The Rise of Deferred Tax Assets in Japan:

The Role of Deferred Tax Accounting in the Japanese Banking Crisis*

Douglas J. Skinner
Graduate School of Business
University of Chicago
dskinner@chicagogsb.edu
April 2008; original version February 2005

Abstract
This paper provides evidence on the role that accounting for deferred taxes played in the recent
financial crisis among the major Japanese banks, dramatized by the collapse of Resona Bank in
2003. Upon adoption of deferred tax accounting in fiscal 1998, the major Japanese banks
immediately recognized net deferred tax assets (DTAs) of 6.6 trillion (approximately $55
billion), or about 29% of bank equity. Without these assets, these banks would have been
insolvent. The evidence supports the conclusion that the Japanese Government and bank
regulators used deferred tax accounting as part of a regulatory forbearance strategy, and that
bank managers responded by using deferred tax assets to supplement their banks regulatory
capital. The results have implications for international accounting standard-setters because they
illustrate how economic incentives can distort the way that accounting rules are adopted and
used.
Key words: Deferred tax assets; Japanese banks; regulatory forbearance; regulatory capital
arbitrage; bank regulation.
JEL Codes: G18, G21, M41.

*I am grateful to Kenichi Akiba, Ned Akov, Anne Beatty, Christa Bouwman, Mitsuhiro Fukao,
Michelle Hanlon, Shigeo Ishigaki, Kazuo Kato, Gregory Miller, Naoko Nemoto, Tsuyoshi
Oyama, Junichi Suzuki, Ross Watts, anonymous referees, and workshop participants at the
AFBC in Sydney, JAR/LBS conference, the NBER Japan Project Meeting, Florida, Houston,
Northwestern, and Stanford for helpful comments and discussions, and to Shinnosuke Iizuka,
Masaki Mizutani, Manabu Sakagami, Yoshiko Imai-Suga, Tomomi Sugiura, and especially
Tomohito Suga for helpful assistance, translation help, and discussions regarding Japanese banks
and Japanese accounting rules. All errors and inaccuracies are my own. Financial support from
the University of Chicago, Graduate School of Business is gratefully acknowledged.

1. Introduction
This paper provides evidence on accounting for deferred taxes by Japanese banks from
fiscal 1998, when deferred tax accounting was first adopted by the banks, through fiscal 2003.
The main goal of the paper is to document the role of deferred taxes in the decade-long crisis in
the Japanese banking sector. I investigate whether: (1) deferred taxes were used by the Japanese
Government and bank regulators at the Ministry of Finance (MOF) and Financial Services
Agency (FSA) as a tool of regulatory forbearance; that is, to give the major Japanese banks
the appearance of financial health when in fact many were insolvent, (2) managers of the banks
themselves used the discretion inherent in deferred tax accounting to practice regulatory capital
arbitrage; that is, to manage reported levels of regulatory capital in such a way as to avoid
falling below minimum capital thresholds.
I present two types of evidence in the paper. First, I provide aggregate evidence on
changes in the financial strength of the major Japanese banks from 1982 to 2003 and show how
deferred tax assets (hereafter, DTAs) became a significant part of the banks regulatory capital.
The bursting of the bubble in Japanese stock and real estate prices in the early 1990s and the
subsequent economic malaise caused a steady decline in the financial strength of these banks.
During the first part of the 1990s, the banks were able to maintain necessary levels of regulatory
capital by realizing gains on their large holdings of equity securities. This source of financial
slack ran out in about 1998.
The timing and circumstances of the introduction of deferred tax accounting in Japan are
consistent with its use as a tool of regulatory forbearance. The rule was introduced in 1998,
when the banks other sources of regulatory capital had been depleted. The rule was introduced
at a time when Japanese accounting rules were set by a committee of the MOF, was issued in

conjunction with Japanese law that allowed deferred taxes to be included on corporate balance
sheets for the first time, and was introduced quickly, with only four months between the initial
exposure draft and the final statement. Perhaps most important, the rule was accompanied by a
decision by regulators at the MOF to allow banks to include DTAs in their regulatory capital.
This decision was unique bank regulators in other countries either do not recognize DTAs at all
or impose a stringent cap. The rule was immediately adopted (earlier than required) by almost
all Japanese banks. Because of the unusually rapid rule-making process, little accounting or
auditing guidance accompanied the new rule, making it difficult for auditors to verify the
reasonableness of the banks DTAs.1 When first recognized in fiscal 1998, net DTAs at the
major Japanese banks totaled 6.6 trillion, or about 29% of shareholders equity; all of the major
Japanese banks would have fallen below minimum capital levels without this accounting
change.2 The recognition of these DTAs allowed the Government to characterize these banks as
healthy, helping to rationalize its decision to inject 7.5 trillion in new capital.
Deferred tax assets continued to be an important source of regulatory capital for Japanese
banks in the years after this, most notably in fiscal 2002 when the major banks DTAs totaled
7.5 trillion, or 60% of equity. The collapse of Resona Bank likely signaled the beginning of the
end for DTAs in Japanese banks. Resona failed in May 2003 when its auditors refused to sign
off on its DTAs, causing it to fall below minimum capital levels. The Government immediately
stepped in to save the bank, injecting 1.96 trillion in new capital. In the period after Resona
there has been a decline in the major banks use of DTAs, although DTAs still represent a
1

Accounting for deferred taxes provides managers with significant discretion because the realizability of DTAs
depends on managers assessments of their firms ability to generate sufficient levels of future taxable income
(Miller and Skinner, 1998; Schrand and Wong, 2003; Dhaliwal, Gleason, and Mills, 2004). Deferred taxes provide
an especially difficult challenge for auditors because there is no objective evidence they can use to verify managers
estimates of the realizability of DTAs.
2
6.6 trillion is equivalent to about $55 billion using the exchange rate in effect in late 1998 (about 120/$). This
exchange rate can be used as a rough approximation throughout the period of this study.

significant fraction of equity for some banks.3

Overall, the evidence supports claims by

economists that accounting helped to prolong the Japanese financial crisis by allowing regulators
and politicians to mask the true extent of the banks economic problems,4 consistent with the
economic consequences literature (Watts and Zimmerman, 1986; Holthausen and Leftwich,
1983).
The second type of evidence that I present is a bank-level cross-sectional analysis of the
regulatory capital arbitrage hypothesis as applied to deferred tax accounting in Japanese banks.5
I find that in F1998 Japanese banks initially recognized large gross DTAs that were mainly
attributable to their large current and past losses and loan loss provisions. Given the relatively
stringent Japanese tax laws, these DTAs largely reflect the economic situation of these banks
rather than accounting discretion. However, I also find that managers of these banks recognized
relatively small valuation allowances against these DTAs, which meant that the net DTAs
recognized by these banks were also large, increasing their regulatory capital.

The banks

recognized these relatively large net DTAs in spite of large and persistent losses, weak financial
positions, and poor future prospects, factors that normally limit the ability of entities to recognize
DTAs. In addition, the future earnings necessary to justify the net DTAs recognized by the
banks in F1998 were substantially larger than the earnings they subsequently realized; further,
these differences are negatively related to the banks regulatory capital positions, indicating that
managers of weaker banks made more aggressive DTA choices (correlation of -.46).

The ratio of net DTAs to Tier I capital was 49% for SMFG, one of the Japanese megabanks, at March 31, 2005.
Beginning in F2005, the FSA has limited the extent to which the major Japanese banks can include DTAs as part of
Tier I regulatory capital (the limit is 40% in F2005, 30% in F2006, and 20% in F2007).
4
For example, see Fukao (1998, 2000), Hoshi (2001), Hoshi and Kashyap (2001). For evidence on regulatory
forbearance during this period, and in particular that bank regulators allowed banks to evergreen loans to impaired
borrowers (zombies) to avoid the realization of losses on their balance sheets, see Peek and Rosengren (2005).
5
Suda (2002) reports evidence broadly similar to mine, although that studys sample and data is less comprehensive.
Gee and Mano (2006) also discuss the role of deferred tax accounting in Japanese banks, focusing on the Japanese
mega banks from 2002 to 2004.

Cross-sectional regressions estimated for F1999 through F2003 provide further support
for the regulatory capital arbitrage hypothesis. While gross DTAs are, as expected under GAAP,
driven largely by past and current profitability, the banks net DTAs are consistently negatively
related to their adjusted regulatory capital positions, indicating that banks with larger capital
deficiencies recognized larger net DTAs. This result holds after controlling for other factors that
affect the realizability of banks DTAs, such as bank size and profitability.
In the end, it is clear that DTAs provided an important source of regulatory capital for
Japanese banks, and that less well-capitalized banks utilized DTAs to a larger extent than
healthier banks. The results raise the question of why managers of these weak banks, which
were at times reporting large and persistent losses, were not required to report larger valuation
allowances against their banks DTAs, and why banks in Japan, unlike those elsewhere in the
world, were permitted to include these assets in their regulatory capital. Based on the evidence
here, it is hard to escape the conclusion that these decisions occurred in Japan as part of the
Governments regulatory forbearance towards the banks.
The evidence that I report illustrates why changing accounting rules is not sufficient to
change financial reporting practice. While the Japanese adopted a deferred tax accounting rule
that is based on and similar to the IFRS rule (IAS-12) and the U.S. rule (SFAS-109), the
evidence here shows that the effect of the Japanese rule was quite different, with the banks
recognizing large net DTAs in spite of relatively clear evidence of financial difficulties, largely
because regulatory and political factors provided incentives for bank regulators and managers to
implement the rule in such a way as to achieve their own regulatory ends. This result should
give pause to those who believe that the adoption of IFRS around the world is likely to lead to
standardization of accounting practice.

The evidence also raises questions about whether Japanese GAAP rules are equivalent
to IFRS, as Japanese regulators have recently suggested in discussions with the European
Commission (EC).

This is an important issue, because Japanese companies rely almost

exclusively on European capital markets for external debt financing.6 At the time the EC started
requiring IFRS (2005), it gave Japan until July 2008 to convince it that Japanese GAAP was
equivalent to IFRS, which has stimulated a great deal of standard-setting activity in Japan.7
The evidence that I provide clearly illustrates that, at least with respect to deferred taxes, the
Japanese adoption of rules that on the surface appear similar to those in other regimes does not
necessarily result in the equivalence of accounting practice.
The evidence also shows that accounting rules, when used for regulatory purposes, are
likely to be affected by political and regulatory incentives. Japan is not alone in this regard.
There is evidence that regulators of U.S. Savings and Loans (S&Ls) practiced regulatory
forbearance during the 1980s when many S&Ls were in serious financial difficulties, and used
regulatory accounting principles (RAP) to help achieve this purpose.8 The difference is that in
Japan regulators decisions affected Japanese GAAP, and so overall accounting practice, rather
than regulatory accounting rules in particular.
Section 2 provides further discussion of the regulatory forbearance argument and the role
of deferred tax accounting, as well as aggregate evidence on the role of deferred taxes in
6

See, for example, Gao (2007).

For example, the Accounting Standards Board of Japan (ASBJ) and IASB announced an agreement known as the
Tokyo Agreement in August 2007 to accelerate the convergence of Japanese GAAP. For a summary of the issues,
see CESR (2007).
8
See, for example, Blacconiere (1991) and Blacconiere et al. (1991). The use of DTAs to supplement the regulatory
capital of Japanese banks (and the associated regulatory forbearance) is similar to the use of supervisory goodwill
by US S&Ls during the early 1980s. See FDIC (1997). Another example is the way that US banks adopted SFAS106 in the early 1990s, as documented by Ramesh and Revsine (2001). In 1993, the last year SFAS-106 could be
adopted, a change in banking regulations forced a closer link between regulatory reporting and GAAP rules.
Ramesh and Revsine show that banks regulatory capital levels systematically affected both how they adopted this
rule (by either writing off OPEB costs all at once or amortizing the cost), and the timing of their adoption of
SFAS-109 which potentially cushioned the blow of SFAS-106.
7

Japanese banks. Section 3 discusses empirical predictions for the bank-level tests. Section 4
reports large sample empirical evidence. Section 5 concludes.
2. Deferred Tax Accounting and Regulatory Forbearance
Regulatory forbearance implies that the Japanese Government, in conjunction with bank
regulators at the MOF and (later) the FSA, chose not to enforce bank capital requirements and
instead implicitly supported insolvent banks until their economic fortunes improved. Whether
this policy decision was optimal from an economic standpoint is beyond the scope of this paper,
and I take the Governments decision to support the banks as given.9 Instead, my interest is in
the role that deferred tax accounting played in the Governments forbearance strategy.
This section describes the background, circumstances, and effects of the adoption of
deferred tax accounting in Japan, in particular by the major Japanese banks. Section 2.1 provides
evidence on the evolution of the regulatory capital of the major Japanese banks from the early
1980s to the late 1990s, and shows that conventional sources of bank regulatory capital had
largely been depleted by 1998. Section 2.2 discusses how the deepening financial crisis forced
the Government and regulators to take a number of measures to boost the regulatory capital of
the banks, and how accounting, particularly deferred tax accounting, played a role in this
process. Section 2.3 discusses how the deferred tax rule was effectively set by the Governments
bank regulators, rather than by independent standard-setters, and how both the timing and
manner of the rules adoption are consistent with its use as a tool of regulatory forbearance.
2.1 Analysis of the capital strength of major Japanese banks, 1982-2003.
Figure 1 plots the major Japanese banks aggregate stockholders equity, stock of available
unrealized gains on securities, and the cumulative after-tax amount of realized gains on these

