How Financial Financial Regulation Work

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1.0 How Government Regulation Work on Bond Market in Japan

1.1.Introduction

Each country shows different development stages in the bond market. Japanese

experience shows that the government bonds are sold mainly to the banking sector in the early

stages of the development of the bond market. However, in year 2006, all these syndicated

sales were abolished. Currently all the Government bonds are sold through market auctions.

There are no forced sales to the financial institutions. Some Asian countries are in the process

of starting the government bond market, as Japan started in 1965. Many lessons could be

learned from the experiences of those overseas. In Japan, the Government bonds whose

maturity was 10 years were the major product issued by the Ministry of Finance (MOF) in the

1970s and 1980s. In the beginning stage of the setting up of the Government bond market, 10

year Government bonds were mainly sold to the financial institutions. Government play the

main role in order to regulate financial market. In japan the ministry of finance(mof) play the

important role to stabilize the bond market.

From 1990s, the MOF started to sell various kinds of government bonds to the market,

namely, short-term, medium-term and long-term. Short-term Government bonds are treasury

bills which are redeemed within one year and they are discounted bonds. Medium-term

Government bonds such as 5 years are mainly sold to banks. Commercial banks in Japan prefer

to hold 4-5 years Government bonds, since the average maturity of deposits is less than 5

years.

It is also advisable to start to purchase long-term Government bonds as an instrument

of the monetary policy. If the commercial banks prefer 5 years government bonds, it would be

better to issue such a maturity. In addition, it could be an instrument of the open market

operations by the Central Bank. Primary market is easier to set up compared with the secondary

market. However, continuous issue of the government bonds for the primary market is

required. Continuous issue of government bonds will allow the market participants to be ready

to participate in the primary market on a regular basis.

At first, a certain maturity of Government bond could be issued, one that mainly

focuses on the banking industry. Such Government bonds preferred by the banks will be 3


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years to 5 years. The term of the Government bonds will be matched with the average

maturity of the bank deposits in each country. Before the secondary market is well developed, it

will be possible for the government to purchase its own security before maturity according to

the needs of banks and pension funds. As private insurance companies and other financial

institutions grow, a greater variety of Government bonds can be issued to match the needs of

the market. The kinds of Government bonds to be issued should be based on the needs of the

market. Therefore, short term Government bonds will mainly be targeted to banks. Long term

Government bonds will mainly be targeted to pension funds initially. Gradually the kinds of

Government bonds will be expanded to much more variety of maturities.

Total tax revenue peaked in 1991 when the bubble economy burst. Income tax started

to decline rapidly after 1991. The Corporate tax also started to decline due to recession. In

1988, consumption tax increased from 3% to 5%, however the consumption tax revenue has

not shown much change since 1999 due to long- term economic recess. Increasing government

expenditure together with gradual decline in tax revenue brought high dependency on

Government Bonds as shown in Figure 1. In 2003 and 2004, the Government Bonds

dependency ratio to total spending went up to 44%.

Figure1


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1.2The History Of Bond Market Development In Japan

The development of the bond market in Japan can be seen with the growth of Japans

government bond (JGB) market. JGBs, which the Government issues for financing purposes play

the central role in Japan's financial and securities markets as a financial instrument traded on

the market with high levels of credit and liquidity Thus, JGBs yields are regarded as

benchmarks of the bond market in Japan. The Japanese economy has developed continuously

since the 1950s. There have been several fluctuations with the Japanese economy, affected in

particular by two major oil crises in 1974 and 1979. Despite these crises, the Japanese economy

did remarkably well until 1989 when the bubble burst. Since the 1990s, the Japanese budget

deficit has been increasing rapidly for a number of reasons: (i) long-term recession and the

decline of tax revenue; (ii) various tax rate reductions introduced in late 1990s; (iii) failure of

the Keynesian Policy which relies on public work to enhance economic recovery immediatelyafter the collapse of the bubbles in 1991; and (iv) an increase in welfare spending such as

medical spending due to the aging population. Thus, the budget deficit climbed to higher than

170% of GDP from 70% in 1993, comparable to the level seen in other OECD nations.

2.0.The Deficit Financing Bond

The Deficit financing bond was issued for the first time after World War II in 1965. In

the 1960s, government bonds were sold to financial institutions (syndicated underwriting).

