boj - functions and operations of the boj

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Bank of Japan 2004Institute for Monetary and Economic Studies (IMES)Bank of JapanCPO Box 203, Tokyo 100-8630, Japan


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Preface to the English Edition of Functions and Operationsof the Bank of Japan

This is the English edition of Atarashii Nippon GinkoSono Kinou to Gyoumu(Functions and Operations of the Bank of Japan), hereinafter referred to as theJapanese edition, written and edited by the Institute for Monetary andEconomic Studies of the Bank of Japan and published by Yuhikaku PublishingCo. Ltd. in December 2000.

The Japanese edition explains the functions and operations of the Bank of

Japan under the new Bank of Japan Law, which went into effect in April 1998.The Japanese edition was prepared by the staff of the Bank withcomprehensive advice from the advisory committee for publication. TheBanks core staff members behind the preparation of the Japanese edition wereMichio Ayuse, Tetsuya Inoue, Tomohiro Tachibana and Wataru Takahashi ofthe Institute for Monetary and Economic Studies, and Shinichi Uchida of thePolicy Planning Office 1. The advisory committee was composed of scholarsand a business person who were interested in the functions and operations of

the Bank, and the Banks executives and staff. The members of the advisorycommittee were Junji Annen, Professor of Seikei University; Shinichi Fukuda,Assistant Professor of the University of Tokyo; Akiyoshi Horiuchi, Professorof the University of Tokyo; Nobuo Inaba, Advisor to the Governor at thePolicy Planning Office of the Bank; Susumu Ito, Director of YuhikakuPublishing Co. Ltd.; Hideki Kanda, Professor of the University of Tokyo; EikoShinotsuka, member of the Policy Board of the Bank; and Kazuo Ueda,

member of the Policy Board of the Bank. I would like to express my gratitudeagain to everyone involved for their active involvement and considerableefforts in the publication.

For the English edition, translations were not prepared for the original prefaceto the Japanese edition and some articles in the Japanese edition that were notconsidered meaningful for non-Japanese readers. An example of such articlesis the column explaining various Japanese terms for "money". On the other

1 All positions given in this preface are those at the time the Japanese edition was prepared.


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hand, the English edition contains a supplement at the end of the book onmajor changes in the Banks operations following the publication of the

Japanese edition.

The English edition was prepared by the staffs of the Institute for Monetaryand Economic Studies and the Public Relations Department of the Bank withsupport from other departments and offices of the Bank. Major contributionswere made by Michio Ayuse, Nami Numoto, Naoyuki Suzuki, and KentaroTamura of the Institute for Monetary and Economic Studies, and Natsuyo Aso,

Misako Inagaki, Shinji Isaki, Kunio Matsuda, Hiroyuki Oie, Masao Oumi,Mariko Takeda, and Tadashi Uhira of the Public Relations Department.

I hope that this book will help deepen the understanding of people overseas,such as those related to governments, central banks, international organizations,financial markets and academic circles, of the functions and operations of theBank, and eventually lead to improvement of the transparency of the Bank,which is one of the underlying principles of the current Bank of Japan Law.

Kunio OkinaDirector-General

Institute for Monetary and Economic StudiesBank of Japan

January 2004


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Contents

Chapter I: Introduction ............................................................................. 1

A. Functions of the Bank of Japan ..................................................................... 21. Functions of the Bank in our daily lives 22. Business operations of the Bank as a bank 33. Issuing money which can achieve the highest settlement finality 44. Issuance and maintenance of money 6

B. Outline of the Bank of Japans Business Operations..................................... 71. Issuance of banknotes and the provision of payment and settlement services 82. Business related to the Banks role as the lender of last resort 93. Business related to conducting monetary policy 104. Treasury funds services for the government 11

C. Innovation in Technology and the Bank of Japan ....................................... 12

Box 1: Central Banks of the World 14Box 2: The Payment and Settlement System, Financial Institutions, and the

Financial System 15Box 3: Objectives of the Bank of Japan Stipulated in the Bank of Japan Law 16Box 4: Independence of Monetary Policy 17Box 5: Transparency of Monetary Policy and of the Bank of Japans Business

Operations 18Box 6: Organization of the Bank of Japan Headed by the Policy Board 21Box 7: Types of Electronic Money and Their Use as a Payment Instrument 23

Chapter II: The Issuance, Circulation, andMaintenance of Bank of Japan Notes ............................... 25

A. Cash and the Bank of Japan ........................................................................ 261. Outline of cash and the issuance of banknotes 262. Characteristics of banknotes 293. History of the banknote issuance system 30

B. Circulation of Banknotes ............................................................................. 311. Flow of banknotes and the role of the Bank 312. Fluctuation in demand for banknotes 34


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C. Maintenance of Banknotes .......................................................................... 351. Maintaining banknotes and making them easier to use 35

2. Security measures of banknotes and international coordination 36

Box 1: How Many Kinds of Banknotes Are Valid Today? 38 Box 2: History of Paper Money before the Introduction of Bank of Japan Notes 39Box 3: Criteria for Exchange of Damaged Banknotes 41

Chapter III: The Bank of Japans Current Account Services ............. 43

A. Outline of the Bank of Japans Current Account Services .......................... 441. Characteristics of BOJ account deposits 442. Types of settlements through BOJ accounts 45

B. Settlement through BOJ Accounts and the Reduction of Settlement Risk .. 471. Settlement through BOJ accounts:

Processing by the BOJ-NET Funds Transfer System 472. Reduction of settlement risk 48

C. Reserve Requirements of Financial Institutions .......................................... 51

Chapter IV: The Payment and Settlement System in Japan andthe Bank of Japans Payment and Settlement Services .. 55

A. Payment and Settlement .............................................................................. 561. Terms relating to payment and settlement 56

2. Payment and settlement services provided by the Bank 56B. Widely Used Payment Instruments in Japan ............................................... 57

1. Cash 572. Demand deposits held with financial institutions 573. BOJ account deposits 58

C. An Overview of Japans Payment and Settlement System.......................... 591. Funds clearing systems 592. Securities settlement systems 64

3. An overview of Japans payment and settlement system 65

D. The Bank of Japans Payment and Settlement Services.............................. 67


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1. Providing payment instruments and managing settlement systems for JGSs 672. Operating the BOJ-NET 68

3. Contributing to the stable operation of the payment and settlement system 694. Introducing the new RTGS system for funds and JGS transfers 76

Chapter V: On-Site Examination and Off-Site Monitoring,and Credit Extension as the Lender of Last Resort ........ 79

A. The Bank of Japans Business Operations related to Financial SystemStability ....................................................................................................... 801. Financial system stability 802. The Banks business operations related to financial system stability 80

B. The Role of On-Site Examination and Off-Site Monitoring ....................... 821. The role of on-site examination and off-site monitoring 822. Relationship between on-site examination and off-site monitoring 85

C. Outline of On-Site Examination and Off-Site Monitoring .......................... 861. Assessment of business operations and

financial condition of individual financial institutions 862. Evaluation of the financial system 89

D. Legal Framework and Procedures of On-site Examination......................... 891. Outline of the legal framework of on-site examination 892. On-site examination procedures 91

E. The Bank of Japans Role as the Lender of Last Resort .............................. 93

Box 1: Role of Banks in Our Daily Lives 94

Box 2: On-Site Examinations by the Bank of Japan and On-Site Inspections by the Government: A Comparison 95

Box 3: Contract regarding On-Site Examination 96Box 4: Points to Check in Examining Risk Management 97Box 5: Four Principles of Conducting Business Necessary to Maintain Financial

System Stability 99


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Chapter VI: The Bank of JapansMoney Market Operations and Lending ....................... 101

A. Price Stability and Monetary Policy.......................................................... 1021. Price Stability 1022. The Banks monetary policy and monetary control 102

B. Monetary Control ...................................................................................... 1041. CABs and monetary markets 1042. Sources of changes in CABs and monetary control 105

C. Money Market Operations......................................................................... 1061. Funds-supplying operations 1092. Funds-absorbing operations 1133. Monetary control through money market operations 1134. Ensuring transparency of the Banks money market operations 119

D. The Bank of Japans Lending Operations ................................................. 1201. Discounting of bills 1202. Loans collateralized by bills, JGSs, and other securities 121