See Hoshi and Kashyap (2004) for discussion and more references.

securities from F1982 through F2002.10 For regulatory purposes the banks are required to
maintain a minimum level of Tier I (core) capital, which corresponds fairly closely to
stockholders equity.11 The cumulative after-tax amount of realized gains shows the extent to
which the banks rely on the gain realizations as a source of capital. Figure 2 plots the major
components of equity from F1993 through F2003. More detailed numbers are provided in
Appendix 1.
Figure 1 shows that the major banks stockholders equity grew steadily during the
1980s. At the end of F1989 cumulative realized gains on securities represented less than 10% of
total equity. At the same time, the banks accumulated large unrealized gains on their holdings of
investment securities. These gains grew from about 9.6 trillion in F1982 (about 1.7 times
equity) to 55 trillion in F1988 (about 3.6 times equity), largely due to the increase in Japanese
equity prices.
This picture changes dramatically in the early 1990s. From F1990 through F1994 total
stockholders equity for the banks stays virtually constant at 21 trillion, with little change in
either paid-in capital or retained earnings. The banks earnings, however, were increasingly due
to realizations of securities gains. These realizations began in the late 1980s, and offset the
banks declining operating earnings. Prior to F1989, realized gains (losses) on investment
securities were small and largely insignificant. In F1989, however, the banks realized gains of
10

Cumulative realized gains on securities are calculated by tax-effecting the gains (losses) assuming a tax rate of
40% and then cumulating, beginning with fiscal 1982.
11
Under BIS rules there are two types of bank capital, referred to as Tier I and Tier II capital. Tier I capital consists
of common stock, preferred stock, capital surplus, minority interest, and retained earnings, minus goodwill, certain
other intangibles and (in countries other than Japan) all or most DTAs. Tier II capital includes items such as
subordinated debt and convertible bonds as well as loan loss provisions. A risk-based capital ratio is computed by
dividing these amounts by risk-weighted assets. Under BIS rules (the Basel Accord) Tier I capital ratio must be at
least 4% of risk-weighted assets while the sum of Tier I and Tier II capital must be at least 8% of this same amount,
with Tier II capital limited to 100% of Tier I capital. Montgomery (2005, pp. 28-29) argues that the Tier I capital
requirement is more stringent for Japanese banks because the components of Tier II capital are more easily managed
by bank managers. As discussed later, capital requirements are slightly different (more onerous) for banks with
international operations than for banks that do not have international operations. Note also that there are differences
in the definition of regulatory capital across the two sets of banks.

2.8 trillion, allowing them to report net earnings of 2.2 trillion. This began a period during
which the major banks relied on the realization of gains to offset poor operating performance, as
shown in the following table (amounts in trillions of yen):

Realized
gains
Pre-tax
earnings,
including
the gains
Net
Income

F1989

F1990

F1991

F1992

F1993

F1994

F1995

F1996

F1997

2.8

1.8

2.1

0.5

2.2

4.0

3.7

3.4

4.3

3.0

2.3

2.0

1.3

0.8

0.1

(3.1)

(0.1)

(5.2)

2.2

1.3

0.9

0.5

0.4

(0.1)

(3.6)

(0.1)

(5.3)

A number of authors interpret the banks gain realizations during this period as income
smoothing (Fukao, 1998; Hoshi and Kashyap, 1999; Shrieves and Dahl, 2003). The practice of
strategically realizing gains and immediately repurchasing the same securities to preserve crossshareholdings is known in Japan as fukumi keiei (hidden asset management).12 In the last three
years of this period (F1995-F1997) even these large gain realizations were not sufficient to offset
the banks operating losses.
Cumulative realized gains on securities totaled 8.3 trillion on an after-tax basis by
F1994, and represented about 39% of equity and 72% of retained earnings. Over the next three
years the banks retained earnings fell from 11.6 trillion in F1994 to only 1.9 trillion in F1997
(see Figure 2). By F1997 cumulative realized gains of 15.2 trillion exceeded total shareholders

12

It is unlikely that the banks large scale sales of securities during this period were motivated by liquidity needs.
As discussed by a number of authors (e.g., Fukao, 1998; Hoshi and Kashyap, 1999; Shrieves and Dahl, 2003), the
securities sold by the banks during this period were largely shares that represented the banks long-standing holdings
of the equity of their corporate lending customers, especially group (keiretsu) companies. To maintain these
relationships and avoid possible retaliatory sales of the banks own shares, the banks immediately bought back the
shares they sold at current market prices. Given the tax consequences of these transactions (the gains were subject
to capital gains tax at rates of about 50%), Shrieves and Dahl (2003) argue that these transactions actually resulted in
net cash outflows to the banks. In November 2000 the JICPA passed a rule preventing the banks from recording
gains on sales of stock that were repurchased shortly thereafter.

equity of 13.6 trillion, meaning that the banks would have had negative equity without the gain
realizations. Total shareholders equity in F1997 was below that of F1996.
By F1997 the major Japanese banks had reached a turning point. Consistently poor
operating performance combined with a substantial decline in the amount of available unrealized
capital gains had largely sapped them of their financial strength.

Overall financial sector

difficulties were highlighted by the collapse of a major bank (Hokkaido Takushoku Bank, a city
bank) and two large securities firms (Sanyo Securities and Yamaichi Securities) in late 1997.
2.2 The Crisis of 1998 and the introduction of deferred tax accounting
The economic and financial situation continued to worsen during 1998 and in October of
that year the Government passed legislation that made public monies totaling 60 trillion (about
12% of GDP) available for capital injections into weak but solvent banks, to nationalize failing
banks, and to protect bank depositors. Soon after this two more major banks Long Term Credit
Bank of Japan and Nippon Credit Bank failed and were nationalized.

This subsection

discusses why the Government decided to inject capital into the banks and how accounting was
used to reduce the political costs of the Governments decision.
Allowing more banks to fail at this time was not an acceptable solution for the Japanese
Government. First, in 1996, because of increasing concerns about the stability of the financial
system, the Government removed the cap on bank deposit insurance, essentially guaranteeing
bank deposits. This made the Government responsible for the financial consequences of bank
failures. Second, because of the central role of the banks in Japans economic system, the failure
of any significant number of banks (especially the main city banks, which sat at the heart of
the Japanese corporate groups) would have had serious consequences for the rest of the
economy, which was already troubled. The failure of these banks would likely have led to the

failure of many of their corporate borrowers, with a number of associated adverse economic
consequences.13 Bank failures, and corporate bankruptcies more generally, were almost unheard
of in Japan at this time.14
The decision to inject capital into troubled banks in 1998 was politically difficult for the
Government. In 1995 and 1996 the Government used taxpayer money to bail out many jusen
(financial institutions similar to credit unions), a decision that was unpopular with the public.15
The Governments handling of the financial crisis led to large losses for the ruling Liberal
Democratic Party (LDP) in upper house elections in the summer of 1998, which forced the
incumbent government to resign. This made the Government reluctant to directly inject capital
into failed banks.
Nevertheless, to avoid further bank failures, in late 1998 the Government injected
approximately 7.5 trillion into the major banks. Given this decision, the issue before the
Government was how to portray the capital injection in a way that would be palatable to the
public. This meant characterizing the banks as undercapitalized but solvent, and so required the
banks to meet regulatory capital requirements.16 One way of achieving this would have been for
the Government to lower the required regulatory capital threshold (8% of risk-weighted assets, at
least half of which must be Tier I capital). However, this would have been costly politically
13

Banks had incentives to continue to lend to weak and effectively insolvent corporate borrowers to prevent them
from having to recognize the associated loan losses. Peek and Rosengren (2005) provide evidence that: (1) firms in
Japan were more likely to receive additional bank credit if they were in poor financial condition, and (2) this
practice (ever-greening) was more prevalent among banks with relatively low regulatory capital and more
extensive corporate affiliations. Caballero et al. (2006) discuss how the continued extension of credit to otherwise
insolvent corporate borrowers (zombies) is part of regulatory forbearance.
14
Prior to mid-1995, no Japanese commercial bank had failed in the postwar period (Peek and Rosengren, 2001).
See Hoshi and Kashyap (2001, pp. 111-112) for a discussion of the convoy system under which bank regulators
required strong banks to merge with any weak banks in danger of failing. According to Hoshi and Kashyap (2001,
Table 6.1), there were three bankruptcies of firms listed on the Tokyo Stock Exchange between 1987 and 1996,
compared to 117 on the NYSE over the same period.
15
According to Hoshi and Kashyap (2001, Ch. 8) the use of public funds to solve the jusen crisis in 1995 outraged
the public. Also see Fukao (2003).
16
The Rapid Recapitalization Act (under which the capital injections were made) specifically required the banks to
be healthy.

10

because the 8% threshold is part of global BIS (Basel) regulatory standards and so would have
been a clear admission both to the Japanese public and to the international financial community
that Japanese banks were too weak to meet international capital standards.17
Given this backdrop, the Government needed a way to convince the public that the major
banks were healthy, in spite of their financial difficulties. Changing accounting rules to achieve
this purpose was a relatively low cost solution because at this time the Government, acting
through the MOF, set both regulatory accounting practice and GAAP rules. Given the relatively
large information and contracting costs in the political and regulatory arenas (Watts and
Zimmerman, 1986; Holthausen and Leftwich, 1983) it is unlikely that the Japanese public had
the incentive to undo the effect of these accounting changes.
The Government, acting through the MOF, made three accounting changes around this
time, all of which had the effect of increasing the banks regulatory capital. First, in early 1998
the MOF changed banking regulations to allow the banks to use either the cost method or the
lower of cost or market (LCM) method to account for investment securities. Previously, the
LCM method had been required. Because, as described above, the banks had largely realized all
of the unrealized gains on their investment portfolios and then immediately repurchased the
same securities (to preserve group cross-holdings), their investment portfolios were largely
marked-to-market. Given the continuing decline in Japanese stock prices during this period, the
LCM rule would have forced the banks to record losses on their portfolios, further reducing Tier
I capital.

17

Such a move would have likely increased the Japan premium a premium Japanese banks with international
operations had to pay relative to their competitors in the U.S. and Europe on interbank borrowings. This premium
emerged a couple of years earlier when the Japanese banks problems first became apparent to the international
banking community, and varied as a function of how effectively the Government was seen to be in dealing with the
problems (Peek and Rosengren, 2001).

11

Second, in March 1998, the Government passed an Act modifying the Commercial Code
to allow financial institutions and certain large companies to revalue their holdings of land, a
practice not otherwise permitted. This allowed these entities to record revaluation gains, because
in many cases the land had been held for so long that even their post-crash values were above
book value (Hoshi and Kashyap, 2001, p. 276). The effect of this law was to increase the banks
shareholders equity and increase regulatory capital.18

In addition, by allowing certain

companies to revalue their holdings of land and so report artificially strong balance sheets, the
banks were able to banks renew loans to these firms and avoid recognition of loan losses (Peek
and Rosengren, 2005).19
For the Japanese public, the most visible problem with the banks was their failure to deal
with their bad loans, which had persisted since the early 1990s when the bursting of the bubble in
real estate prices first created problems for borrowers. Consequently, another important political
goal for the Government was to show that the capital injections were being used to help resolve
the banks bad loan problems.
From the regulators standpoint, deferred tax accounting was advantageous in this regard
because it allowed them to make an implicit deal with the banks: in exchange for recognizing
higher loan loss provisions, the regulators agreed to allow the banks to recognize partially
offsetting DTAs.20 As discussed in Section 3.1, given the way Japanese tax law treated loan
losses, this naturally led weaker banks (with larger non-performing loan problems) to recognize
larger DTAs, and so provided a natural accounting hedge for the banks capital deficiencies.
18

Specifically, the banks could include 45% of the revaluation gains in Tier II capital. The land revaluation law did
not directly increase Tier I capital of the banks.
19
The companies to which the law applied were typically large corporate borrowers in particular industries, such as
real estate development and construction, to which the banks had leant heavily in the 1980s bubble years and
which suffered the most when real estate collapsed in the early 1990s.
20
A number of current and former Bank of Japan officials characterize this implicit deal as providing the banks with
a soft landing in dealing with their bad loan problems.

12

Importantly, because the deferred tax effects are run through income and then into retained
earnings, DTAs represent Tier I capital, a regulatory treatment unique to Japan.21
The effects of the land revaluations and the adoption of deferred tax accounting are
shown in Figures 2 and 3 and Appendix 1. The land revaluation reserve appears in equity for the
first time in F1998 at an amount of 1.4 trillion, or a little over 10% of total stockholders equity
at the previous year-end.

