lump sum
distribution.
Similarly, excess distributions made after death
are subject to an additional estate tax of 15%.
Both the excess distribution penalty and the combined plan
limit (which applies to any employee who participates in a
qualified defined benefit plan and a qualified defined
contribution plan of the same employer) were designed to
safeguard against an individual accruing excessive tax-favored
retirement benefits under multiple plans. There is considerable
duplication in the application of the two provisions. Because
the combined limit is the far more complicated provision -- and
because it, unlike the 15% excise tax, applies only to the plans
of a single employer -- we believe, as reflected in the
Administration's proposal to repeal the combined limit, that the
cause of pension simplification would be better served by
repealing the combined limit than by repealing the 15% penalty.
Repeal of the more burdensome provisions will best promote
simplification. H.R. 2037 also proposes to repeal the combined
limit while leaving the 15% penalty in place.
OTHER ADMINISTRATION PROPOSALS BENEFITING SMALL BUSINESS

Before concluding this testimony, I would like to note that
the Administration has also taken a number of further steps to
provide overall tax relief for small businesses and lessen their
administrative burdens.
For example, we have
•

supported the permanent extension and increase of the
tax deduction for the cost of health insurance for
self-employed individuals and their families;

•

clarified that subchapter S corporations may enter into
partnerships with partners that could not themselves
qualify as S corporations, including nonresident
aliens, thereby providing S corporations with
flexibility in raising additional capital and
structuring their business relationships;

•

supported in 1993 an increase in the amount of capital
investment that businesses can expense from $10,000 to
$25,000 in order to reduce the cost to small business
of items that increase their productivity, such as
office machinery, computers, and copiers (Congress
increased the expensing limit to $17,500);

-21-

•

proposed and supported enactment of a provision that
exempts 50 percent of the capital gains from the sale
of small business stock;

•

supported enactment of a provision encouraging
investment in small businesses by allowing gain from
the sale of publicly traded stock to be invested taxfree in specialized small business investment
companies;

•

issued guidance that simplified the calculation for
computing the individual alternative minimum tax;

•

issued guidance to simplify the determination of
depreciation deductions, allowing taxpayers to group
certain assets in one or more "general asset accounts";
and

•

provided that the rules governing the timing of hedging
gains and losses do not apply to small cash-method
taxpayers, even though such taxpayers receive the
benefit of the character provisions in those
regulations.

In addition, we have made several recent proposals to reduce
administrative and legal compliance costs imposed on small
businesses. With respect to independent contractors, the IRS
recently announced a nationwide training program that will
reinforce the position that using independent contractors can be
a legitimate business practice that will not be challenged by the
Service. To further assure fairness and uniformity in
application of the independent contractor rules, the IRS program
also provides for National Office review of proposed compliance
projects.
In addition, the IRS is continuing its program of
reaching market segment understandings, using a working group of
both industry and IRS representatives to reach mutual
understandings of how the independent contractor rules should
apply to specific industries.
The Administration recently requested comments on whether an
unincorporated entity should be permitted to elect to be treated
as a partnership by simply checking a box on its tax return.
This simple election would replace application of a complicated
set of criteria that had resulted in complexity and uncertainty.
Also, we recently proposed a Simplified Tax and Wage Reporting
System that will ultimately enable an employer to file a single
return providing payroll information electronically, thus
eliminating the need to file similar data in multiple places.
On the legislative front, the Administration has proposed
further increasing the self-employed health insurance deduction
-22-

to 50 percent. This will further reduce the disparity in tax
treatment between self-employed individuals and employees.
CONCLUSION

The proposals before the committee today include potential
statutory changes that would provide meaningful pension
simplification.
It is encouraging that these proposals have many
provisions in common. We look forward to continuing to work with
Congress on a bipartisan basis to enact pension simplification
that will encourage small businesses to provide retirement
benefits for their employees.
Madam Chair, that concludes my formal statement.
I will be
pleased to answer any questions you or other Members may wish to
ask.

-23-

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Simplifying,-

PENSIONS

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REVIEW

PRESIDENT BILL CLINTON
VICE PRESIDENT

JUNE

AI.

1995

GORE

TABLE OF CONTENTS

OVERVIEW
Introduction
Highlights of the High Priority Actions
Offer the IINational Employee Savings Trust
NEST - A
simplified pension plan for small businesses
Provide a simplified, design-based alternative for 401 (k) defined
contribution plans, for all employers
Repeal the family aggregation rule and the combined limits on
contributions and benefits for those with multiple plans, and
eliminate or simplify other unnecessary or overlapping
requirements
Streamline Form 5500 reporting for all pension plans
Simplify and expedite the prohibited transaction exemption
process
Expand the Pension Benefit Guaranty Corporation IS missing
participant program to enable more of those promised a
pension to get it, even if their company goes out of
business

1
1
3

HIGH PRIORITY ACTIONS

3
5

5
6
6

SIMPLIFY PENSION PLANS FOR SMALL BUSINESS
1.
The NEST -- A Simplified Plan for Small Business
2.
Repeal the Family Aggregation Rule
3.
Eliminate Special Restrictions on Plans Maintained by the
Self-Employed
4.
Simplify Substantial Owner Rules Relating to Plan
Terminations

8
8
10

IMPROVE AND EXPAND 401 (k) PLANS
5.
Eliminate Uncertainty and MonitOring of Contributions
Through Design-Based Safe Harbors
6.
Facilitate Testing by Using Prior Year Data
7.
Improve Fairness of Corrective Distribution Rules
8.
Permit Tax-Exempt Organizations to Maintain 401 (k) Plans
9.
Conform 401 (k) Distribution Rules for Rural Cooperatives

Simplifying Pensions

11
12

13
15
16
17
18

SIMPLIFY PENSION RULES
10.
Eliminate Excessive Testing By Simplifying the Definition of
"Highly Compensated Employee"
11 .
Exempt Defined Contribution Plans from the Minimum
Participation Rule
12.
Eliminate Special Vesting Schedule for Multiemployer Plans
13.
Allow Triennial Actuarial Valuations for Multiemployer Plans
14.
Eliminate Partial Termination Rules for Multiemployer Plans
15.
Eliminate the Combined Plan Umit on Contributions and
Benefits (Section 41S(e))
16.
Simplify Contributions and Benefits Limits for Governmental
Plans and Multiemployer Plans
17.
Allow Tax-exempt Organizations to Provide Excess Benefit
Plans
18.
Simplify Deduction Rules for Multiemployer Plans
19.
Repeal Rule Requiring Employer Plans to Commence
Minimum Distributions Before Retirement
Simplify Taxation of Annuity Distributions
20.
IMPROVE ADMINISTRATION OF PROHIBITED TRANSACTION RULES
21 .
Simplify Prohibited Transaction Exemption Procedures
22.
Simplify Prohibited Transaction Exemptions for SelfDirected ERISA Plans

19
19
21
22
23
24

25
27
28
29
30
31
32
32

STREAM LINE PENSION PLAN REPORTING AND DISCLOSURE
23.
Streamline ERISA Annual Report (Form 5500 Series)
24.
Provide Uniform Information Reporting Penalties
Simplify ERISA Advance Notice of Benefit Reductions
25.
26.
Streamline the ERISA Summary Plan Description Filing
Requirements

34
34
36
37

PREVENT LOSS OF BENEFITS
27.
Expand PBGe's Missing PartiCipant Program

39
39

OTHER PROPOSALS
28.
Miscellaneous Simplification Provisions
Elimination of Half-Year Requirements
Provide Consistent Treatment for Disabled Employees
Eliminate Unintended Cost of Reversions for Government
Contractors
Allow IRS to Determine Church Plan Status Under ERISA
Extend Date for Adoption of Plan Amendments

Simplifying Pensions

40
40
40
40

40
41
42

OVERVIEW

The most important job of our government in this new
era is to empower the American people to succeed in
the global economy. We've got to have a government
that can be a real partner in making this new economy
work for a/l of our people. We ought to foster more
savings and personal responsibility. "

President Clinton -- January 24, 1995
Introduction
In the twenty years since Congress enacted the Employee Retirement Income
Security Act of 1974 (ERISA) to protect the pension promises made to employees, the
pension laws and regulations have become extremely complicated. There are many
reasons: the desire of employers to have a high degree of flexibility in designing plans
that best suit their work force; policy decisions to try to ensure that all employees
receive similar tax and savings benefits from retirement plans as are available to
highly compensated employees and business owners; the need to prevent'specific
tax-shelter abuses; and limitations on penSion accumulations to raise revenue.
While each of these may be good causes, and the private sector pension system has
been greatly strengthened as a result of ERISA, the cumulative result -- together with
virtually annual legislative changes -- had been to raise compliance and
administrative costs to a level where many small employers, in particular, feel they
cannot offer retirement plans to their employees. For example, while 73% of full-time
workers in private firms with 1000 or more workers were covered by retirement plans
in 1993, only 24% of those in firms with fewer than 100 employees were covered.
It is time to cut through complex rules that are outmoded, redundant, or no longer
necessary to achieve policy goals. With these changes, more employers, both large
and small, can make the smart decision: to provide their employees with a simple,
tax-advantaged way to save for retirement. And, by reducing administrative
expenses, more of the money spent by employers to maintain pension plans can go to
benefits, rather than to lawyers, accountants, consultants and actuaries.

Simplifying Pensions

We can do this without opening the system to abuses or breaking the bank:
•

We can tell employers with 401 (k) plans that if they make a meaningful
contribution on behalf of each employee, or provide a smaller
contribution plus a significant match, we'll give them a safe harbor from
antidiscrimination testing that is so complex and expensive that the
federal government exempted its own pension plan from the
requirements.

•

We can make life even Simpler for the smallest employers - those with
100 or fewer employees. We can let them combine the advantages of
both IRAs and 401 (k) plans to provide a new, simple plan - we call it
the National Employee Savings Trust or NEST where no
discrimination testing is required, there are simple limits on contributions,
and employees manage their own accounts.

•

We can stop treating family employees like mere appendages of a
business owner, letting wives and husbands, and sons and daughters
who work hard in family businesses earn pension benefits of their own.

•

We can turn the seven-part definition of "highly compensated employee"
into a two-part definition that's so easy an employer could figure it out
without a lawyer or accountant.

•

We can get rid of a limit on contributions and benefits for employees who
have two types of plans with the same employer, leaving in place a
simpler rule enacted in 1986 to replace it. The limit is so complicated
that virtually no one computes it correctly.

•

We can reduce the application to defined contribution plans of rules
meant primarily for defined benefit plans. And we can reduce the
application to multiemployer plans of rules meant primarily for single
employer plans.

•

We can give employees of tax-exempt organizations the opportunity to
participate in the 401 (k) defined contribution plans available to other
employers.

•

We can make sure that all participants in pension plans will get the
benefits they have earned when their retire, even if their employer
terminates the plan -- or even goes out of business -- and the
employee has years to retirement.

Simplifying Pensions

•

We can repeal a provision of ERISA that requires employers to send us
copies of plan documents we simply warehouse - only to have us ask
them for another copy when an employee asks us for one!

These changes, and most of the other proposals in this report will require legislation.
However, over the years there has been strong bipartisan support in Congress for
pension simplification,. and we are hopeful that our sensible, cost-effective proposal will
be adopted.
But there is Simplification that we can do administratively too:
•

We can Significantly simplify both the content and the means of filing the
annual report that pension and health and welfare plans file with the
government to enable us to check compliance with the law.