E. Issuing of Substitute Certificates ............................................................... 122

Box 1: Money Market Operations by the Bank of Japan 124Box 2: Money Markets and the Call Market 126Box 3: Tanshi Companies and Securities Finance Companies 128

Chapter VII: Statistics, Research and Studies, andPublic Relations ............................................................... 129

A. Compiling and Publishing Statistics.......................................................... 130

B. Research and Studies................................................................................. 1331. Research 1332. Studies 136

C. Public Relations......................................................................................... 137


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Box 1: What Is Money Stock? 140Box 2: History and Revisions of the Wholesale Price Index 141

Box 3: The Bank of Japans Currency Museum 142Box 4: What Is an Archive? 144Box 5: What Is the Central Council for Savings Information? 145

Chapter VIII: International Operations and Services .147

A. The Bank of Japans International Operations and Services ..................... 148

B. Services Provided as Part of the Bank of Japans Cooperation withForeign Central Banks and International Organizations............................ 1491. Transactions with foreign central banks and international organizations 1492. Technical assistance 150

C. International Operations Conducted on Behalf of the Government........... 1511. Foreign exchange market and purposes of foreign exchange intervention 1512. The Banks business operations related to foreign exchange intervention

and foreign exchange reserves 152

3. Procedures of foreign exchange intervention 1534. Other business operations, including that conducted

under the Foreign Exchange and Foreign Trade Law 154

D. Responding to International Financial Crises............................................ 1571. International financial markets and international financial crises 1572. Monitoring of international financial markets

and response to international financial crises 158

Box 1: The Bank of Japans Participation in Major International Forums 160Box 2: What Are Bridging Loans? 162

Chapter IX: The Bank of Japans Treasury Funds Services ............. 163

A. Treasury Funds Services ........................................................................... 1641. Government-related services of the Bank 164

2. Treasury funds services and the agent system 1643. The flow of treasury funds services 1654. The significance of the Banks provision of treasury funds services 168


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5. Improvement in the efficiency of treasury funds services 171

B. The Governments Cash Management ...................................................... 1721. The government deposit balances fluctuations and the Banks services 1722. The Banks services related to the governments cash management 175

Box 1: A Brief History of the Bank of Japans Treasury Funds Services 177Box 2: On-line Processing of Treasury Funds Services Overseas

and the Bank of Japans Efforts 178

Chapter X: The Bank of JapansJapanese Government Securities Services ..................... 179

A. Services Related to Japanese Government Securities (JGSs).................... 1801. Overview of the Banks JGS services 1802. Services related to the issuance of government securities 1813. Services related to registration and book-entry transfer of JGSs 1854. Services related to payment of principal and interest on JGSs 190

B. Services related to Custody of Securities .................................................. 192

Box 1: Types of Japanese Government Securities (JGSs) 193Box 2: Prohibition against the Bank Underwriting JGBs and TBs and Extending

Loans to the Government 195Box 3: Deciding the Total Amount of JGS Issuance and the Amount Underwritten

by the Syndicate 196Box 4: Flow of Issuance Procedures in Syndicate Underwriting 197

Appendixes ........................................................................................... 199

Appendix 1: Organization of the Bank of Japan ............................................ 199

Appendix 2: The Bank of Japans Accounts .................................................. 203

Appendix 3: Bank of Japan Releases of Statistics and Other Materials......... 207

Appendix 4: Releases and Publications Related to Public Relations Activities.. 213Appendix 5: The Revisions of the Bank of Japan Law.................................. 216


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Appendix 6: References for the Japanese edition........................................... 236

! " ! " !

Supplement ........................................................................................... 239

1. Issues relating to Chapter I......................................................................... 244[Related to Section A] 244

2. Issues relating to Chapter II ....................................................................... 248[Related to Section A] 248

[Related to Section B] 249

3. Issues relating to Chapter III ...................................................................... 250[Related to Section A] 250

4. Issues relating to Chapter IV...................................................................... 252[Related to Section D] 252

5. Issues relating to Chapter V ....................................................................... 257[Related to Section A] 257

6. Issues relating to Chapter VI ...................................................................... 265[Related to Section A] 265[Related to Section C] 270[Related to Section D] 299

7. Issue relating to Chapter VII ...................................................................... 310[Related to Section A] 310

8. Issue relating to Chapter VIII..................................................................... 314[Related to Section B] 314

9. Issue relating to Chapter IX ....................................................................... 315[Related to Section A] 315

10. Issues relating to Chapter X ..................................................................... 319[Related to Section A] 319

! " ! " !

Index ....................................................................................................... 327


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Chapter I Introduction

The Bank of Japan is an organization that contributes to the stability of thedaily lives of the people and sound development of the national economy byappropriately controlling the volume of money in the economy and ensuringthe smooth circulation of money.

***

As Japans central bank, the Bank issues Bank of Japan notes (banknotes).

Besides cash, i.e., banknotes and coins, people also use bank deposits asmoney to make payments for transactions in goods and services, becausethey have confidence in deposits as they can be exchanged for cash atanytime.

To maintain public confidence in money, it is necessary that (1) the value ofmoney is stable, in other words, prices of goods and services must be stable(price stability), and (2) the payment and settlement system is reliable andefficient, so that money necessary for economic activity circulates smoothlythroughout the economy (financial system stability).

To achieve these objectives, the Bank conducts monetary policy and acts asthe lender of last resort through its various business operations.

In recent years, innovation in information technology has transformedfinancial markets and the business of financial institutions. Toaccommodate to these changes, the Bank continuously reviews its businessoperations to provide central bank services that are useful to the public.

***


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Chapter I: Introduction

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A. Functions of the Bank of Japan

1. Functions of the Bank in our daily livesThe Bank of Japan currently issues Bank of Japan notes (banknotes) in fourdenominations1,000 yen, 2,000 yen, 5,000 yen, and 10,000 yenandworks daily to ensure their smooth flow throughout the economy so that peoplecan use their money with confidence, anywhere and anytime. The outstandingamount of banknotes, including those issued in the past and still valid, totaledabout 57 trillion yen as of the end of March 2000. 1 Other services provided bythe Bank that are familiar to people in their everyday life include the central

banks functions of ensuring the smooth disbursement/receipt of thegovernments funds (treasury funds), e.g., the payment of pensions andcollection of taxes. While it is financial institutions (including post offices)that actually disburse the pension payments to beneficiaries, it is the Bank thatentrusts financial institutions to pay on the due date without fail through anetwork connecting financial institutions. The Bank transfers funds from thegovernments account to the financial institutions current accounts at the Bankand instructs them to make such payments. The Bank contributes to thestability of daily lives in Japan and the sound development of the national

economy through the issuance of banknotes, its control over the volume ofmoney in the economy, and its work to ensure the smooth circulation of money.The Bank was founded in 1882 as Japans central bank. The Bank is a

legal person managed and operated under the Bank of Japan Law which wascomprehensively revised in 1997 and came into effect in 1998. 2

In contemplating what functions the Bank, or more generally, a central bank, fulfills with regard to its national economy, it is possible to view itsfunction from several different perspectives. For example, focusing on thecentral banks business operations, it functions as the bank issuing banknotes,

as the bank of banks, and as the bank of the government. In terms of the rolesit plays, it conducts monetary policy and acts as the lender of last resort. Its

1 For more information on Japanese banknotes that are valid today, see box 1 for chapter II.

2 The Bank was established under the Bank of Japan Act in 1882. The Bank of Japan Law wasenacted in 1942 during the war, to replace the Bank of Japan Act, and no major revisions weremade for over 50 years. However, the globalization of the economy and financial system, as wellas the increased emphasis on market mechanisms triggered discussion about updating the central

banking system. Against this background, the Bank of Japan Law of 1942 was revised

comprehensively in 1997 under the two principles of independence and transparency of the Banksmonetary policy and business operations. For more information on the revision process, seeappendix 5.


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policy objectives are to ensure price stability and maintain financial systemstability.

Looking at these different functions and objectives of the central bank,how are they related to each other? For example, what is the relationship between the roles of the bank in the conduct of monetary policy and as thelender of last resort, and why is the central bank responsible for both? What isthe relationship between the two objectivesprice stability and financialsystem stability? Why is the central bank 3 charged with carrying out this

public mission, rather than the government or other government agencies?To provide answers to these questions, the sections below explain these

functions of the Bank based on the idea that the Bank is, above all, a bank, and

only differs from other banks because it issues banknotes.

