Miyakodayori 12

Yanagisawa Gets It

For those who are following the Japanese news, recent comments by Mr. Yanagisawa, Minister for the Financial Services Agency (FSA), must be catching your attention. He is stressing the need to restructure both the financial sector and the corporate sector. He is also urging the banks to write off non-performing assets instead of putting up reserves for possible losses. Having already received questions from several people, I suspect that many readers of the Miyakodayori might be interested in Mr. Yanagisawa's intention. I will try to explain what he is trying to say, to the best of my knowledge.

Mr. Yanagisawa is asserting that "kansetsushokyaku", setting aside loan loss provisions for non-performing loans, is not sufficient in finalizing the losses and to make the balance sheets of the banks more transparent. What has often happened in the past decade was that additional provisions became necessary as the result of the continuous drop in the value of the collateralized real estate and deterioration in the performance of the borrowers. Furthermore, since "kansetsushokyaku" does not improve the financial condition of the borrowers, restructuring of the borrowing companies has not really occurred. In most cases, the situation of the over-leveraged companies just worsens.

MOF used to be reluctant to allow "kansetsusyokyaku" for fear of tax revenue losses, but under pressure from the market to dispose of bad loans, they allowed banks to do "kansetsushokyaku" quickly to clean up their balance sheets. However, this policy backfired due to the continuous decline of land prices. The US Resolution Trust Corp. (RTC) did exactly the opposite: they forced S&Ls to write off bad loans and sell lands accordingly. Land prices went down, bottomed out and quickly rose again. This is what we lack in Japan, and Yanagisawa's proposal would in effect force the banks to do this.

For these reasons, Mr. Yanagisawa argues that "chokusetsushokyaku," the writing off of non-performing loans, should be put into place more widely. By getting the non-performing loans off the balance sheets, the financial condition of banks would be much more transparent. "Chokusetsushokyaku" results in sales of the loans, debt forgiveness, the Japanese version of Chapter 11, or liquidation. Aside from liquidation, the other three would lead to improved chances for the borrowing companies to be revived. Even liquidation, by unleashing the resources trapped in the over-leveraged companies, can contribute to the economy. Those resources may be better utilized by healthier companies.

To facilitate "chokusetsushokyaku," he is urging the government to study measures to create a market for trading loans. He is also hinting that company split-off, enabled by the revision of the Commercial Code last year, can be used to separate divisions of the over-leveraged firms into good companies and bad ones. With the split-off, banks can continue lending to the good companies while liquidating bad ones. This would contribute to the meaningful restructuring of the borrower. He is even suggesting that the FSA would not penalize banks for recording substantial losses if they are the results of serious debt restructuring efforts.

To avoid the emergence of debt forgiveness plans, which just delay the ultimate restructuring of the borrower, he is expressing the willingness of the FSA to check the plans to see if they really lead to the true restructuring and the revival of the borrower. He is arguing that "time-buying" plans, while incurring small losses for a short period of time, can lead to a bigger loss for the banks and hence to taxpayers, who are behind the public money injected to the banks. (By the way, I believe that as a major shareholder of the banks, the government, represented by the FSA, has a responsibility to check the appropriateness of the general activities of the banks with a view to maximizing shareholder value.) He is also pointing out that, especially for the construction companies, the reorganization of the industry is a prerequisite for the revival of the borrower. Our construction industry is extremely fragmented, with about 600,000 companies, among which very few make profits. This structure has been reinforced by the way in which public work projects were given to the companies, in a manner preferential to smaller companies and joint ventures. He is probably saying that Ministry of Infrastructure can have a meaningful role in accelerating the consolidation of construction companies by changing the way in which they sponsor public work projects. The working group, initiated by Mr. Yanagisawa among the three ministries (the FSA, Ministry of Infrastructure, and METI), can accelerate this process.