•

We can make it much easier for plans to get permission to enter into
transactions that are in the best interest of the plan but that technically
are prohibited transactions.

•

We can make certain that employers don't have to send employees
duplicative notices or notices of plan changes that don't affect them.

Increasing the retirement income security of American workers is important, and
increasing retirement plan coverage and benefits is a logical and effective way for the
public and private sectors to work together with individual workers to achieve this goal.
The package we are presenting today is a cost-effective beginning. We intend to
continue to work with all concerned parties and with the Congress to ensure greater
simplification of our pension system and greater retirement income security for all
American workers.
Highlights of the High Priority Actions

Although this report proposes 28 High Priority Actions for pension simplification, six of
these actions are of particular importance in achieving the goals of simplification.

•

Offer the "National Employee Savings Trust" - NEST - A simplified pension
plan for small businesses
Small businesses are least able to deal with the complexity of current law, and
their employees are the least likely to be covered by a retirement plan today.
Therefore, we propose a new, simple retirement plan for employers with 100 or
fewer employees. As many as 15 million workers who have no employer

Simplifying Pensions

retirement plan could become eligible for the new plan, which would be known
as the National Employee Savings Trust, or "NEST."
The NEST would operate through individual IRA accounts for employees, and
would incorporate the most attractive features of the 401 (k) plan, the fastest
growing employer retirement plan in America today. By eliminating or greatly
simplifying many of the rules that apply to other qualified retirement plans,
including 401 (k)s, the NEST would remove the key obstacles that currently
deter many small employers from setting up retirement plans.
For example, for purposes of the NEST, this proposal would eliminate:
•

the special nondiscrimination test that applies to employees' 401 (k)
salary reduction contributions;

•

the special nondiscrimination test that applies to an employer's matching
contributions;

•

the top-heavy rules;

•

the limit on profit-sharing plan deductions; and

•

employers' reporting requirements.

The proposal would simplify:
•

the limits on contributions;

•

the rules governing employees' eligibility to participate; and

•

employers' disclosure requirements.

A NEST could provide for employer contributions and for 401 (k)-type

tax-

favored employee contributions by salary reduction. And employers could use
their contributions to encourage each of their employees to contribute by
offering to "match" employees' salary reduction contributions dollar-for-dollar
for the first 3% of employee compensation and at least 50 cents on each
contributed dollar for the next 2% of employee compensation. All NEST
contributions would be made to an IRA established for each participating
employee, and employers would contribute according to either of two "safe
harbor" formulas.

Simplifying Pensions

•

Provide a simplified, design-based alternative for 401 (k) defined
contribution plans, for all employers
The 401 (k) plan generally allows employees to contribute toward their
retirement savings on a tax-favored, salary reduction basis. These plans often
provide for the employer to make contributions that "match" the employee
contributions. Yet in order to ensure that lower paid workers get reasonable
contributions compared to those received by the highly paid, extensive and
often costly nondiscrimination tests apply.
We propose two important Simplifications to the complex nondiscrimination tests
that apply to 401 (k) plans. In addition, we would allow employers (regardless of
size) that sponsor 401 (k) plans to avoid the nondiscrimination tests altogether
by making the same type of safe harbor contributions that would apply to the
NEST.

•

Repeal the family aggregation rule and the combined limits on
contributions and benefits for those with multiple plans, and eliminate or
simplify other unnecessary or overlapping requirements
Repeal the family aggregation rule. We propose to repeal the so-called family
aggregation rule. Currently, multiple family members employed by the same
firm are penalized if one of them either owns 5% or more of the firm. or is one
of the ten highest paid employees. This unfairly prevents the family members
from receiving the full retirement benefits they could have if they were unrelated
employees. In addition, the family aggregation rule greatly complicates
nondiscrimination testing, particularly for family-owned or operated businesses.
Repeal the combined limit. We propose to repeal the excessively complex
"combined limit" that currently applies to an employee's contributions and
benefits when an employee participates in both a defined contribution plan and
a defined benefit plan of the same employer. The calculation of this limit -often referred to as section 415(e) of the Internal Revenue Code -- is
exceedingly cumbersome. It requires information concerning a plan
participant's entire work history, and it is commonly performed incorrectly. The
goals of the combined limit are already adequately met by an excise tax
enacted by Congress in 1986.
Simplify the definition of "highly compensated employee" to ease plan
administration. We also propose to simplify radically the definition of "highly
compensated employee." Virtually every nondiscrimination test for pension
plans (and health and welfare plans) involves identifying the employer's highly
compensated employees. This term is currently defined by reference to a

Simplifying Pensions

complicated seven-part test that considers pay for both the current and
preceding year. In addition, this test classifies many middle-income workers as
"highly compensated employees" who are, as a result, prohibited from receiving
better benefits.
Our proposal replaces the seven-part test with a simple two-part test: a highly
compensated employee would be anyone who either owns more than 5% of an
employer or is paid more than $80,000, based on pay in the prior year. The
$80,000 threshold would save many middle-income Americans from being
disadvantaged by nondiscrimination rules that were originally meant to help
them.
Exempt defined contrjbution plans from the minimum particjpation reQuirement.
Every qualified defined benefit plan and defined contribution plan currently must
cover at least 50 employees or, in smaller companies, 40% of all employees of
the employer. This minimum participation rule was generally intended to
prevent the use of individual defined benefit plans to give high paid employees
better benefits than those provided to others under a separate plan. Because
the abuses addressed by the rule are unlikely to arise in the context of defined
contribution plans, the rule adds unnecessary administrative burden and
complexity for those plans. We would repeal the requirement for defined
contribution plans.
•

Streamline Form 5500 reporting for all pension plans
Each year, over 750,000 pension and welfare benefit plans are required to file
the Form 5500 with the Internal Revenue Service (IRS). The form provides
detailed information concerning a plan's financial condition, funding, investments
and operations, and allows the pension enforcement agencies to evaluate
compliance with the complex pension rules. The form is filed and processed as
if it were a tax return, although it is an annual information report. In accordance
with a National Performance Review (NPR) recommendation, we propose to
significantly simplify and shorten the form and to develop software that will allow
plans to file the form electronically, using a self-editing program. The new form
will be available for public comment before the end of 1995 and completed
early in 1996. The revised filing .system will be implemented for 1996 plan
years, for which returns must be filed in July 1997.

•

Simplify and expedite the prohibited transaction exemption process
A "prohibited transaction" is generally any transaction between a plan and a
person who is considered a "party in interest" or a "disqualified person."
Prohibited transactions may trigger an excise tax and civil and criminal liability.

Simplifying Pensions

On the other hand, many transactions that are technically prohibited are
inconsequential or are completely consistent with a plan fiduciary's
responsibilities to participants, and so the Department of Labor (DOL) grants
exemptions in most cases. However, the current DOL process, which treats
each requested exemption as unique and entitled to all statutory procedural
protections, can take up to two years. We would, administratively, guarantee a
DOL response within 45 days for transactions DOL determined to be
substantially similar to exemptions previously granted to the same or other
plans. In addition, we would simplify the process for exempting another class
of prohibited transactions - - involving self-directed accounts - - that both the
IRS and DOL currently must act on, by designating DOL the primary decisionmaker and limiting the time within which the IRS must object or concur.
•

Expand the Pension Benefit Guaranty Corporation's missing participant
program to enable more of those promised a pension to get it, even if
their company goes out of business
Under the Retirement Protection Act, enacted in December, employers who are
terminating defined benefit plans guaranteed by the PBGe must register
"missing" participants - - participants the plan sponsor cannot locate, who have
often left the company's employment years earlier - - with the PBGe and either
transfer funds to the PBGe or purchase annuities for these participants.
Previously missing participants who learn of a plan's termination can then
contact the PBGC rather than having to trace the funds of an often-defunct
employer. In addition, the PBGC has developed a fairly effective system for
tracing such participants and providing them benefits. We propose to expand
this program to defined benefit plans (other than governmental plans) that are
not guaranteed by the PBGe and to defined contribution plans.

Simplifying Pensions

HIGH PRIORITY ACTIONS
SIMPLIFY PENSION PLANS FOB SMALL BUSINESS

1. The NEST -- A Simplified Plan for Small Business
Act;on: Create a new, Simple retirement savings plan targeted to small employers and
designed to encourage coverage of all employees. The new plan would be known as
the National Employee Savings Trust ("NEST').
Background: The administrative cost and complexity associated with traditional
qualified retirement plans often discourage small employers from sponsoring these
plans. For employers with few employees, the cost of maintaining the plan may even
exceed the benefits provided to employees. As a result, pension coverage of
employees of small employers is significantly lower than the pension coverage of
employees of larger employers. Existing plans deSigned for small employers are
generally perceived as overly complicated and impractical. Where these plans are
used, there is significant noncompliance with the statutory requirements.
Description: A NEST is a tax-favored retirement savings plan designed to provide
small employers with a simple, cost-effective means of providing a retirement plan for
their employees. It achieves these goals primarily by eliminating several complex
nondiscrimination tests that apply to traditional qualified plans and, instead, simply
requires an employer to make NEST contributions in accordance with one of two
specified plan designs. The key features of the NEST are:

•

Any employer with 100 or fewer employees would be eligible to maintain a
NEST.

•

Each employee, age 21 or older, who completed two years of service with the
employer would participate in the NEST. However, an employer would not be
required to make nonelective contributions for an employee with less than
$5,000 of compensation for the year.

•

The NEST would have to be designed to satisfy one of the following two
formulas:

Simplifying Pensions

(1)

The employer contributes at least 3% of pay for each eligible employee.
In addition employees may be given the opportunity to make salary
reduction (or "elective contributions.
ll

)

(2)

The employer contributes at least 1% of pay for each eligible employee.
In addition, employees must be given the opportunity to make elective
contributions. Employee elective contributions of up to 3% of
compensation must be matched by the employer dollar-for-dollar. The
employer match for elective contributions above 3% of compensation
(and up to 5% of compensation) must be at least 50 cents per dollar of
elective contributions. No employer matching contribution is allowed for
elective contributions in excess of 5% of compensation.

•

All contributions would be made to an IRA and would be immediately 100%
vested. However, withdrawal of any NEST contribution would be restricted for
two years.

•

An employee's annual elective contributions to a NEST would be limited to
$5,000. Employer nonelective contributions would be limited to 5% of an
employee's compensation (of up to $150,000). No other contribution or
deduction limits would apply to the NEST.

•

An employer would generally be allowed to make contributions for all
employees to the same financial institution. However, an employee could
subsequently move the NEST funds to an IRA at another financial institution.

•

NEST accounts would be portable -- NESTs could originate and receive
rollovers from any other IRA, and NESTs could receive rollovers from qualified
plans.

Simplifying Pensions

Repeal the Family Aggregation Rule

Action: Eliminate the rule that requires certain highly compensated employees and
their family members to be treated as a single employee.
Background: Under current law, if an employee is a family member of either a morethan-5% owner of the employer or one of the employer's 10 highest-paid highly
compensated employees, then any compensation paid to the family member and any
contribution or benefit under the plan on behalf of the family member is aggregated
with the compensation paid and contributions or benefits on behalf .of the highly
compensated employee. Therefore, the highly compensated employee and the family
member(s) are treated as a single highly compensated employee. For purposes of
this rule, an employee's "family member" is generally a spouse, parent, grandparent,
child, or grandchild (or the spouse of a parent, grandparent, child, or grandchild).