! Box 1: Central Banks of the World

2. Business operations of the Bank as a bank

Individuals and firms make deposits with financial institutions, and they

withdraw cash from their deposits when they need to make payments in cash,or use their deposits to make payments by funds transfers between bankaccounts. Financial institutions use the funds deposited with them in a range ofinvestment activities such as making loans or trading in bonds.

The Bank does not accept deposits from individuals or firms, but doesaccept them from financial institutions. These deposits are accepted in theBanks current accounts (BOJ accounts). Financial institutions can havemoney on hand by withdrawing their deposits in BOJ accounts or use thesedeposits to settle transactions with financial institutions by funds transfers

between BOJ accounts. In addition, the Bank buys and sells Japanesegovernment securities (JGSs), bills and other instruments as well as makingloans to financial institutions holding BOJ accounts. In these respects, the

3 The Bank is a legal person under Article 6 of the Bank of Japan Law and a juridical persondesignated as having affairs closely related to the administrative processes of the State under theAdministrative Procedure Law. The Bank has paid-in capital of 100 million yen, 55 percent ofwhich is provided by the government, with the remaining 45 percent coming from the privatesector. Subscription certificates issued by the Bank are traded in the over-the-counter market, but

holders of those securities have no rights in the management of the central bank. The Bankshighest decision-making body is the Policy Board, whose members are appointed by the Cabinetwith the approval of the Diet (see box 6).


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Banks banking services are not greatly different from those of the privatefinancial institutions.

In one important respect, however, the Bank is different from any other bank: it issues banknotes. It should also be noted that financial institutionsdeposits in BOJ accounts have a similar function to banknotes in that thesedeposits can be exchanged for banknotes at anytime.

3. Issuing money which can achieve the highest settlement finality

Today, certain types of deposits held by individuals and firms at financialinstitutions and deposits held by financial institutions in BOJ accounts at theBank (together called deposit money) function as important paymentinstruments in addition to cash, which consists of banknotes and coins. 4 Ofthese, cash and deposits in BOJ accounts 5 are extremely safe money, as theissuer is free of default, and can achieve the highest settlement finality. 6

For example, when one goes shopping and the payment is of smallvalue, one hands over cash at the cashier and this achieves the highestsettlement finality. People obtain cash by making a withdrawal from theiraccounts at financial institutions. Therefore, financial institutions maintain acertain amount of cash on hand, in anticipation of payment in response to such

request, by withdrawing cash from their BOJ accounts (see chart 1-1).Larger payments for transactions are often made by funds transfers tothe payees account at a financial institution. In this case, if the payer and

payee hold accounts with different financial institutions, funds transfer between financial institutions needs to be settled by debits and credits to theirBOJ accounts for achieving the highest settlement finality. Likewise, fundstransfers for transactions between financial institutions are mostly settledthrough their BOJ accounts (see chart 1-2).

4 Coins are issued by the government. More specifically, the government issues the coins to theBank, which then distributes them to financial institutions (see chapter II).5 Banknotes issued by central bank and deposits in the central bank current accounts together aresometimes called central bank money (see B.3). The term high-powered money is also used torefer to the characteristics of these funds.6 The term highest settlement finality in this book is often referred to as ultimate settlement inrecent years. For the highest settlement finality, see chapters II and IV.


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Chart 1-1 Settlement of a Transaction in Cash

Buyer A

Withdrawal of cash

Credits seller Bsaccount

Debits AAsBOJ account

Credits BBsBOJ account

Seller B

Deposit of cash

Bank BBBank AA

Bank of Japan

! +

! +A

BBAA

B

Withdrawal fromAAs BOJ account Deposit to BBs

BOJ account

Purchase of goods

Payment in cash

Chart 1-2 Settlement of a Transaction using Deposits

Buyer ARequest of fundstransferWithdrawal offunds

Debits As account Credits Bs account

Debits AAsBOJ account

Credits BBsBOJ account

Seller B Notification of credit toBs account

Bank BBBank AA

Bank of Japan

! +

! +A

BBAA

BRequest of fundstransfer from AAsBOJ account to BBs

Notification ofcredit to BBsBOJ account

Purchase of goods


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In this manner, cash and deposits in BOJ accounts can achieve thehighest settlement finality for all kinds of transactions. As mentioned earlier,

certain types of deposits at financial institutions also function as money because public confidence in deposits is maintained since they can easily beexchanged for the same value of cash.

4. Issuance and maintenance of money

One of the inherent characteristics of a central bank such as the Bank is that itissues money by which the highest settlement finality can be achieved, andmaintains the function of money. 7 In other words, the central bank ensures that

people can use their money with confidence.Two conditions are necessary to achieve public confidence in money.

First, the value of money must be stable. In other words, prices must bestable. 8 The second condition is that arrangements for payment and settlement(payment and settlement systems), and more broadly the financial system, must

be stable and efficient. A sharp fall in the value of money due to inflation, orto loss of public confidence in payment and settlement using deposits atfinancial institutions due to financial instability, could lead to paralysis of the

payment and settlement functions of both cash and deposit money. In that

event, people might begin to use foreign currencies to make payments, and inextreme cases they might even resort to barter transactions. This is the primaryreason why the objectives of central banks are to ensure price stability andmaintain financial system stability. 9 These two factors are the basis orinfrastructure for economic activity to proceed stably and efficiently, allowing

people to lead orderly daily lives in todays monetary economy.To stabilize the value of money, central banks conduct monetary policy

by controlling the overall volume of money in the economy and interestratesthe prices of moneythrough a variety of ways of providing

7 This point becomes clearer upon examination of the history of central banks (for example, for thehistory of the Bank of England, see box 1). For a discussion of the background to the foundationof the Bank and the history of Japans banknote issuance system, see chapter II.8 The stability of the value of a currency has two aspects: the stability of its value relative todomestic prices (price stability), and the stability of its value relative to currencies of othercountries (foreign exchange rate stability). There is a global consensus that central banks shouldaim for price stability.9 To achieve financial system stability, the government also plays an important role in improvingthe legal foundations of the financial system and the regulation of financial institutions. The Bank

contributes to the stability of the payment and settlement system and the financial system by providing payment instruments and operating the payment and settlement system, as well as byacting as the lender of last resort (see chapters IV and V).


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B. Outline of the Bank of Japan

s Business Operations

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money by which the highest settlement finality can be achieved. In the eventthat the stability of the payment and settlement system or that of the financial

system is jeopardized, the funds that the central bank provides in its role as thelender of last resort are also money by which the highest settlement finality can be achieved. It is vital that the central bank be able to provide such money,which people can accept with confidence, especially at times of financialsystem instability. The reason why the Bank conducts monetary policy andacts as the lender of last resort stems from the Banks role as the sole providerof money by which the highest settlement finality can be achieved.

The Banks mission of maintaining the function of money can beefficiently carried out through its banking services. It is important that this

mission is aimed at ensuring a stable basis for the peoples living. Thisthinking was formed based on past experiences such as inflation and various

problems arising from unstable money, and in most countries it is understoodthat the mission is best pursued by a central bank acting independently. This iswhy a central bank, which should be independent from the government andcarries out banking services, is necessary for the task of maintaining thefunction of money rather than the government or other government agencies.

! Box 2: The Payment and Settlement System, Financial Institutions, and the FinancialSystem

! Box 3: Objectives of the Bank of Japan Stipulated in the Bank of Japan Law! Box 4: Independence of Monetary Policy! Box 5: Transparency of Monetary Policy and of the Bank of Japans Business

Operations! Box 6: Organization of the Bank of Japan Headed by the Policy Board

B. Outline of the Bank of Japans Business Operations

The section above discussed the functions of the Bank of Japan related to theissuance of money by which the highest settlement finality can be achieved andthe maintenance of the function of money. Based on this, the following sectiondiscusses the business operations of the Bank in four categories: (1) issuance of

banknotes and provision of payment and settlement services; (2) businessrelated to the role as the lender of last resort; (3) business related to conducting

monetary policy; and (4) treasury funds services for the government. Relevantchapters are indicated for each of these business operations as reference.


