Policy Update 001

What to expect from the Takenaka Project Team

TSURU Kotaro
Senior Fellow, RIETI

The project team headed by Financial Services Minister Heizo Takenaka to discuss measures to dispose of banks' nonperforming loans was unable to unveil its interim report on Oct. 22, as had been initially planned, due to opposition from the ruling coalition parties. The team's final report is now to be released by the end of the month together with a package of measures aimed at providing a safety net to deal with the negative effects of accelerated bad-loan disposal.

While one reason for the stiff resistance may be the fact that the team's discussions were conducted behind closed doors, without sufficient explanation to the ruling parties, this is inevitable if drastic policies are to be pursued with speed. Rather, it is unsightly to see politicians making a fuss by saying, "Measures such as these will only adversely affect stock prices." 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? Minister Takenaka came under fire for his remarks in a recent magazine interview that he does "not hold the idea that they (banks) are too big to fail," but this is a fair argument. This holds as true for big banks as it does for big corporations. In this regard, it may be said that the government's decision to approve of too big to fail policy in the distribution industry set a precedent and left a source of future trouble.

One item in the draft of the Takenaka team's interim report that was reportedly opposed by ruling party lawmakers and the banking industry was the issue of a tougher calculation standard for how deferred tax assets (taxes paid in advance for money funneled into loan-loss reserves that are not considered a loss on the balance sheet) can be calculated into banks' capital bases. There is criticism that a substantial reduction of the amount of such assets that can be included as capital would only be "fiddling with tax-effect accounting" and "a sudden change of rules," and this is not altogether off the mark. Issues such as how assets and loan-loss allowances should be assessed and set will always be a gray area and no matter how the rules are established, there will always be a certain degree of arbitrariness. For this very reason, the debate may never converge if standards or rules are discussed as if they are the essence of the problem. Meanwhile, the fact that tax deferred assets account for a large percentage of the capital bases of many banks in itself should be clear evidence of the fragility of banks' capital bases, as these assets cannot be recovered if a bank falls into the red, even if losses actually materialize with a loan becoming irrecoverable.

As for the issue of utilizing the Resolution and Collection Corp. to dispose of bad loans, there has been perpetual debate over what price the RCC should pay for the loans, such as the oft-heard suggestion that prices be set at a level that would not hurt banks. But standard banking theory dictates that having asset management companies like the RCC purchase loans cheaply (this, from the banks' point of view, means selling off their loans at a major loss) would increase their incentive to reclaim the loans. At the same time, this would be a double incentive for banks, because after they shed off their bad loans, they can concentrate on their core business. Thus, if the RCC were to purchase sour loans at a high price, it would diminish its incentive to collect the loans, and this would only result in an increase in the financial burden on taxpayers. If the precondition for the RCC's role in stabilizing the financial sector is that banks should not lose money when selling off their dud loans, then it will only serve as a new receptacle for the banks' losses, and it cannot be expected to function as it was originally intended.

What I expect most from the project team's final report is a clear direction on the issue of governance, which is one of the so-called Three Takenaka Principles (stricter loan assessment, improvement of capital bases and better governance). The issue of nationalizing banks should be understood as one temporary option to improve governance, not a goal in itself. It is, of course, important to take such steps as stiffening criminal punishments for breach of trust (at least to a level on a par with that of the United States in the wake of the savings and loan association failures) and having management step down when public money is injected into a bank. But in the case of Japanese banks, we cannot possibly expect the management of a bank to change simply with the installation of new leaders, because the new managers would simply be people who have been pushed to the top through internal promotion and, as such, would be of the same stripe as their predecessors. Drastic reforms, therefore such as inviting new managers from other industries or from overseas, are needed to reform banks now.

Related article:
The Dilemma Facing Financial Policy: The Merits and Demerits of Signaling

>> Original text in Japanese

October 24, 2002

October 24, 2002