A similar family aggregation rule applies with respect to the $150,000 annual limit on
the amount of compensation that may be taken into account under a qualified plan.
(However, under these prOVisions, only the highly compensated employee's spouse
and children or grandchildren under age 19 are aggregated.)
These family aggregation rules greatly complicate the application of the
nondiscrimination tests, particularly for family-owned or operated businesses, and may
unfairly reduce retirement benefits for the family members who are not highly
compensated employees.
Description: The family aggregation rules would be repealed.

Simplifying Pensions

Eliminate Special Restrictions on Plans Maintained by the Self-Employed

~ct;on:

Eliminate the special plan aggregation rules that apply to certain qualified
employer retirement plans maintained by self-employed individuals.

Background: Prior to the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) ,
numerous special rules applied to qualified retirement plans that covered selfemployed individuals. Almost all of these special rules were repealed by TEFRA.
However, special aggregation rules that do not apply to other qualified retirement
plans still apply to qualified plans that cover an "owner-employee" (i.e., a sole
proprietor of an unincorporated trade or business or a more-than-10% partner of a
partnership). These aggregation rules generally require affected plans to be treated
as a single plan and affected employers to be treated as a single employer. For
example, under one of the special rules, if an owner-employee controls more than
one trade or business, then any qualified plans maintained with respect to those
trades or businesses must be treated as a single plan and all employees of those
trades or business must be. treated as employed by a single employer. The special
aggregation rules afford plan participants little, if any, protection because they are
largely duplicative of the general aggregation rules that apply to all qualified employer
plans, including plans that cover self-employed individuals.
DescriPtion: The special aggregation rules for qualified plans that cover owneremployees would be repealed.

Simplifying Pensions

. Simplify Substantial Owner Rules Relating to Plan Terminations

Action: Simplify the rules that phase in PBGC-guaranteed benefits for a "substantial
owner" who is a participant in a terminating plan.
Background: ERISA contains very complicated rules for determining the PBGC-

guaranteed benefits of an individual· who owns more than 10 percent of a business (a
"substantial owner") and who is a participant in the business's terminating plan. These
rules were designed to prevent a substantial owner from establishing a plan,
underfunding it, and terminating it in order to receive benefits from the PBGC. Under
the rules, the PBGC guarantee with respect to a participant who is not a substantial
owner is generally. phased in over five years from the date of the plan's adoption or
amendment. However, for a substantial owner, the guarantee is generally phased in
over thirty years from the date the substantial owner begins participation in the plan.
The substantial owner's benefit under each amendment within the 30 years before
plan termination is separately phased in. As a result, when a plan covering a
substantial owner is terminated, the PBGC must obtain plan documents from as long
as 30 years ago. This is frequently difficult if not impossible.
Description: The same five-year phase-in that currently applies to a participant who

is not a substantial owner would apply to a substantial owner with less than a 50%
ownership interest. For a substantial owner with a 50% or more ownership interest (a
"majority owner"), the phase-in would depend on the number of years the plan has
been in effect, rather than on the number of years the owner has been a participant.
Specifically, the guaranteeable plan benefit for a majority owner would be 1/30 for
each year that the plan has been in effect. (Benefits under plan amendments would
not be separately phased in.) Under this approach, the fraction would be the same for
each majority owner, eliminating the need for separate computations based on
documents as many as 30 years old. However, a majority owner's guaranteed benefit
would be limited so that it could not be more than the amount that would be
guaranteed under the regular five-year phase-in applicable to other participants.

Simplifying Pensions

IMPROYE AND EXPAND 401 (k) PLANS

Eliminate Uncertainty and Monitoring of Contributions Through DesignBased Safe Harbors

Actjon: Provide design-based nondiscrimination safe harbors that would give
employers the option of avoiding all ADP (actual deferral percentage) and ACP
(average contribution percentage) testing.

BackgrQund: The ADP test generally applies to the elective contributions (typically
made by salary reduction) of all employees eligible to participate in a 401 (k) plan. The
test requires the calculation of each eligible employee's elective contributions as a
percentage of the employee's pay. The ADP test is satisfied if the plan passes either
of the following two tests: (1) the average percentage of elective contributions for
highly compensated employees does not exceed 125% of the average percentage of
elective contributions for nonhighly compensated employees, or (2) the average
percentage of elective contributions for highly compensated employees does not
exceed 200% of the average percentage of elective contributions for nonhighly
compensated employees, and does not exceed the percentage for non highly
compensated employees by more than two percentage points. The ACP test is
almost identical to the ADP test, but generally applies to employer matching
contributions and after-tax employee contributions under any qualified employer
retirement plan.
The annual application of these tests, and correcting violations of these tests, is
complicated and often costly. Most cases require either constant monitoring and
adjustments of contributions over the course of the year Of complicated correction
procedures and information reporting after the end of the year.

DescriPtion: The proposal would provide two alternative "design-based" safe harbors.
If a plan were properly designed, the employer would avoid all ADP and ACP testing.
Under the first safe harbor, the employer would have to make nonelective
contributions of at least 3% of compensation for each nonhighly compensated
employee eligible to participate in the plan. Alternatively, under the second safe
harbor, the employer would have to provide a 100% matching contribution on an
employee's elective contributions up to the first 3% of compensation, and a match of
at least 50% (but no more than 100%) on the employee's elective contributions up to
the next 2% of compensation. The second safe harbor also would require the
employer to make a nonelective contribution of at least 1% of compensation for each
eligible nonhighly compensated employee.
Under both safe harbors, the nonelective employer contributions and the matching
employer contributions would be nonforfeitable immediately (Le., 100% vested) and

Simplifying Pensions

generally could not be distributed prior to the participant's death, disability, termination
of employment, or attainment of age 59 1/2. In addition, each employee eligible to
participate in the plan would have to be given notice of his or her rights and
obligations under the plan within a reasonable period before any year begins.

Simplifying Pensions

Facilitate Testing by Using Prior Year Data

l\ctioo: Adopt a look-back method for determining allowable contribution levels for
highly compensated employees in order to eliminate the need for on-going testing or
post-year-end corrections.
Background: The ADP test and the ACP test generally compare the average
contributions for highly compensated employees for the year to the average
contributions for nonhighly compensated employees for the same year. Because the
current year average for the nonhighly compensated employees is not known until the
end of the year, this almost always requires either constant monitoring and
adjustments over the course of the year or complicated correction procedures and
information reporting after the end of the year.
Description: To eliminate this unnecessary uncertainty and complexity, the proposal
would modify the ADP and ACP tests to require the average contributions for highly
compensated employees for the current year to be compared to the average
contributions for nonhighly compensated employees for the preceding year.

Simplifying Pensions

Improve Fairness of Corrective Distribution Rules

Action: Provide a method for correcting nondiscrimination test violations that does not
disproportionately favor the most highly compensated employees.
Background: Under current law, when the ADP or ACP test is violated, correction is
made by reducing the excess contributions of highly compensated employees
beginning with employees who have deferred the greatest percentage of pay. This
method illogically favors the most highly paid of the highly compensated employees:
their contributions, as a percentage of pay, are likely to be lower than the percentage
contributions of lower-paid highly compensated employees, even if the dollar amount
of their contributions is higher. For example, if an officer makes $65,000 and
contributes $5,000 (7.7% of pay), his contribution would be reduced before that of a
CEO who makes $150,000 and contributes $9,000 (6% of pay). In addition, it is
usually simpler to determine the total dollar amount contributed by an employee than
to determine what percentage of pay that dollar amount represents.
Descriptjon: The simplified correction method would require excess contributions to be
distributed first to those highly compensated employees who deferred the highest
dollar amount for the year. Under this method, the lower paid highly compensated
employees would no longer be disadvantaged by the correction method.

Simplifying Pensions

Permit Tax-Exempt Organizations to Maintain 401 (k) Plans

Action: Modify the tax law to delete the Code provision that prohibits organizations
exempt from income tax, including Indian tribes, from maintaining section 401 (k) plans.
Background: Except for certain plans established before July 2, 1986, "an organization
exempt from income tax is not allowed to maintain a 401 (k) plan. This rule prevents
many tax-exempt organizations from offering their employees retirement benefits on a
salary reduction basis. Although tax-sheltered annuity programs can provide similar
benefits, many types of tax-exempt organizations are also precluded from offering
those prog rams.
DescriPtion: The proposal would delete the Code provision that prohibits organizations
exempt from income tax, including Indian tribes, from maintaining 401 (k) plans.

Simplifying Pensions

Conform 401 (k) Distribution Rules for Rural Cooperatives

Action: Conform the distribution rules for 401 (k) plans maintained by rural
cooperatives with the distribution rules that apply to other 401 (k) plans.
Background: Under a 401 (k) plan, distributions are allowed only after separation from
service, death, disability, attainment of age 59 1/2, and certain other specified events.
However, 401 (k) plans maintained by rural electrical cooperatives or cooperative
telephone companies are money purchase pension plans. Therefore, in accordance
with the distribution restrictions generally applicable to pension plans, these plans
cannot allow distributions on account of a participant attaining age 59 1/2.
Description: The rules for 401 (k) plans of rural cooperatives would be conformed to
those that apply to other 401 (k) plans by allowing distributions after attainment of age
59 1/2. (Note: Proposal 28 would change the age 59 1/2 rule to an age 59 rule.)

Simplifying Pensions

SIMPLIFY PENSION RULES

Delete Unnecessary Tests and Special 'Rules
10. Eliminate Excessive Testing By Simplifying the Definition of UHighly
Compensated Employee"
Action: Simplify the definition of "highly compensated employee" that is used to test
qualified employer retirement plans for nondiscrimination.
Background: A qualified employer retirement plan must satisfy a variety of
nondiscrimination tests to ensure that it does not discriminate in favor of "highly
compensated employees." As a result, all of the nondiscrimination tests require the
employer to identify its "highly compensated employees." This term is currently
defined by reference to a complicated test that consists of seven major elements. An
employee is treated as a highly compensated employee for the current year, if, at any
time during the current year or the preceding year, the employee:

(1) owned more than 5% of the employer,
(2) received more than $100,000 (as indexed for 1995) in annual compensation from
the employer,
(3) received more than $66,000 (as indexed for 1995) in annual compensation from
the employer and was one of the top-paid 20% of employees during the same year,

or
(4) was an officer of the employer who received compensation greater than $60,000
(as indexed for 1995).
However, these four rules are modified by'three additional rules.
(5) An employee described in any of the last three categories for the current year but
not the preceding year is treated as a highly compensated employee for the current
year only if he or she was among the 100 highest paid employees for that year.
(6) No more than 50 employees or, if fewer, the greater of three employees or 10% of
employees are treated as officers.
(7) If no officer has compensation in excess of $60,000 (for 1995) for a year, then the
highest paid officer of the employer for the year is treated as a highly compensated
employee.

Simplifying Pensions

This test is not only complicated, it classifies many middle-income workers as "highly
compensated employees" who are then prohibited from receiving better benefits than
others.
Description: The current seven-part test would be replaced by a simplified two-part
test: an employee would be a "highly compensated employee" for the current year
only if the employee owned more than 5% of the employer during the current or
preceding year or had compensation from the employer of more than $80,000
(indexed annually for cost of living) during the preceding year. This dollar threshold
would mean that many middle-income Americans would no longer be subject to
nondiscrimination restrictions.

Simplifying Pensions

11.