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1. Issuance of banknotes and the provision of payment and settlementservices

A fundamental service provided by the Bank is to make cash easy to use, andto ensure that individuals and firms can use cash with confidence for paymentand settlement of transactions. This involves ensuring that banknotes aredistributed smoothly all around the country through financial institutions tomeet demands for cash by the public. The Bank must also exercise qualitycontrol to ensure that these banknotes are always in good condition.Prevention of counterfeiting is another important task of the Bank, and Japanmeets high global standards in this regard. Services concerning banknotes areexplained in chapter II, The Issuance, Circulation, and Maintenance of Bankof Japan Notes.

In addition to cash, deposits financial institutions hold with the Bank are payment instruments by which the highest settlement finality can be achieved.The Bank provides current account services to financial institutions and avariety of payment and settlement services through these BOJ accounts. TheBank operates a computer network system called the Bank of Japan Financial

Network System (BOJ-NET) to ensure safe and efficient payment andsettlement services. The Bank continues to improve payment and settlement

systems and implements measures to reduce various risks related to settlement.The Bank conducts monetary policy and acts as the lender of last resortthrough transactions with financial institutions in its banking services, andthese transactions are settled using deposits in BOJ accounts at the Bank. 10

Chapter III, The Bank of Japans Current Account Services, explainscurrent account services that the Bank provides to financial institutions, whichare the basis of the Banks activities. Chapter IV, The Payment andSettlement System in Japan and the Bank of Japans Payment and SettlementServices, discusses the structure of Japans payment and settlement system

and the Banks role in the system. Chapter V, On-Site Examination and Off-Site Monitoring, and Credit Extension as the Lender of Last Resort, discussesthe significance of financial system stability and the Banks roles inmaintaining it. The Bank accepts deposits from foreign central banks andinternational organizations, and at times extends credits to them. Theseinternational aspects of the Banks business operations are discussed in chapterVIII, International Operations and Services.

10 Under the reserve requirement system, financial institutions are required to maintain a certain

fraction of deposits received from their customers as reserves in the form of deposits at the Bank(see chapter III).


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2. Business related to the Banks role as the lender of last resort

For a discussion of the Banks role as the lender of last resort, it is necessary torecognize that the financial system is made up of a large number of financialinstitutions. People can send funds from their own financial institution to anaccount held by an individual or a firm anywhere in the country because all thefinancial institutions are linked in a network. Naturally, there is a complex setof obligations between these institutions. If a problem develops with some ofthese obligations, a chain reaction of default could occur, and the publicconfidence in the entire financial system could be lost, possibly causing runson banks. The possibility of causing such a chain reaction of settlementfailures to other financial institutions or to other financial markets is calledsystemic risk. 11

To prevent the materialization of such systemic risk, the Bank providesfunds temporarily to financial institutions that are facing difficulty in raisingfunds 12 from markets. Since the Bank extends loans to these institutions tomaintain financial system stability when no one else will, it is called the lenderof last resort. Given that the central bank stands at the center of the paymentand settlement system, it is in an ideal position to monitor financial marketsand each financial institutions liquidity management. The Bank monitors on a

daily basis individual financial institutions operations, and developments infinancial markets. The Bank also conducts on-site examinations of financialinstitutions to obtain an accurate picture of their financial condition. Thefindings from these monitoring and examinations not only help to support theBanks role as the lender of last resort in maintaining financial system stability,

but also provide valuable information in conducting monetary policy and other business operations.

These activities are discussed in detail in chapter V, and together withchapter IV it provides an overall picture of risks in Japans payment and

settlement system and its financial system. As the globalization of financialmarkets progresses, it has become increasingly important to cooperate withforeign central banks and international organizations to prevent thematerialization of systemic risk. These issues are discussed in chapter VIII.

11 For a discussion of systemic risk, see chapter IV.12 For a discussion of financial institutions liquidity management, see chapter V.


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3. Business related to conducting monetary policy

Central banks control over interest rates and the volume of money in theeconomy is a function which derives from its exclusive authority to providecentral bank money (banknotes and deposits in BOJ accounts), the volume ofwhich ultimately affects the total volume of money in the economy. 13 TheBank conducts such control through its banking services. For instance, whenthe Bank buys JGSs or bills that are held by financial institutions (known as apurchasing operation or a funds-supplying operation), those funds aretransferred to the sellers BOJ accounts and increase the volume of central

bank money. In the opposite case, when the Bank sells financial assets in its possession (known as a selling operation or a funds-absorbing operation),the volume of central bank money is reduced. A similar effect is seen whenthe Bank makes loans to or collects loans from financial institutions.

By changing the size and timing of funds supplying/absorbingoperations, the Bank controls 14 interest rates in money markets, where financialinstitutions borrow/lend funds. This has a ripple effect on interest rates inother markets, and on the interest rates at which financial institutions lend toindividuals and firms, allowing the effects of the central banks monetary

policy to pervade the financial system. 15 The Bank strives to achieve its

ultimate goal of price stability by conducting its monetary policy in thismanner. For a detailed explanation of the mechanisms by which the Bankconducts its monetary policy, such as through market operations and lending,see chapter VI, The Bank of Japans Money Market Operations and Lending.The current account services provided to financial institutions that are the basisof these operations are explained in chapter III.

It is extremely important for the effective conduct of monetary policy tocompile statistics and to carry out research and studies on the economy and

prices. Such research and studies are also indispensable for the Banks

13 Financial institutions deposit money is supplied by their credit creation function, and central banks can influence the level of money stock, including deposit money, by controlling the volumeof central bank money, that is, the sum of banknotes in circulation and deposits in BOJ accounts(see box 1 for chapter VII). The sum of central bank money plus coins in circulation is called themonetary base and the Bank publishes on a monthly basis the amount outstanding data, the growthrate, and statistics explaining the relation between the monetary base and various transactionsconducted by the Bank (see appendix 3).14 As of September 2000, the Bank guides the uncollateralized overnight call rate to the targetedlevel decided by the Policy Board at Monetary Policy Meetings (see chapter VI).15

The Bank implements monetary policy by conducting monetary control, changing the level ofthe official discount rate (the rate at which the Bank makes loans to financial institutions; seechapter VI), and changing the reserve requirement ratio (see chapter III).


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11

business operations related to financial system stability and for conductingother business operations. With a view to achieving higher transparency in its

monetary policy and business operations, the Bank is engaged in a wide varietyof public relations activities. These activities of the Bank are described indetail in chapter VII, Statistics, Research and Studies, and Public Relations.To fully understand Japans economic and financial situation, it is alsonecessary to pay heed to economic and financial developments overseas aswell as trends in international financial markets. From that perspective, theBank maintains close contact with foreign central banks and internationalorganizations, to share information and engage in joint research and analysis

projects. These efforts are explained in detail in chapter VIII.

4. Treasury funds services for the government

As part of its banking services, the Bank accepts deposits from the governmentand provides various services related to payment and receipt of thegovernments money (treasury funds services), for example receipt of nationaltaxes and payments for public works and pensions. The Bank also providesservices related to the issuance and settlement of JGSs. 16 Payments andreceipts of treasury funds make up a significant part of the economic activity of

both individuals and firms, and the Bank makes great efforts to make thesetransactions as convenient as possible for the people. The JGS market formsthe core of Japans financial markets, and the Banks effort to make issuanceand settlement as smoothly as possible plays a significant role in improving thefunctionality of the financial system as a whole. These activities are describedin detail in chapter IX, The Bank of Japans Treasury Funds Services, andchapter X, The Bank of Japans Japanese Government Securities Services.The Banks intervention in the foreign exchange market, as the agent of theJapanese government, is discussed in chapter VIII.

16 It is because of these functions that the Bank is sometimes referred to as the bank of thegovernment. The transactions between the Bank and the government differ, however, from those

between financial institutions and individuals or firms. For example, as explained in chapter X, theBank is prohibited by law from providing credit to the government by extending loans or

underwriting JGSs except in very limited, exceptional cases. In addition, whether a central bankcan handle treasury funds operations varies from country to country. For these reasons, it is notwidely accepted that one of the central banks functions is as the bank of the government.