Furthermore, JGBs were purchased by the Bank of Japan one year after issue; the maturity of

JGBs was 1 year in 1960s and 1970s in the sense that the JGB could be purchased after being

held by the financial institutions for one year if required, despite the face maturity being 10

years. In 1966, JGB underwriting by the Trust Fund Bureau (MOF) had started. The main

sources of the Trust Fund Bureau fund came from postal savings, post life insurance and

Government pension fund reserves. High household savings were kept mainly in private

financial institutions as deposits or government postal savings. Postal savings in Japan offered aunique financial product which private banks were not allowed to issue. Namely, 10 year

deposits (Teigaku Deposits) whose interest rates were fixed for 10 years and could be

withdrawn any time after 6 months. Since Japanese postal savings were entrusted to the

Ministry of Finance for 7 years for fixed interest rates, postal savings could provide a fixed


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interest product on a long-term basis. At this time Private banks offered only 1 year deposits.

Postal savings attracted numerous customers

Figure 2

3.0Quality Enhancing Of The Bond Market

In contrast to the continuous growth of the Government bond market, the corporate

bond market has not been developed. In 1905, issues of non-collateral corporate bonds law

were implemented and new issues of corporate bonds were increased. However, huge issues

of corporate bonds created defaults of bonds. In 1935, quality enhancing of the bond market

started. Regulation of the new issues of corporate bonds, such as proper conditions and

collateral based conditions continued until the 1990s. Thus, the corporate bond market was not


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developed in Japan. Furthermore, Japanese Government banks provided long-term loans to

corporations in the past which contributed less dependency on corporate bonds by firms. Table

1 denotes the amount of trade in the bond market in Japan. The majority of the bond market

is the Government bond and the share of the corporate bond is relatively small.

4.0Refunding Bonds and Fiscal Loan Bonds

The JGB issue numbers have been on the increase in recent years. While the JGB issue

amount often refers to that of new financial resource bonds (construction bonds + special

deficit financing bonds), securities issued by the central Government also include refunding

bonds and fiscal loan bonds. As we reviewed in the previous section, the total issue amount of

these Government bonds was increasing at a dramatic pace particularly in the recent years.

Although the issue amount of new financial resource bonds had been hovering between 30

and 40 trillion since FY1998, it reduced to under 30 trillion in FY2006. However the total

issue amount of JGBs, including refunding bonds, increased from 70 trillion to over 80 trillion

from FY1998 to FY2000. Furthermore, launch of fiscal loan bonds in FY2001 pushed it to over

130 trillion, and since then it has been continuously increasing. In FY2006, however, the total

amount was at the same level as in FY 2005, approximately 165 trillion.


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4.0.Variety of Japanese Government bonds to satisfy demand from the market

4.1.Types of JGBs classified by method of issuance

As Table 2 shows, there are many types of JGBs and methods of issuance in Japan.

What follows is an overview of types of JGBs and their issuance methods. JGBs are the

securities issued by the central Government. The central Government pays the bondholders,

interests on the securities and repays the principal amount (i.e., redemption). Interest is

payable on a semiannual basis and the principal amount is redeemed at maturity. There are six

categories of JGBs currently issued: (i) Short term (6-month and 1-year Treasury Bills); (ii)

medium term (2-year and 5-year Bonds); (iii) long term (10-year Bonds); (iv) super long term

(15-year floating rate, 20-year, 30-year Bonds and 40-year bonds); (v) JGBs for individual

investors (5-year and 10-year); and (vi) inflation-indexed bonds (10-year). As Table 3 shows,

the long-term JGBs (10 years or more), the benchmark of the market, account for more than

50% of all JGBs outstanding.

5.2.Demand side of Japanese Government Bond

As is shown in Figure 3 and Table 2, JGBs are mainly held by banks, other financial

institutions and insurance companies due to high savings ratios in the past. Holdings by

foreigners are quite small compared with other major countries. In June 2007, the ratio of

holdings by foreigners was only 5.8%. Households purchases have increased recently (5.1%)due to low interest rate on bank deposits (by zero interest rate policy conducted by BOJ).

18.8% of JGBs are held by financial institutions, 21.7% by postal savings, 9.2% by postal life

insurance, 9.3% by private life insurance, 10.3% is held by public pension funds and 4.1% is

held by private pension funds.


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Figure 3

Table 2


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Table 3

Table 4


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4.2.1 Discount bonds

The short-term JGBs are all discount bonds, meaning that they are issued at the price lower

than the face value. No interest payments are made, but at maturity the principal amounts are

redeemed at face value. For example, if the maturity of the bond is 100 yen and it were sold at

95 yen, the interest payment at the maturity becomes 5 yen which is equivalent of the interest

rate of 5.2% (=5/95).

