October 17, 2002
Since Prime Minister Junichiro Koizumi's recent Cabinet reshuffle, there has been momentum to "inject public funds into banks" and "accelerate the disposal of bad loans." These catch phrases, however, are no different from what had been argued during the previous public fund injection in 1999. At that time, Japanese banks had supposedly adopted stricter asset assessment criteria.
But the failures of Sogo Co. in 2000 and Mycal Corp. in 2001 revealed that their major lenders had been, in fact, applying lenient standards in assessing loans to these two big retailers and neither of them had been classified as borrowers with a high risk of bankruptcy. Subsequently, the Financial Services Agency conducted special inspections into banks lending, reclassifying loans in line with tougher criteria. Still, rational suspicion remains prevalent among the general public that loans to corporate borrowers on the verge of collapse may be creeping among those classified as performing or risk-monitored, or that banks have not set aside enough loan loss reserves for loans to such high-risk borrowers.
In response to a market that demands the acceleration of bad loan disposal, the FSA has accelerated the disposal of loans to borrowers classified as virtually insolvent. Yet, in taking this course, there remains a widespread suspicion that high-risk borrowers are hidden among non-risk and risk-monitored borrowers.
Verifying whether or not this suspicion is true must be the first step of the acceleration of bad loan disposal. This requires strict asset assessment, as stressed by Financial Services Minister Heizo Takenaka, who concurrently serves as minister for economic and fiscal policy. But it is not enough to simply tell to the people, "We have carried out strict asset assessment." With people's distrust increasing, sufficient disclosure of assessment results is indispensable to restoring public confidence in banks' asset assessment. Disclosing the specific names of debtor companies and banks should be avoided, as it would trigger unnecessary credit uneasiness. Instead, the government should compile the assessment results of assets held by major banks, then, disclose the compiled data as an indicator to show the extent of soundness of overall assets. Disclosing this information would help enable the general public to have a common benchmark of the conditions of banks' assets and on the progress of bad loan disposal.
First of all, the government may disclose the top three lenders' classification and loan loss coverage ratios concerning loans to the major companies that have failed in the past two years. And the government should create an easy-to-understand benchmark for scrutinizing big, troubled companies, for instance, those with share prices that often fall below 100yen and those having interest-bearing liabilities more than ten times annual operating profits. How banks classify loans to such companies and how much loan loss provisions the banks set aside for them should be compiled for disclosure. By verifying the results of FSA's inspections through separate inspections by the Bank of Japan, the credibility of the assessment results would be enhanced.
This thorough disclosure of compiled information is prerequisite to the implementation of truly strict assessment of banks' assets if the government is not to fall into the same rut as the last public fund injection, which failed to fix the problem.
Proceeding on a truly strict asset assessment would bring with it a range of difficult problems. When banks are under-capitalized, an additional infusion of public funds would be necessary. As a consequence, previously injected public funds would not be returned, posing a major problem as to determining who should take responsibility for the failure to recover the public funds. Also, once strict assessment criteria are adopted, the consolidation or liquidation of troubled companies must proceed along with the reorganization of industry. As companies and banks consolidate, unemployment would inevitably increase. To cope with this, the government must expand its safety net including its unemployment compensation insurance system, thereby, softening the pain to the nation's economy.
To accelerate bad loan disposal, a czar of sorts that would oversee financial, industrial, employment and fiscal areas by eliminating the existing sectionalism of administration, must be established, so that a comprehensive package of policies can be implemented in an orderly manner.
Author, Keiichiro Kobayashi
Fellow
Research Institute of Economy, Trade and Industry (RIETI)
Editor-in-Chief, Ichiro Araki
Director of Research
Research Institute of Economy, Trade and Industry (RIETI)
e-mail: araki-ichiro@rieti.go.jp
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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).