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12

C. Innovation in Technology and the Bank of Japan

Recent years have seen vast global changes in how financial transactions areconducted and in how financial institutions operate. These changes include theglobalization of financial markets, the development and spreading use ofderivatives and other innovative transaction methods and financial products,and the progress of deregulation in the financial sector. One common factorunderlying all of these developments is the innovation in informationtechnology, including the development of computers and advancedcommunications technology. Central banks have to accommodate theirservices to these changes in the financial environment.

Looking first at the banking services of central banks, it is necessary tomake money by which the highest settlement finality can be achieved easier touse, by making cash easier to use and improving the processing of the currentaccount services through computer networks such as the BOJ-NET. If people

become reluctant to use money provided by central banks for payment becauseit is inconvenient to use, central banks become less able to perform itsfunctions. Further, the emergence of new forms of financial transactions andfinancial markets often necessitates changes in the operational instruments andmethods central banks use to conduct money market operations. Central banksalso need to introduce advanced information processing technology in thehandling of government securities and treasury funds services for theconvenience of people.

The development of new financial products and financial transactionsfostered by advances in financial engineering has brought central banks newchallenges in terms of conducting monetary policy and maintaining financialsystem stability. When a new financial product comes to be used as a paymentinstrument, this can drastically change the range of money that the central bankaims to control. If the distinction between banks and nonbanks becomes lessmarked, central banks may have to change the set of institutions with whichthey conduct their market operations. The development of so-calledelectronic money also raises new issues related to the fundamental questionsof What is money? and What are banks? and could significantly changethe very nature of financial transactions.

! Box 7: Types of Electronic Money and Their Use as a Payment Instrument


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C. Innovation in Technology and the Bank of Japan

13

While advances in financial engineering have made financialtransactions more efficient, risks in financial markets have become

increasingly difficult to identify, and systemic risk has come to have a greaterglobal impact. In their on-site examinations and off-site monitoring, central banks must keep up with these changes by developing new methods and waysof carrying out examinations and monitoring. Globalization of financialactivities makes it possible for both individuals and firms to engage intransactions that extend far beyond national borders, which increases theimportance of international cooperation between central banks. In the long run,the role of central banks will change to respond to these developments.

This book attempts to explain the current business operations of the

Bank of Japan as accurately and as understandably as possible, and it also aimsto give an overview of the changes and trends in central bank services

prompted by technological innovation.It is difficult to foretell the outcome of advances in financial

engineering, or the impact they will ultimately have on our economy andsociety. As long as our actual economic activity is based on a monetaryeconomy, however, it will remain true that peoples confidence in money

whatever changes or evolution of form it may undergoin other words,the fact that the function of money is maintained appropriately forms the basisof all varieties of economic activity and the everyday life of the people. Therole of the central bank is to respond appropriately to innovations in financialengineering, and to provide central bank services that are useful to theeconomic activity of the people. This requires central banks to keep reviewingand improving their services. The Bank is constantly mindful of thisresponsibility.


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Box 1 Central Banks of the World

Most countries have a central bank. Central banks take many forms, but one prototype can be seen in the Bank of England, which was founded in 1694 as acommercial bank conducting ordinary banking business. Over the course ofthe next century, the Bank of England earned a particularly important statusamong commercial banks, and following the financial crisis of 1825, othercommercial banks deposited their reserves with the Bank of England, therebyeffectively establishing a payment and settlement system centered on the Bankof England. The Bank Charter Act of 1844 designated the Bank of Englands

banknotes as legal tender. As the case of the Bank of England shows, a central

bank is an institution that has developed naturally as a result of theconcentration of currency issuance and interbank settlement at a single bank.

Among central banks that developed later in other countries, most wereestablished by law concerning central bank from the beginning. One exampleis the U.S. Federal Reserve System consisting of: the Board of Governors ofthe Federal Reserve System, as one of the governmental agencies governingthe Federal Reserve System; twelve regional Federal Reserve Banksconducting central bank services; and member commercial banks holdingstocks in one of the twelve Federal Reserve Banks. Another example is theEuropean Central Bank (ECB). The member states of the European Uniondrew up a treaty to establish the ECB and issue a single currency, the euro.The ECB sets the monetary policy direction, and the member central banksconduct their operations according to the direction.

Table for Box 1 Worlds Central BanksYear of foundation Name Country (currency)

1668 (worlds oldest) Sveriges Riksbank Sweden (krona)

1694 Bank of England United Kingdom (poundsterling)1882 Bank of Japan Japan (yen)1913 Federal Reserve System United States (U.S. dollar)1998 European Central Bank EU member states 1 (euro)

Note: 1. Eleven of the European Unions 15 member states now participate in theEurosystem (one more member state will participate from January 2001). For a listof the countries, see table 2-1 in chapter II.


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Box 2 The Payment and Settlement System, Financial Institutions, andthe Financial System

For an economy to develop, it is vital that the transfer of money needed for allforms of economic activity takes place smoothly, and that savings be usedeffectively for investment. A great variety of financial transactions take placewith great frequency in financial markets in the process of transferring moneyand bridging the gap between savings and investment. Given thesetransactions, a huge volume of funds and securities are transferred. A transferof funds or a delivery of securities that completes a transaction is known assettlement. The arrangement for transferring funds and securities, which

often consists of facilities such as computer systems and networks, and isoperated under a common set of rules and agreements among relevant parties,as well as relevant laws and regulations, is commonly known as payment andsettlement system (see chapter IV). The term payment and settlement systemis used to indicate one specific payment and settlement system, as well as anations payment and settlement system as a whole, which is made up ofindividual payment and settlement systems. In this book, the term refers to

both individual systems and the system as a whole, with its meaning clarifiedwhere necessary.

Financial institutions play a role in ensuring that transactions take placesmoothly in financial markets. Many kinds of financial institutions are activein Japan, ranging from banks, securities companies, and insurance companies,with which the general public are familiar, to specialists such as foreignexchange brokers (see chapter VIII). In this book, the term financialinstitutions is used to embrace all of these types of institutions in principle,and where necessary the term is clarified to indicate a more limited range ofinstitutions.

The term financial system is used in this book to mean a total systemcomprising payment and settlement systems, various financial markets, andfinancial institutions (see chapter V).

For an economy to achieve stable growth, it is essential to ensuresmooth operation of the payment and settlement system, which is anarrangement to transfer funds and securities, so that funds and risks can betransferred and allocated efficiently through the financial system. To this end,the Bank of Japan works to maintain financial system stability through itsvarious business operations for maintaining an efficient and sound payment

and settlement system and through its role as the lender of last resort (see B.2.).


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Box 3 Objectives of the Bank of Japan Stipulated in the Bank of JapanLaw

The new Bank of Japan Law promulgated in 1997 sets the Bank of Japansobjectives as follows.Article 1 The objective of the Bank of Japan, as the central bank of Japan, is

to issue banknotes and to carry out currency and monetary control.2. In addition to what is prescribed by the preceding Paragraph, the

Banks objective is to ensure smooth settlement of funds among banks and other financial institutions, thereby contributing to themaintenance of an orderly financial system.

Article 2 Currency and monetary control shall be aimed at, through the pursuit of price stability, contributing to the sound development ofthe national economy.

Article 1, Paragraph 1 stipulates that one of the Banks objectives is toissue banknotes and conduct monetary policy (which in the law is termedcurrency and monetary control). Article 2 of the law stipulates that pricestability should be pursued through monetary policy to ensure the sounddevelopment of the national economy.

The Banks second objective as stipulated in Article 1, paragraph 2, isto ensure smooth and stable operation of the payment and settlement systemthrough measures such as acting as the lender of last resort so as to maintainfinancial system stability.

In this way, the Bank of Japan Law makes it clear that the objectives ofthe Bank are to ensure price stability and maintain financial system stability(see also appendix 5).


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Box 4 Independence of Monetary Policy

It has become the norm throughout the world that monetary policy in pursuit of price stability is conducted by a central bank independent from the government.This is because it is easy for those conducting monetary policy to come

under pressure to adopt inflationary policies. Looking at the past history ofcentral banks, there are many cases where an increase in issuance of currencyto cover government spending such as war expenses sparked severe inflation.Central banks are often pressured to take measures to stimulate the economy inthe short run since there is a time lag before inflation actually surfaces even ifthe central bank has taken an easier monetary policy.

