Japanese banks on a downward spiral
The Japanese government may be ready to bail out the banks but unless it can restart the economy the current bad loan crisis will continue, writes David Pilling
Published: January 28 2002 18:19 | Last Updated: January 28 2002 22:18
It says much about attitudes to Japanese banks these days that, when Standard & Poor's chief credit officer for Asia-Pacific recently described the banking system as"technically insolvent", his comments caused barely a ripple among his audience. That is because most experts without a vested interest in saying otherwise agree that the world's second biggest banking system is essentially bust.
"Problem loans probably far exceed the total equity of the banking system," says Akio Mikuni, president of Mikuni & Co, an independent credit rating agency."By realising loan losses or closing unprofitable operations, the Japanese banking system as a whole would have to be nationalised or given more money."
This realisation is confronting Junichiro Koizumi, the prime minister, with an acute policy dilemma and may yet force him into an embarrassing policy U-turn. While Mr Koizumi has talked tough about injecting market disciplines into the Japanese economy and capping government debt issuance, he may soon be forced to resort to an old-fashioned government bail-out of the banking industry.
Non-performing loans, which even by the government's conservative estimates are running at Y43,000bn ($320bn), are about 8 per cent of gross domestic product, more than double the level prevailing during the US savings and loan crisis of the 1980s. In fact, they may turn out to be much higher since, with interest rates at virtually zero, even the walking dead of the corporate world can service their debts.
True, in the nine years to last March, banks wrote off Y72,000bn in bad loans, according to estimates by Yoshimasa Nishimura, a professor at Waseda University and a former head of bank regulation. But as fast as old problem loans are dealt with, new ones - multiplied by the black magic of persistent deflation - are being created."They can try to deal with either the old non-performing loans, or the new ones, but not both," says Brian Waterhouse, an analyst at HSBC.
That is not all. Banks' core capital, while technically meeting regulatory requirements, has been padded with preferential shares (the legacy of previous government cash injections that must be repaid), as well as deferred tax income on profits that are unlikely ever to materialise. If these are stripped out, says Fitch Ibca, a ratings agency, most institutions will fail to meet Basle capital adequacy criteria. Some will even have negative capital.
Unease about the financial system has bubbled to the surface in recent weeks with the collapse of Ishikawa Bank, the first big regional institution to fail since 1999, after the Financial Services Agency stepped up its inspections. Nervousness is being exacerbated by the planned phasing out of a blanket guarantee on bank deposits, which has prompted a gradual outflow of deposits from second-tier banks and the occasional request from anxious customers to exchange their cash for gold.
From April 1, only the first Y10m of time deposits will be insured against bank collapse, a change that led Moody's to put big Japanese banks on negative outlook last week. For now, depositors can protect themselves by shifting money to other types of accounts. But by April 2003 protection on these, too, will be subject to the Y10m cap. Ratings agencies are now talking openly about the near-inevitability of a government bail-out to recapitalise the banks.
As yet, there is no such sense of panic in Japan, largely because the public shares the rating agencies' belief that the government has the wherewithal to prop up the system. But if Japanese people are not yet alarmed, the same cannot be said of international observers. Last week Paul O'Neill, the visiting US Treasury secretary, warned that"a banking system that is struggling to rid itself of bad and risky loans can exert a tremendous drag on the real economy". Mr O'Neill urged the Koizumi administration to"deal with the problem in its full extent, rather than through a series of partial measures designed to minimise the immediate cost."
He was speaking only days after banks - roundly applauded by the Japanese government - bailed out Daiei, the country's biggest supermarket chain, which is groaning under Y2,200bn of debts. Last week three of its creditor banks, UFJ, Fuji and SMBC, put the finishing touches to a Y420bn bail-out designed to spare the Japanese retailer the fate of Kmart, its less cosseted US counterpart. The"restructuring", under which Daiei's current management will stay and the company is allowed to keep such core activities as its professional baseball team, may still prove insufficient.
Ratings agencies say the three banks with greatest exposure to Daiei were well enough provisioned to have written off all its debts - but none is in the rudest of health. All have sharply increased their estimates for loan-loss charges this year while two have dipped into precious capital to meet increased provisioning requirements. James Fiorillo, banking analyst at ING, says that a Daiei could have been"catastrophic" for the banking system:"You don't want the sky falling down when you're trying to rebuild the foundations."
If even these top-flight banks are struggling to keep pace with corporate bankruptcies, which rose to near-record levels last year, what hope is there for the rest of the system? According to tax statistics, about 70 per cent of Japanese companies lost money last year. Mr Mikuni says this is creating a huge"black hole" in the economy. He estimates corporate losses as equivalent to 6 per cent of gross domestic product."Company losses are now mushrooming so the banks can no longer support everyone," he says.
Difficulties in the banking system are not an isolated phenomenon but the flip-side of an economy lunging into its third recession in a decade, says Prof Nishimura. The fear is that, even if individual banks could survive debt write-offs on a Daiei scale, a series of such bankruptcies could drag down the banking system.
"The banks are weak not just because of the non-performing loans but because Japan's economy has itself weakened and will possibly weaken further still," says Prof Nishimura. The idea that the economy is credit-starved and would spring back into action if the banking system were fixed is nonsense, he says. There is simply no demand for credit in a contracting and deflating economy.
The financial problems of the banks are due not only to their past lending decisions and their inability to write off bad debt. They are also having difficulty making enough money in interest on loans because short-term interest rates are practically zero. A gloomy Bank of Japan official points out that, with the overnight call rate at just 0.001 per cent, a bank that lends Y10bn will make a profit of Y278. That is not enough to buy a cup of coffee, let alone to cover the cost of making the loan.
As a result, banks have largely ceased to perform their function of credit creation. Last year, an increasingly desperate BoJ increased the base money supply by 16.4 per cent. But the flood of yen made little difference to the real economy: money supply stagnated, while bank lending and consumer prices continued on their third straight year of decline.
The banks and the real economy have thus become locked together in a downward spiral, making it hard to fix one without repairing the other. It looks increasingly likely that the government will soon have to spend another round of taxpayers' money to recapitalise the banks. But even if it does, it will still face the intractable problem of getting the economy moving. If it cannot do so, the bad-loan cycle will be in danger of starting all over again.
Additional reporting by John Thornhill
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