Encouraging signs from Japan's smoldering banking system

By Christopher Lingle

SYDNEY (JP): Finally, Japan has allowed a foreign-capital based institution of significant size to participate in local financial markets. A long reluctance to embrace its promised "Big Bang" financial reforms may be over judging from the sale of the Long-Term Credit Bank of Japan (LTCB) to Ripplewood Holdings.

Accepting a price of 120 billion yen, the government showed its willingness to sell off the temporarily nationalized LTCB even though its asset base of about 12 trillion yen is nearly 100 times the purchase price. Of course, this was not merely an act of generosity. It was a sensible step to cut losses to the taxpayers while resolving a messy problem as soon as possible.

On the surface, it may not sound like such a good deal for Ripplewood. In order to close the deal, Japan's Financial Reconstruction Commission (FRC) insisted that Ripplewood Holdings not sell LTCB's outstanding loans within three years following the transfer. Other conditions were that there would be no great haste in calling loans in while being willing to extend low- interest loans to corporate clients so they could meet higher interest obligations on existing loans.

Although the sale of LTCB is but a tip of a very nasty iceberg that is Japan's banking muddle, it is a crucial first step. Last year, Japan's major banks announced record bad loan write-offs and record losses, declaring that bad debts from the late 1980's bubble economy had been eliminated. They also pledged to post pre-tax profits in the next fiscal year.

Yet this year saw reports of record bad loan write-offs and losses for almost all the major banks. It has been reported that 17 major banks wrote off 10.065 trillion yen in bad loans in the latest reporting season, with all but the Bank of Tokyo- Mitsubishi (BTM) reporting losses.

Total losses for the major banks were 5.99 trillion yen this year, an amount that exceeded 1998 losses by yen 1.74 trillion. Sakura's losses (754 billion yen) were the largest. Once the world's largest company as measured by market capitalization, the Industrial Bank of Japan made provisions worth 924 billion yen and experienced a pre-tax loss of 352 billion yen after a 358 billion yen loss in the previous year.

It could be that problem loans remaining on the books are at about the same scale as those currently written off. At the end of the March fiscal year, the total value of problem loans was said to be 21 trillion yen. Despite estimates that reserves are between 21 and 25 trillion yen, there are 132 trillion yen of loans to real estate, construction and non-bank financial companies is at risk.

Assessment of the credits of Japan's banks is fraught with difficulty. The FRC revealed that 75 percent of the borrowers classified by the banks as "sound" were the source of loan losses. There is the impending impact of corporate debt restructuring and continuing write-offs of bad loans currently held in the banking sector. Some loans considered sound at the moment doubtless will go bad as corporate shakeouts continue. In all events, the government has spent about 7.5 trillion yen (about US$72.11 billion) to bail out its troubled banks with few signs of any clear improvement in banks' circumstances.

Japan's government pursued a strategy of directed development whereby banks were used as the principal vehicle for lending. Banking officials could more readily be pressured to go along with the preferences of bureaucrats and politicians for government-guided lending toward favored export-oriented industries.

By channeling the bulk of investment funds through banks, it was easier to politicize the decisions on projects since they would be outside the scrutiny of more discerning investors as in capital markets. In turn, capital tended to be used inefficiently leading to excess production capacity or failed ventures.

Government-directed investments and subsidized interest rates encouraged formation of massive conglomerates, keiretsu, which diverted vast amounts of funds into what have proved to be activities that were not economically viable.

It is encouraging that concrete actions have been taken to address Japan's banking crisis. Perhaps more importantly, these actions may be the death knell for business as usual in Japan's financial system. Its "convoy system" involved two elements. First, banks tended to move in unison in support of specific projects or export-oriented lending. Second, government assistance insured that none of the banks could fail.

Breaking up the will encourage a shift away from the dominance of banks as providers of investment funds towards an open and competitive capital market. In turn, there will be a diversification of the sources of funds and introduce more corporate accountability.

It appears that a considerable portion of Japan's current economic and financial crises arose from self-inflicted wounds arising from the politicization of its domestic financial market. Therefore, Japan's recovery will require greater liberalization of global capital flows and increased development of domestic capital markets. At last, some steps seem to be taken in the right direction.

The writer is an independent corporate consultant and author of The Rise and Decline of the Asian Century. His E-mail address is: CLINGLE@ufm.edu.gt.