With regard to this point, the Bank of Japan Law states: The Bank ofJapans autonomy regarding currency and monetary control shall be respected(Article 3, Paragraph 1). Article 5, Paragraph 2 of the Bank of Japan Lawstates that due consideration shall be given to the autonomy of the Banks

business operations.To ensure the independence of the Bank, members of the Policy Board,

which is the Banks highest decision-making body, cannot be dismissed forholding opinions at variance with the government, and the government cannotorder the Bank to undertake any particular policy action or to conduct any

particular business operation.Of course it is important that the Banks monetary policy is consistent

with the governments basic economic policy framework, so Article 4 of theBank of Japan Law states that the Bank shall always maintain close contactwith the government and exchange views sufficiently. The Bank of JapanLaw also allows representatives of the government to attend Monetary PolicyMeetings of the Policy Board, to give their views and submit proposals, orrequest that the Board postpone a vote on monetary policy measures until thenext meeting.

The government representatives have no votes in the monetary policydecisions, and the decisions are made only by a majority vote of the nineMembers of the Policy Board (see also appendix 5).


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Box 5 Transparency of Monetary Policy and of the Bank of JapansBusiness Operations

The Bank of Japan Law stipulates the independence of the Bank of Japan, andat the same time it requires the Bank to make its policy-making process openand transparent so that the Bank does not become biased. Article 3, Paragraph2 of the Bank of Japan Law requires the Bank to endeavor to clarify to the

public the content of its decisions, as well as its decision-making process. Inaccordance with this provision, the Bank strives constantly to improve thetransparency of its policy and business operations.

After each Monetary Policy Meeting (MPM), the Policy Board makes

public the decisions reached at the MPM, including the guidelines for moneymarket operations and the Banks assessment of economic and financialdevelopments, and the Bank also releases the outline of the discussions(minutes) of the MPMs and will publish a detailed record of the discussions tenyears after each meeting (transcripts; Article 20 of the law). Other mattersdecided at the Policy Board meetings are disclosed in Nippon Ginko Seisaku

Iinkai Geppou (Monthly Report of the Policy Board of the Bank of Japan,available only in Japanese).

The Bank also publishes an outline of its business operations in therelevant business year, as specified in Article 55 of the law. A report oncurrency and monetary control is submitted to the Diet twice a year, and theGovernor or a designated representative appears before Diet committees, onrequest, to explain the Banks policies, business operations, and balance sheetconditions (Article 54 of the law).

See the table below for a list of the Banks publications on its policiesand business operations.

In addition, the Bank undertakes a wide variety of activities to informthe public, through various channels ranging from press conferences andspeeches of the Governor, other Policy Board Members, executives and staff toinformation on its Web site (http:www.boj.or.jp/en/index.htm). The Bank alsoexchanges views with a wide range of people in economic and financial circles,and takes in a variety of opinions from the general public. Through theseactivities, the Bank aims to explain the thinking behind its policies and

business operations, thereby increasing its accountability regarding its policies(see also appendix 5).


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Table for Box 5 Releases and Publications on Monetary Policy and theBanks Business Operations 1

Title Frequency of publication

Contents

Announcement ofMonetary PolicyMeetingDecisions 2

After eachmeeting

Announcement of decisions on matters relatedto monetary policy, including guidelines formoney market operations and changes in theofficial discount rate decided at each MonetaryPolicy Meeting held twice a month in

principle. Released in principle immediatelyafter each meeting.

Minutes ofMonetary PolicyMeetings 2

After eachmeeting

Summary of discussions at each MonetaryPolicy Meeting held twice a month in

principle. The minutes of each meeting areapproved at the first or the second MonetaryPolicy Meeting held around one month afterthe meeting concerned, and released afterapproval.

Transcripts ofMonetary PolicyMeetings 3

Ten yearsafter eachmeeting

Transcripts of discussions at each MonetaryPolicy Meeting held twice a month in

principle. The transcripts of each meeting will be released ten years after the meeting

concerned.Monthly Reportof RecentEconomic andFinancialDevelopments 2

Monthly Analyses of the economic and financialdevelopments on which decisions on moneymarket operations are based. The reportconsists of The Banks View and TheBackground. The Japanese and Englishversions of The Banks View and theJapanese version of The Background arereleased on the next business day after theapproval of The Banks View at the firstMonetary Policy Meeting of the month. TheEnglish version of the The Background isreleased within a few business days from therelease of The Banks View. In April andOctober, the Outlook and Risk Assessment ofthe Economy and Prices is also included as

part of the Monthly Report. The Outlook andRisk Assessment covers a longer period oftime and provides the Policy Board membersforecast of real GDP, the domestic wholesale

price index, and the consumer price index as a

reference.


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Nippon GinkoSeisaku IinkaiGeppo (Monthly Reportof the PolicyBoard of the Bankof Japan) 2,4

Monthly Monthly report of activities by the PolicyBoard, including decisions on monetary policyand on other matters by the Policy Board,minutes of Monetary Policy Meetings, andMonthly Report of Recent Economic andFinancial Developments.

SemiannualReport onCurrency andMonetaryControl 2,5

Semiannually Report to the Diet on the Banks monetary policy as specified in Article 54 of the Bank ofJapan Law.

Outline of

BusinessOperations forFiscal XXXX 2,5

Annually Outline of the Banks business operations in

each fiscal period as specified in Article 55 ofthe Bank of Japan Law.

Statement by theGovernor 2

Ad hoc basis The Banks view on monetary policy and thefinancial system at important junctures.

Summary of thePress Conferences

by BankExecutives 2

After each pressconference

Summary of the press conferences by Bankexecutives.

Speeches by BankExecutives 2

After eachspeech

Speeches by Bank executives.

Annual Review 2 Annually Review of monetary and economicdevelopments, an outline of the Banksorganization, activities, financial statements,and other materials.

FinancialStatements 2

Semiannually Report on the Banks balance sheet (assets,liabilities, and capital accounts) and thestatement of income during the periodconcerned.

Bank of JapanAccounts 2

Three times amonth

Report on the amount outstanding of majoritems of the Banks balance sheet (assets,

liabilities, and capital accounts), at the end ofthe ten-day period concerned.

Notes: 1. As of October 2000. Distributed free of charge at the Public Relations Departmentat the head office.

2. Releases and most of the articles included in these publications are available fromthe Bank of Japans Web site (http://www.boj.or.jp/en/index.htm for English, andhttp://www.boj.or.jp/ for Japanese).

3. No transcripts have yet been published.4. Available only in Japanese.5. Available only in Japanese, but summary of the text is available in English.


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Box 6 Organization of the Bank of Japan Headed by the Policy Board

The Policy Board is the Bank of Japans highest decision making body. TheBoard comprises the Governor, two Deputy Governors, and six appointedmembers. These nine members are appointed by the Cabinet and approved bythe Diet (see appendix 1). The Chairman of the Policy Board is elected by theBoard members among themselves. As of September 2000, the Governor ofthe Bank has been elected Chairman of the Policy Board.

The Policy Board discusses all important policy decisions of the Bank,and makes its decisions by a majority vote. The Bank of Japan Law of 1997stipulates that certain policy matters must be decided by the Policy Board, as

outlined in the table below. These matters span a wide range from the Banksmonetary policy and business operations to internal management. The PolicyBoard meets more than twice a week to handle its extensive agenda.

Policy Board meetings where matters related to monetary policy such asthe official discount rate, the guideline for money market operations, theframework for market operations, and the Banks view of economic andfinancial developments are decided, are called Monetary Policy Meetings(MPMs). In principle, MPMs are held twice a month separately from otherPolicy Board meetings. The schedule for MPMs for the following six monthsis made public.

Table for Box 6 Matters that must be decided by the Policy Board (underArticle 15 of the Bank of Japan Law)

Matters related to monetary policy(Paragraph 1)

Other matters (Paragraph 2)

(1) The official discount rate(2) The guideline for money market

operations(3) The reserve requirement ratio(4) The instruments for market

operations (e.g., operation schemes,types of collateral)

(5) The Banks view of economic andfinancial developments

(1) Issues related to maintainingfinancial system stability (e.g., on-site examinations)

(2) International financial business (e.g., bridge loans)

(3) Internal management (e.g., budget,organization)

(4) Reports, rules (e.g., reports to theDiet, by-laws)

(5) Other matters deemed necessary bythe Policy Board


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The Banks Governor, Deputy Governors, Executive Directors, and thestaff are responsible for carrying out the Banks business operations according

to the decisions made at the Policy Board. For this purpose, the Bank has itshead office in Tokyo, 33 branches and 13 local offices across the country, ofwhich one is a computer center, and six overseas representative offices (seeappendix 1). A new cash operations center is under construction.

