S&P: Analysis of Japan's banking sector

Cutting NPL ratios by half is only a passing point in the rehabilitation of Japan's banking sector. Coping with NPLs will continue to be an issue as long as banks take credit risks. Therefore, the level of the banks' credit costs after the normalization of the revenue environment following the removal of legacy NPLs, is a key to the banks' future profitability.

To estimate the banks' future credit costs, it is useful to review the historical data in other countries where the operating environment is "normal" to the extent that distorting factors, including deflation and the collapse of the asset bubble, are absent, even though accounting methods for credit cost are different. For all rated major banks in OECD countries, average credit costs to average loans fluctuated between 0.68% and 1.14% over the past five years (see Table 2). The average credit cost ratio for these banks over this period was 0.91%. This level of fluctuation in the credit cost ratio is unremarkable.

For major banks in the U.S., where the size of financial institutions is relatively large like in Japan, the five-year average credit cost ratio was 1.07%, which is on par with that of the major banks in OECD countries. However, volatility is not low, with a standard deviation at about 0.36%, and the largest deviation in the last five years was 1.54%, which was partly due to the effects of the slump in technology companies (see Table 3). Given these overseas examples, it is unlikely that credit costs for the major Japanese banks will remain stable between 0.3%-0.4% as estimated in their business plans such as those submitted to the FSA.

Assuming the fluctuation in credit costs for Japanese banks at the U.S. level of 0.36%, profit and loss for banks with ¥50 trillion of loan assets, the average for the mega banks, would vary by about ¥180 billion. This is equivalent to about 20% of the average core profit of the mega banks in fiscal 2003. In other words, even if the business environment improves to the same extent as in the U.S., Japanese banks could be exposed to a risk of an increase or decrease in credit costs equivalent to about 20% of core profit.

If the trends in credit costs in the U.S. over the last five years are applied to Japan, average credit costs would stand at about 1.0% of core profit. Credit costs need to be covered by loan spreads, while adequate capital is built up in preparation for an expected rise. However, Japanese banks' loan spreads (loan management yield minus funding costs including expenses) are currently less than 1%, which is still not enough to cover the banks' credit costs, even if the revenue environment stabilizes to the same extent as the U.S.

Japanese banks' lending to large borrowers remains a high proportion of their credit portfolios, although the level of concentration is reducing. In general, many Japanese banks still tolerate high concentration risk, with credits to the 20 largest borrowers (excluding the public sector such as the central and local governments) sometimes exceeds 100% of their Tier 1 capital. However, this ratio has declined somewhat in fiscal 2004 as banks have reduced lending through direct write-offs, loan sales, and debt-for-equity swaps, while increasing their capital.

According to Japan's banking law, banks are not allowed to extend credit to a single borrower, in principle, totaling more than 25% of their capital. Even if banks comply with these provisions, there have been many cases in which banks' business results have deteriorated significantly because of management difficulties at just a few large borrowers. In its rating analysis, Standard & Poor's generally analyzes risks more prudently for borrowers to which the lender's exposure exceeds 5% of adjusted total equity. The size of the exposure is not the sole factor that determines the size of risk. However, the larger the exposure is, the larger the impact on the lender if a borrower experiences financial difficulty, and thus large exposures need to be assessed carefully.

In addition, diversification of borrowers would be ineffective if there is strong correlation in business results between individual borrowers. Therefore, it is preferred practice to establish credit limits for each company, corporate group, or industry to diversify risks in real terms, ensuring stable credit costs and consequently stable profitability for the Japanese banks.

To alleviate the difficulty of quickly eliminating existing concentration risks, it can be effective to use tools such as credit default swaps (CDS). Expansion of the syndicated loan and credit derivative markets would enable banks to transfer their exposure to large borrowers to third parties, and more easily control concentration risks. In terms of systems, incentives to correct concentration risk would increase if the concentration ratio of large borrowers was included in inspections of bank soundness, as in France and Canada, or if the disclosure of the amount of credit to large borrowers was required, as in Italy.

Japanese banks are currently focusing on loans to SMEs and retail borrowers. These trends, together with the greater utilization of the various tools such as CDS, should enable Japanese banks to remedy their credit concentration risks gradually.

