61. Bank Reform in Japan

Seriously?

THIS might, just might, be a turning-point for the crisis at Japan's banks. Just as ev­eryone was beginning to think the banks would stagger along half-dead for ever, a trio of powers has emerged—and it seems to be bent on real reform. In a striking break with the past, the Financial Services Agency (FSA), the Bank of Japan (BOJ), and the Keidanren, the powerful group representing business interests, have all reached an understanding. As early as next month, a broad set of finan­cial and structural reforms to clean up the banks and their borrowers could be set out.

Hakuo Yanagisawa, the minister in charge of financial affairs, is leading the at­tack. This week he demanded that banks write off their bad loans rather than just set aside provisions to cover potential losses. That practice often understates bad loans, which have worsened at many banks, lead­ing to a second round of losses. Mr Yanagi­sawa has also urged banks to speed up their bad-loan disposals. Banks have ditched some ¥70 trillion ($620 billion) of non-per­forming loans over the past ten years; that much and more still sits on their books.

If banks get more serious about excising bad debts, many will end up in the red when they next close their books. Mr Yanagisawa has indicated that as long as they show they are serious about cleaning up, then the FSA will tolerate this. In turn, the central bank, a long-time advocate of wholesale bank re­form, is also ready to help, by setting up a mechanism to provide needed liquidity to cash-strapped banks.

Many weak, indebted borrowers would be driven out of business should the banks start writing off bad debts and cutting credit lines. That is why the Keidanren's support for painful reform is startling, if welcome. Its chairman, Takashi Imai, conceded this week for the first time that pain, at least in the short term, was necessary to revive corporate for­tunes. "Unless some of the players jostling around [in the corporate sector] leave the field," he said, "we won't be able to shake off this unhealthy deflation."

There is little doubt that the weakness of the stockmarkets, which are hovering close to a 15-year low, has prompted the latest flurry of reforming zeal. But whether banks can be cajoled into acting is still unclear. With luck, they will grab this opportunity to clean up their books. After all, most are al­ready being pushed to the brink by huge bankruptcies, actual or pending, such the collapse of Phoenix Resort, a resort operator, which failed on February 19th with ¥270 bil­lion of liabilities. If they fail to act, the FSA could use the threat of stricter inspections, for one, to prod them.

Mr Yanagisawa has already accom­plished a good deal since he was appointed minister (for the second time) last Decem­ber. He still has a long way to go. For starters, he must explain the nitty-gritty of his re­forms, and how they will be carried out. One issue is how the banks are to write off their bad loans. There are several ways this could be done. Simply to forgive debt would raise questions of moral hazard, inviting compa­nies to take wild risks on the assumption that they would be bailed out. Selling bad loans to third parties in the market for distressed debt would help banks, but would leave the problems of the corporate sector unresolved. One solution might be to split companies into good bits, which survive, and bad bits, which are got rid of.

Another matter which has not yet been addressed is the issue of management responsibility. The managers that got banks into this mess are still at their desks, and it is hard to see how revived banks can prosper in future under such a benighted lot. Fur­thermore, Mr Yanagisawa's assumption that banks will not need another injection of public funds in order to survive these mas­sive write-offs may also prove mistaken.

The biggest risk is that Mr Yanagisawa may not be around to push through his re­forms. Cutting off credit lines and forcing companies to go bust would meet with a deal of opposition, not least from the ruling Liberal Democratic Party. Yoshiro Mori, the prime minister, gets more unpopu­lar by the day. Mr Mori, a pork-barrel politi­cian, is unlikely to back full-scale bank re­form in his present, vulnerable state. Yet should he go, there are no guarantees that Mr Yanagisawa will be asked to stay on to com­plete the job.