The introduction of deferred tax accounting had an even more

substantial effect on the banks stockholders equity. In total, net DTAs of 8.9 trillion were
recognized by Japanese banks at the F1998 year-end, of which the major banks recognized 6.6
trillion, close to half of total equity at the previous year-end (Figure 3 and Appendix 1).22
Together, these two components accounted for about 35% of bank equity at the F1998
year end, with DTAs playing the major role. In addition, at the same time the Government
injected 7.3 trillion into the major banks, of which 6.1 trillion increased equity (see Figure 2).
Without these two accounting changes and the injection of capital, bank capital at the end of
F1998 would have been only 8.7 trillion, considerably lower than the already low 13.6 trillion
at the previous year-end.
To clearly demonstrate the effect of deferred tax accounting on the banks regulatory
capital positions, I computed Tier I capital before inclusion of net DTAs and the capital

21

BIS guidelines specifically indicate that assets should be measured conservatively and that regulators are
expected to adjust GAAP-based financial statements for both intangible assets (including goodwill) and deferred tax
assets (BIS, 2000). In the U.S., the Feds risk-based capital guidelines limit the amount of DTAs included in Tier I
capital to the lesser of: (i) the amount of DTAs expected to be realized within one year, and (ii) 10 percent of Tier I
capital. These guidelines also exclude goodwill and certain other intangible assets from Tier I capital.
22
When the amount of the land revaluation was first included in equity in March 1999, the law required it to be
shown net of tax, with the corresponding DTL included in the liabilities section of the balance sheet. The law also
specifically indicated that because of the statutory and temporary nature of the land revaluation, this DTL amount is
to be recorded separate from the entitys other deferred tax assets and liabilities. Consistent with this, deferred tax
footnotes (including the table that details the components of deferred tax assets and liabilities) exclude mention of
the land revaluation DTL, with all disclosure related to the land revaluation included in a separate footnote. In
addition, Japanese entities do not net the land revaluation DTL against the other DTAs and DTLs. Because of this
special nature of this DTL and its separation from all other deferred tax amounts, it is ignored in computing the
appropriate level of the valuation allowance for DTAs.

13

injections for the 15 banks that received capital injections from the Government in early 1999.23
For 12 of the 15 banks, Tier I capital would have fallen below the 4% minimum without the
inclusion of net DTAs, and all of the 15 banks would have fallen below the 8% total capital
minimum without the inclusion of net DTAs.24 Thus, without the DTAs all of Japans major
banks would have fallen below minimum regulatory capital requirements, which would have
precluded the capital injections, causing them to fail.

This would have led to a crisis of

unprecedented magnitude given the size and significance of these banks.

2.3 Was deferred tax accounting part of the overall reform of accounting standards in Japan?
The way that deferred tax accounting was adopted in Japan supports the argument that its
adoption was part of the Governments regulatory forbearance strategy. First, at this time
Japans accounting rules were effectively set by the Government, a result of Japans traditional
code law system.25 Second, the rule was pushed through quickly (in comparison to the speed
of the normal accounting standard-setting process) and adopted early by virtually all Japanese
banks. Third, as discussed above, bank regulators at the MOF allowed the banks to include
DTAs in Tier I capital, a decision that is contrary to usual BIS practice and that was unique to
Japan.26

23

14 of the 15 banks that received capital injections were major banks. The other bank was Yokohama Bank, the
largest regional bank at the time. Bank-level data on regulatory capital and capital injections are from Fukao (2000)
and Nakaso (1999).
24
All of these banks were designated as banks with international operations (international banks); as such, the
minimum total capital requirement was 8%, consistent with BIS rules internationally. In contrast, the Government
imposed a less stringent 4% requirement on Japanese banks with no international operations (domestic banks).
25
Japans system is known as the Triangular Legal System because financial reporting rules are determined by
three related sets of laws, the Commercial Code, the Securities and Exchange Law, and the Corporate Income Tax
Law (JICPA, 2006, Accounting and Disclosure System in Japan, available at http://www.jicpa.or.jp/n_eng/eaccount.html). Japan has been moving away from this traditional code law type of system and in 2001 set up an
independently funded private sector standard-setter, the Accounting Standards Board of Japan, modeled after the
U.S. FASB. The link between the Japanese tax code and financial reporting rules has become progressively weaker,
beginning in the mid-1990s.
26
It is possible that the Japanese banks DTAs had economic value, and so were appropriately included in Tier I
capital. However, because they view the value of these assets as uncertain bank regulators around the world almost
universally exclude all or most DTAs from Tier I capital, along with goodwill and most other intangibles (see, e.g.,

14

In 1998, Japanese accounting standards were set by the Business Accounting Deliberation
Council (BADC). This body was a committee of the MOF; as such it was likely to be influenced
by the Governments regulatory goals. The timing and manner in which the deferred tax rule
was adopted is consistent with this regulatory influence. In June 1998, the MOF and Ministry of
Justice issued a joint report reinterpreting the Commercial Code to allow deferred tax assets and
liabilities to be recognized on corporate balance sheets. Also in June 1998, the BADC issued its
initial exposure draft on deferred tax accounting which was followed, in October 1998, by a final
statement.27 The statement went in effect in F1999 (the fiscal year ended March 2000) but
allowed earlier adoption. Virtually all Japanese banks adopted the rule early, in F1998, even
though the rule was issued only five months before the fiscal period.28 The fact that deferred tax
accounting was adopted so quickly made it difficult for auditors, with no previous experience of
deferred tax accounting, to assess the reasonableness of the banks deferred tax accounting
choices in that year.
In 1996, the Japanese Government announced a package of financial reforms known
collectively as the Big Bang. This included a mandate to modernize Japanese accounting
standards, and to adopt standards that were accepted world-wide.

Thus, an alternative

interpretation is that deferred tax accounting was adopted in F1998 as part of the accounting
Big Bang. While possible, the fact that other accounting reforms were adopted after deferred
tax accounting makes this explanation less likely.

Fair value accounting for investment

securities was not adopted until F2001, even though this rule would seem to be especially
BIS 2000). In addition, as I discuss below, it is hard to argue that the Japanese banks DTAs were unusually
valuable in fact, my evidence shows the opposite and supports the conclusion that, especially at this time, the
Japanese banks DTAs had little economic value.
27
In contrast, the BADC issued an exposure draft on accounting for financial instruments in June 1998, but did not
require this new accounting until F2001.
28
According to the Bank of Japan (1999), 134 banks adopted the rule early at the March 1999 year end and only
four regional banks did not adopt the rule at this time.

15

important in an economy where banks, other financial institutions, and many non-financial
companies hold large portfolios of investment securities.29
3. Empirical Predictions
Section 2 provides arguments and evidence to support the view that deferred tax
accounting was introduced in Japan as part of the Governments regulatory forbearance strategy.
This section motivates more specific empirical tests of the regulatory forbearance argument and
the related prediction that managers of Japanese banks practiced regulatory capital arbitrage.
The regulatory forbearance argument implies that the inclusion of DTAs in banks
regulatory capital was inappropriate because these assets were of questionable economic value.
It is possible that Japanese banks DTAs did, in fact, have economic value and were
appropriately included as part of regulatory capital. Consequently, the first part of the empirical
analysis assesses the realizability of the banks DTAs. Section 3.1 discusses the Japanese GAAP
rule on deferred taxes and relevant Japanese tax law.
Closely related to regulatory forbearance is the argument that Japanese bank managers
managed their banks capital levels to meet regulatory requirements, a practice known as
regulatory capital arbitrage.

Section 3.2 discusses previous evidence on regulatory capital

arbitrage in Japanese banks and develops this prediction in the context of deferred tax
accounting.
3.1 Japanese GAAP rules for deferred tax assets and the relevant tax law
The Japanese accounting rule for deferred taxes (described further in Appendix 2) is
similar to SFAS-109 in the U.S. in requiring recognition of both deferred tax assets and liabilities
along with a valuation allowance that reflects the extent to which any resulting DTAs are not

29

Conversely, given the fact that Japan is traditionally a code law country, with close ties between the tax code and
accounting rules, it is not clear why deferred tax accounting would be a pressing concern.

16

realizable. The most subjective part of this rule is the determination of the valuation allowance,
which involves assessing the realizability of the entitys DTAs. SFAS-109 states that a valuation
allowance is to be recognized if, based on the weight of available evidence, it is more likely
than notthat some portion or all of the deferred tax assets will not be realized (FASB, 1992,
para. 17 (e), emph. in original).
The Japanese GAAP rule does not have an analogous clear statement of how the level of
the valuation allowance should be determined. Instead, as discussed in more detail in Appendix
2, in November 1999 the Japanese Institute of CPAs (JICPA) issued guidance regarding the
evidence necessary to justify the realizability of DTAs. This guidance became the de facto
standard.

It classifies entities into five categories based on their taxable income and past

earnings stability. Entities with sufficient taxable income and/or stable past profitability (the
first two categories) are permitted to recognize DTAs in full. Because of their persistent losses
during this period few Japanese banks satisfied these conditions and so fell instead into a third
category. For entities in this category DTAs are limited to an amount that can be justified based
on a schedule of the entitys temporary differences, subject to an overall limitation that DTAs not
exceed the tax benefits of taxable income expected over the next five years. This made it crucial
for the banks to project sufficient taxable income over this period.
Japanese tax law, at least as it pertains to banks, is generally more stringent than that in
the U.S. Loan losses are not deductible until the loans are actually disposed of, meaning that the
borrower goes bankrupt (a rare occurrence in Japan) or the loan is sold. This meant that there is
a relatively long lag between when loan losses are recognized for book and tax purposes, which
leads to relatively large DTAs.

17

During the period of this study, Japanese law allowed tax losses to be carried forward for
five years with no carryback. These rules are also more restrictive than those in the U.S. As
with U.S. GAAP, tax loss carryforwards automatically generate DTAs. It then becomes a matter
of managerial judgment as to whether the associated DTAs are realizable and to what extent a
valuation allowance is necessary. Previous research shows that U.S. managers typically set the
valuation allowance to track the extent of loss carryforwards, indicating that the realizability of
DTAs attributable to carryforwards is questionable.30 This tendency should be stronger in Japan
given the more restrictive carryforward rules.
Another significant source of deferred taxes for Japanese banks during this period was
the unrealized gains and losses on investment securities that resulted from the banks adoption of
fair value accounting (required beginning in F2001). Under this accounting rule, the tax effects
of the unrealized gains and losses included in equity result in deferred tax liabilities and assets.
Given the magnitude of Japanese banks stockholdings, these tax effects are relatively large.
This discussion suggests that Japanese banks, especially before the introduction of fair
value accounting, will have relatively large gross DTAs given the likely magnitude of the
temporary differences associated with their loan loss provisions and their tax loss carryforwards.
The recognition of these gross DTAs is largely non-discretionary. The more difficult accounting
question, involving significant managerial discretion, is whether and to what extent these DTAs
are realizable, and so the empirical tests (Section 4) separately analyze the determinants of the
banks gross DTAs, valuation allowances, and net DTAs.
3.2 Bank managers regulatory capital arbitrage incentives
Regulatory capital arbitrage occurs when bank managers exploit the discretion available
under banking regulations to report regulatory capital levels that satisfy the necessary
30

See, e.g., Miller and Skinner (1998) or Schrand and Wong (2003).

18

thresholds.31 Ito and Sasaki (2002) show that in the early 1990s, when BIS rules were adopted in
Japan, bank managers responded by issuing subordinated debt and curtailing new loan activity,
to help their banks meet Tier II capital requirements. This was necessary to offset sharp declines
in the value of the banks portfolios of investment securities (see Section 2.1) that would
otherwise have reduced the banks Tier II capital. Shrieves and Dahl (2003) show that over the
period from 1989 to 1996 managers of Japanese banks timed the realization of securities gains
and managed reported loan loss provisions to smooth reported income and bolster their banks
regulatory capital levels, consistent with the discussion in Section 2.1.
I investigate whether managers of Japanese banks exploit their discretion under deferred
tax accounting rules to practice regulatory capital arbitrage. The specific argument that I test is
that Japanese banks deferred tax accounting choices are driven by bank managers incentives to
increase reported levels of regulatory capital in the face of shortages of other components of that
capital. This leads to the cross-sectional prediction that the relative level of banks net DTAs is
inversely related to regulatory capital levels, other factors held constant.
4. Empirical Evidence
4.1 Sample and preliminary evidence
To generate a sample of banks with available data for F1998 I identify all Japanese banks
on the Compustat Global Financial Services database, sort them by total assets, and choose the
largest 100 banks. This procedure captures all of the major Japanese banks and most of the

31

A number of papers investigate how managers of U.S. banks trade off the incentives provided by regulatory
capital regulations, tax incentives, and financial reporting incentives. For example, see Moyer (1990), Scholes,
Wolfson, and Wilson (1990), Beatty, Chamberlain, and Magliolo (1995), and Collins, Shackelford, and Wahlen
(1995).