4.2.2 Fixed-rate coupon bonds

All medium- (2-year and 5-year bonds), long-(10-year bonds), super-long-term bonds (20-

year, and 30-year bonds (except for the 15-year floating-rate bonds)) and JGBs for individual

investors (5-year) are the bonds with fixed-rate coupons. Figure 4 shows the fluctuations of

10-year JGB yield in the market. The interest rate on 10-year JGBs is determined by the market

when it is issued. With fixed-rate coupon-bearing bonds, the interest calculated by the coupon

rate determined at the time of issuance is paid on a semiannual basis until the security matures

and the principal is redeemed at face value.

4.2.3 Floating rate bonds

The 15-year floating-rate bonds and the JGBs for individual investors (10-year) feature their

coupon rate that varies according to certain rules. The inflation-indexed bonds is a security of

which the principal amount is linked to the consumer price index (CPI). Thus, although their

coupon-rate is fixed, the interest payment also fluctuates.

4.2.4 Abolished bonds

In the past, there used to be some other types of JGBs. However, after the August 1988

issue of 3-year fixed rate bonds, the September 2000 issue of 5-year discount bonds, the

February 2001 issue of 4-year fixed-rate bonds, the March 2001 issue of 6-year fixed-rate


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bonds, and the November 2002 issue of 3-year discount bonds, these bonds have been stopped

being issued due to lack of demand from the market.

4.2.5 JGB for individual investors

Individual investors, compared with financial institutions, now account for a much smaller

share in JGB holdings. However, they tend to be relatively stable and long-term bondholders.

Thus, it should make the market stable and enable us to finance more smoothly to diversify the

bondholder composition further, with particular emphasis on individuals. For these reasons, the

Ministry launched in March 2003 the bonds specifically designed for individual investors.

Furthermore, in January 2006, we started to issue a new model of JGBs for individual investors,

5-year fixed-rate bonds. Following is the overview of two types. JGBs for individual investors are

issued on a quarterly basis most likely on the 15th day of April, July, October and January

and the flotation term starts during the first half of March, June, September and December. It is

available at financial institutions, such as security companies, banks and post offices. Along

with other conventional JGBs, it is issued and fully managed paperless in exclusive accounts for

JGBs at financial institutions or post offices.


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Table 5

6.0 Debt Management Policies

It is important for the debt-issuing authority to make the market more competitive and

efficient. In October 2004, the MOF introduced the JGB Market Special Participants Scheme, a

new framework to ensure stable JGB issues based more on market principles. With massive

issuance Government bonds (JGB) expected to continue in future yearsJGB issuance plans

must be formulated with the utmost care to ensure a reliable and smooth issuance process. To

achieve this, the MOF (Ministry of Finance) holds a close dialogue with the market through

various meetings. including (i) the meeting of JGB market special participantsin order to

grasp market needs in a careful. On the other handthe authorities should not focus just on

current market needs; the authorities should also properly formulate and implement systems

and mechanisms that are necessary in building a medium-to-long term JGB management

policy. There are several important steps to be taken by the Government so as to inform the

market participants of their planned demand.


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7.0 Types of JGBs Classified By Funding Purposes

The JGB issuance plan of each year is announced based on the different kinds of

Government bonds classified by funding purposes, namely: (i) new financial resource bonds

(construction bonds); (ii) new financial resource bonds (deficit financing bonds), (iii) refunding

bonds; and (iv) FILP bonds. These bonds are not different from each other when it comes to

holdings and transactions as financial products.

7.1. Construction bonds (new financial resource bonds)

Article 4(1) of the Public Finance Law prescribes that annual government expenditure has to

be covered in principle by annual government revenue generated from other than Government

bonds or borrowings. But as an exception, a proviso of the Article allows the Government to

raise money through bond issuance or borrowings for the purpose of public works, capital

subscription or lending. Bonds governed by this proviso of Article 4(1) are called construction

bonds. The Article prescribes that the government can issue construction bonds within the

amount approved by the Diet, and the ceiling amount is provided under the general provisionsof the general account budget. When intending to get approval for this ceiling amount, the

Government is obliged to submit to the Diet a redemption plan that shows the redemption

amount, the redemption method and the redemption dates for each fiscal year.