Exempt Defined Contribution Plans from the Minimum Participation Rule

Action: Eliminate the requirement that a defined contribution plan cover at least 50
employees or, in smaller companies, 40% of all employees of the employer.
Background: Under current law, every qualified defined benefit plan or defined
contribution plan is required to cover at least 50 employees or, in smaller companies,
40% of all employees of the employer. This rule was generally intended to prevent an
employer from establishing individual defined benefit plans for highly compensated
employees in order to provide those employees with more favorable benefits than
those provided to lower paid employees under a separate plan. The rule prevents an
employer from favoring one small group of participants over another by, for example.
covering them under two separate plans and funding one plan better than the other.

As applied to defined contribution plans, the minimum participation rule adds
complexity for employers without delivering commensurate benefits to the system.
•

The 50 employee/40% rule currently acts as a largely redundant backstop to
the nondiscrimination rules designed to prevent qualified retirement plans from
unduly favoring the top group of employees. Since 1986. when the minimum
participation rule was enacted (along with other. more extensive
nondiscrimination requirements), regulations have further limited the potential
for discriminatory practices that originally caused the minimum participation rule
to be applied to plans other than individual defined benefit plans.

•

All defined contribution plans are generally fully funded and, therefore, there is
no risk that an employer will favor participants in one plan over participants in
another by providing more favorable funding.

Thus, the abuses intended to be addressed by the minimum participation requirement
are unlikely to arise in tha context of defined contribution plans. This requirement
adds unnecessary administrative burden and complexity with respect to these plans.
DescriPtion: The minimum participation rule would be repealed for defined
contribution plans.

Simplifying Pensions

12.

Eliminate Special Vesting Schedule for Multiemployer Plans

AcUoo: Eliminate the 10-year vesting schedule currently allowed only for
multiemployer plans, so that multiemployer plans will be subject to the same 5- or 7year vesting schedules as all other qualified employer retirement plans.
Background: The accrued benefits of a collectively bargained employee under a
multiemployer pension plan are not currently required to become nonforfeitable (Le.,
."vested") until the employee has completed 10 years of service. If the employee's
employment terminates before then, all benefits can be lost. Accrued benefits of all
other employees (i.e., employees under all non-multiemployer plans and any
noncollectively bargained employees under a multiemployer plan) must vest after five
years of service, or after seven years if partial vesting begins after three years.
DescriPtioa The special 10-year vesting rule applicable to multiemployer plans would
be repealed.

Simplifying Pensions

13.

Allow Triennial Actuarial Valuations for Multiemployer Plans

Action: Allow multiemployer plans to return to triennial. rather than annual. actuarial

valuations.
Background: An employer's annual deduction for contributions to a defined benefit
plan is generally limited to the amount by which 150% of the plan's current liability (or,
if less. the plan's accrued liability) exceeds the value of the plan's assets. Because
the annual calculation of the 150% limit requires an actuarial valuation. defined benefit
plans are required to have an actuarial valuation no less frequently than annually.
However. under a separate proposal (see proposal 18). the 150% limit would be
eliminated for multiemployer plans and. therefore, annual valuations would be
unnecessary and overly burdensome for these plans.
DeScription: Actuarial valuations would be required no less frequently than every three
years. rather than annually, for multiemployer plans.

Simplifying Pensions

14.

Eliminate Partial Termination Rules for Multiemployer Plans

Action: Eliminate the partial termination rules for multiemployer plans.
Background: When a qualified employer retirement plan is terminated, all plan
participants are required to become 100% vested in their accrued benefits to the
extent those benefits are funded. In order to prevent an employer from evading this
rule simply by amending the plan to exclude nonvested employees or by laying off
nonvested employees before terminating the plan, a qualified employer retirement plan
must also provide that, upon a "partial termination," all affected employees must
become 100% vested in their benefits accrued to the date of the termination, to the
extent the benefits are funded.

Whether a partial termination has occurred in a particular situation is generally based
on the specific facts and circumstances of that situation, including the exclusion from
the plan of a group of employees who have previously been covered by the plan, by
reason of a plan amendment or severance by the employer. In addition, if a defined
benefit plan stops or reduces Mure benefit accruals under the plan, a partial
termination is deemed to occur if, as a re~ult, a potential reversion of plan assets to
the employer is created or increased.
Over the years, court decisions have left unanswered many key questions as to how
to apply the partial termination rules. Accordingly, .applying the rules can often be
difficult and uncertain, especially for multiemployer plans. For example, multiemployer
plans experience frequent fluctuations in partiCipation levels caused by the
commencement and completion of projects that involve Significant numbers of union
members. Many of these terminated participants are soon rehired for another project
that resumes their active coverage under the plan. In addition, it is common for
participants leaving one multiemployer plan's coverage to maintain service credit under
a reciprocal agreement if they move to the coverage of another plan sponsored by the
same union. As a result, these partiCipants do not suffer the interruption of their
progress along the plan's vesting schedule that ordinarily occurs when an employee
stops being covered by a plan.
Given these factors, and the related proposal to require multiemployer plans to vest
participants after five (instead of the current 10) years of service, the difficulties
associated with applying the partial termination rules to multiemployer plans outweigh
the benefits.
DescriPtion: The requirement that affected participants become 100% vested in their
accrued benefits (to the extent funded) upon the partial termination of a qualified
employer retirement plan would be repealed with respect to multiemployer plans.

Simplifying Pensions

Simplify Rules Governing Contributions and Deductions
15.

Eliminate the Combined Plan Limit on Contributions and Benefits (Section
41S(e»

Action: Repeal the extremely complex combined limit on contributions and benefits
that apply when an employee is covered under both a defined contribution plan and a
defined benefit plan of the same employer.
Background: An employee who participates in a qualified defined benefit plan and a
qualified defined contribution plan of the same employer must currently satisfy a
combined plan limit. This limit is satisfied if the sum of the "defined benefit fraction"
and the "defined contribution fraction" is no greater than 1.0.

The defined benefit fraction measures the portion of the maximum permitted defined
benefit that the employee actually uses. The numerator is the projected normal
retirement benefit, and the denominator is generally the lesser of 125% of the dollar
limitation for the year ($120,000 for 1995), or 140% of the employee's average
compensation for the three years of employment in which the employee's average
compensation was highest.
The defined contribution fraction measures the portion that the employee actually uses
of the maximum permitted contributions to a defined contribution plan for the
employee's entire career with the employer. The numerator is generally the total of
the contributions and forfeitures allocated to the employee's account for each of the
employee's years of service with the employer. The denominator is the sum of a
calculated value for each of those years of service. The calculated value is the lesser
of 125% of the dollar limitation for that year of service ($30,000 for 1995), or 35% of
the participant's compensation. Because of the historical nature of this fraction, its
computation is extremely cumbersome and requires the retention of various data for
an employee's entire career.
The combined plan limit is not the only Code provision that safeguards against an
individual accruing excessive retirement benefits on a tax-favored basis. There are
maximum limits for both defined benefit and defined contribution plans. In addition, a
15% "excess distribution" penalty was enacted in 1986 to achieve many of the same
goals as the combined plan limit. A distribution is generally considered an "excess
distribution" to the extent all distributions to an individual from all of the individual's
qualified employer plans and IRAs exceed $150,000 during a calendar year. The limit
is $750,000 for a lump sum distribution. Excess distributions made after death are
subject to an additional estate tax of 15%. Other rules also protect against excessive
benefits.

Simplifying Pensions

Because other provisions of the Code go far toward ensuring that an individual cannot
accrue excessive retirement benefits on a tax-favored basis, the extreme complexity
of the combined plan limit is not justified.
DescripUQo: The combined plan limit (Code section 415(e)) would be repealed.

Simplifying Pensions

16.

Simplify Contributions and Benefits Limits for Governmental Plans and
Multiemployer Plans

Action: Exempt governmental plans and multiemployer plans from certain limitations
on benefits and contributions.
Background: Annual additions to a defined contribution plan for any participant are
limited to the lesser of $30.000 (for 1995) or 25% of compensation. Annual benefits
payable under a defined benefit plan are limited to the lesser of $120.000 (for 1995) or
100% of "three-year-high average compensation." If benefits under a defined benefit
plan begin before social security retirement age. the dollar limit must be reduced.
Reductions in the dollar or percentage limit may also be required if the employee has
fewer than 10 years of plan partiCipation or service. Certain special rules apply to
governmental plans.

These qualified plan limitations are uniquely burdensome for governmental plans,
which have long-established benefits structures and practices that may conflict with
the limitations. In addition. some state constitutions may prohibit the changes needed
to conform the plans to these limitations.
These limitations also present problems for many multiemployer plans. These plans
typically base benefits on years of credited service, not on a participants
compensation. In addition. the 100%-of-compensation limit is based on an
employee's average compensation for the three highest consecutive-years. This rule
often produces an artifiCially low limit for employees in certain industries, such as
building and construction. where wages vary significantly from year to year.
Description: The rules for governmental plans and multiemployer plans would be
modified to eliminate the 100-percent-of-compensation limit (but not the $120,000
limit) for such plans. and to exempt certain survivor and disability benefits from the
adjustments for early commencement and for participation and service of less thaf'l 10
years. In addition, certain employee salary reduction contributions could be counted
as "compensation" for purposes of applying the limitations on benefits and
contributions. To the extent that governmental employers have previously made
elections that would prevent them from utilizing these Simplification prOVisions, the
proposal would allow those employers to revoke their elections.

Simplifying Pensions

17.

Allow Tax-exempt Organizations to Provide Excess Benefit Plans

AcUQo: Exempt "excess benefit plans" from the restrictions on nonqualified deferred
compensation provided under section 457 of the Code.
BackgrQund: The amount of compensation provided to an employee under a
nonqualified deferred compensation arrangement maintained by a for-profit
organization generally is not subject to any limitation. In addition, such deferred
compensation is not taxable to the employee until it is paid or otherwise made
available to the employee to draw upon at any time.

In contrast, with few exceptions, section 457 of the Code subjects all nonqualified
deferred compensation arrangements maintained by state and local governments and
tax-exempt organizations to special, more restrictive rules. First, the amount deferred
for any participant under such arrangements must generally be limited to $7,500 per
year. Second, if this dollar limit and other restrictions are not satisfied, the deferred
compensation is taxed to the participant in the first taxable year in which the
compensation is not subject to a substantial risk of forfeiture, even if the compensation
is not paid or otherwise made available to the participant until a later date.
An "excess benefit plan" is a nonqualified deferred compensation plan maintained by
an employer solely for the purpose of providing benefits for certain employees in
excess of the limitations on annual contributions and benefits imposed by section 415
of the Code (Le., the lesser of $30,000 or 25% of compensation for a defined
contribution plan, and the lesser of $120,000 or 100% of compensation for a defined
benefit plan). If an employee's qualified plan contributions or benefits exceed these
limits, an excess benefit plan may provide the excess contributions or benefits on a
nonqualified basis. Thus, an excess benefit plan simply provides to certain employees
-- those whose contributions or benefits are reduced by the limits - contributions or
benefits that are already provided to other employees under a qualified plan.
However, even though there is no opportunity under an excess benefit plan to provide
management employees with disproportionately higher benefits than those provided to
lower paid employees, the restrictions of section 457 still apply to such a plan if it is
maintained by a state and local government or tax-exempt organization. These
employers are therefore at a distinct disadvantage in attempting to provide all
employees with proportionate contributions or benefits.