If this is his proposal, how should we assess it? Let me give my personal view on this. As we have written several times in the Miyakodayori, we believe that the restructuring of the balance sheets of the financial sector and the corporate sector is essential for the revitalization of the Japanese economy. Mr. Yanagisawa's initiative, I believe, is very much in line with our viewpoint and prescription. His initiative exceeds the previous policies of the Japanese government on two points. The favored way to deal with the non-performing loans has been "kansetsushokyaku." Mr. Yanagisawa's proposal is advocating for a big step forward to clean up banks' balance sheets. While previous policies have been limited to the financial side, Mr. Yanagisawa is urging us to go beyond, to reach the borrower side as well. As the true restructuring of the financial sector cannot be achieved without the restructuring of the corporate sector, his initiative is very significant. On the other hand, his proposal is not 100% perfect. He is not mentioning the need for further capital injection. I believe that if non-performing loans, including the potential ones, are disposed of right away, additional capital injection might be necessary. Hence, I believe that further injection should not be prematurely ruled out. When he talks about "chokusetsushokyaku", he does not necessarily emphasize the need to liquidate. I believe that if a business has lost its viability, it must be liquidated. He does not appear to be enthusiastic about the Japanese version of Chapter 11 either. I believe that it can be a very useful method to restructure over-leveraged firms.

With these deficiencies, we have to be realistic. The major banks are not yet in the mood to ask for additional capital injection. There are too many politicians who may not like the idea of seeing small companies in their home towns being liquidated. The perception of Chapter 11-type proceedings has not yet improved substantially. So, while I still hope for further improvements to his initiative, his current efforts deserve high marks. His initiative is one of the few bright spots in the Japanese economy.

Is there anything that we can do to ensure that his initiative is realized and hopefully has a major positive effect on the economy? Sure, there is a lot that can be done. The Ministry of Infrastructure and METI can play a meaningful role in the restructuring of the corporate sector. Other ministries, including MOF and the Ministry of Justice, may be able to take measures to facilitate debt restructuring. The BOJ can ease the possible pain associated with the restructuring efforts by engaging in quantitative easing of monetary policy. This would be in line with my argument in Miyakodayori 10, to use the monetary policy, not as a "drug" to get a short term pain relief, but as the "anesthesia" for the necessary surgery. This chance for a policy mix between balance sheet restructuring and monetary policy appears not to be so remote. The last line of the statement issued by the BOJ on February 28th, announcing its decision to cut the interest rate by 0.1% (a small step to be sure), stresses the need to restructure the financial and the corporate sector. If restructuring is seriously attempted, would it be too optimistic to expect that the BOJ might take some actions to assist such serious efforts? I do not know the answers yet. But I do have my personal hopes.

Mr. Yanagisawa faces an uphill battle to achieve what he is proposing. The banks and a large number of politicians are not on his side at the moment. Cooperation within the Japanese government may not be enough. There are very few other moments when support and encouragement from the treasury departments and the central banks of other major industrialized nations can be helpful. Investors and analysts, or the "market," can have a substantial role in supporting and encouraging Mr. Yanagisawa's challenge.

His initiative, coupled with cooperation from the BOJ, is probably the best strategy to lead the Japanese economy out of the long tunnel of stagnation. We, as Japanese, must do what we have to do. But the future of the Japanese economy, I believe, should be a matter of some concern for the players outside of Japan as well, especially when the U.S. economy is slowing down.

We are among the first to support his initiative. How about you?

Author, Tatsuya Terazawa
Special Research Fellow, RIETI, M.E.T.I.
e-mail: terazawa-tatsuya@meti.go.jp
tel: 03-3501-1480 fax: 03-3501-1704

Editor in Chief, Nobuo Tanaka
Executive Director, Research Institute of Economy, Trade and Industry, M.E.T.I.
Research Institute of Economy, Trade and Industry, IAI
e-mail: tanaka-nobuo@rieti.go.jp
tel: 03-3501-1362 fax: 03-3501-8391

The opinions expressed or implied in this paper are solely those of the author, and do not necessarily represent the views of the Ministry of Economy, Trade and Industry (METI), or of the Research Institute of Economy, Trade and Industry (RIETI).

March 2, 2001