Over time, Standard & Poor's expects main banks' supportive stance toward major borrowers will change. At least in the near term, Standard & Poor's believes that the continuing practice to forgive the debt of major customers could result in significant credit costs. This practice has not been strongly opposed by shareholders of banks, bank regulators, the media, or the public, and banks are not wary of forgiving credit to failing borrowers. In addition, as in the cases of Mitsubishi Motors and Sojitz, repeated instances of debt forgiveness to individual borrowers are not uncommon. Increased loans to SMEs and retail borrowers may help alleviate risks of Japanese banks' excessive support to large borrowers. In comparison with larger borrowers, credit problems stemming from loans to SMEs are more likely to be resolved before they become very serious, since banks are far less motivated to extend unreasonable additional loans or postpone action.

Credit costs for Japanese banks may fluctuate even after the operating environment is normalized. Loan-to-deposit margins for Japanese banks are much lower than that for U.S. and European banks. The gap in interest rates—interest rates on loans minus interest rates on deposits—is between 1.35%-1.97% at major Japanese banks, compared with over 3% at many U.S. banks (see Table 4). The narrow margin reflects the Japanese banks' lower lending to relatively profitable retail borrowers and SMEs, intense competition in lending amid increasing deposits and low demand for funds, and underdeveloped risk management systems to set appropriate interest rates based on risks.

In fiscal 2002, Japan's major banks focused on expanding their loan spreads as one of their key management goals. However, the focus seems to have shifted back to banks' outstanding loan balances recently, which is highly likely to lead to reduced loan spreads over the next few years. This is because total deposits exceed total lending by more than ¥140 trillion, and thus Japanese bank managements are now struggling to locate lending opportunities to use these surplus funds (see Chart 4).

A strong correlation exists between loan-to-deposit margins and the proportion of lending to SMEs in each bank's total loans (see Chart 5). Although most major banks are still restrained in their lending to SMEs, some, such as Sumitomo Mitsui Banking Corp. (SMBC), are becoming more aggressive in lending to this sector. However, loans to SMEs usually carry higher credit risks. Therefore any rise in loan-to-deposit margins should be examined for a possible increase in risk.

The speed at which the four mega bank groups are expanding their retail business has lagged far behind their original plans, announced when the groups were formed around 2000. The degree of achievement by each group is not easily identified, however, since most of the groups announce their final results only on a stand-alone basis, while releasing earnings forecasts on a consolidated basis. Mitsubishi Tokyo Financial Group (MTFG) discloses its forecasts and results on a consolidated basis, despite some differences in definitions. In fiscal 2003, MTFG's net operating income from retail business (consolidated net operating profit before inter-company elimination adjustments) was about 50% lower than its operating earnings (net operating profit plus operating income of the group) of MTFG at its foundation.

However, the four major bank groups are aggressively expanding lending to retail customers, as well as to SMEs, following an easing in NPL burdens. For example, Mizuho Financial Group strengthened its retail-lending business through a business alliance with a major finance company, Orient Corp., while SMFG and MTFG have allied with consumer finance companies as equity method subsidiaries. Earnings from retail businesses are expected to increase by ¥20 billion-¥30 billion in total (current profit of subsidiary companies multiplied by estimated equity before goodwill) owing to their affiliations with consumer finance companies. In addition, some bank groups have formed alliances with finance companies that have stakes in credit card companies or operate their own credit card business (see Chart 6).

Nevertheless, reducing expense ratios in retail businesses will be a key for the banks to strengthen profitability through alliances with affiliated companies. According to the banks' data, expense ratios in the retail operations of UFJ Bank and SMBC were high, at over 70% as of September 2004, compared with Citigroup in the U.S. and HSBC in the U.K., which stood at about 50% (see Table 5). One of the major reasons for this gap is the difference in size of the banks' operations. The retail operations of major banks in the U.S. and European countries, which can include SME business, have strong operating efficiencies and their earnings levels are generally higher than that of Japanese banks. In addition, in some cases in the U.S. and Europe, a financial subsidiary with strong operating efficiency boosts the group's profitability. For example, The Associates, a finance company acquired by Citigroup, maintained its expense ratio at a low 33% in 2000 just before the acquisition.

While the ratio of fee income to gross revenue at Japanese banks remains far below that of their overseas peers (see Chart 7), it is improving slowly. Although the increase is partly attributable to the fact that gross revenue decreased in the first half of fiscal 2004 due to lower profits on bond holdings, particularly JGBs, this contributed only 1% to this ratio. Japanese banks' fee incomes are lower than that of their international peers by about 30%-50%, although the gap is gradually narrowing.