Description: The proposal would exempt excess benefit plans of state and local
governments and tax-exempt organizations from section 457. The exemption would
not apply to an excess benefit plan that also provides benefits in excess of other
qualified plan limitations.

Simplifying Pensions

18.

Simplify Deduction Rules for Multiemployer Plans

Actjon: Repeal the 150% limitation on deductible contributions for multiemployer

plans.
Background: An employer's annual deduction for contributions to a defined benefit
plan is generally limited to the amount by which 150% of the plan's current liability (or,
if less, 100% of the plan's accrued liability) exceeds the value of the plan's assets.
The 150%-of-current-liability limit is intended to limit the extent to which an employer
can deduct contributions for liabilities that have not yet accrued.

However, an employer has little, if any, incentive to make "excess" contributions to a
multiemployer plan. The amount an employer contributes to a multiemployer plan is
fixed by the collective bargaining agreement, and a particular employer's contributions
are not set aside to pay benefits solely to the employees of that employer. Moreover,
no reversions are permitted from multiemployer plans.
Description: Because the 150% limit on deductible contributions needlessly

complicates the deduction rules for multiemployer plans. the 150% limit would be
eliminated for those plans. Therefore. the annual deduction for contributions to a
multi employer plan would be limited simply to the amount by which the plan's accrued
liability exceeds the value of the plan's assets.

Simplifying Pensions

Eliminate and Simplify Rules Governing Distributions
19.

Repeal Rule Requiring Employer Plans to Commence Minimum
Distributions Before Retirement

Action: Eliminate the requirement that distributions from a qualified employer plan to
an employee (other than a more-than-5% owner) who continues to work for the
employer maintaining the plan must begin at age 70 1/2.
Background: Under current law, an employee who participates in a qualified employer
retirement plan must begin taking distributions of his or her benefit by the April 1
following the year in which he or she reaches age 70 1/2. Generally, the so-called
"minimum distribution" for any year is determined by dividing the employee's account
balance or accrued benefit by the employee's life expectancy as of that year. If the
employee is still working and accruing new benefits at age 70 1/2, the new benefits
must be taken into account to determine the minimum amount required to be
distributed for the same year. In effect, a portion of each year's new benefit accrual is
required to be distributed in the same year. This almost simultaneous pattern of
contributions and required distributions causes considerable complication and
confusion.
Description: The requirement to distribute benefits before retirement would be
eliminated, except for employees who own more than 5% of the employer that
sponsors the plan. Instead, distributions would have to begin by the April 1 following
the later of the year in which the employee reached age 70 1/2 or the year in which
the employee retired from service with the employer maintaining the plan. If payment
of an employee's benefits were delayed past age 70 1/2 pursuant to this rule, the
benefits ultimately paid at retirement would have to be actuarially adjusted to take into
account the delay in payment. Without this adjustment, the delay in payment could
cause the employee to "lose" the benefit payments that would otherwise have been
paid between age 70 1/2 and retirement.
The age 70 1/2 requirement would continue to apply to IRAs. Because an IRA is not
maintained by an employer, the initial payment date for an IRA cannot be tied to
retirement from the employer maintaining the plan. (Note: Proposal 28 would change
the age-70 1/2 rule to an age-70 rule.)

Simplifying Pensions

20.

Simplify Taxation of Annuity Distributions

Action: Replace the existing multiple and complex rules for calculating the taxable
portion of an annuity payment with a single, simplified method that is currently allowed
as an alternative method.
Background: If an employee makes after-tax contributions to a qualified employer
retirement plan or IRA, those contributions (i.e., the employee's "basis") are not taxed
upon distribution. When the plan distributions are in the form of an annuity, a portion
of each payment is considered nontaxable basis. This nontaxable portion is
determined by multiplying the distribution by an exclusion ratio. The exclusion ratio
generally is the employee's total after-tax contributions divided by the total expected
payments under the plan over the term of the annuity.

The determination of the total expected payments, which is based on the type of
annuity being paid, often involves complicated calculations that are difficult for the
average plan participant. Yet the burden of determining the exclusion ratio almost
always falls on the individual receiving the distribution.
Because of the difficulty an individual may face in calculating the exclusion ratio, and
in applying other special tax rules that may be applicable, the IRS in 1988 provided a
Simplified alternative method for determining the nontaxable portion of an annuity
payment. However, this alternative has effectively added to the existing complexity
because taxpayers feel compelled to calculate the nontaxable portion of their
payments under every possible method in order to ensure that they maximize the
nontaxable portion.
Description: A simplified method for determining the nontaxable portion of an annuity
payment, similar to the current Simplified alternative, would become the required
method. Taxpayers would no longer be compelled to do calculations under multiple
methods in order to determine the most advantageous approach.

Under the simplified method, in most cases, the portion of an annuity payment that
would be nontaxable is generally equal to the employee's total after-tax employee
contributions, divided by the number of anticipated payments listed in a table (based
on the employee's age as of the annuity starting date).

Simplifying Pensions

IMPROYE ADMINISTRATION OF PROHIBITED TRANSACTION RULES

21.

Simplify Prohibited Transaction Exemption Procedures

Action: Develop a prohibited transaction class exemption that would allow the DOL to
expeditiously process exemption requests that involve prohibited transactions
substantially similar to those described in individual exemption previously granted to
the same or another plan.
Background: A "prohibited transaction" is generally any transaction between a plan
and a person who is considered a "party in interest" or "disqualified person" with
respect to the plan. Unless exempt by statute or by an "individual" or "class"
exemption, a prohibited transaction may trigger an excise tax under the Code, and
may give rise to civil or criminal liability under ERISA. The DOL generally has
authority to exempt any person or transaction, or class of persons or transactions,
from the prohibited transaction rules under both the Internal Revenue Code and
ERISA.

Under the statute, an exemption may not be granted unless the DOL finds that the
exemption is: (') administratively feasible, (2) in the interests of the plan and of its
participants and beneficiaries, and (3) protective of the rights of participants and
beneficiaries of such plan. In addition, notice of a proposed exemption must be
published ·in the Federal Register, and interested parties must be notified of the
proposed exemption and be given an opportunity to comment and a hearing to
present their views. Under these mandatory procedures, it can take up to two years
to obtain an individual exemption.
Description: A class exemption, to be developed by the DOL would exempt all
transactions that the DOL determined to be substantially similar to previously granted
individual exemptions. For transactions within its scope, the class exemption would
guarantee a DOL response within 45 days.

Simplifying Pensions

22.

Simplify Prohibited Transaction Exemptions for Self-Directed ERISA Plans

Action: Simplify the prohibited transaction exemption procedures for plans with
participant-directed accounts ("404(c) plans").
Background: ERISA sets forth certain fiduciary responsibilities that apply with respect
to pension plans. For this purpose, a fiduciary includes, among others, any person
who exercises any discretionary control respecting the management or disposition of
plan assets. However, ERISA section 404(c) generally provides that, if a plan
participant exercises control over assets in his or her account,· the participant will not
be deemed to be a fiduciary by reason of the exercise of such control, and no person
who is otherwise a fiduciary will have fiduciary liability as a result of the participant's
exercise of control. Because of this exemption, a participant's direction of the
investment of his or her account will not give rise to a prohibited transaction under
ERISA. Such participant direction may, however, give rise to a prohibited transaction
under the Code.

Reorganization Plan No. 4 of 1978 generally provides the DOL with authority to grant
exemptions from the prohibited transaction provisions of both ERISA and the Code.
However, the Reorganization Plan also provides that, with respect to transactions that
are exempt from ERISA's prohibited transaction provisions pursuant to ERISA section
404 (c) , the Secretary of Treasury has the authority to grant exemptions from the
prohibited transaction provisions of the Code. As a result, if a 404(c) plan wishes to
take advantage of a DOL prohibited transaction class exemption, the 404(c) plan must
apply to the IRS for an exemption from the prohibited transaction provisions of the
Code, whereas a non-404(c) plan can rely on the DOL class exemption with respect
to both the ERISA and Code prohibited transaction rules. A similar issue arises with
respect to individual exemptions as well.
The DOL has developed significant prohibited transaction exemption expertise since
the effective date of the Reorganization Plan. Therefore, in the vast majority of cases,
it is inefficient and needlessly time-consuming for the IRS to process these exemption
requests.
Description: The IRS would issue a class exemption that would provide a prohibited
transaction exemption for all transactions under a 404(c) plan for which the DOL has
granted a class exemption, unless the IRS notified the DOL otherwise within a
prescribed time after being notified that the DOL's class exemption was pending. The
IRS class exemption would also provide an exemption for any transaction under a
404(c) plan for which the DOL has granted an individual exemption, but only if the IRS
explicitly concurred with the individual exemption within a prescribed time.

Simplifying Pensions

STREAMLINE PENSION PLAN REPORTING AND DISCLOSURE

23.

Streamline ERISA Annual Report (Form 5500 Series)

Act;oa: Streamline the Form 5500 Series annual reporting requirements for employee
benefit plans, and pursue methods for simplifying and expediting the receipt and
processing of Form 5500 information and data through the use of advanced computer
technologies.
Background: Each year, over 750,000 pension and welfare benefit plans are required
to file an annual return/report (the Form 5500 Series) regarding their financial
condition, investments, and operations. The Form 5500 series was developed by the
DOL, PBGC, and IRS (the UAgencies") to enable employers and plan administrators to
satiSfy their statutory annual reporting obligations under Titles I and " of ERISA and
the Internal Revenue Code by filing a single form. The Form 5500 Series is the
primary source of information concerning the operation, funding, assets, and
investments of pension and other employee benefit plans. Accordingly, the Form
5500 Series is not only an important enforcement and research tool for the Agencies,
but a source of information and data utilized by other federal agencies, Congress, and
the private sector in assessing employee benefit, tax, and economic trends and
policies. The Form 5500 Series is currently received and processed by the IRS
through three designated IRS Service Centers.

The Agencies recognize that compliance with Form 5500 Series annual reporting
requirements is a lengthy and complex process, resulting in the imposition of
approximately 35 million burden hours on the universe of filers annually. The
AgenCies also recognize that the receipt and processing of the Form 5500 Series
through the systems established for the receipt and processing of tax returns results in
compliance and processing inefficiencies and delays. Currently, it costs the Agencies
approximately $22 million annually to receive and process Form 5500 Series reports.
In an effort to both reduce reporting burdens and facilitate annual reporting
compliance, the Agencies are attempting to substantially simplify the Form 5500
Series. The Agencies are also examining ways by which to simplify and expedite the
receipt and processing of the Form 5500 Series, while substantially reducing filer
compliance burdens and government processing costs, through the use of an
electronic filing system and government-provided personal computer software.
The Agencies believe that meaningful burden hour and cost reductions can be
achieved only through an integrated implementation of changes to both the Form 5500
Series and the processing system. The National Performance Review (NPR)
determined that manual preparation and processing of the Form 5500 Series are
time-consuming and costly to the federal government and filers alike. The NPR
concluded that an automated processing system, with the availability of personal

Simplifying Pensions

computer software for the preparation and filing of the Form 5500 Series, should
reduce filer costs of preparing forms. and government processing costs, while
enhancing the government's ability to protect the benefits of American workers as a
result of more timely and accurate information.
Description: The current Form 5500 Series would be significantly revised to
streamline or eliminate certain information that the Agencies determine is not required
to discharge their statutory responsibilities. Following development of a revised Form
5500 Series, the Agencies would pursue establishment of an automated filing system
for receipt and processing of Form 5500 Series information and data, as well as
computer software to be made available for Form 5500 Series filers.