The Banks services related to treasury funds and Japanese governmentsecurities require transactions with individuals, firms, and government officesacross the country. Therefore, the Bank entrusts some of these services to

private financial institutions that are designated as the Banks agents, and postoffices also provide such services (see chapters IX and X).


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Box 7 Types of Electronic Money and Their Use as a PaymentInstrument

Various pilot projects in a past few years have made the term electronicmoney very familiar. Electronic money is an electronic instrument that

performs the function of money. Electronic money can be broadly divided intotwo types based on how it is transferred.

The first type is electronic money that is issued in exchange for cash ordeposit money. The monetary value is transferred by exchanging electronicdata to settle economic transactions. For example, by debiting a depositaccount of a financial institution and storing the value as data in an IC card

beforehand, an individual can make payments for goods and services bytransferring the electronic data stored in the card to the sellers card. This typeof electronic money is referred to as the stored-value product, because themoney is stored on the IC card. Its function is very similar to prepaid cardssuch as telephone cards.

Another type is an arrangement for giving instructions for fundstransfers, electronically. For example, an individual can make payments forgoods and services by giving instructions to debit its bank account and creditthe sellers bank account through the exchange of electronic data on theInternet or through computer networks. This type of electronic money is calledthe access product because customers access financial institutions thatmanage their accounts to instruct funds transfers. Its function is very similar to

bills and checks.Pilot tests of these types of electronic money have shown that they can

be used as money to settle economic transactions. In particular, stored-value products are used as a payment instrument that avoids the need forsmall change for low-value payments.

Money has not just been used for payments but has also been used asa means of savings, and also as a standard of value. In the future, it may

become possible to pay interest on electronic money, just as it is paid ondeposits, or a new type of electronic money that has the characteristics of boththe types mentioned above may be invented. Further, if it becomes possible tosafely transfer a large value of funds on the Internet, this could allow electronicmoney to replace conventional money not only in its function as a paymentinstrument, but also in the various other functions of money in our society.


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Chapter II The Issuance, Circulation, and Maintenance ofBank of Japan Notes

The Bank of Japan issues, circulates, and maintains Bank of Japan notes.This chapter explains these activities, and provides some information on thecharacteristics of Bank of Japan notes and related matters.

***

The Bank is the sole issuer of banknotes in Japan. It issues Bank of Japan

notes (banknotes) in four denominations: 10,000 yen, 5,000 yen, 2,000 yen,and 1,000 yen.

As stipulated in the Bank of Japan Law, these banknotes are legal tender, alegally defined payment instrument that should not be refused by anycreditor in satisfaction of any debt, and by which the highest settlementfinality can be achieved. They are widely used, primarily in face-to-facetransactions of low value.

Banknotes enter circulation when financial institutions receive them at thehead office and branches of the Bank, and their current accounts at the Bankare debited. Individuals and firms obtain banknotes at financial institutionscounters, cash dispensers or automated teller machines (ATMs), bywithdrawing money from their accounts. Banknotes are used to pay forgoods and services or to make payments for financial transactions. They arethen brought back to financial institutions as deposits made by individualsand firms, and returned to the Bank.

Various measures, including steps to prevent counterfeiting, are taken tomake Bank of Japan notes easy to use and reliable.

***


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Chapter II: The Issuance, Circulation, and Maintenance of Bank of Japan Notes

26

A. Cash and the Bank of Japan

1. Outline of cash and the issuance of banknotesCash consists of banknotes and coins, and is a payment instrument widely usedto make payments for various economic transactions (see chapter IV), togetherwith demand deposits 1 people hold with financial institutions.

Printed banknotes and minted coins need to be put into circulation forthe economy to use them. Banknotes, or Bank of Japan notes, aremanufactured by the Japanese government (Ministry of Finance) and aredelivered to the Bank of Japan in exchange for the cost of their production.Banknotes begin circulating when they are transferred to financial institutions(see B.1) and the equivalent amount is debited from the institutions currentaccounts at the Bank (referred to as BOJ accounts, see chapter III). They aredeemed to be issued by the Bank at this point. Article 46 of the Bank of JapanLaw stipulates that the Bank shall issue banknotes, and thus the Bank isreferred to as the sole issuer of banknotes in Japan. The issuance of banknotesis one of the objectives of the Bank of Japan (Article 1, Paragraph 1 of theBank of Japan Law). The banknotes issued are entered as liabilities in theBanks balance sheet (see appendix 2).

Coins, unlike banknotes, are issued by the Japanese government. Coinsare minted by the government (Ministry of Finance) and are deemed to beissued when they are delivered to the Bank as stipulated in Article 4 of the LawConcerning the Unit of Currency and the Issuance of Coins. Banknotes andcoins are similar, however, in that both are put into circulation from thecounters of the Bank. In Japan, banknotes and coins are both produced by thegovernment (Ministry of Finance), but banknotes are issued by the Bank andcoins are issued by the government. Practices regarding the production andissuance of banknotes and coins vary from country to country (see table 2-1).

The Bank issues banknotes in four denominations:2 10,000 yen, 5,000

yen, 2,000 yen, and 1,000 yen (see table 2-2). Coins are issued in sixdenominations (excluding commemoratives): 500 yen, 100 yen, 50 yen, 10 yen,

1 Demand deposits are deposits from which depositors can withdraw cash on demand, such ascurrent deposits and ordinary deposits. Because of their highly liquid nature, these deposits areused as a payment instrument (see chapter IV).2 At present, only four designs of these denominations of banknotes (see table 2-2) are issued, thatis, paid to financial institutions over the counters at the head office and branches of the Bank. A

total of 19 kinds of banknotes are valid at present, but the remaining 15 are not reissued for furthercirculation after returning to the Bank (see box 1 and the Banks Web site athttp://www.boj.or.jp/en/index.htm to see the kinds of banknotes that are valid today).


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5 yen, and 1 yen. As of end-March 2000, approximately 61 trillion yen of cashwas in circulation, of which banknotes accounted for 93 percent. Banknotes

account for such a large portion of cash in circulation mainly because of theirlarger face values.

Table 2-1 Issuers of Banknotes and Coins in Selected Countries and theEuro Area

Banknotes Coins

Issuer Manufacturer Issuer ManufacturerJapan Central bank Government

(PrintingBureau,Ministry ofFinance)

Government Government(MintingBureau,Ministry ofFinance)

U.S.A. Central bank 1 Government Government GovernmentEuroarea

Nationalcentral bank ofeach MemberState 2

Nationalcentral bank,government,

private entities

in eachMember State 3

Government ofeach MemberState

Government ofeach MemberState

U.K. Central bank 4 Central bank 4 Government GovernmentCanada Central bank Private entities Government Government

Notes: 1. The Board of Governors of the Federal Reserve System retains the right to issue banknotes. The Board is a federal government agency and is the supremedecision-making body of the Federal Reserve System. In practice, each of thetwelve Federal Reserve Banks is authorized by the Federal Reserve Act to issue

banknotes.2. The euro area comprises 11 Member States of the European Union (EU) that

adopted the euro as the single European currency in January 1999: Belgium,Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria,Portugal, and Finland (Greece became the twelfth Member State of the euro areain January 2001). Since that time, the Governing Council of the European CentralBank (ECB), the ECBs decision-making body, has retained the right to issue

banknotes, but euro banknotes will be issued by the national central banks of theeuro area. Euro banknotes will be put into circulation after the transition period,which ends on December 31, 2001, and until that date the present national

banknotes in the euro area will be put into circulation (starting on January 1, 2002,each national central bank will withdraw its present national banknotes).

3. Varies from country to country.


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4. In the United Kingdom, for historical reasons, banknotes issued by private bankshave been used in Scotland and Northern Ireland in parallel with those issued by the

Bank of England. However, the private issuing banks are, in principle, required tohold an amount of Bank of England notes equal to the outstanding amount of theirown banknotes issued.