Major bank groups in the U.S. and Europe generate stable income from a variety of sources, including investment banking, asset management and investment, credit cards, deposit account charges, insurance policy sales, and securities brokerage. In the case of UBS AG, which has strength in global asset management, the bank earns relatively high fee incomes that account for more than 50% of its gross revenue.

Japanese banks have also made some progress in increasing fee income through sales of investment trusts and insurance to retail customers, and syndicated loans and derivative products to corporate customers. Although concerns remain over new entrants to the trust business and a downward trend in stock brokerage commissions, deregulation of securities brokerage and over-the-counter sales of insurance products should contribute to increase in earnings to some extent. Insurance products, in particular, are expected to make effective profit contributions as deregulation is implemented in phases, given the relatively higher fees and low surrender ratios of this business. In securities brokerage services, opened to banks in December 2004, SMBC has already started aggressive marketing particularly in foreign bonds. With the full introduction of the payoff imminent, depositors growing interest in financial products other than deposits should also provide further opportunities to increase fee income.

While the profit contribution from these fee businesses is small compared with that of lending, increasing fee income would help stabilize and diversify earnings from a credit assessment perspective.

High proportions of low-profit assets, such as cross-held shares and loans to affiliate companies, characterize the asset profiles of the major Japanese banks. For example, Japanese banks still have large equity portfolios compared with banks in the U.S. and Europe, despite reductions through stock sales. At the end of September 2004, the equity holdings of the major banks in Japan were still high at 82% of their Tier 1 capital, which was far higher than the 10%-20% at U.S. and European banks, excluding German banks. In addition, investments in JGBs and lending to the Deposit Insurance Corp. of Japan and other government-related entities to cover gaps between deposits and loans pushes interest rates downward.

Rising long-term interest rates will lead to losses on Japan Government Bond (JGB) portfolios, while those losses will be covered by higher short-term rates, which in general enhance the interest income of banks. Unfortunately, information that may be helpful in simulating such profit and loss outcomes under various interest rate scenarios is very rarely disclosed. Given that a rise in interest rates leads to a rise in lending rates to some extent and a rise in deposit rates to a lesser extent, such a trend should boost profitability materially. Therefore, even if the long-term interest rate rises and the price of JGBs falls, the mega banks are unlikely to suffer a net loss as long as the long-term interest rate does not exceed 3% (these assumptions follow from the basis point values as of Sept. 30, 2004, and do not take into consideration hedging or position changes).

The ratings on Japanese banks incorporate a possible rise in long-term interest rates, but not a rapid rise. If rates increase, banks are expected to adjust their positions under their loss-cut rules to minimize the impact on their coverage ability. However, if the long-term interest rate rises more rapidly than expected, banks may not be able to adjust their positions fast enough, eroding their financial standing and putting downward pressure on ratings.

Regional banks, in particular, are more sensitive to rising rates, as they have large JGB holdings relative to the size of their lending portfolios, and government bonds tend to have longer maturities. Therefore, if regional banks fail to act quickly to mitigate risks when long-term interest rates start to rise, their credit qualities will be under even greater pressure than those of major banks. It should also be noted that the regional banks in general have poorer risk management systems than the major banks, partly because of the smaller size of their asset portfolio.

Deterioration of domestic corporate performance directly leads to increased credit costs for banks. If credit costs increase to more than 2% of the banks' outstanding lending balance, achieving a net profit would be difficult (see Table 7). Considering their concentrated credit exposure, Japanese banks may need to incur credit costs at the same level or even higher than those borne by major banks overseas, even after the profit environment returns to normal.

The recovery of loan demand in the corporate sector and the subsequent increase in lending should in principle have a positive impact on banks' profitability. The key challenge is whether the banks can increase lending while keeping their own cost of credit low. Even if lending increases, it could be a negative factor for a bank's credit quality if it is followed by an increase in credit costs. A major determinant for possible upgrades is therefore the banks' abilities to increase lending steadily while securing appropriate spreads for the risks they undertake.

An increase in fee income does not generally involve any additional credit risk. Also, fee income is not directly affected by corporate performance, acting as a stabilizing factor against profit volatility. Given such factors, an increase in fee income has a large positive impact on the credit quality of banks. Continuing deregulation and enhanced marketing efforts should contribute toward fee income growth from investment trusts and insurance products, while income relating to JGBs is expected to decrease. Standard & Poor's rating analysis assumes that fee income will account for an increasingly large portion of gross profit for Japanese banks.