Simplifying Pensions

24.

Provide Uniform Information Reporting Penalties

Action: Conform the penalties for failure to provide information reports with respect to
pension payments with the general penalty structure for failure to provide information
returns under the Code.
Background: The penalty structure for failure to provide information reports with
respect to pension payments is currently separate and different from the penalty
structure that applies to information reporting in other areas. The penalty for failure to
file a Form 1099-R is currently $25 per day per return, up to a maximum of $15,000
per year per return. The penalty for failure to file Form 5498 is currently a flat $50 per
return, with no maximum, regardless of the number of returns.

In contrast, the penalty for failure to file any other information return is generally $50
per return up to $250,000 per year, with lower penalties and maximums if the return is
filed within speCified times. (The penalty is $15 per return filed late but within 30 days
and $30 per return filed late but on or before August 1.) Lower maximums also apply
to persons with gross receipts of no more than $5 million. The penalty for failure to
furnish a payee statement is $50 per payee statement up to $100,000 per year.
Separate penalties apply in the case of intentional regard of the requirement to furnish
a payee statement.
Description: In order to provide uniformity, the penalties for failure to provide
information reports with respect to pension payments would be conformed to the
general penalty structure .. Thus, the penalty for failure to file Form 1099-R would
generally be reduced. The penalty for failure to file Form 5498 would generally remain
the same as under current law, but would no longer be unlimited. In addition, for both
Form 1099-R and Form 5498, the penalties would be reduced if the forms were filed
late but within speCified times. Under the conformed penalty structure, the penalty for
failure to file Form 1099-R would generally be reduced for any return that was late by
more than two days.

Simplifying Pensions

25.

Simplify ERISA Advance Notice of Benefit Reductions

Action: Issue administrative guidance stating that the statutory 15-day advance notice
of plan amendments significantly reducing the rate of future benefit accrual need not
be given to any person who will be unaffected by the reduction.
Background: ERISA (section 204(h» provides that a pension plan may not be
amended to significantly reduce the rate of future benefit accrual unless the plan
administrator provides a written notice to participants, certain persons entitled to plan
benefits under a domestic relations court order, and any union representing plan
participants. The notice is required to set forth the plan amendment and its effective
date, and must be provided after the amendment has been adopted but not less than
15 days before its effective date. Concerns have been expressed about the risk that
the statute might be interpreted to require that notice of an amendment affecting only
certain employees be provided to all participants, including retirees, terminated vested
employees, and other classes of participants who would clearly be unaffected by the
amendment but who might be confused or inappropriately alarmed if they received the
notice.

The notice requirement originated in a legislative proposal to require notice of a
complete cessation of benefit accrual ("freezing" a plan). It was subsequently
expanded to cover significant reductions in the rate of accrual.
A pension plan termination includes, and goes beyond, a complete cessation of benefit
accruals. ERISA requires an employer terminating a plan covered by PBGC insurance
to give 60-day advance notice to participants of the employer's intent to terminate. In
this case, the additional 1S-day advance notice of a reduction in benefit accruals is
redundant.
Description: Treasury/IRS would issue administrative guidance making clear that the
ERISA notice is not required to be given to any individual who will be unaffected by
the plan amendment. The guidance would also state that the notice is not required
when a plan covered by PBGC insurance issues a notice of intent to terminate in
accordance with ERISA's plan termination requirements. In addition to addressing
other issues relating to the ERISA notice, the guidance would clarify that, pursuant to
the terms of the statute, the notice is required only for reductions in the rate of benefit
accrual.

Simplifying Pensions

26.

Streamline the ERISA Summary Plan Description Filing Requirements

Actjon: Eliminate the requirement that all summary plan descriptions (SPDs) be filed
with the DOL, and authorize the DOL to obtain SPDs from plan administrators for
purposes of responding to individual requests or monitoring compliance.
Background: Under ERISA, administrators of employee pension and welfare benefit
plans are required to furnish each partiCipant and beneficiary with an SPD, summaries
of material modifications to the SPD (SMMs), and, at specified intervals, an updated
SPD. Filed SPDs, SMMs, and updated SPDs are required to be made available for
public disclosure. These requirements are administered by the DOL's Pension and
Welfare Benefits Administration (PWBA). The SPD is intended to provide partiCipants
and beneficiaries with important information concerning their plan, the benefits
provided by the plan, and their· rights and obligations under the plan. The primary
purpose of having SPDs filed with the DOL is to have them available for participants
and beneficiaries who are unable or reluctant to request them from their plan
administrators. However, because SMMs are not required to be filed with DOL until
210 days after the end of the plan year, there is little, if any, certainty that the SPD
information on file with the DOL at any given point in time is up-to-date.

PWBA annually receives approximately 250,000 SPD and SMM filings. Although
PWBA's cost for maintaining a filing, storage, and retrieval system for SPDs is
relatively small, approximately $52,000 annually, compliance with the SPD filing
requirements costs plan administrators approximately $2.5 million annually, with the
annual imposition of an estimated 150,000 burden hours. On average, PWBA
receives requests annually for about two percent of the filed SPDs. Many of the
requests for SPDs come from researchers and others who are not plan participants
and beneficiaries. While there is some limited benefit from the federal government
receiving and storing SPDs, the costs to the public and private plan administrators
clearly outweigh the benefits. This conclusion is consistent with the findings of the
National Performance Review.
Description: The proposal would amend ERISA to eliminate the requirement that all
SPDs be filed with the DOL, and would authorize the DOL to obtain SPDs from plan
administrators for purposes of responding to individual SPD requests or monitoring
compliance with the SPD requirements. This approach would substantially reduce
costs and burdens for public and private plan administrators, while preserving the
ability of the DOL to assist participants who are unable or reluctant to request SPDs
from their plan administrators.

Simplifying Pensions

PREVENT LOSS OF BENEFITS
27.

Expand PBGe's Missing PartiCipant Program

ActiQn: Extend the miSSing participant program to be established by the PBGe to
defined benefit plans not covered by the PBGC and to defined contribution plans.
Background: When a qualified employer retirement plan is terminated, there may be
plan participants who cannot be located after a diligent search. If the plan is a defined
benefit plan covered by the PBGe, the plan administrator must generally distribute
plan assets by purchasing irrevocable commitments from an insurer to satisfy ail
benefit liabilities. If the plan is a defined contribution plan or other plan not covered by
the PBGe. plan assets still must be distributed to participants before the plan is
considered terminated.

Because of the problems that a plan administrator may face under these rules when
plan partiCipants cannot be located, the Retirement Protection Act (RPA). enacted as
part of the General Agreement on Tariffs and Trade (GATT) in 1994. provided special
rules for the payment of benefits with respect to missing participants under a
terminating plan. The rules require the plan administrator to (1) transfer the missing
participant's designated benefit to the PBGe or to purchase an annuity from an insurer
to satisfy the benefit liability, and (2) provide the PBGe with information and
certifications with respect to the benefits or annuity as the PBGe may specify. These
rules will be effective after final regulations to implement them are adopted by the
PBGe.
As currently enacted, these RPA rules would apply only to defined benefit plans that
are covered by PBGe. Yet other defined benefit plans, as well as defined contribution
plans, face similar problems when they terminate.
Description: The PBGC's program for missing participants would be expanded to
defined benefit plans (other than governmental plans) not covered by the PBGe and
to defined contribution plans (other than governmental plans). This would provide
employers with a uniform method of dealing with missing participants, and would
provide missing participants with a central repository location for locating their benefits
once a plan has been terminated.

Simplifying Pensions

OTHER PROPOSALS
28.

Miscellaneous Simplification Provisions

•

Elimination of Half-Year Requirements
Background: Distributions from qualified plans and IRAs prior to age 59 1/2 are
subject to a 10% penalty. In addition, under certain plans (such as 401 (k)
plans), distributions before age 59 1/2 are generally prohibited. Minimum
distributions from IRAs and qualified employer plans are required to begin upon
attainment of age 70 1/2. (Note: Proposal 19 would eliminate the requirement
that distributions from qualified employer plans begin by age 70 1/2 for
employees, other than more-than-5% owners, who have not yet retired.)
Description: To simplify these prOVisions, all references to age 59 1/2 would be
changed to age 59, and all references to age 70 1/2 would be changed to age
70.

•

provide Consistent Treatment for Disabled Employees
Background: An employer may elect to continue making deductible
contributions to a defined contribution plan on behalf of disabled employees
who are not highly compensated.
Description: In order to simplify the rules for disabled workers and to
encourage contributions for disabled workers, the need for an employer to
make an election would be eliminated and plans would generally be allowed to
provide for contributions for disabled highly compensated employees, as well as
for disabled nonhighly compensated employees.

•

Eliminate Unintended Cost of Reversions for Goyernment Contractors
Background: If a pension plan terminates and "excess assets" revert back to
the employer, that reversion is subject to an excise tax as high as 50%.
However, certain government contracting regulations require that a portion of
any reversion from a plan maintained by a government contractor be paid to the
United States. The portion paid to the United States is nevertheless subject to
the reversion excise tax. Because the excise tax was intended to apply only to
amounts received by the employer, government contractors that face plan
terminations may experience unintended and unreasonably high costs.

Simplifying Pensions

Description: Amounts that are required to be repaid to the United States by
reason of the applicable government contracting regulations would be exempt
from the reversion excise tax.

•

Allow IRS to Determine Church Plan Status Under ERISA
Background: An employer retirement plan that satisfies the definition of a
"church plan" under ERISA is generally exempt from Title I of ERISA. An
employer retirement plan that satisfies a very similar definition of a "church
plan" under the Internal Revenue Code is exempt from certain current Code
requirements, such as current-law minimum coverage and vesting. However,
under the Code, a church plan can make an election to be subject to these
requirements. A plan that makes such an election is no longer exempt from
ERISA.

As a result of these rules, a plan that wishes to be sure of its status as a
church plan must currently seek both a private letter ruling from the IRS (which
requires a user fee) and an advisory opinion from the DOL The DOL begins its
review only after the plan obtains a private letter ruling. However, despite the
similarity of the ERISA and Code definitions of "church plan, there is room for
disagreement between the DOL and the IRS. If the DOL requires a church
plan to be modified in order to satisfy the ERISA definition, the plan may be
required to obtain another private letter ruling (and pay another user fee)
regarding the status of the modified plan.
II

Under current law, the Code election that results in ERISA coverage applies
only to pension plans; it does not apply to health and other welfare benefit
plans. A church employer may, therefore, end up with a pension plan that is
subject to ERISA and a welfare benefit plan that is exempt from ERISA. This
may create confusion among employees who participate in both plans. In
addition, the welfare benefit plan is subject to any applicable state law, while
ERISA preempts the application of state law to a pension plan that elects
ERISA coverage.
DescriPtion: ERISA would no longer provide a separate definition of "church
plan." Instead, ERISA would provide that a plan that satisfied the definition of a
church plan contained in the Code would be exempt from ERISA. In addition,
ERISA would be amended to allow a church plan that is a welfare benefit plan
to elect ERISA Title I coverage after providing notice to the DOL in accordance
with DOL regulations, but only if the employer made a similar election for its
pension plans. The DOL would, therefore, reserve the right to deny ERISA
coverage to a welfare benefit plan where appropriate.