19

regional banks and so includes the majority of Japanese banks, and the very large majority on a
value-weighted basis.32
Ninety-two banks have sufficient financial statement detail (hand collected from their
financial statements) to be included in the sample. Three regional banks did not adopt deferred
tax accounting until F1999 and so are removed from this part of the analysis. I omit Bank of
Tokyo-Mitsubishi (BTM) and Mitsubishi Trust & Banking because these banks (part of the same
group) were listed in New York and used U.S. GAAP. I also remove Long Term Credit Bank
because it failed in late 1998, distorting its numbers. These exclusions leave 86 banks: eight city
banks, one long term credit bank, six trust banks, and 71 regional banks.
Table 1, Panel A reports descriptive statistics on the size, profitability, and deferred tax
positions of these banks in F1998. The primary source of financial statement data is the NEEDS
database from Nikkei (Nihon Keizai Shimbun, America, Inc.). These are large banks, with mean
(median) total assets of 7,608 billion (2,761 billion).33 Japanese banks initially recognized
DTAs that are large relative to their equity and assets. Mean (median) net DTAs are 96 billion
(25 billion) compared to mean (median) stockholders equity of 322 billion (114 billion). At
the mean (median), these DTAs represent 34% (21%) of the banks stockholders equity and
1.1% (0.9%) of total assets.
Table 1, Panel A reports three measures of bank profitability: current return-on-assets
(ROA), average ROA over the three prior years, and the number of losses reported by the bank

32

This initial set includes the nine main city banks in existence at that time, three long-term credit banks (IBJ,
Long Term Credit/Shinsei, and Nippon Credit/Aozora), the major trust banks, as well as many of the regional banks
(including both the tier one and tier two regional banks). According to the Bank of Japan (1999), there were a total
of 144 Japanese banks at this time, including 64 regional banks and 61 Tier 2 regional banks.
33
Using an exchange rate of 120/$, these amounts translate into $63 billion ($23 billion). The largest Japanese
banks are also large by world standards. The largest five Japanese banks included here (Fuji, Sumitomo, Sakura,
Dai-Ichi Kangyo, and Sanwa) had total assets ranging from $408 billion to $483 billion in F1998. The Bank of
Tokyo Mitsubishi (which I exclude) had total assets of $618 billion in F1998. In comparison, Citibank had total
assets of $669 billion in F1998.

20

over the three prior years.34

These numbers make it clear that Japanese banks initially

recognized relatively large net DTAs in spite of poor current and prior profitability. Mean
(median) ROA in F1998 is -0.78% (-0.38%); 55% of the banks report losses in this year. Mean
(median) average past ROA is -0.02% (0.11%); 46% of the banks report losses on average over
the past three years. The poor current and past profitability of the banks raises questions about
the realizability of their DTAs unless these banks were expecting a significant reversal of
fortune, an unlikely prospect given the state of the Japanese economy at this time. I present
evidence on these banks profitability in the five years after F1998 in Table 3.
Panel B of Table 1 presents details of the banks deferred tax numbers. The banks gross
DTAs are similar in size to the net DTAs reported in Panel A, with a mean (median) of 103
billion (25 billion), because these banks generally do not report significant DTLs or valuation
allowances. Only 30 banks report DTLs, which have a mean (median) value of 0.8 billion (0),
and only 16 banks report valuation allowances, which have a mean (median) value of 5.6
billion (0).
Schrand and Wong (2003) provide evidence on the deferred tax positions of 235 US
banks upon their adoption of SFAS-109 in 1992. DTAs outweigh DTLs for US banks as well.
As in Japan, this is mainly due to differences between the book and tax treatment of loan losses,
although this temporary difference is larger for Japanese banks because of the more stringent
deductibility requirements of Japanese tax law. Schrand and Wong report that while all of the
banks in their sample report DTAs, 98% also report DTLs. Schrand and Wong also find that US
banks recognize DTLs that are typically 60-70% of their DTAs. The differences in the extent of
these banks DTLs presumably result from differences in the banks book-tax situations. The US

34

Throughout the paper, ROA is calculated to exclude the effects of deferred tax accounting by using pretax
earnings in the numerator and lagged total assets adjusted to exclude DTAs in the denominator.

21

banks larger levels of DTLs relative to DTAs increase the realizability of DTAs, reducing the
need for a valuation allowance. This makes it harder to understand why the Japanese banks have
little or no valuation allowances.35
As expected, the principal source of the Japanese banks DTAs are temporary differences
due to the banks loan loss provisions, which represent a mean (median) 65% (68%) of DTAs.
Tax loss carryforwards account for a mean (median) 9% (0%) of DTAs; 18 banks report this
component. These numbers are similar to those for US banks. Schrand and Wong (2003) report
that, on average, the temporary difference related to loan loss provisions accounts for about 60%
of these banks DTAs while tax loss carryforwards represent around 5% of DTAs.
Schrand and Wong (2003) report that 39% of the banks in their sample report a valuation
allowance, which averages about 11% of the underlying gross DTAs. Only eight Japanese banks
(20%) report a valuation allowance, which average only 3% of gross DTAs. Unlike differences
between the underlying DTAs and DTLs, these differences are harder to explain as being due to
differences in the tax laws, and support the prediction that managers of Japanese banks were
relatively aggressive in their initial recognition of net DTAs.
Because the major banks differ along several dimensions from regional banks, Table 2
compares gross and net DTA numbers, valuation allowances, bank capital ratios, and

35

The numbers for the Bank of Tokyo-Mitsubishi (BTM), which uses US GAAP, are quite different to those of the
other major Japanese banks. In F1998, it reports net DTAs that are generally smaller than those of the other
Japanese banks (about .5% of total assets and 14% of equity), has a valuation allowance that represents about 19%
of its DTAs and recognizes DTLs that represent 47% of DTAs. The main source of BTMs DTLs is unrealized
gains on investment securities, which were not recognized at this time under Japanese GAAP. BTM uses Japanese
GAAP numbers for purposes of calculating its regulatory capital ratios. Using these numbers (for which footnote
data is not available), the net DTA ratios increase to .8% of assets and 24% of equity, supporting the idea that
Japanese GAAP and/or its interpretation/enforcement allows for more liberal recognition of DTAs. An important
caveat, however, is that its Japanese deferred tax numbers exclude DTLs related to unrealized gains on investment
securities.

22

profitability data for the 15 major banks in the sample to those for the 71 regional banks.36 Data
on bank capital ratios is also from Nikkei. I collect and report data on both Tier I capital ratios
and overall capital ratios (the numerator of the overall capital ratio is the sum of Tier I and Tier
II capital net of certain adjustments).
Unsurprisingly, the regional banks are much smaller than the major banks. Using either
total assets or stockholders equity, the median major bank is about ten times larger than the
median regional bank. There is some evidence that gross DTAs are proportionately larger at the
major banks mean (median) gross DTAs deflated by stockholders equity for the major banks
is 48.9% (31.7%) versus 34.4% (16.7%) for the regional banks, although only the difference in
medians is statistically significant. The larger gross DTAs of the major banks are likely due to
their poorer current and past profitability as shown in the bottom of the table, current and past
ROA numbers, as well as the count of past losses, indicate substantially worse profitability at the
major banks (differences statistically significant at the 1% level or better).
The major banks have proportionately larger loss carryforwards and smaller loan losses
than the regional banks. Because loss carryforwards are usually viewed as less realizable than
other components of banks DTAs, this implies that these banks would record larger valuation
allowances than the regional banks. There is some evidence of this in Table 2; the mean
(median) valuation allowance for the major banks is .098 (.009) versus .008 (0) for the regional
banks, although only the difference in medians is statistically significant. These differences are
small in economic terms, however, which means the major banks report larger net DTAs than the

36

Historically in Japan the various types of banks the city banks, long-term credit banks, trust banks, regional
banks, and sogo (second-tier regional banks) perform different economic functions and serve different types of
customers, the result of banking regulation (Hoshi and Kashyap, 2001). The city banks lent mainly to large
corporate customers and operated large branch networks, usually in urban areas. These banks sat at the center of the
main corporate groups (keiretsu) in Japan, often with their affiliated trust banks. In contrast, the regional banks
typically operated as full service banks in limited geographical areas, usually one or two prefectures.

23

regional banks. While mean net DTAs are the same when deflated by equity, the difference in
medians is substantial (28.7% versus 16.7%) and statistically significant at the 5% level (twotailed). The differences are more evident when I deflate by total assets, with differences in
means and medians both significant at the 1% level. This suggests that managers of the major
banks were more aggressive in their recognition of net DTAs than managers of the regional
banks.
The evidence also shows that the major banks core capital is substantially weaker than
that of the regional banks.37 At the end of F1996 [F1997], the major banks had mean (median)
Tier I capital ratios of 5.3% (4.8%) [5.4% (5.0%)], compared to corresponding ratios of 6.7%
(6.5%) [7.2% (6.8%)] for the regional banks, differences that are statistically significant at better
than the 1% level under two-tailed tests. In contrast, the total capital ratios of the two sets of
banks are approximately the same, with no statistically significant differences. For example, at
the end of F1997, the major banks had mean (median) total capital ratios of 10.4% (9.8%),
compared to 10.0% (9.9%) for the regional banks.38
4.2 Is the optimism inherent in managers deferred tax choices related to their banks regulatory
capital positions?
To this point, the evidence shows that when Japanese banks adopted deferred tax
accounting: (1) they recognized gross DTAs that were large relative to their total assets and
stockholders equity, (2) they recorded little/no valuation allowances, resulting in relatively large
net DTAs, (3) they were largely unprofitable and had been so for some time, (4) the major banks
recognized larger net DTAs than the regional banks, in spite of being less profitable with less
37

Because the data on the regulatory capital levels of most banks is missing from the Nikkei database in F1998, I
compare the banks capital levels using the numbers reported at year-end F1997 and F1996.
38
Tier II capital is defined slightly differently for banks with international operations (most of the major banks are in
this category) than for other banks (most of the regional banks are in this category). For example, Tier II capital for
banks in the latter category excludes unrealized gains on investment securities.

24

Tier I capital. Further, as documented in Section 2.2, 15 major banks received capital injections
from the Government in early 1999. Prior to receiving these capital injections, all of these banks
would have fallen below minimum regulatory capital requirements without the recognition of
DTAs. All of this evidence is consistent with regulatory forbearance. This subsection provides a
further test of this argument by testing: (i) whether managers deferred tax accounting choices
implied expectations about future earnings that were systematically too optimistic, and (ii)
whether any observed over-optimism is negatively related to the banks regulatory capital
positions, as predicted under the regulatory capital arbitrage hypothesis.
Unfortunately, analysts earnings forecast data, which could have served as an unbiased
estimate of managers expectations, are not available for these banks. As an alternative measure
of managers expectations of future earnings, I use the banks realized earnings over the five
years after F1998 and compare this amount to the earnings managers implicitly expected over
this period, as indicated by their banks net DTAs. This allows me to assess the reasonableness
of managers claims as to the realizability of their banks DTAs.
Table 3 reports three variables. First, I compute the minimum taxable income necessary
over the next five years to support the net DTAs recognized by the banks in F1998.39 To obtain
this number, I divide each banks net DTAs by an assumed 50% tax rate, which approximates the
corporate tax rate in Japan at this time. I compare this amount to the (pretax) earnings the banks
actually realized over the next five years, and compute the difference between these amounts.
These three amounts are available for 70 banks (almost all of the major banks merged with one

39

I use a five year period because: (1) this was the tax loss carryforward period in Japan at this time (Section 3.1),
(2) JICPA guidelines on assessing the realizability of DTAs also require income to be estimated over this period
(Section 3.1), and (3) it seems unlikely that managers could reliably estimate earnings over a period longer than five
years.

25

another over the five year period, which reduces the available sample). All numbers are deflated
by total assets in fiscal 1998, adjusted to exclude DTAs.
The results in Table 3 show that the net DTAs recognized by bank managers in F1998
implied that they expected their banks to earn a mean (median) total ROA of 1.89% (1.42%)
over the subsequent five years. While modest in absolute terms, these amounts are large relative
to the banks current and past earnings, summarized in Table 1 (for example, median F1998
ROA was -0.38%).

These numbers are also substantially larger than what the banks

subsequently earned. These banks earned a mean (median) total ROA of -0.15% (0.03%) over
the five years after F1998, with half of the banks reporting overall losses. Thus, differences
between the two sets of numbers are large the mean (median) difference is -2.04% (-1.72%) of
total assets, with managers of 60 banks (86%) being overly optimistic. This is strong evidence
that managers estimates of bank earnings were systematically too optimistic. Moreover, the
correlation between these earnings forecast errors and the banks regulatory capital positions
(measured using the Tier I capital ratios in March 1997) is -.46 (significantly different from zero
at the 1% level), implying that the managerial optimism embedded in the DTA numbers is
inversely related to regulatory capital levels.40 Managers of banks with the weakest capital
positions were the most optimistic.
The table also reports the results of this analysis separately for the major and regional
banks, although only six major banks have available data. Managers of the major banks are
especially optimistic: the larger net DTAs recognized by these banks represent average expected
40

The correlation is even stronger if I measure the banks regulatory slack as the difference between their total
capital and the relevant regulatory minimum (8% for banks with international operations and 4% for other banks). It
is possible that managers expectations at this time were not biased because of regulatory capital incentives but
rather were systematically optimistic because of the underlying macroeconomic environment. However, by this
time the Japanese economy was clearly mired in a slump, making a rebound unlikely. In addition, macro-driven
systematic optimism does not explain the negative cross-sectional correlation between managers over-optimism and
regulatory capital slack.

26

future earnings of 3.81% of total assets (median, 3.22%) compared to subsequent realized
performance of -2.04% (median, -1.54%), for an average difference of 5.85% (median 5.33%).
These differences are clearly substantial in economic terms and are statistically significant at the
5% level.

