Japan's Nonperforming Loans

Happy Halloween! In Japan, the debate is heated about the issue of disposing nonperforming loans (NPLs) which is as gigantic and scary as a monster pumpkin. RIETI Report explains the background of this issue and how our fellows see the current discussions about NPLs.

Late 1980s-1992: Land and property asset prices shoot up. Companies embark on aggressive investment in land, heavily borrowing loans from banks by offering stock and land as collateral. Land prices begin to fall in 1991 and stock prices in 1992, putting a number of corporate borrowers under Heavy debt burdens. The public generally remain unaware of the situation.

1992: Prime Minister Kiichi Miyazawa refers to the need to inject public funds into banks to bail them out of their bad loan problem. The government, however, concludes the infusion of public funds is unnecessary perceiving stock price falls as a temporary phenomenon.

1993: A series of small financial institutions, typically credit unions, fail. But it is widely perceived that these failed institutions should be absorbed by healthy banks.

1995:"Jusen" housing loan companies fail, leaving agricultural cooperative-related financial institutions with massive soured assets and liabilities to banks. Due partly to political muscle exercised by legislators backed by farmers, ¥685 billion in public funds are used to solve the jusen problem but the scheme proves to be extremely unpopular among the general public. The use of public funds to help dispose of bad loans thereafter becomes taboo.

1996-1997: Although land and stock prices continue to fall, the economy bottoms out with Japan's GDP posting an annual growth of 3 to 4 percent. In the fall of 1997, three major financial institutions fail ? Sanyo Securities Co. in October, followed by Hokkaido Takushoku Bank and Yamaichi Securities Co. in November ? show signs of a major financial crisis.

1998: Several trillion yen in public funds are injected into major banks in March to calm the situation and revamp banks' financial health. In the fall, the Bank Recapitalization Law is enacted, thereby, setting aside a total of ¥60 trillion in public funds for banks'recapitalization. In October, the Long-Term Credit Bank of Japan goes bust.

1999: A total of ¥7 to ¥8 trillion in public funds are injected into major banks in March to dodge a financial crisis. The situation seems to have calmed but bad loans continue to increase.

2002: In September, the Bank of Japan announces a scheme to purchase stocks held by banks. In the Cabinet reshuffle later in the month, Financial Services Minister Hakuo Yanagisawa, who has been opposed to infusing public funds into banks, is replaced by Heizo Takenaka who concurrently serves as state minister in charge of fiscal and economic policy. A plan that calls for the government and the BOJ to work in unison to bring an early end to the bad loan problem is put forward. A project team of private-sector specialists is launched to discuss a scheme to inject public funds based on the perception that no economic recovery is possible without resolving the bad loan problem. Due to opposition from the ruling Liberal Democratic Party and others, the team fails to announce a scheme for accelerating bad loan disposal on October 22 as initially planned. The team finally announces the scheme yesterday (October 30) together with a package of measures to tackle deflation. Senior LDP members remain firmly opposed to a controversial plan to lower the amount of deferred tax assets (future refund of overpaid taxes) that can be counted as part of banks' capital. Three principles set forth by Financial Services Minister Takenaka's project team call for strict asset assessment, capital reinforcement and strengthened governance. Of these, emphasis on banks'governance is a major difference from the last public fund infusion in 1999.

Helpful reference sites:
Deposit Insurance Corp. of Japan: http://www.dic.go.jp/english/index.html
Financial Services Agency: http://www.fsa.go.jp/indexe.html

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The project team headed by Financial Services Minister Heizo Takenaka to discuss measures to accelerate bad loan disposal, was unable to unveil an interim report on October 22, as had been initially planned. Asked how he assesses this turn of evens, RIETI Fellow Keiichiro Kobayashi said,"There is nothing wrong with announcing the bad loan disposal scheme together with safety net measures to deal with unemployment and reduce the negative impact on small and midsize enterprises. The delay in announcing the bad loan disposal scheme surely sent out a negative message to the Japanese public and people overseas took it as an indication that Japan is in a state of confusion. But I do believe the Takenaka team's scheme is pointing to the right direction."

On October 22, visiting U.S. Treasury Undersecretary John Taylor said in Tokyo that the U.S. strongly supports Finance Service Minister Takenaka's principles on bad loans, expressing high expectations on the planned acceleration scheme. Despite these relatively favorable views and support overseas, why does the project team face fierce criticism at home?
Responding to this question, Kobayashi cited several factors:
1) people are concerned about the negative impact of implementing the bad loan disposal scheme without providing a proper safety net to soften its negative impacts,
2) heavily indebted companies are afraid that banks would no longer allow for the rollover of their loans once stricter assessment standards are adopted as called for by the planned scheme, and
3) politicians are lobbying against the scheme. When the Unites States sends a message to encourage Japan to quickly revitalize its economy, some people in Japan take it as ill-intended advice by American financial institutions trying to buy Japanese assets at discounted prices.
Kobayashi, however, said the U.S. really means it when it calls for a stronger Japanese economy.

RIETI Senior Fellow Kotaro Tsuru said it is unsightly to see politicians making a fuss by saying,"Measures such as these will only adversely affect stock prices." He went on to say,"They are just like overprotective parents who storm in to complain to a teacher (the Takenaka team) who is trying to get their children (banks) back into shape both physically and mentally, just because the pupils have caught a slight cold (stock prices fall). To what extent do they have to spoil their children and bring them to ruin to be satisfied?" Tsuru said he counts especially on the strengthening of banks' governance among the three Takenaka principles, noting that the possibility of nationalization should be deemed as a temporary option to strengthen governance, not as a goal in itself.

Related columns by RIETI Fellows
"What to expect from the Takenaka Project Team" by Kotaro Tsuru
Click here

"Sufficient Disclosure of Asset Assessment Results Vital to Solving Bad Loan Problem" by Keiichiro Kobayashi
Click here

"The Essence of Japan's Non-performing Loan Problem" by Yoichi Takahashi, Consulting Fellow, RIETI
Click here