Simplifying Pensions

•

Extend Date for Adoption of Plan Amendments
BackgrQund: Plan amendments that are made to reflect amendments to the
Internal Revenue Code must generally be made by the employer's- income tax
return due date for the employer's taxable year in which the change in the law
occurs.
Descript;Qo: In order to ensure that plan sponsors have adequate time to
amend plan documents for the pension Simplification provisions, an extended
amendment period would be provided.

Simplifying Pensions

Addendum to
Attaclunent A

DEFINITION OF LEASED DfPLOYEE
Current

Law

Individuals who are -leased employees- of a service recipient are considered to be
employees of that recipient for all qualified retirement plan purposes. A -leased employee
is any person who is not a common-law employee of the recipient and who provides services
to the.recipients if (1) the services are provided pursuant to an agreement between the
recipient and the employer of the service provider, (2) the person has performed the sei'vices
for the recipient on a substantially full-time basis for at least one year," and (3) the services
are of a type historically performed, in the business field of the recipient, by employees.
W

Reasons for Change
The historically performed standard produces many unintended and inappropriate
results. For example, under this standard, employees and partners of a law f1IlI1 could be
leased employees of a client of the firm if they work a sufficient number of hours for the
client and it is not unusual for employers in the client's business to have in-house counsel.

Proposal
The "historically performed" test would be replaced by a test that considers whether
the services performed for the recipient are performed under significant direction or control
by the recipient.
This provision would generally be effective for years be~il1ning after December 31,
1995. The provision would not apply to relationships that have been previously determined
h\" ;11~ IRS rulin£ not to involve leased employees.

ATTACHMENT B
f./ IJ f:"

'I'J

{/! ... ~,.,\~,

mE NEST - A SIMPLE PLAN FOR- SMALH)BUSINESS

Current Law

JEP j d .,- 0
,JJ

u /

865'

Under current law, an individual may contribute up to the lesser of $2,000 or the
amount of the individual's compensation (wages and self-employment income) to an
individual retirement arrangement (lRA)1 each year. (The dollar limit is $2,2501f the
individual's spouse has no compensation.) These contributions are fully deductible only if
the individual (and spouse, if any) is not an active participant in an employer-sponsored
retirement plan or has adjusted gross income (AGI) no greater than $40,000 for a married
taxpayer filing a joint tax return, $25,000 for a single taxpayer, or $0 for a married taxpayer
filing a separate return. Once AGI exceeds these thresholds, the deduction begins to be
phased out, so that the allowable deduction is zero for a married taxpayer filing a joint
return, a single taxpayer, and a married taxpayer filing a separate return once AGI reaches
$50,000, $35,000, and $10,000, respectively. To the extent that an individual is not eligible
for deductible IRA contributions, he or she may make nondeductible IRA contributions (up to
the contribution limit).
The earnings on IRA account balances are not included in income until they are
withdrawn. Withdrawals from an IRA (other than withdrawals of nondeductible
contributions) are includible in income, and must begin by age 70 112. Amounts withdrawn
before age 59 1/2 are generally subject to an additional 10% tax. The additional tax does not
apply to distributions upon the death or disability of the taxpayer or withdrawals in the form
of substantially equal periodic payments over the life (or life expectancy) of the IRA owner
or over the joint lives (of life expectancies) of the IRA owner and his or her beneficiary.
Simplified employee pensions (SEPs) and, for employers with 25 or fewer employees,
salary reduction SEPs (SARSEPs), are employer-sponsored plans under which employer
contributions and, in the case of SARSEPs, employee-elected salary reduction contributions
ar;? made to IRAs established by employees. An employer that adopts a SEP must contribute
to the SEP for every employee who has attained age 21, has worked for the employer during
at least three of the immediately preceding five years, and is J'aid at least $400 (for 1995, as
adjusted for cost of living) by the employer for the year. Thus, for example, an employer
would have to make a SEP contribution for an employee who worked for the employer one
hour per year in the preceding three years and worked 40 hours (and earned $400) in the
current year, if the employer was making contributions for any other employee for the year.
SEPs do not allow employees to make electi\~ contributions through salary reduction.

I An individual retirement arrangement (IRA) may be an individual retirement account or
an individual retirement annuity. An individual retirement account must generally be a trust.
However, a custodial account generally is treated as a trust if the custodian is a bank (or
other person approved by the IRS) and the custodial account meets all of the requirements
that a trust must meet.

SARSEPs allow employees to make elective contributions, but cannot provide for
employer matching contributions. SARSEPs are available only to for-profit employers that
had 25 or fewer employees at all times during the preceding year. In addition, special
eligibility and nondiscrimination rules apply to SARSEPs. If at least 50 % of the eligible
employees do not choose to make elective contributions to a SARSEP in a year, then no
employee can make elective contributions. An employer with 25 or fewer employees may
fall below the 50% threshold (and out of SARSEP eligibility) from year to year.
SARSEPs are subject to the top-heavy rules~ A SARSEP is considered top-heavy if
the aggregate accounts of key employees in the plan exceed 60% of the aggregate accounts of
all employees in the plan. If a SARSEP is top-heavy and any key employee of the employer
makes elective contributions of at least 3 % of pay, then the employer must make minimum
contributions of 3 % of pay for all non-key employees -- even if those non-key employees
also make elective contributions of 3 % of pay.

Reasons for Chanee
The tax-favored employer retirement plans currently available under the Internal
Revenue Code (the "Code") have not been sufficiently successful in attracting small
employers. In 1993, for example, only 24% of full-time workers in private firms with fewer
than 100 employees were covered by employer retirement plans. In contrast, 73 % of fulltime workers in firms with 1,000 or more workers were covered.
The administrative cost and complexity associated with traditional qualified retirement
plans often discourage small employers from sponsoring these plans. For employers with
few employees, the cost of maintaining the plan may even exceed the benefits provided to
employees. As a result, pension coverage of employees of small employers is significantly
lower than the pension coverage of employees of larger employers.
SEPs and SARSEPs, which were designed for small employers, are perceived by
many employers as overly complicated and impractical. The "nondiscrimination and
eligibility rules applicable to SARSEPs make it difficult for an eligible employer to maintain
a SARSEP on an ongoing basis. An eligible employer cannot encourage employees to make
elective contributions by offering to match employee contributions dollar-for-dollar or
otherwise. The inability to offer matching contributions also makes it difficult for the
employer to satisfy the SARSEP nondiscrimination test. Under the SARSEP
nondiscrimination test, elective contributions for any highly compensated employee are
Ii mi ted to 125 % of the average elective contributions for all nonhighly compensated
employees for the year. Thus, highly compensated employees are limited to very low levels
of elective contributions unless other employees make significant elective contributions -which they are less likely to make without the incentive of a matching contribution.
Concerns have also been raised that, where SEPs and SARSEPs are used, there may be
significant noncompliance with the statutory requirements.

-2-

Proposal
The proposal would provide a new, simple retirement plan for employers with 100 or
fewer employees. The new plan would be known as the National Employee Savings Trust,
or "NEST."
The NEST would operate through individual IRA accounts for employees, and would
incorporate design-based nondiscrimination safe harbors similar to those the Administration is
proposing for 401(k) plans. By eliminating or greatly simplifying.many of the rules that
apply to other qualified retirement plans, including 401(k) plans, the NEST would remove
the key obstacles that currently deter many small employers from setting up retirement plans.
The current SEP and SARSEP rules would not be eliminated or modified, but would remain
in place.

Funding Through 1RAs
New plan would use IRAs as the funding vehicle: All employee and employer
contributions to NESTs would be made to IRAs, and the IRA rules would govern except
where specified otherwise.
Initial use of specific financial institution: In order to simplify plan administration for
employers, an employer could, without fiduciary exposure, require that all of its participating
employees use a designated financial institution's IRAs as the recipient of NEST
contributions -- but only if participants were notified in writing that the contributions could
be moved (in a trustee-to-trustee transfer) without penalty to another IRA at any time. This
noti fication could be incorporated into the annual disclosure to employees regarding the
NEST (described below) or could be provided separately.
ElI1ulm'('r Eli~ibilirv

100 employee limit: Any employer, including a tax-exempt organization or
government, would be eligible to make a NEST program available to its employees in a
gIven year if the employer had no more than 100 employees in the prior year. For this
purpose, employees would be counted only if they had at least $5,000 of compensation (as
reported on Form W-2) from the employer. The "employer" would be determined on a
"controlled group" basis (i.e., aggregating 80% affiliates).
Two-year grace period: If an eligible employer established a NEST program and,
subsequently, the number of employees grew to exceed 100 (based on the prior year), the
employer would continue to be eligible for the current and subsequent year. After that twoyear "grace period," the employer would cease to be eligible unless the employee count again
dropped to 100 or fewer (based on the prior year).

-3-

For example, assume Company A has 90 employees in Year 1, 95 employees in Year
2, 101 employees in Year 3, 103 employees in Year 4, 102 employees in Year 5, and 99
employees in Year 6. Company A would be eligible to make a NEST program available to
its employees in Years 2 and 3, based on having had no more than 100 employees in the
prior year, and in Years 4 and 5, based on the two-year grace period. Company A would
lose its eligibility for Year 6 (because it had more than 100 employees in Year 5 and was no
longer in the grace period relating to Year 2), but would be eligible again for Year 7 (based
on having had no more than 100 employees in Year 6). No NEST contributions would be
permitted for a year in which the employer was not eligible.
Acguisitions: If an eligible employer ceased to meet the 100-employee test because it
was acquired by another entity, only the acquired (previously eligible) entity would continue
to be eligible during the two-year grace period.

Employee Elieibi/iry

ParTicipaTe and VesTine

Two-year eligibility: Each employee who attained age 21 and completed two
consecutive years of service with the employer would be eligible to participate. A "year of
service" would be defined as a calendar year during which an employee's W-2 compensation
from the employer was at least $5,000. An employer could choose to allow all employees to
participate earlier than upon attainment of age 21 and completion of two years of service.
Participating employees who drop below the $5.000 threshold or whose employment
terminates mid-year: Once an employee became eligible, the employee would be entitled to
make elective contributions and receive any employer matching contributions even if, during
the current calendar year, the employee's W-2 compensation from the employer was less
than $5,000. However, no nonelective employer contributions would be required unless the
employee had at least $5,000 of compensation from the employer for the calendar year. If
an employee had at least $5,000 of compensation for the year, he or she would have to
receive a nonelective employer contribution for the year even if no longer employed on the
last day of the year.
100% vesting: All contributions would be 100% vested immediately.

No Nnndiscriminarinn TeSTing
Nondiscrimination tests not applicable: NESTs would not be subject to:
•

the top-heavy rules;

•

the nondiscrimination rules that apply to elective contributions under a 401(k) plan
(the" ADP" test);

•

the nondiscrimination rules that apply to matching contributions (the" ACP" test); or
-4-

•

the nondiscrimination rules that apply to SEPs and SARSEPs. (Thus, there would be
no 50% participation requirement, no 125 % test, and no social security integration.)