Differences for the regional banks are also positive (mean (median) of 1.68%

(1.59%)) and statistically significant at the 1% level, but clearly smaller than those for the major
banks (differences between the two sets of are also significant better than the 1% level).
4.3 Are managers deferred tax choices related to their banks regulatory capital positions?
This subsection provides further evidence on the regulatory capital arbitrage hypothesis
by examining the prediction that the net DTAs recognized by bank managers are negatively
related to their banks regulatory capital slack. I first report results for F1998, the year that
deferred tax accounting is adopted by the banks (see Table 4), followed by results for F1999
through F2003 (Tables 5 and 6).
For F1998, Table 4 reports cross-sectional regressions of three dependent variables the
banks gross DTAs, valuation allowances, and net DTAs on control variables and a proxy for
the managers regulatory capital arbitrage incentives. The DTA variables are deflated by total
assets (adjusted to remove the effects of DTAs) while the valuation allowance is deflated by
gross DTAs. These regressions control for the nature of the banks DTAs (the fraction due to
loan losses and tax loss carryforwards), the banks size (log of total assets), and their current and
past profitability (current and average past pretax ROA). To proxy for managers regulatory
capital incentives, I include the banks March 1997 Tier I capital ratio (labeled BIS397). I use this
proxy because March 1999 (F1998) Tier I capital levels are not available from Nikkei for most
banks (the same is true in March 1998).41 Because of the differences between major and

41

As an alternative measure of regulatory capital slack, I also computed the difference between the banks total
regulatory capital ratios and the appropriate regulatory minimum (8% for banks with international operations and

27

regional banks, I also include a regional bank dummy. Data are available for 69 banks. In the
regressions that examine managers deferred tax accounting choices (the valuation allowance
and net DTAs), I also include the banks average realized future ROA, computed over as many
of the next five years as are available, to proxy for managers contemporaneous earnings
expectations which should drive their recognition decisions under GAAP.

Because of

heteroskedasticity due to the large differences in bank size, the t-statistics are computed using
White (1980) heteroskedasticity-consistent standard errors.
The first regression in Table 4 shows that the most important explanatory variable for
gross DTAs is past bank profitability this variable is strongly negatively related to gross DTAs
and is largely responsible for the adjusted R-squared of 85%.42 This is expected because banks
with poorer past profitability and larger loan loss provisions naturally record larger gross DTAs.
I also find that larger banks and (after controlling for size) regional banks report lower gross
DTAs, on average. The coefficient on the regulatory capital variable is positive and significant (t
= 3.36) indicating that banks with stronger capital positions tend to report larger gross DTAs.
The next regression assesses the determinants of the banks valuation allowances. Unlike
gross DTAs, managers exercise discretion over the valuation allowance. This regression again
has good fit, with an R-squared of 63%. The results indicate that banks with relatively more
DTAs due to loan losses, higher past (and current) profitability, and higher expected future
profitability have lower valuation allowances.

These results are all consistent with more

realizable DTAs leading to lower valuation allowances, as the normal application of GAAP
would imply. I also find, however, that after controlling for these factors there is a positive
4% otherwise). The results are largely consistent with those reported in Table 4 (although in the net DTA
regression, the regulatory capital variable is significantly negative, consistent with regulatory capital arbitrage).
42
The correlation between average past ROA and current ROA is .78, making it hard to determine the separate
contribution of these variables. Because these variables are so highly collinear, I include only past ROA in the
reported regressions. Inferences are very similar when either or both variables are included.

28

relation between regulatory capital slack and the valuation allowance (t = 2.46), implying that
managers of weaker banks set the valuation allowance lower (and so record larger net DTAs),
consistent with the regulatory capital arbitrage argument.
The banks net DTAs reflect the banks (largely non-discretionary) gross DTA positions
and their managers valuation allowance decisions. This is the most critical variable since it
directly measures the contribution of DTAs to core capital. The only significant variables in this
regression are past profitability which, although negative and highly significant (t = -4.37), is not
as important as in the gross DTA regression, and future ROA, which is positive and significant (t
= 2.04), implying that managers report higher net DTAs when they expect their banks to be more
profitable in the future, as expected under GAAP.

The coefficient on regulatory capital,

although negative, is not statistically significant, inconsistent with regulatory capital arbitrage.
I next examine the banks deferred tax accounting choices from F1999 through F2003,
the last year for which I have data. Table 5 reports descriptive statistics for each of these years,
while Table 6 reports annual cross-sectional regressions analogous to those reported in Table 4.
In Table 5 I again present the numbers separately for the major and regional banks because of the
significant differences between these banks, differences that become more pronounced beginning
in F2001 when the major banks merged to form five large banking groups (megabanks). For
these years, I report the banks Tier I capital ratios along with an adjusted core capital ratio
which excludes the effects of DTAs. This variable shows what the banks core capital position
would have been without DTAs; I also report (in parentheses) the number of banks that would
have fallen below the regulatory core capital minimum without deferred taxes.

In the

29

regressions, this variable serves as a measure of managers regulatory capital incentives because
it directly measures the banks regulatory slack.43
Table 5 shows a number of trends in the banks financial performance and deferred tax
positions over this period along with differences between the major and regional banks. It is
clear that DTAs continue to comprise a significant part of the banks capital in F1999: the major
(regional) banks average Tier I capital ratio is 6.8% (7.4%) with net DTAs and 5.1% (4.7%)
without net DTAs; 15 banks would have fallen below the 4% threshold without DTAs. The
numbers in F2000 are similar to those in F1999. In F2001, the situation worsens appreciably: the
major banks report losses that average about 1.5% of assets in this year and the banks core
capital position (before considering DTAs) worsens noticeably due to the losses and (for the
major banks) the introduction of fair value accounting. All four of major banks and 17 regional
banks would have had capital deficiencies in F2001 without DTAs. Consistent with regulatory
capital arbitrage, the banks net DTA positions increase significantly in this year, especially for
the major banks. For the major banks net DTAs represent a mean (median) 59% (60%) of equity
and represent around half of Tier I capital in this year.
The major banks continue to report losses in F2002, eroding Tier I capital even further; at
the same time, these banks net DTAs increase to a mean (median) 78% (79%) of shareholders
equity and contribute to well over half of their Tier I capital. While some of this year-to-year
43

I have also calculated regulatory slack relative to the banks required total capital ratios. To do this, I take the
difference between the banks total capital levels and the appropriate regulatory threshold (8% for international
banks and 4% for domestic banks). The results in Table 6 are generally weaker when I use this alternative measure
of slack. This is expected because net DTAs comprise Tier I capital and because the Tier I capital requirement is
typically more difficult to achieve (Montgomery, 2005). Consistent with this, when I compare the domestic and
international banks, I find no statistically significant differences in their Tier I capital ratios. However, I find that
banks with international operations have significantly higher (at better than the 1% level) total capital levels than
domestic banks (expected since Tier II capital is defined more broadly for these banks), but that differences in the
two sets of banks total regulatory slack (defined as their total capital levels net of the regulatory minima) are
significant in the opposite direction. That is, banks with international operations have significantly lower levels of
total regulatory slack than the domestic banks domestic banks have relatively high levels of total regulatory slack
(median 5.5%) compared to banks with international operations (median 2.9%) and their own levels Tier I capital
slack (median 2.8%).

30

variation is due to (largely non-discretionary) variation in the banks gross DTAs, the net DTAs
reflect bank managers judgments about realizability in spite of their worsening financial
condition, the major banks report larger net DTAs, consistent with regulatory capital
arbitrage/forbearance. Notice that the extent to which the major banks DTAs are due to loss
carryforwards increases and the proportion due to loan losses falls, which also suggests that their
realizability declines. Finally, in F2003 the banks profitability and capital positions improve,
and both the major and regional banks reduce their net DTAs. Thus, these numbers show that
changes in the banks net DTAs tend to be inversely related to their financial performance and
the realizability of the DTAs, a correlation that is inconsistent with what we would expect under
GAAP but consistent with regulatory capital arbitrage.44
Table 6 reports annual cross-sectional regressions for F1999 through F2003. I use the
same dependent variables as in Table 4. To measure managers regulatory capital incentives, I
use the banks Tier I capital ratios adjusted to remove the effects of DTAs, which directly
measures regulatory slack. To proxy for expectations about future earnings, I again include a
future realized earnings measure although as the years progress from F1999 to F2003 there are
fewer available years of future ROA.45 For the years F2001-F2003, after fair value accounting
for investment securities was required in Japan, the regressions also include a variable that
captures the extent to which the banks DTAs (DTLs) are attributable to unrealized losses (gains)
on investment securities. Other variables are defined identically to those in Table 4. The gross
DTA regressions are reported in Panel A, the valuation allowance regressions in Panel B, and the
net DTA regressions in Panel C. I discuss the results year by year.
44

Another possibility consistent with GAAP is that improvements in profitability led to utilization of tax loss
carryforwards and so to declines in DTAs.
45
For the F1999 regressions, future ROA is averaged over as many years as each bank has available from F2000F2003 (maximum of four), for the F2000 regressions, future ROA is averaged over as many years as are available
from F2001-F2003 (maximum of three), etc., with no future ROA data available for the F2003 regressions.

31

Similar to Table 4, the F1999 and F2000 gross DTA regressions indicate that past
profitability (again highly correlated with current profitability, which I exclude from the
regressions) is the most important determinant of the banks gross DTA positions, as expected
under GAAP. The adjusted capital variable is not significant in these regressions. This variable
is, however, negative and statistically significant at the 1% level in the net DTA regressions in
both years (t-statistics of -2.6 and -3.8) suggesting that weaker banks report higher net DTAs,
other factors held constant, consistent with the regulatory capital arbitrage argument. The past
profitability variable is also significant in the net DTA regressions, although with smaller
coefficients than in the gross DTA regressions.
The evidence in favor of regulatory capital arbitrage becomes stronger in F2001 and
F2002. Once again, in the gross DTA regressions the coefficient on past profitability is negative
and highly significant while that on adjusted capital is also negative but only significant in
F2001. The adjusted capital variable is not significant in the valuation allowance regressions. In
fact, the only variable that is significant in these regressions is past profitability, which is
negative, suggesting that less profitable banks have higher valuation allowances, consistent with
GAAP.

The adjusted regulatory capital variable is negative and significant in the net DTA

regressions, again consistent with the regulatory capital arbitrage argument (in these two years
the t-statistics on the regulatory capital arbitrage variables are -4.6 and -3.2). The unrealized
gain/loss variable is highly significant in the net DTA regressions in both F2001 and F2002,
suggesting that the tax effects of these items have an impact on the banks net DTA positions. In
F2002 (but not F2001) net DTAs are significantly larger for major banks than for the regional
banks (t = -3.4), other things held constant.

32

In F2003, average past profitability has a less important effect on deferred taxes, with tstatistics of only -1.8 in the gross DTA regression, -2.0 in the valuation allowance regression,
and -0.2 in the net DTA regression. More importantly, however, the coefficient on the adjusted
capital variable is again significantly negative in the net DTA regression (t = -2.8), consistent
with regulatory capital arbitrage. Similar to F2002, the regional bank dummy is significantly
negative in the net DTA regression, implying that the major banks report larger net DTAs, other
factors held constant.
To summarize, these results show that average past profitability is consistently
significantly negatively related to the banks gross DTAs, as expected under GAAP. This
variable is also negatively related to the banks valuation allowances, suggesting that less
profitable banks report higher valuation allowances, also consistent with the normal application
of GAAP. However, I also find that the adjusted capital variable is consistently and significantly
negatively related to the banks net DTAs, consistent with regulatory capital arbitrage. There is
also evidence in F2002 and F2003, after the emergence of the megabanks, that these banks
report higher net DTAs than other banks. Neither of these results holds as strongly in the gross
DTA regressions, consistent with them reflecting managerial decisions under regulatory capital
arbitrage.
5. Conclusion
I argue that deferred tax accounting was introduced in Japan in 1998 at least partly as a
tool of regulatory forbearance, to help the banks meet regulatory capital requirements. This
interpretation is supported by the following: (1) the Japanese Government (including bank
regulators) could not allow any significant number of banks, especially the major banks, to fail,
largely because of the central role these banks played in the economy, (2) during the period from

33

F1989 to F1997 the banks realized large gains on their holdings of investment securities, but by
1998 this source of regulatory slack had largely been used up, (3) deferred tax accounting was
adopted by an accounting rule-making body which was part of the Ministry of Finance, the bank
regulator at the time, (4) the Government and its regulators introduced a number of other
accounting and regulatory changes at this time that enabled the banks to increase their regulatory
capital, including a decision to allow the banks to include DTAs in regulatory capital, a policy
unique to Japan and inconsistent with how BIS rules are implemented elsewhere, (5) because of
the relatively stringent Japanese tax laws, deferred tax accounting enabled the weakest banks
(with the largest loan losses and poorest profitability) to recognize the largest DTAs, and so
provided an effective way of increasing regulatory capital for the weakest banks, and (6)
deferred tax accounting was introduced contemporaneously with a large capital injection from
the Government into the major banks; without the increase in regulatory capital due to DTAs,
these banks would have been insolvent, complicating the politics of the Governments decision
to inject capital.
Consistent with this view, I show that the weakest banks did in fact recognize the largest
net DTAs, that many of these banks recognized these assets in spite of large current and past
losses, that the expected future earnings necessary to justify the banks DTAs largely failed to
materialize, and that this over-optimism was inversely related to the strength of the banks
regulatory capital positions. These results are confirmed in cross-sectional regressions, which
analyze the determinants of the banks gross DTAs, valuation allowances, and net DTAs. While
the banks gross DTAs and valuation allowances are both well-explained by current and past
profitability, after controlling for other determinants their net DTAs are inversely related to

34

adjusted regulatory capital, consistent with regulatory capital arbitrage on the part of bank
managers.
Overall, the evidence supports the idea that deferred tax accounting was introduced by
Japanese regulators to help encourage weaker banks to face up to their bad loan problems by
offering a soft landing. The evidence raises the question of whether, given the prolonged
financial crisis in Japan, politicians and regulators were justified in using DTAs as a way of
managing the financial crisis. The evidence also illustrates how political and regulatory forces
influence how accounting rules affect actual financial reporting practice. Consequently, this
evidence reinforces concerns about whether the introduction of standardized accounting rules
(such as IFRS) around the world will actually result in effective standardization of accounting
practice.