Table 2-2 Banknotes Issued Today

Size (mm) Major designDenomi-nation(yen)

Height Width Front BackWatermarkdesign

Tactilemarks forthe visuallyimpaired

10,000 76 160 YukichiFukuzawa(A pioneer ofmodernthought in theMeiji periods)

A pair of pheasants

YukichiFukuzawa

JapaneseBraille forvowel u

5,000 76 155 Inazo Nitobe(An educator inthe Meiji,Taisho, and

Showa period)

Mt. Fuji Inazo Nitobe

JapaneseBraille forvowel i

2,000 76 154 Shureimon Gate(The gate toShuri Castle inOkinawa built

by King Shoseiof the RyukyuKingdom in the16th century)

A scenefrom theTale ofGenji and

portrait ofits author,MurasakiShikibu

Shureimon Gate

JapaneseBraille forni,meaningtwo

1,000 76 150 Soseki Natsume (Aleadingnovelist in theMeiji andTaisho periods)

A pair ofcranes

Soseki Natsume

JapaneseBraille forvowel a

! Box 1: How Many Kinds of Banknotes Are Valid Today?


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2. Characteristics of banknotes

Banknotes are a widely used payment instrument, especially for payments oflow value. Banknotes are often used in face-to-face transactions, in which cashis handed directly from one party to the other. The use of banknotes to make

payments for a wide range of economic transactions (general usability) andtheir acceptance by anyone (general acceptability) stem from the followingcharacteristics (see also chapter IV).

First, Article 46 of the Bank of Japan Law stipulates that banknotesshall be used for payment as legal tender without limits, in other words, theyare a legally defined payment instrument that should not be refused by anycreditor in satisfaction of any debt. 3 Banknotes is a payment instrument bywhich the highest settlement finality can be achieved. Unlike payment bycredit card or funds transfer between bank accounts, payment in banknotesdoes not require the intermediation of financial institutions 4 or any other third

parties. Banknotes also guarantee anonymity, 5 since it is difficult to know whoused them when, where, or for what purpose.

While banknotes have these advantages, they also have shortcomings.Safekeeping and transporting them incur considerable costs, if the volume of

banknotes is large or if they are transported over long distances. They also

carry the risk of loss, theft, fire, or other damage.To avoid these risks, funds transfer between bank accounts, which doesnot involve physical movement of cash, is commonly used. Credit cards and

prepaid cards are popular payment instruments, and debit cards 6 have also beenintroduced. The development of electronic money that employs encryptiontechnology has progressed (see box 7 for chapter I), and pilot projects have

3 Under Article 7 of the Law Concerning the Unit of Currency and the Issuance of Coins, coins arealso a legally defined payment instrument that should not be refused by a creditor. However, therecipient may refuse to accept more than 20 coins of the same denomination in one payment, sincethe use of too many coins in one payment may make it difficult for the recipient to count or keepthem.4 When payment is made by credit card or funds transfer between bank accounts, funds aretransferred not only between the payer/recipient and the financial institutions with which they holdaccounts, but also between the financial institutions involved (see chapter IV).5 Prepaid cards also guarantee anonymity. However, they can only be used in a limited range oftransactions, and thus cannot be considered generally accepted.6 Cash cards issued by financial institutions are the most common form of debit card. When a

cardholder presents such a card to a retailers cashier and enters the personal identification number,funds are immediately debited from the cardholders demand deposit account at the financialinstitution that issued the card.


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been conducted to test new payment instruments, which have low handlingcosts while retaining some of the advantages of conventional banknotes.

At present, the amount of banknotes in circulation relative to GDP ishigher in Japan 7 than in other major industrial countries. Although the reasonsfor this are not entirely clear, several contributing factors are often cited: (1)the Japanese social custom of using banknotes as cash gifts on ceremonialoccasions such as weddings and funerals, New Years, and farewells; (2) thefact that Japan is a relatively safe place to carry cash; (3) easier access to cashdue to expanded networks of cash dispensers and ATMs; 8 and (4) publicconfidence in banknotes owing to the relatively small number of counterfeits.

3. History of the banknote issuance systemThe Bank issued its first banknotes in 1885, three years after its founding (see

box 2). Originally, banknotes were convertible notes whose convertibility tosilver was guaranteed; when the gold standard was adopted in 1897, they

became convertible into gold. Under this standard money system, 9 the Bankwas required to hold standard money (gold or silver) and other reserve assetsequivalent to the outstanding amount of banknotes issued 10 (this is called thestandard money reserve requirement). The standard money system ceased to

7 In 1998, the amount of cash (banknotes and coins) in circulation as a percentage of GDP stood at11.0 percent in Japan, the highest among the Group of Ten countries, well above the level inGermany (6.4 percent) or the United States (5.3 percent). (Source: BIS Committee on Paymentand Settlement Systems, Statistics on Payment Systems in the Group of Ten Countries, Figuresfor 1998, February 2000.)8 In 1998, the number of cash dispensers and ATMs per million persons in Japan stood at 1,127,the highest among the Group of Ten countries, well above the United States (692) and Germany(556). (Source: BIS, Committee on Payment and Settlement Systems, Statistics on PaymentSystems in the Group of Ten Countries, Figures for 1998, February 2000.)9

Under a standard money system, the value of a national currency such as the yen or the dollar isfixed to a specified commodity. Rare and durable precious metals (e.g., gold or silver) werecommonly used as the commodity (standard money). When Japan adopted the standard moneysystem under the New Currency Act of 1871 (see box 2), the value of one yen was fixed at par tothe value of 1.5 grams of pure gold. To link the value of the currency and standard money, thegovernment or the central bank usually guaranteed the convertibility of paper money (banknotes)for a certain amount of standard money (convertible system) and authorized free export and importof the standard money.10 The Bank entered the banknotes (convertible banknotes) it had issued as liabilities on its balancesheet, while reserve assets (gold, silver, or to a limited extent prime assets such as public bonds)were entered as assets. Even since the adoption of the fiat money system (see the main text), Bank

of Japan notes are still entered as liabilities. Entering issued banknotes as liabilities is a common practice among major central banks, including the Federal Reserve Bank in the United States andthe Bank of England in the United Kingdom.


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B. Circulation of Banknotes

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function as the gold standard was suspended (the convertibility of banknotesinto gold was suspended) in 1931 and Japan moved into a state of war. In 1941,

Japan adopted a fiat money system, and the standard money reserverequirements were abolished. The Bank of Japan Law of 1942 stipulated thereserve for banknote issuance system, which required the Bank to hold primeassets equivalent to the amount of banknotes outstanding, and the maximumissuance limit system, which set the upper limit of the amount of banknotesoutstanding. These two systems were abolished under the Bank of Japan Lawof 1997, about 50 years after the end of World War II. The changes were mademainly for the following reasons: (1) under the fiat money system, the stabilityof the value of banknotes should be maintained through the Banks appropriate

conduct of monetary policy rather than through a direct link with the value ofassets held by the Bank; 11 and (2) the amount of banknotes in circulationchanges relative to the level of economic activity, and since the issuance limithad been changed to accommodate the actual amount of banknote issuance, thesignificance of the banknote maximum issuance limit system had already

begun to fade.

! Box 2: History of Paper Money before the Introduction of Bank of Japan Notes

B. Circulation of Banknotes

1. Flow of banknotes and the role of the Bank

This section will explain the channels of banknote circulation. The principalchannel of circulation starts when financial institutions receive banknotes at thecounters of the Bank of Japans head office and branches. 12 Individuals andfirms then obtain banknotes by withdrawing money from their deposit accountsat financial institutions. The banknotes are used for various purposes, and thenthey return to the Bank via financial institutions. 13 The Bank and financial

11 To earn the publics confidence in the banknotes it issues, it is also important that the Bankmaintain its own financial soundness.12 To ensure that banknotes are smoothly distributed in areas that are not near the head office or a

branch of the Bank, the Bank designates specific offices of financial institutions as custodians tohold unissued banknotes (banknote custody system). These banknotes are deemed to be issuedwhen they are paid out to other financial institutions from the custodians.13 The principal channel of circulation for coins is the same as for banknotes. Namely, they aredistributed from the Bank to financial institutions and from there to individuals and firms.


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institutions

boj - functions and operations of the boj

Documents