December 10, 2002
Rebuilding the Japanese banking sector requires the resolution of both the stock and flow problems associated with banks: the accumulation of non-performing loans (NPLs) on the stock side, and the low profitability of the banking business on the flow side. While disposing of NPLs, it is important to ensure that the banks make accurate judgments regarding the fate of each corporate borrower, by adopting strict standards for asset assessment. Meanwhile, to improve profitability, banks must reinforce governance and innovate their business models.
The proposed but aborted re-examination of the tax effect accounting system (capital reinforcement) - an area in which the government's comprehensive counter-deflationary package is said to have become "toothless" - had been aimed at the pursuit of these two goals. Despite this setback, however, the Program for Financial Revival has managed to implement a series of other hard-to-swallow yet important measures, and there is still hope for the actual implementation of the package.
The true value of the program hinges on how soon proposed key measures, such as another round of special inspections of banks by the Financial Services Agency and the subsequent announcement of gaps between banks' own assessment and the results of the FSA inspection, can be implemented. If the government fails to act quickly, the program would indeed be toothless. In this sense, the package is to face the true test in its implementation.
The Japanese economy is experiencing modest debt deflation: prices continue to fall as companies and banks - suffering from the burden of excessive debts and NPLs, respectively - are forced to sell their products and assets at losses. Thus, while deflation is a cause of the further increase in NPLs, the continuation of the NPL problem is also a cause of deflation. Reducing banks' NPLs is a vital policy for severing the mechanism of debt deflation (or the vicious cycle of deflation and increases in NPLs), and this is the policy agenda that must be given top priority if Japan is to be pulled out of its ongoing economic disarray.
While NPLs are being disposed, the reconstruction of borrowing companies must proceed in a systematic manner, and an efficient safety net must be created in order to cope with the short-term increase in bankruptcies and unemployment.
A financial revival and an industrial revival will not happen simultaneously, so two sets of measures should be implemented on separate timetables. Measures for banks - stricter asset assessment standards, reinforced provisioning requirements, and the infusion of public funds - should be implemented within several months. While measures for companies - liquidation, reconstruction, and business transfer - should be carried out in an orderly manner over a period of several years, as such schemes involve employment adjustments.
As for the safety net, the government should promptly announce the amount of planned expenditures on employment-related measures (for instance, pledging to spend 10 trillion yen over three years), to provide the general public with a sense of assurance. But we must remember that fiscal reform will become an issue of top priority when the two- to three-year period of intensive NPL disposals is over, and when the private-sector economy is back on a path of sustainable growth in several years. Therefore, in the implementation of fiscal measures to strengthen the safety net, the government must clarify its long-term fiscal reform plan, the implementation of which should begin in several years.
Meanwhile, in accordance with the progress of NPL disposal and corporate reconstruction, the Bank of Japan must help abate deflationary pressure by providing sufficient liquidity in the money market.
This essay is a translation of an article published in the November 19, 2002 issue of "Shukan Ekonomisuto" (Weekly Economist) magazine.
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).