7.2 Special deficit-financing bonds (special law enacted for each fiscal year)

When estimating a shortage of government revenue despite the issuance of construction

bonds, the Government can issue Government bonds based on a special law to raise money for

the purpose of other than public works and the like. Given their nature, these bonds are called

"special deficit-financing bonds". As is the case with construction bonds, the Government can

issue special deficit-financing bonds within the amount approved by the Diet and the ceiling


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amount is provided under the general provisions of general account budget. The Government

is also required to submit a redemption plan to the Diet for reference. Special deficit-financing

bond issuance must be made in exceptional cases. Therefore, the Government has to minimize

the issue amount as much as possible within the amount approved by the Diet, while taking

into account the state of tax and other revenues. In this context, it is allowed to issue special

deficit-financing bonds even during the accounting adjustment term. Specifically, the

Government is allowed to issue special deficit-financing bonds until the end of June in the next

fiscal year, in order to adjust issue amount of special deficit-financing bonds until the end of

May in the next fiscal year; the deadline for collecting the tax revenue for the fiscal year

7.3. Refunding bonds (Article 5(1) and 5-2 of the special account law of the Government

Debt Consolidation Fund)

Pursuant to Articles 5(1) and 5-2 of the Special Account Law of Government Debt

Consolidation Fund, the Government is allowed to issue refunding bonds to secure funds for

consolidation or redemption of Government bonds. In the issuance of refunding bonds, the

Government is not required to seek Diet approval for the maximum issuance amount.

6.4. Fiscal Investment and Loan Program (FILP) bonds

The FILP was originally receiving money from postal savings, post life insurance and

pension fund reserves. They are loaned to government banks and government corporations so

as to implement policies such as low interest rate loans by government banks. This systemchanged its structure in 2001. The FILP stopped receiving money from postal savings, post

life insurance and pension reserves, instead the FILP started to introduce the FILP bonds to the

market. Postal savings, post life insurance and pension reserves started their own portfolio

investments rather than depositing their money in the FILP system.


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8.0 Buy-back program

The buy-back program is a scheme for the Government to retire debt by buying back

outstanding immature bonds. The buy-back program is similar to advance redemption in thatboth are meant to retire debt before maturity. Butthere is a difference. With advance

redemptionthe debt is repaid in principle at face value in complete disregard of the will of

bondholders. With the buy-back programthe debt is bought back only from the bondholders

willing to take part in the deal. In the past the buy-back program used to be implemented on

very limited occasions such as when an heir pays government bonds as the tax in kind

pursuant to the inheritance Tax Law or when the deposit a candidate set aside pursuant to

the Public Office Election Law has to be confiscated upon losing an election. To level out JGB

redemptions with maturities heavily concentrated on FY2008 government improved the

existing system in June 2002 by revising the Law on Buy-backs and Retirement of Government

Bondsand by taking other actions. In February 2003we began to buy back bonds maturing

in FY2008. At this point in timeGovernment are buying back bonds covering a wide range

of years to maturity in order to maintain or enhance liquidity in the JGB market. Government

are buying back bonds held by private financial institutions through auctions. Government also

bought back and retired bonds held by the Bank of Japan and the Fiscal Loan Special Account

9.0 Government Bond Administration (the Law concerning Government Bonds)

The Law concerning Government Bonds stipulates basic matters that range from

Government bond issuance to administrative procedures regarding the outstanding issues.

Provisions in the law can be classified into the following five categories:

(i) The MOF decides the terms of issuance and other Government bond issuance-related matters; and matters necessary for principal and interest payments and

certificates and their registration.

(ii) The BOJ is entrusted with JGB-related administrative tasks.


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(iii) Registration of government bonds

(iv) Relief measures for damaged or lost bearer Government bonds

(v) Extinctive prescription of Government bonds

Where there is no stipulation in this law, the civil law, the commercial law, or general

principles, such as trade practices, will apply. Specific procedures regarding issuance and

redemption of Government bonds are prescribed in the Regulations on Government Bonds, the

Ordinance on Government Bond Issuance, the Bank of Japan Regulations on the Administrative

Treatment of Government Bonds, and the Ordinance on Special Treatment Procedures at the

Bank of Japan for Principal and Interest Payments on Government Bonds.

10.0 Interest rate set by government

In Japan, all the interest rates of the Government bonds are currently determined by the

market. Demand and supply of the Government bonds determine the daily interest rates.

However in the early stages in the progress of the development of the financial market of the

1960s and 1970s, the interest rates were set by the Government. Deposit rate of interest,

prime lending rate of interest and government bond rates were all set by the Government. In

those days, Japanese financial markets were isolated from the international financial markets

and the economy was dominated by the bank financing.

11.0 Conclusion

As conclusion it is clearly show how japans government regulation work on bond . It

also show the japans government play important role to stabilize bond market through many

regulation. And under the government of Japan, ministry Of Finance (MOF ) applying a lot of

regulation on bond which influent the bond market. The regulation also show the direct and

indirect intervention by government on bond market


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12.0 Reference

Naoyuki Yoshino(2008). Bond Market Development in Japan. Keio University. [on-line]Available: http://www.unescap.org/pdd/projects/bondmkt/3_bond_Japan.pdf

http://www.boj.or.jp/en/type/ronbun/mkr/data/mkr0908.pdf

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