35

Appendix 1
Major Components of Stockholders Equity for the Major Japanese Banks, F1982-F2003, as well as Net Deferred Tax Assets,
Unrealized Gains on Investment Securities, and Certain Data on the Effect of Realized Gains.
Panel A: Annual Data, F1982 to F2003
1982
Components of
Stockholders Equity:
Earned Surplus
Paid-in Capital

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

3924
1598
5522
-

4414
1691
6105
-

4889
1734
6623
-

5475
1966
7441
-

6299
2195
8494
-

7417
3770
11187
-

8944
6365
15309
-

10213
9350
19563
-

11160
9419
20579
-

11773
9439
21212
-

11953
9440
21393
-

5522

6105

6623

7441

8494

11187

15309

19563

20579

21212

21393

Unrealized Gains
(Losses)

9575

15574

18194

25939

40340

47385

55371

44721

34958

17269

17792

Realized Gains
(Losses)
Cumul.net of tax real.
gains/(losses)

-187

-86

37

38

-145

64

653

2773

1793

2116

543

-164

-142

-119

-206

-167

224

1888

2964

4234

4559

Land Revaluation
Reserve
Unrealized Gain
(Loss) on AFS Sec.
Total Stockholders
Equity
Deferred Tax Assets

36

Appendix 1 (Cont.): Annual Data, F1982 to F2003

Components of
Stockholders Equity:
Earned Surplus
Paid-in Capital
Land Revaluation
Reserve
Unrealized Gain
(Loss) on AFS Sec.
Total Stockholders
Equity
Deferred Tax Assets
Unrealized Gains
(Losses)
Realized Gains
(Losses)
Cumul.net of tax real.
gains/(losses)

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

12079
9578
21657
-

11638
9805
21443
-

7870
9855
17725
-

7451
10671
18122
-

1933
11626
13559
-

2590
18848
21438
1399

3789
18702
22491
1404

4358
18027
22385
1327

858
16971
17829
1072

-898
13572
12674
853

1492
13013
14505
619

446

-894

-520

1635

21657

21443

17725

18122

13559

22837

23895

24158

18007

13007

16759

6648

5731

5279

7997

7848

5493

20386

9002

16523

8753

2737

2816

7477

258

-1149

-378

NA

2205

4069

3680

3449

4323

1983

4730

2073

-1302

NA

5882

8323

10532

12601

15195

16385

19222

20467

20471

19690

NA

All amounts in billions of Japanese yen. All data from Bank of Japan website, Financial Statements of Japanese Banks, http://www.boj.or.jp/en/stat/stat_f.htm.
These data are also published in the Bank of Japan Quarterly Bulletin, usually in the November issue of each year. I define the set of major Japanese banks in the
same way as the Bank of Japan. The set includes the seven city banks (Mizuho, Bank of Tokyo-Mitsubishi, UFJ, SMBC, Resona, Mizuho Corp., and Saitama
Resona), the five large trust banks, as well as two long term credit banks, Shinsei Bank and Aozora Bank. This set is defined at the end of fiscal 2002. At the
end of fiscal 1999, the set of major banks was defined as the nine city banks then in existence, the seven largest trust banks, and the three long-term credit banks.
For 1989 and thereafter, realized gains (losses) are realized gains on stocks less realized losses on stocks plus realized gains on real estate less realized losses on
real estate. These numbers are not separately reported before 1989, so I use temporary income net of temporary expenses instead during 1982 to 1988.
These categories include the aforementioned realized gains and losses as well as other items.

37

Appendix 2: Deferred Tax Accounting in Japan

The Japanese GAAP rule for tax effect accounting, Accounting Standards for Tax Effect
Accounting was issued by the Business Accounting Deliberation Council (BADC) in 1998.
The rule itself, at the equivalent of about five pages of English text, is relatively brief, consistent
with the proposition that Japanese GAAP for deferred taxes gave only very basic accounting
guidance, at least initially.46
The rule states that, consistent with conventional deferred tax accounting under the assetliability method, DTAs and liabilities are to be recognized based on temporary differences
between the accounting and tax bases at which assets and liabilities are recognized on the
balance sheet. In addition, net operating loss carryforwards are to be treated in the same manner
as temporary differences, and thus give also rise to DTAs.
With regard to the realizability of DTAs, the rule states only that temporary differences
are to be recognized as DTAs or liabilities unless they are not expected to be collected or paid
in future accounting periods and that the collectability (sic) of DTAs is to be reviewed
annually (para. 2.1). An Interpretive Note appended to the rule provides a little more detail,
stating that (a) deferred tax asset may be recognized only to the extent that an underlying
temporary difference is expected to result in a reduction in taxable income, and tax payments, for
the accounting period in which the temporary difference reverses; no deferred tax asset may be

46

This discussion is based on an English translation of certain Japanese GAAP rules (FASF, 2002), available from
the Financial Accounting Standards Foundation (FASF) of Japan, which oversees the Accounting Standards Board
of Japan (ASBJ). These bodies were set up in 2001, and are the Japanese equivalents of the US standard-setting
organizations (the Financial Accounting Foundation, or FAF, and the Financial Accounting Standards Board, or
FASB, respectively). The BADC was the predecessor to the ASBJ. I have also checked this information to that
provided by Yoshinori Kawamura of Waseda University, on his unofficial web site Accounting News in Japan
http://www2g.biglobe.ne.jp/~ykawamur/. Mr. Kawamura provides English translations of many Japanese GAAP
rules and related interpretations and releases. This summary is also based on discussions with officials at the ASBJ
and with several Japanese CPAs

38

recognized beyond this limit (Note 5). Unlike the US rule, there is no specific discussion about
the circumstances under which DTAs should be reduced to their realizable value.47
More guidance about how to interpret this rule was provided by the Japanese Institute of
CPAs (JICPA) in November 1999, eight months after the first set of financial statements using
deferred tax accounting were issued.48 This statement provides specific guidance about how to
assess the realizability of DTAs. Similar to the US rule, the statement makes the realizability a
function of the companys past profitability and taxable income. To do this, the interpretation
places companies into one of five categories:
1. Companies with sufficient taxable income to fully cover their temporary differences
in every year (four or more consecutive years including the current year). These
companies are permitted to fully recognize their DTAs with no limitations.
2. Companies with stable profitability over the period (the three previous years plus
the current year) but without sufficient taxable income to fully cover their temporary
differences. These companies also fully recognize their DTAs based on a schedule
indicating the timing and amount of temporary difference reversals.
3. Companies with unstable profitability whose taxable income is insufficient to fully
cover the temporary differences. These companies can recognize DTAs based on a
schedule indicating the timing and amount of temporary difference reversals, subject

47

The US rule devotes about two pages to a discussion of the conditions under which a valuation allowance for
deferred tax assets is needed. The general principle is that a valuation allowance is to be recognized if, based on
the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not
be realized (emph. in original). The statement then provides detailed discussion and examples of the types of
evidence that should be considered in making this judgment. In US GAAP, more likely than not connotes a
relatively low threshold for recognition of the allowance, as compared to the use of a term such as probable which
is read to imply a probability higher than 50%.
48
Judgment on Recoverability of Deferred Tax Assets, Auditing Committee Report No. 66, JICPA, November
1999. This discussion is based on a Bank of Japan (August 2002 Quarterly Bulletin, p. 30) summary of the
statement and an English translation of the statement made for me by Yoshiko Imai-Suga.

39

to a ceiling equal to their estimated taxable income over a period over which taxable
income can be rationally or reasonably forecast (generally five years).
4. Companies with large loss carryforwards (unless those are due to extraordinary
factors) at the end of the period. DTAs can be recognized to the extent of the
taxable income definitely expected over the next fiscal year, i.e., a one year
limitation on DTAs. (If the tax loss carryforwards are due to unusual events such as
restructurings, the company may record DTAs using the category 3 rule.)
5. Companies that have recorded loss carryforwards for the past three or more
consecutive years and that are expected to record loss carryforwards again in the next
year. DTAs cannot be recognized.
In practice, it turns out that Category 3 was the one into which most Japanese banks were
classified by their auditors, at least in the years after deferred tax accounting was initially
adopted, and that the deferred tax asset rule for that category became the de facto audit standard
for the banks. This fact, combined with the fact that Japanese tax law allows companies to carry
losses forward for five years but no longer, made five years a very important threshold in
deferred tax accounting for Japanese banks.
The JICPA issued further guidance on accounting for DTAs in January 2001.49 Among
other things, this document provided more specific guidance on the criteria to be used in
assessing the amount, if any, to be deducted from DTAs (para. 21). There are three main
criteria: (1) the sufficiency of taxable income, based on earning capacity. The words it is
expected, and highly probable are used three times in this section to describe estimates of future

49

Practical Guidelines on Accounting Standards for Tax Effect Accounting in Non-Consolidated Financial
Statements, Accounting System Committee, JICPA, January 2001, as translated by the FASF (2002). A closely
related document with much very similar wording was also released at this time (Practical Guidelines on
Accounting Standards for Tax Effect Accounting in Consolidated Financial Statements).

40

taxable income of sufficient amount to realize the reversal of temporary differences and/or tax
loss carryforwards; (2) the existence of tax planning; (3) the sufficiency of taxable temporary
differences. These criteria are similar to those listed in SFAS-109 under US GAAP.
Finally, in February 2003, the chair of the JICPA, Mr. Akio Okuyama, sent a letter to the
heads of all of the major audit firms in Japan.50

The letter indicated that as part of the

Governments Program for Financial Revival announced in October 2002, the Government
(and in particular the FSA, under Mr. Takenaka) was undertaking a number of measures to
strengthen the banking system, including confirming the reasonableness of accounting for DTAs
and strengthening the external auditors function. This letter was sent at the behest of the
Government, and reiterates the factors that are relevant to making judgments about the
realizability of banks DTAs.

The letter further encourages audit firms to make strict

assessments of banks DTAs. The letter apparently was a result of high level negotiations
between the JICPA and the FSA, the outcome of which was to require the Japanese audit
professions to get tougher on their bank clients on the deferred tax asset issue.51

50

I am grateful to Tomo Suga and Yoshiko Imai-Suga for providing me with a translation of this letter.
The JICPA was thus able to avoid the perceived ignominy of an FSA regulation specifically limiting the
recognition of bank deferred tax assets.

51

41

Table 1
Descriptive Statistics on the Deferred Tax Positions of Japanese Banks upon Adoption of Deferred Tax Accounting in Fiscal
1998 (amounts in millions). Obs. = 86 banks.
Panel A: Basic Balance Sheet Descriptive Statistics

Mean
Median
Std. Devn.
Min.
Max.

Stockholders
Equity

Total
Assets

Net Deferred
Taxes

Net DT/Total
Assets

322,273
114,322
537,935
-102,234
2,403,075

7,607,973
2,760,736
13,280,390
960,991
57,933,043

96,278
24,848
190,090
2,616
1,069,258

.011
.009
.006
.003
.037

Net
DT/Stockholders
Equity
.339
.214
.344
.005
1.781

Current year
ROA

Average past
ROA

Count of past
losses

-0.78%
-0.38%
1.27%
-5.55%
0.54%

-0.02%
0.11%
0.49%
-2.17%
0.61%

0.78
1.00
0.87
0
3.00

Panel B: Descriptive Statistics on Deferred Taxes of Banks with Available Footnote Information

Mean
Median
Std. Devn.
Min.
Max.
#>0

Deferred
Tax Assets

Deferred Tax
Liabilities

Valuation
Allowance

Loan Loss
Provision/DTA

102,653
25,119
203,380
2,616
1,211,483
86/86

804
0
3,728
0
30,607
30/86

5,569
0
23,162
0
130,442
16/86

.646
.680
.145
.259
.915
na

Loss
Carryforwards
/DTAs
.087
0
.143
0
.597
na

Notes. Total assets and stockholders equity are from Compustat Worldscope. Net deferred taxes is net deferred taxes from the banks balance sheet (i.e.,
deferred tax assets net of both the valuation allowance, if any, and deferred tax liabilities, if any). The ratios are net deferred tax assets (Net DT) deflated by total
assets and stockholders equity respectively. ROA is pretax income divided by lagged total assets (ROA). Average past ROA is the average of the three past
years ROA. Count of past losses is the number of losses in the past three fiscal years. Deferred tax assets (DTAs) is gross deferred tax assets before subtracting
the valuation allowance, if any. Loan loss provision is the amount of the banks deferred tax assets comprised of temporary differences due to book-tax
differences in accounting for loan losses. Loss carryforwards is the amount of the banks deferred tax assets attributable to tax loss carryforwards. The deferred
tax variables are from bank financial statements while the financial variables (except total assets and stockholders equity) are from the Nikkei NEEDS database.
Note that the ROA and loss count variables are based on only 52 banks (data not yet updated to include the other banks).