HCE determinations irrelevant: Because NESTs would not be subject to any
nondiscrimination tests, an employer that offers a NEST would not be required to determine
which employees are "highly compensated employees."
Contributions

NESTs would receive nonelective employer contributions and, depending on the
option selected by the employer, elective contributions and employer matching contributions.
Design-based safe harbors: In lieu of top-heavy and nondiscrimination rules, every
NEST would be required to satisfy one of the following two design-based safe harbors
(generally similar to the Administration's proposed 401(k) safe harbors):
(1)

The employer makes nonelective contributions of at least 3 % of compensation2 for
each eligible employee. The employer may choose to allow employee elective
contributions in addition to the employer nonelective contributions. If the employer
chose to allow employee elective contributions, the employer could also choose to
make matching contributions -- but only in accordance with the matching contribution
formula described in (2), below, and only if employees were provided notice of the
matching contributions as part of the annual disclosure described below.

(2)

The employer makes nonelective contributions of at least 1 % of compensation for
each eligible employee and allows employee elective contributions. The employer
must provide a 100% matching contribution on the employee's elective contributions
up to 3 % of compensation and a matching contribution of at least 50% (and no
greater than 100%) on the next 2 % of employees' elective contributions. The
employer may not provide any other matching formula, including a more generous
formula. Although this safe harbor would require a 1 % nonelective employer
contribution, the top-heavy rules would not apply, as noted above. This means that
those employers that otherwise would have been required to make a 3 % top-heavy
minimum contribution for each non-key employee, would have to make only a 1 %

The $150,000 compensation limit that applies for purposes of the deduction and
contribution limits for qualified plans, SEPs, and SARSEPs would apply for purposes of
determining safe harbor and other contributions. However, for this purpose, a simplified
definition of compensation would apply -- compensation would be determined before elective
contributions were subtracted from compensation. Similarly, the definition of
"compensation" would be simplified for a self-employed individual participating in a NEST
by not subtracting deductible contributions or the self-employment tax deduction.
2

-5-

nonelective contribution. In addition, all employers that offer a NEST would be
relieved of the requirement to test for top-heavy status.
Employee elective contributions: The limit on employees' annual elective
contributions (Le., salary reduction contributions) to a NEST (currently $9,240 in the case of
elective contributions to 401(k) plans) would be $5,000. The limit would remain at $5,000
until the section 402(g) limit exceeded $10,000; then, the NEST limit would be indexed to
(and remain at) one half of the section 402(g) limit for each year.
Employer matching contributions: The limit on employer matching contributions
depends on which of the two design-based safe harbors the employer chooses for the year.
Under the first safe harbor, the "3%-nonelective-contributions safe harbor," no employer
matching contributions are required, but they are permitted. However, if the employer
selects the "matching contribution safe harbor" (the second safe harbor), employer matching
contributions are required. All employer matching contributions are limited in accordance
with the matching formula described above; other formulas and additional matching
contributions are not permitted.
Nonelective employer contributions: A NEST could provide for discretionary
nonelective employer contributions in excess of the safe harbor minimums (1 % or 3 %) from
year to year. Any such nonelective employer contributions in excess of the 1 % or 3 %
minimums would have to be an equal percentage of compensation for all eligible employees.
Total nonelective contributions (both the safe harbor minimums and discretionary
contributions) could not exceed 5 % of compensation.
Section 404 deduction limit not applicable: The employer would be permitted to
deduct the elective, matching, and nonelective contributions described above (within the
limits described) without regard to any separate percent-of-compensation limitation (i.e.,
there would be no limit comparable to that imposed by section 404(a)(3».
Till7ine ()( C()l1frihllfi()ns

Quarterly employer contributions: Employer matching contributions would be
required to be deposited in employees' accounts (IRAs) no less frequently than quarterly.
Employer nonelective contributions would also be required to be deposited no less frequently
than quarterly -- but only for employees who were paid at least $5,000 as of the end of the
quarter (measured from January I of that year). If an employee did not reach the $5,000
threshold until the second, third, or fourth calendar quarter, the employer would be required,
after the threshold had been reached, to make nonelective contributions for both the current
and all preceding calendar quarters in the year. Contributions for any calendar quarter
would be required to be deposited within 45 days after the end of that quarter.

-6-

Distributions
Two-year holding period: NEST contributions (and attributable earnings) would be
subject to a two-year holding period beginning on the date of contribution. 3 This two-year
restriction on withdrawals would apply whether or not the participant had incurred a
termination of employment.
Otherwise, distributions from NEST IRAs would be subject to the same rules as
distributions from IRAs generally (as distinguished from 401(k) or other qualified plans) -no other restrictions would be imposed, but an additional 10% tax would apply to
distributions before age 59 112. During the two-year holding period, contributions and
earnings could be rolled over to another IRA -- but the original two-year holding period
would continue to apply to the rolled-over amounts in the recipient IRA.
Rollovers: NESTs could originate and receive transfers from other IRAs (whether
NESTs, SEPs, SARSEPs, or other IRAs). NESTs could also receive rollovers from
qualified plans. All movement of NEST funds to other IRAs, whether or not during the twoyear holding period, would be required to be carried out in the form of a trustee-to-trustee
transfer. Any amounts rolled over to a NEST would not be subject to the two-year holding
period unless they were amounts from a NEST for which the two-year holding period had
not yet elapsed.

Miscellaneous
Other plans maintained by the employer: An employer that maintains a NEST could
maintain additional tax-qualified plans, other than a plan that allows for elective contributions
or matching contributions. For example, if the employer maintained a 401 (k), salary
reduction or matching 403(b), or SARSEP plan and wished to establish a NEST, it would
have to freeze (but not terminate) the 401(k), 403(b), or SARSEP plan. However, an
employer could maintain both a NEST and a defined benefit plan.
If an employer did maintain another plan, compliance of the NEST with the NEST
requirements would be determined without regard to the other plan. The other plan would
have to take the NEST into account only for purposes of the section 404 deduction limits and
the section 415 contribution and benefits limitations. The top-heavy rules and
nondiscrimination rules, for example, would apply to the other plan without regard to the
NEST; the NEST would not affect the compliance of the other plan with these rules.
If an employee who participates in a NEST also participates in a separate employer's
401(k), 403(b), or SARSEP plan, the section 402(g) elective deferral limit for that employee

3 For purposes of this rule, a contribution made on any date within a calendar year
would be deemed to be made on the first day of that year.

-7-

would be coordinated. Elective contributions to the NEST would have to be taken into
account in determining whether the $9,240 or $9,500 limit had been exceeded under the
other plan, but any elective contributions made to the other plan would not be taken into
account in determining whether the $5,000 NEST limit had been exceeded.
Coordination with IRA deduction rules: NESTs would be treated as qualified plans
for purposes of the IRA deduction phase-out rules. Thus, employees who participated in a
NEST and had AGI in excess of the applicable thresholds would be phased out of making
deductible IRA contributions. This is the same rule that currently applies to SEPs and
SARSEPs.
IRS model form: The IRS -would be directed to issue a model NEST document, but
vendors and employers would have the option of using their own documents.
Reporting: An employer maintaining a NEST would not be subject to any reporting
requirements (e.g., Form 5500 filing). However, the NEST trustee or custodian would be
required to report NEST contributions on Form 5498, on which IRA contributions are
reported.
Disclosure: Employees would be required to be notified annually in writing of their
rights under the plan, including, for example, the right to a matching contribution.
Similarly, if an employer wanted to switch between safe harbor formulas, the employer
would be required to notify eligible employees which formula would be used for a year no
later than a reasonable time before the employer required employees to make their elections
for the year.
Calendar plan vear: The calendar year would be the plan year for all NESTs and
would have to be used in applying all NEST contribution limits, eligibility. and other NEST
requirements.
These provisions would be effective for years beginning after December 31, 1996.

ATTACHMENT C
(EXTRACT)

SEP I D35

00 I 8 6 9

WRITTEN STATEMENT OF LESLIE B. SAMUELS
ASSISTANT SECRETARY (TAX POLICY)
DEPARTMENT OF THE TREASURY
BEFORE THE
HOUSE COMMITTEE ON WAYS AND MEANS

Mr. Chairman and Members of the Committee:
I am pleased to submit this statement presenting the views
of the Administration on miscellaneous revenue issues as
described in the July 10, 1995, pamphlet prepared by the Joint
Committee on Taxation1 ("JCT Pamphlet").
The Committee has before it over 250 proposals repr:esenting
sUbstantive changes to a wide range of tax provisions. Many of
these proposals deal with complex provisions of the law.
In many
cases, the proposals raise questions whether existing law should
be thoroughly reviewed and subject to hearings, considering,
among other things simplification and rationalization. For
instance, Treasury is studying the treatment of financial
instruments and entities engaged in financial services
transactions and ways to modernize their regulatory and tax
treatment.
Some proposals that are the subject of these hearings
might more appropriately be conside~ed in the context of such a
modernization effort.
In developing our positions on the proposals before the
Committee, we have relied on a number of tax policy principles.
One such principle is tax simplification. Given the widespread
interest that has been expressed in simplifying the tax code, we
believe that in evaluating these proposals, great weight should
be given to the extent that they may either simplify or
complicate the tax laws. Many taxpayers have complained that one
of the greatest sources of complexity in the tax laws is frequent
change in the law. We urge the Committee in considering these
miscellaneous proposals to bear in mind the additional complexity
that may result from large numbers of even meritorious changes in
the tax laws.

Joint Committee on Taxation, Description of Miscellaneous
Tax Proposals (JCS-19-95), July 10, 1995.

The Administration strongly supports many of the
simplification provisions contained in H.R. 3419, as it passed
the House in the 103rd congress and as proposed to be modified in
the JeT Pamphlet. The Administration has recently announced
additional tax simplification proposals.
For instance, last month the President announced a pension
simplification package. A number of the miscellaneous tax
proposals included in these hearings are the same as or similar
to items in the Administration's pension simplification proposal.
We believe that the complexity of the private pension system has
raised the compliance and administrative costs of maintaining a
plan to a level that discourages certain employers, particularly
small employers, from providing any retirement plan for their
employees. Accordingly, one of the principal elements of the
Administration's proposed pension simplification package is a
new, simple retirement plan for employers with 100 or fewer
employees, known as the NEST (or National Employee Savings
Trust). The NEST would combine the most attractive features of
IRAs and 401(k) plans, and would not be subject to the top-heavy
rules or to any other complex nondiscrimination rules. We look
forward to working with Congress on a bipartisan basis to achieve
this and other pension simplification this year.
In June, President Clinton also announced proposals, as part
of the Administration's Reinvention of Government II (REGO II)
initiative, to simplify the tax and wage reporting system, and to
expand the Internal Revenue Service's partnership program with
state tax authorities. We note that one of the simplification
proposals in H.R. 3419 would permit IRS to enter into cooperative
agreements with State tax authorities. The Administration
supports this provision and is eager to work with the Committee
to improve it.
In addition to tax simplification, the Administration has
relied on several other tax principles in evaluating the
miscellaneous proposals that are before the Committee. We oppose
"rifleshot" measures that provide special tax relief to a
targeted group of taxpayers. We generally oppose purely
retroactive provisions that seek to supplant the judicial
process. We favor equity among similarly situated taxpayers. We
insist upon the administrability of each provision.
Finally, to
the extent that miscellaneous tax proposals represent tax
expenditures, the relevant cost to taxpayers, and whether there
are proposed revenue-raising offsets, are important factors to be
considered.
The Administration's view with respect to many of the
proposals under consideration today assumes that appropriate
revenue measures will be proposed. Consequently, even for tax
proposals that are meritorious, they must be offset by revenueraising provisions that are compatible with the principles of

deficit reduction. Moreover, even if appropriate revenue-raising
offs