Nevertheless, competition in fee-income businesses is intensifying. Discounts now found in stock brokerage and trust fees are expected to spread to other types of products, such as investment trust sales fees. As competition heats up, banks will need to provide more sophisticated goods and services to customers to maintain fee margins. A key challenge for the mega banks will be to provide multiple, attractive fee services that can generate more profit from their vast customer accounts. Deregulation on insurance products and consolidation in and among bank groups will also be key factors affecting credit qualities.

Beginning in fiscal 2001, Japanese banks fully adopted new standards for financial product accounting. This move affected capital adequacy figures and certain other financial data. As Standard & Poor's analysis of banks has already factored in the changes, the application of the new standards was not the direct cause of recent credit rating revisions.

In March 1998, Japanese banks were authorized to begin valuing other marketable securities available for sale, which mainly represent cross-shareholdings, at original cost rather than the lower-of-cost-or-market method. By fiscal 1998, all major banks except BTM had switched to the original-cost method. For bonds, banks have always had the option of selecting the original cost or lower-of-cost-or-market method. With a few exceptions, almost all Japanese banks have elected to use original cost. Prior to the adoption of the mark-to-market rule, Japanese banks primarily used the original cost method to determine the carrying value of market-traded securities.

In September 2000, all Japanese banks were ordered to begin valuing their "trading account securities" at market cost. Following this, banks disclose unrealized gains and losses on "other marketable securities available for sale" in their financial statements, first in their footnotes from September 2000, then in their capital (after adjusting tax effect) from September 2001. When the market value of stock declines considerably (more than 50% according to the FSA manual) with no prospect for recovery, resulting valuation losses now also need to be shown on the income statement.

Japanese banks' cross shareholdings, which are classified as other marketable securities available for sale, are very large relative to their equity. As a result, the switch to mark-to-market accounting is likely to cause substantial fluctuations in balance sheet equity as stock prices rise and fall. The deduction of unrealized losses on other marketable securities available for sale can also have a major impact on Tier 1 capital. Furthermore, a drop in stock prices can reduce distributable profits, since unrealized losses are also deducted from this figure. This situation will continue as long as the banks continue to hold large amounts of securities, including cross-shareholdings.

To tackle the size of shareholdings, the government enacted legislation in November 2001 prohibiting banks from holding stock in excess of their capital. Banks, including long-term credit banks Norinchukin Bank and Shinkin Central Bank and their subsidiaries, became required to use their equity as the upper limit for holdings of stock and similar instruments. Following the protracted slump in stock prices, the legislation was revised in July 2003 and the enforcement was postponed to September 2006.

In February 2002, the government established the Banks' Shareholding Purchase Corp. (BSPC) to enable banks to sell their stock in an orderly manner. The entity is scheduled to operate until Sept. 30, 2006. Until revisions to the legislation in July 2003, banks needed to make a deposit equivalent to 8% of the price of shares sold to the BSPC. Stock purchases by the BSPC totaled ¥1,385.3 billion at the end of January 2005. In addition, between November 2002 and the end of September 2004, the BOJ purchased banks' stocks that met its rating or liquidity criteria. The BOJ's stock purchases have been relatively large, totaling ¥2,018 billion by September 2004 out of a purchase ceiling of ¥3 trillion, mainly because the BOJ scheme has not required banks to provide a deposit when they dispose of shares.

Japanese companies introduced tax effect accounting in fiscal 1999, one year after the major banks. Banks are thus able to record deferred tax assets (in effect, prepaid taxes) on taxes paid on write-offs of problem loans that were not treated as tax-deductible. These deferred tax assets can then be used at a time when the write-offs can be recognized as losses for tax purposes. In addition to benefiting from the temporary differences in tax obligations resulting from the posting of deferred tax assets, banks can, in the event that their taxable income is negative, carry the loss forward for up to five years to offset taxable income. Consequently, unrealized losses on securities must also be viewed with these tax-related implications in mind. At September 2004, net base deferred tax assets (gross deferred tax assets minus valuation reserves and deferred tax liability) totaled ¥5.1 trillion at the seven major bank groups. This amount has decreased in recent years due to progress in disposals of NPLs, and a drop in unrealized losses on securities due to higher stock prices. As the overall possibility of realizing tax credits derived from deferred tax assets is increasing based on improving revenue outlooks for Japanese banks, asset quality problems have recently been alleviated. However, the ratio of net base deferred tax assets (gross deferred tax assets minus deferred tax liabilities on the balance sheet) to Tier 1 capital of 31% remains higher than that of major overseas banks at less than 15%.