42

Table 2: Descriptive Statistics, including Deferred Tax Positions, of the Major and Regional
Japanese Banks in Fiscal 1998
Major Banks
(obs. = 15)

Regional Banks
(obs. = 71)

Test for
Difference

Total Assets

29,074,115
(29,296,192)

3,072,872
(2,466,136)

t = 4.72
Z = 5.20

Stockholders Equity

1,245,415
(1,310,325)

127,243
(103,929)

t = 5.57
Z = 5.47

Gross DTAs/SE

.489
(.317)

.344
(.167)

t = 1.28
Z = 2.65

Loan loss provisions/Gross

DTAs

.557
(.608)

.665
(.687)

t = -2.24
Z = -2.34

Tax loss carryforwards/Gross

DTAs

.198
(.152)

.063
(0)

t = 3.06
Z = 4.36

Valuation Allow./Gross
DTAs

.098
(.009)

.008
(0)

t = 1.52
Z = 3.85

Net DTAs/SE

.339
(.287)

.339
(.167)

t = 0.01
Z = 2.25

Net DTAs/TA

.016
(.013)

.009
(.007)

t = 3.62
Z = 3.81

Tier I Capital Ratio, 3/98

.054
(.050)

.072
(.068)

t = -4.19
Z = -3.53

Tier I Capital Ratio, 3/97

.053
(.048)

.067
(.065)

t = -3.20
Z = -4.32

Total Capital Ratio, 3/98

.104
(.098)

.100
(.099)

t = -0.87
Z = -0.42

Total Capital Ratio, 3/97

.094
(.092)

.095
(.094)

t = -0.73
Z = 0.74

Current year ROA

-1.9%
(-1.3%)

-0.6%
(0.1%)

t = -2.89
Z = -3.43

Average past ROA

-0.6%
(-0.4%)

0.1%
(0.3%)

t = -4.38
Z = -4.15

Count of past losses

1.69
(2)

.61
(0)

t = 6.50
Z = 4.19

Notes. Gross deferred tax assets (Gross DTAs) is gross deferred tax assets (i.e., before deducting the valuation
allowance and deferred tax liabilities). Net deferred taxes (Net DT) is net deferred taxes from the banks balance sheet
(i.e., deferred tax assets net of both the valuation allowance, if any, and deferred tax liabilities, if any). Total assets and
stockholders equity are from Compustat Worldscope. Loan loss provisions/Gross DTAs is the proportion of gross
deferred tax assets attributable to the book-tax difference between the way that banks account for loan loss provisions
for accounting and tax purposes. Tax loss carryforwards/Gross DTAs is the proportion of gross deferred tax assets

43

represented by tax loss carryforwards. Valuation allow./Gross DTAs is the valuation allowance for DTAs deflated by
gross DTAs. Tier I capital ratio is the banks Tier I capital divided by risk-weighted assets at a given year end. Total
capital ratio is the banks total capital ratio (Tier I capital + Tier II capital net of certain adjustments divided by riskweighted assets. ROA is pre-tax income divided by lagged total assets (ROA). Average past ROA is the average of
the three past years ROA. Count of past losses is the number of losses in the past three fiscal years. The deferred tax
variables are from bank financial statements while the financial variables (except total assets and stockholders equity)
including regulatory capital are from the Nikkei NEEDS database.

44

Table 3
Comparison of Future Earnings Implicit in Japanese Banks F1998 Net Deferred Tax Assets
with Realized Earnings for 70 Banks with Available Data.
Aggregate Expected ROA
over F1999-F2003 Implied
by Banks Net DTAs
(1)

Aggregate Realized ROA

over F1999-F2003
(2)

Difference
Between (1) and (2)
(Forecast Error)
(3)

Mean
(p-value)
Median
(p-value)
Number (%) > 0

1.89%
(< .0001)
1.42%
(< .0001)
70 (100%)

-0.15%
(.417)
0.03%
(.999)
35 (50%)

2.04%
(< .0001)
1.72%
(<.0001)
60 (86%)

Major Banks (N = 6)
Mean
(p-value)
Median
(p-value)
Number (%) > 0

3.81%
(.006)
3.22%
(.031)
6 (100%)

-2.04%
(.075)
-1.54%
(.219)
1 (17%)

5.85%
(.002)
5.33%
(.031)
6 (100%)

Regional Banks (N = 64)

Mean
(p-value)
Median
(p-value)
Number (%) > 0

1.71%
(< .0001)
1.33%
(< .0001)
64 (100%)

0.03%
(.862)
0.21%
(.708)
53 (83%)

1.68%
(< .0001)
1.59%
(< .0001)
48 (80%)

t = 2.50
Z = 2.99

t = -2.24
Z = -2.49

t = 4.18
Z = 3.51

Test for difference between

major and regional banks:

Notes. I compute (1) by dividing the banks F1998 net DTAs by 50%, which approximates the Japanese corporate tax
rate at this time. This calculation yields the minimum taxable income necessary over the next five years to realize the
tax benefits in the banks net DTAs. I compute (2) as the sum of the banks realized pretax earnings over the F1999
through F2003 period. Both variables are deflated by total assets in F1998 (adjusted to remove the effects of DTAs).
The p-values are from t-tests (for means) and Wilcoxon Z-statistics (for medians).

45

Table 4
Cross-sectional Fiscal 1998 OLS Regressions of Gross Deferred Tax Assets (DTAs, deflated by Total Assets), the Valuation
Allowance for DTAs (deflated by Gross DTAs), and Net DTAs (deflated by Total Assets) on Variables that Proxy for their
Economic Determinants and Regulatory capital arbitrage/Forbearance Incentives. Sample comprises 69 Japanese banks with
available data in Fiscal 1998.
Dependent
variable

Intercept

LL/Gross
DTA*

CF/Gross
DTA*

Regional
Dummy*

Size*

Average
Past ROA

BIS397

Future
ROA

Adj. R2

Gross
DTAs/TA

.04
(2.13)

-.03
(-.51)

.04
(.42)

-.09
(-2.45)

-.03
(-2.26)

-2.73
(-7.50)

.28
(3.36)

.849

VA/Gross
DTA

.28
(1.05)

-.17
(-2.33)

-.10
(-.76)

-.05
(-.81)

-.02
(-1.08)

-18.5
(-3.60)

2.71
(2.46)

-5.88
(-2.02)

.630

Net DTAs/TA

-.01
(-.45)

.04
(.52)

-.04
(-.41)

.01
(.43)

.01
(1.23)

-1.37
(-4.37)

-.07
(-1.15)

.37
(2.04)

.614

Notes. Gross deferred tax assets (Gross DTA) is gross deferred tax assets (i.e., before deducting the valuation allowance and deferred tax liabilities). Valuation
allow.(VA)/Gross DTAs is the valuation allowance for DTAs deflated by gross DTAs. Net deferred taxes (Net DTAs) is net deferred taxes from the banks
balance sheet (i.e., Gross DTAs net of both the valuation allowance, if any, and deferred tax liabilities, if any). Total assets are adjusted to remove the effect of
DTAs for purposes of calculating both the DTA dependent variables and ROA. Loan loss provisions (LL)/Gross DTAs is the proportion of gross deferred tax
assets attributable to the book-tax difference between the way that banks account for loan loss provisions for accounting and tax purposes. Tax loss
carryforwards (CF) /Gross DTAs is the proportion of gross deferred tax assets represented by tax loss carryforwards. Size is the log of total assets. Average past
ROA is the average of the three past years ROA. ROA is calculated on a pretax basis. Regional dummy is set to one for regional banks and zero otherwise.
BIS397 is the banks Tier I capital ratio at year-end March 1997. Future ROA is average bank ROA computed over F1999 through F2003 (or fewer years if full
time-series not available). The deferred tax variables are from bank financial statements while the financial variables are from the Nikkei NEEDS database.
White (1980) heteroskedasticity-consistent t-statistics in parentheses. *The coefficients on these variables have been multiplied by 10.

46

Table 5
Comparison of the Deferred Tax Positions and Associated Variables for the Major Banks in Japan to those of the Regional
Banks, F1999 through F2003
Fiscal
Year

Gross
DTAs/SE

Val. Allow.
/Gross DTAs

Net
DTAs/SE

Tier I Cap.
(%)

Adj. Cap.
(%)

ROA (%)

Loan Losses/
Gross DTAs

Carry
Forwards/
Gross DTAs
Maj. Reg.
.150
.035
.025
.000

F1999
n = 11, 70

Maj.
.453
.273

Reg.
.239
.175

Maj.
.122
.038

Reg.
.022
0

Maj.
.269
.252

Reg.
.229
.175

Maj.
6.83
6.68

Reg.
7.43
7.59

Maj.
5.05
4.65
(1)

Reg.
5.80
6.16
(14)

Maj.
.26
.33

Reg.
.13
.21

Maj.
.598
.699

Reg.
.691
.704

F2000
n = 12, 58

.470
.302

.250
.180

.138
.075

.035
0

.279
.261

.146
.114

6.62
6.45

7.80
7.75

4.84
4.80
(1)

6.72
6.81
(7)

.10
.24

-.05
.14

.575
.612

.638
.661

.172
.164

F2001
n = 4, 66

.750
.730

.349
.271

.154
.147

.071
.002

.591
.596

.246
.195

5.25
5.42

7.36
7.37

2.47
2.73
(4)

5.62
5.87
(17)

-1.54
-1.50

-.31
.07

.481
.475

.622
.636

F2002
n = 3, 67

1.251
1.246

.375
.301

.315
.298

.086
.008

.783
.789

.266
.226

5.30
5.50

7.29
7.31

2.14
2.24
(3)

5.35
5.56
(20)

-1.01
-0.77

-.08
.16

.348
.372

F2003
n = 3, 65

1.135
1.196

.297
.238

.355
.320

.092
.030

.582
.541

.169
.134

5.50
5.76

7.73
7.62

2.91
3.21
(3)

6.42
6.50
(13)

.21
.40

.34
.37

.310
.225

DTLs/Gross
DTAs
Maj.
.009
.004

Reg.
.003
0

.031
0

.032
.021

.539
.385

.166
.166

.030
0

.050
.052

.298
.114

.605
.617

.371
.393

.055
0

.047
.047

.224
.092

.620
.620

.417
.423

.061
0

.118
.130

.430
.303

Notes. Maj. denotes major banks while reg. denotes regional banks. The number of observations reported in the left-hand column is the number of major banks
followed by the number of regional banks. Gross deferred tax assets (Gross DTA) is gross deferred tax assets (i.e., before deducting the valuation allowance and
deferred tax liabilities). Valuation allow./Gross DTAs is the valuation allowance for DTAs deflated by gross DTAs. Net DTAs is net deferred taxes from the
banks balance sheet (i.e., Gross DTAs net of both the valuation allowance, if any, and deferred tax liabilities, if any). Tier I Cap. is the banks Tier I capital ratio
in a given year. Adjusted capital is the banks Tier I capital ratio excluding net DTAs (numbers in parentheses are the number of banks in a given group that fall
below the required 4% minimum when DTAs are not considered). ROA is current year pretax ROA. Loan losses/Gross DTAs is the proportion of gross
deferred tax assets attributable to the book-tax difference between the way that banks account for loan loss provisions for accounting and tax purposes.
Carryforwards/Gross DTAs is the proportion of gross deferred tax assets represented by tax loss carryforwards. DTLs is deferred tax liabilities. The deferred tax
variables are from bank financial statements while the financial variables (except stockholders equity) are from the Nikkei NEEDS database.

47

Table 6: Deferred Tax Regressions for Japanese Banks, F1999 through F2003.
Panel A: Dependent Variable: Gross DTAs/TA
Fiscal
Year

Obs.

1999

80

2000

69

2001

60

2002

66

2003

64

Intercept

LL/Gross
DTA*

CF/Gross
DTA*

Regional
Bank
Dummy*

URGL on
Inv. Sec.*

Size*

Average
Past ROA

Adj. Tier I
Capital

Adj. R2

.03
(2.96)
.04
(2.81)
.01
(.67)
.02
(1.92)
.03
(2.41)

.05
(1.20)
.01
(0.17)
.03
(.63)
.04
(.90)
.05
(.86)

.21
(1.51)
-.00
(-0.05)
.05
(.66)
.04
(.41)
.07
(.63)

-.09
(-2.40)
-.07
(-1.87)
.01
(.43)
-.09
(-1.86)
-.08
(-1.79)

-.03
(-2.39)
-.03
(-2.07)
.01
(1.36)
.00
(.46)
-.01
(-.72)

-1.29
(-3.59)
-1.24
(-5.32)
-.90
(-8.70)
-1.02
(-4.62)
-.66
(-1.82)

.10
(1.25)
.01
(.38)
-.07
(-2.56)
-.06
(-1.65)
-.06
(-1.64)

.757

.01
(.82)
.03
(1.55)
.03
(2.19)

.776
.784
.747
.646

48

Panel B: Dependent Variable: Valuation Allowance/Gross DTAs

Fiscal
Year

Obs.

1999

80

2000

66

2001

60

2002

64

2003

64

Intercept

LL/Gross
DTA

CF/Gross
DTA

Regional
Bank
Dummy

URGL on
Inv. Sec.

Size

Average
Past ROA

Future
ROA

Adj. Tier I
Capital

Adj. R2

.51
(2.21)
.19
(.66)
.45
(1.56)
.40
(1.22)
.49
(1.53)

-.03
(-.49)
-.09
(-1.01)
-.16
(-1.13)
-.19
(-1.15)
-.15
(-.77)

.20
(1.04)
-.42
(-2.18)
-.22
(-.66)
.09
(.26)
-.15
(-.45)

-.13
(-1.86)
-.08
(-.99)
-.07
(-.73)
-.08
(-.57)
-.11
(-1.14)

-.04
(-1.94)
.00
(.17)
-.02
(-.71)
-.01
(-.46)
-.02
(-.63)

-9.06
(-1.73)
-13.3
(-3.18)
-15.0
(-3.30)
-15.2
(-2.42)
-18.8
(-2.02)

5.87
(1.41)
6.36
(1.24)
1.14
(.31)
.18
(.07)
-

.03
(.02)
-.67
(-.88)
-1.39
(-1.60)
-.93
(-1.01)
-.94
(-1.01)

.472

-.04
(-1.94)
-.02
(-.58)
.02
(.61)

.327
.426
.369
.370

49

Panel C: Dependent Variable: Net DTAs/TA

Fiscal
Year

Obs.

1999

80

2000

66

2001

60

2002

64

2003

64

Intercept

LL/Gross
DTA*

CF/Gross
DTA*

Regional
Bank
Dummy*

URGL on
Inv. Sec.*

Size*

Average
Past ROA

Future
ROA

Adj. Tier I
Capital

Adj. R2

.00
(.14)
.03
(2.73)
.01
(1.83)
.02
(3.60)
.03
(3.78)

.02
(.75)
.01
(.18)
.01
(.45)
.07
(2.10)
.06
(1.53)

-.05
(-1.04)
.05
(.57)
.07
(1.19)
.02
(.50)
.08
(1.23)

.02
(.79)
-.04
(-2.00)
.01
(.25)
-.07
(-3.40)
-.07
(-2.43)

.01
(1.87)
-.01
(-1.57)
.01
(1.08)
-.01
(-1.04)
-.02
(-2.15)

-.48
(-3.83)
-.44
(-3.74)
-.25
(-2.70)
-.42
(-3.85)
-.04
(-.22)

.07
(.61)
-.01
(-.12)
.22
(1.83)
.12
(1.23)
-

-.07
(-2.61)
-.17
(-3.79)
-.08
(-4.63)
-.06
(-3.18)
-.06
(-2.75)

.664

.10
(11.00)
.08
(7.05)
.08
(7.28)

.699
.874
.803
.763

Notes. Gross deferred tax assets (Gross DTA) is gross deferred tax assets (i.e., before deducting the valuation allowance and deferred tax liabilities). Valuation
allow./Gross DTAs is the valuation allowance for DTAs deflated by gross DTAs. Net deferred taxes (Net DTAs) is net deferred taxes from the banks balance
sheet (i.e., Gross DTAs net of both the valuation allowance, if any, and deferred tax liabilities, if any). Total assets are adjusted to remove the effect of DTAs for
purposes of calculating both the DTA dependent variables and ROA. Loan loss provisions (LL)/Gross DTAs is the proportion of gross deferred tax assets
attributable to the book-tax difference between the way that banks account for loan loss provisions for accounting and tax purposes. Tax loss carryforwards (CF)
/Gross DTAs is the proportion of gross deferred tax assets represented by tax loss carryforwards. URGL on Investment Securities is the ratio of the amount of
deferred tax assets (liabilities) attributable to unrealized losses (gains) on investment securities. This only applies in F2001 and later. Size is the log of total
assets. Average past ROA is the average of the three past years ROA. ROA is calculated on a pretax basis. Regional dummy is set to one for regional banks
and zero otherwise. Adjusted Tier I capital is the banks Tier I capital excluding net DTAs. Future ROA is average bank ROA averaged over as many years as
are available from the next fiscal year through F2003 (not available in F2003). The deferred tax variables are from bank financial statements while the financial
variables are from the Nikkei NEEDS database. White (1980) heteroskedasticity-consistent t-statistics in parentheses. *The coefficients on these variables have
been multiplied by 10.

50

Fig. 1: Plot of total SE (solid line), total unrealized gains on securities (short dashes), and
cumulative after-tax realized gains on securities and real estate (longer dashes) for major
Japanese banks, 1982-2002. Amounts in billions of Japanese yen.
60000

50000

40000

30000

20000

10000

0
1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

-10000

51

Figure 2: Components of Major Japanese Banks' Stockholders' Equity, F1993 to F2003

30000

25000

20000

URGL

15000

Land Rev.
Public funds
RE
10000

PIC

5000

0
1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

-5000

52

Figure 3: Major Japanese Banks' Stockholders' Equity and Net Deferred Tax Assets, F1993 to F2003
30000

25000

20000

SE
DTAs

15000

10000

5000

0
1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

53

References
Amyx, Jennifer A. 2004. Japans Financial Crisis. Princeton University Press (Princeton, NJ).
Aoki, Masahiko, Hugh Patrick, and Paul Sheard. 1994. The Japanese Main Bank System: An
Introductory Overview. In The Japanese Main Bank System. Masahiko Aoki and Hugh
Patrick (eds.), Oxford University Press.
Bank of Japan. 1999. Profits and Balance-Sheet Developments of Japanese Banks in Fiscal 1998,
Bank of Japan Quarterly Bulletin, November 1999.
Bank of Japan. 2001. Developments in Profits and Balance Sheets of Japanese Banks in Fiscal
2000 and Banks Management Tasks, Bank of Japan Quarterly Bulletin, November 2001.
Bank of Japan. 2003. Review of Japanese Banks Activities: Profits and Balance Sheets in Fiscal
2002. August 2003. Bank of Japan.
Beatty, A., S. Chamberlain, and J. Magliolo. 1995. Managing Financial Reports of Commercial
Banks: The Influences of Taxes, Regulatory Capital and Earnings. Journal of Accounting
Research 33: 231-262.
BIS. 2000. Report to G7 Finance Ministers and Central Bank Governors on International
Accounting Standards, Basel Committee on Banking Supervision, Basel: April 2000.
Blacconiere, Walter G. 1991. Market reactions to accounting regulations in the Savings and Loan
Industry. Journal of Accounting and Economics 14: 91-113.
Blacconiere, Walter G., Robert M. Bowen, Stephan A. Sefcik, and Christopher H. Stinson. 1991.
Determinants of the use of regulatory accounting principles by Savings and Loans. Journal of
Accounting and Economics 14: 167-201.
Caballero, Ricardo J., Takeo Hoshi, and Anil K. Kashyap. 2007. Zombie lending and depressed
restructuring in Japan. Working paper. MIT, University of California at San Diego, and
University of Chicago. September. Forthcoming, American Economic Review.
CESR (the Committee of European Securities Regulators). 2007. CESRs advice on the
equivalence of Chinese, Japanese and US GAAPs. Consultation paper, December. Available
at http://www.cesr-eu.org/index.php?page=contenu_groups&id=46&docmore=1 (last accessed
April 1, 2008).
Collins, Julie H., Douglas A. Shackelford, and James W. Wahlen. 1995. Bank differences in the
coordination of regulatory capital, earnings, and taxes. Journal of Accounting Research 33,
263-291.
Dhaliwal, Dan, Cristi A. Gleason, and Lillian F. Mills. 2004. Last Chance Earnings Management:
Using the Tax Expense to Meet Analysts Forecasts. Contemporary Accounting Research 21, 2
(Summer).

54

FASF Japanese Accounting Standards on CD-ROM: Release 2002: Selected Accounting Standards
of Japan and other Japanese Accounting Pronouncements translated into English as of
December 31, 2000. Published by the Financial Accounting Standards Foundation of Japan,
Tokyo, Japan, March 2003.
Federal Deposit Insurance Corporation (FDIC). 1997. History of the Eighties Lessons for the
Future. Volume I: An Examination of the Banking Crises of the 1980s and Early 1990s.
Washington, D. C.: December 1997.
Financial Accounting Standards Board. 1992. Statement of Financial Accounting Standards No.
109: Accounting for Income Taxes. Norwalk, CT: Financial Accounting Standards Board.
Fukao, Mitsuhiro, 1998, Japanese Financial Instability and Weaknesses in the Corporate
Governance Structure, Seoul Journal of Economics 11, 4 (Winter): 381-422.
Fukao, Mitsuhiro, 2000, Recapitalizing Japans Banks: The Functions and Problems of Financial
Revitalization Act and Bank Recapitalization Act. Keio Business Review 38: 1-16.
Fukao, Mitsuhiro, 2003a, Financial sector profitability and double-gearing. In Structural
Impediments to Growth in Japan, Magnus Blomstrom, Jenny Corbett, Fumio Hayashi, and Anil
Kashyap (eds.), University of Chicago Press.
Fukao, Mitsuhiro, 2003b, Weakening Market and Regulatory Discipline in Japanese Financial
System, Working paper, Keio University, Tokyo, Japan.
Gee, Maria A., and Tomoko Mano, 2006, Accounting for Deferred Taxes in Japanese Banks and
the Consequences for Their International Operations. Abacus 42: 1-21.
Holthausen, R. W. and R. W. Leftwich. 1983. The Economic Consequences of Accounting Choice.
Journal of Accounting and Economics 5: 77-117.
Horiuchi, A. and K. Shimizu. 2001. Did amakudari undermine the effectiveness of regulatory
monitoring in Japan? Journal of Banking and Finance 25: 573-596.
Hoshi, Takeo. 2001. What Happened to Japanese Banks? Monetary and Economic Studies.
February 2001. 1-30.
Hoshi, Takao, and Anil K. Kashyap. 1999. The Japanese banking crisis: Where did it come from
and how will it end? NBER Macroeconomics Annual 14: 129-201.
Hoshi, Takeo, and Anil K. Kashyap. 2001. Corporate Financing and Governance in Japan: The
Road to the Future. Cambridge, Mass.: The MIT Press.
Hoshi, Takeo, and Anil K. Kashyap. 2004. Japans Financial Crisis and Economic Stagnation.
Journal of Economic Perspectives 18, 1 (Winter 2004): 3-26.

55

Ito, Takatoshi, and Yuri Nagataki Sasaki. 2002. Impacts of the Basle Capital Standard on Japanese
Banks Behavior. Journal of the Japanese and International Economies 16, 372-397.
Kawamura, Yoshinori. 1998. BADC Proposes Accounting for Income Taxes.
http://www2g.biglobe.ne.jp/~ykawamur/
Miller, Gregory S., and Douglas J. Skinner. 1998. Determinants of the Valuation Allowance for
Deferred Tax Assets Under SFAS No. 109. The Accounting Review 73 (2): 213-233.
Moyer, Susan. 1990. Capital Adequacy Ratio Regulations and Accounting Choices in
Commercial Banks. Journal of Accounting and Economics 13, 123-154.
Nakaso, Hiroshi. 1999. Recent Banking Sector Reforms in Japan. Economic Policy Review
Federal Reserve Bank of New York. July 1999 5 (2): 1-7.
Peek, Joe, and Eric S. Rosengren. 2001. Determinants of the Japan premium: actions speak louder
than words. Journal of International Economics 53: 283-305.
Peek, Joe, and Eric S. Rosengren. 2005. Unnatural selection: perverse incentives and the
misallocation of credit in Japan. American Economic Review 95: 1144-1166.
Ramesh, K., and Lawrence Revsine. 2001. The effect of regulatory and contracting costs on
banks choice of accounting method for other postretirement benefits. Journal of Accounting
and Economics 30: 159-186.
Scholes, M. S., G. P. Wilson, and M. A. Wolfson. 1990. Tax planning, regulatory capital
planning, and financial reporting strategy for commercial banks. Review of Financial Studies
3: 625-650.
Schrand, Catherine M. , and M. H. Franco Wong. 2003. Earnings Management Using the
Valuation Allowance for Deferred Tax Assets Under SFAS No. 109. Contemporary
Accounting Research 20 (3): 579-611.
Shrieves, Ronald E., and Drew Dahl. 2003. Discretionary accounting and the behavior of
Japanese banks under financial duress. Journal of Banking and Finance 27, 1219-1243.
Suda, Kazuyuki. 2002. On the determinants of accounting for taxes on income and the value
relevance of deferred tax assets. Annals of Economics and Business 52: 65-97 (Research
Institute for Economics and Business Administration, Kobe University). (In Japanese)
van Rixtel, Adrian A. R. J. M., and Wolter H. J. Hassink. 2002. Monitoring the monitors: are old
boy networks being used to monitor Japanese private banks? Journal of the Japanese and
International Economies 16: 1-30.
Watts, R. L., and J. L. Zimmerman, Positive Accounting Theory. (Englewood Cliffs: Prentice Hall,
1986)

56