Since fiscal 1998, Japanese banks have been categorizing loans based on a self-assessment system, so that reserves can be set aside in a manner that reflects the true quality of assets. Prior to this system, tax-deductible reserve additions were possible only after a bank had conducted lengthy negotiations with tax authorities. The resulting difficulty in setting aside tax-deductible reserves was undoubtedly one reason why banks delayed action on the problem loan issue. Since the introduction of self-assessments, some banks have started direct write-offs, without first setting aside reserves, of the unrecoverable portions of loans to bankrupt and quasi-bankrupt borrowers.

In the first quarter of fiscal 2002 (ended June 30, 2002) the major banks and several regional banks began releasing quarterly financial reports. As further disclosure, such as the composition of profits and losses, was initiated in fiscal 2004, the seasoning of this data over a full year will facilitate year-on-year comparison of quarterly data from fiscal 2005.

Accounting for the impairment of fixed assets is an accounting standard requiring a corporation to report the difference between the book value and the fair value of a fixed asset as a loss if the fair value drops significantly. This standard will be compulsorily applied to all listed companies from fiscal years beginning on or after April 1, 2005 with early adoption permitted for fiscal years ending on or after March 31, 2004. Some banks including Resona Holdings, Shizuoka Bank, Fukuoka Bank and Hiroshima Bank have already adopted this accounting standard. The accounting for impairment of fixed assets standard is less likely to have a direct and significant impact on the financial profile of banks that usually do not own large fixed assets including factories. Among the rated banks that have already adopted impairment accounting, relatively large impairment losses reported include ¥27.8 billion recorded by Resona Holdings for fiscal 2003 (ended March 2004) and ¥2.4 billion posted by the Bank of Fukuoka for the first half of fiscal 2003 (ended September 2004). However, as banks that adopted these standards earlier have relatively sound financial profiles, a more significant impact is expected for some banks when the standards are applied to all Japanese banks. As the banks have some discretion in applying the standard, it should also be noted that losses are not always calculated by the same method. Key points in calculation methods include whether a grouping for calculation of the future recoverable amount is based on sufficiently small units, such as the branch unit, and whether the independence from banks is ensured in appraisal of real estate properties. If a bank owns large unutilized assets with no prospects for being utilized as business assets, the reported loss amount is likely to increase. In general, banks with weaker financial profiles tend to postpone the recognition of losses incurred in the past. The impact of the compulsory application of the accounting standard for impairment of fixed assets is expected to be more significant on these banks.

Japanese banking regulatory agencies are aiming to establish frameworks similar to those used in the U.S. Specifically, this involves enhancing transparency through the disclosure of more information and greater use of external auditing. Banks are also encouraged to maintain a sound financial position by adhering to market principles. The goal is to foster an environment in which banks assume responsibility for their own actions within the scope of a clear set of guidelines and regulations. Until the 1998 establishment of the Financial Supervisory Agency, the predecessor of the Financial Services Agency, Japanese banks ranked well below global standards for financial disclosure. Certain information was submitted only to regulatory authorities. The authorities provided "administrative guidance" and other directions, not all of which were prescribed in the rules. Under this system, the government often influenced decisions made by banks' senior management. It is not surprising, therefore, that the scale of the banks' credit problems took some time to surface, as well as for corrective measures to be implemented.

To break away from this ineffective system, authority to regulate banks was largely transferred from the Ministry of Finance (MOF) to the independent FSA in 1998. During the transitional period between 1998 and 2000, some of the planning and policy-making responsibilities remained with the MOF. The Financial Reconstruction Commission was responsible for the oversight of insolvent banks. In 2001, all of these functions were unified under the FSA.

As the sole regulatory body, the FSA is responsible for all financial institutions in Japan, including banks, credit unions, credit cooperatives, securities companies, and insurance companies. Between 1998 and 2000, the FSA adopted measures aimed at eliminating delays in dealing with problem loans and preventing "moral hazard" at financially weak institutions.

As a result, the overseers of Japan's financial system have made some progress toward establishing tighter rules over the past few years. However, compared with most industrialized countries, Japan still relies heavily on the principle of forbearance. In 2002, for example, the government stated its intention of delaying the implementation of limits on insurance for deposits of all types.

In addition to the financial revitalization program and subsequent development of guidelines, the government has implemented some measures to advance financial system reform. These including acceleration of NPL disposals so that the bad debts of the major banks will be halved by the end of fiscal 2004, and implementing concrete conditions for the conversion of state-owned preferred shares.

Restrictions on major shareholders are specified in the amended Japan Banking Law, which was enacted on Nov. 2, 2001. One change was a requirement that shareholders holding more than 5% of a bank's equity report regularly to the government. Furthermore, shareholders deemed to have a significant influence on bank management (as a rule, holding at least 20% equity of a bank or a bank holding company) are designated "important shareholders" and, as such, must obtain prior approval to establish equity positions of this scale. These shareholders can be required to submit reports and undergo investigations in cases where such action is believed to be critical to preserving sound and appropriate management practices at a bank. When the condition of a bank worsens, and a recovery is judged to be possible if certain actions are taken, important shareholders holding more than half of the bank's equity may be asked to take action to ensure the soundness of the bank.

The FSA grants licenses to ordinary banks under the Banking Law and to long-term credit banks under the Long-Term Credit Bank Law. The Banking Law contains requirements concerning restrictions on business activities, the preservation of a certain level of financial strength, regulatory supervision, inspections, and processes for liquidations when necessary.

The BOJ inspects banks that maintain current deposits at the central bank. The FSA also conducts inspections of all licensed banks. In conjunction with the FSA, the respective prefectures and the Ministry of Agriculture, Forestry and Fisheries conduct inspections of agricultural cooperative banks.

Since the second half of fiscal 2000, the FSA has conducted "special inspections" of large borrowers at major banks in addition to its ordinary inspections. The purpose was to ensure that banks classify borrowers in a manner that reflects changes in operating results and market conditions in a timely manner, and that reserves and write-offs are made accordingly. As a result, the difference in classifications of the same borrower between different banks has diminished, since the inspections are usually executed around the same time. However, the inspections do not necessarily provide a picture of overall lending trends at major banks, given that they cover only 161 borrowers with total loans at ¥13.1 trillion (at the first half of fiscal 2002), which is small compared with total lending.

Japanese banks that do not operate internationally can choose to comply with either Bank for International Settlements (BIS) capital adequacy guidelines or domestic guidelines. The domestic standard requires banks to maintain capital (Tier 1 plus Tier 2 capital minus deductions) of at least 4% of risk assets. Regarding the new BIS standard scheduled to be implemented in fiscal 2006, while domestic guidelines have not been finalized yet, international standard is likely to require banks to maintain capital of at least 8%, same as before.

The primary difference between the calculation of BIS and domestic capital ratios is that the domestic standard does not include interest-rate, stock, and other forms of market risk in calculating risk assets, and does not add Tier 3 capital to equity. At banks using BIS guidelines, 45% of unrealized gains on other marketable securities for sale are included in Tier 2 capital. Under domestic standards, however, unrealized gains are not included in Tier 2 capital (numerator of the capital ratio), but are also not included in risk assets (denominator of the capital ratio).

At ordinary banks, credit extended to any single borrower cannot exceed 25% of the sum of capital and loan loss reserves.

Under the Japanese commercial code, earnings eligible for distribution as dividends at all companies, including banks, are defined as follows:

Distributable profit as dividends = Net worth (including net unrealized gains/losses on equities) - Paid-in capital - Statutory reserves - Net unrealized gains on equities (if applicable).

Here, unrealized gains or losses on equities refers to gains or losses on "other marketable securities available for sale" net of tax effects. Consequently, unrealized gains on these securities do not contribute to earnings that can be distributed as dividends, while unrealized losses reduce these earnings.

Normally, banks are required by the Banking Law to increase their legal reserves to equal paid-in capital. While the commercial code stipulates a level of one-quarter of paid-in capital, the Banking Law applies a higher standard from the standpoint of maintaining the soundness of the banking industry. Meanwhile, according to the commercial code, which applies to bank holding companies, statutory reserves need only be one-quarter of paid-in capital, well below the 100% requirement. Some banks established the holding companies to ensure a source of dividends by transferring a portion of their legal reserves, which could boost distributable profit.