Breaking the Bank: Japan's Bad Loans. (Global Notebook)

By Fujii, Rina | Harvard International Review, Summer 2003 | Go to article overview

Breaking the Bank: Japan's Bad Loans. (Global Notebook)


Fujii, Rina, Harvard International Review


Although Japanese banks closed L their account books at the end of the fiscal year in March 2003, they can never close their eyes on the ever-present problem posed by bad loans at home.

Non-performing loans began to plague financial institutions in the post-bubble economy and have become a huge liability, with the total burden for banks estimated to be anything from US$350 billion to US$600 billion. Since Japanese banks make money from debt financing as opposed to equity financing, bad loans deprive banks of ready capital due and keep them in a constant balancing act. Indeed, the predicted tightening of capital adequacy ratios by Heizo Takenaka, the new Minister of Financial Services, left banks scrambling to raise funds before the end of the 2002 fiscal year.

However, higher levels of capital will not be enough to resolve this festering problem, which threatens to implode on a spectacular scale if the banks run out of capital and collapse. The strain placed by bad loans on Japanese financial institutions is so severe that a real recovery will require significant pain in the short term for gain in the long term. Both the government and the financial industry in Japan must renounce the lax or timid moves taken in the past and adopt a hard-headed approach, identifying and calling in more non-performing loans even if it means admitting that the problem is far larger than previously reported. A realistic assessment will also mean that Japanese banks and insurers must brace themselves for restructuring and corporate failures. Yet while politicians and businessmen have constantly carped of reform over the past decade, there was no significant change. Now is the time to take action so Japan can ride the next wave of global economic growth with ready capital and stable ba nks.

Japan's bad loans are an unwanted inheritance from the financial bubble of the 1980's. After the collapse in the early 1990s, businesses that had previously borrowed money were no longer able to pay back their loans. In most economies, creditor banks would have demanded payment and non-performing borrowers would have been declared insolvent, forcing them to close. In Japan, the banks shouldered their debts despite the probability that they would never be repaid. Social pressures discouraged causing bankruptcies and unemployment. For example, until the severe recession in the 1990s, Japanese corporate culture was famous for ensuring employment in the same firm from university graduation to retirement. The extent to which financial institutions neglected bad loans was exposed in November 1997, when several major securities corporations, most famously Yamaichi Securities, suffered collapses due to their inability to raise short-term funds for operation. The failures came as an immense shock, especially since th ey seemed to express the end of traditional Japanese economic and business values. While banks ignored non-performing loans to prevent firm failure and unemployment, the collapse of the old-line Yamaichi, employer of over 7,500 employees and victim of US$25 billion in bad loans, showed that a system of denial and deception would no longer work.

The situation worsened in 1998, when all of Asia entered a financial crisis. However, the Japanese government was reluctant to take drastic measures to set banks straight. Instead of allowing more troubled banks and brokerages to fail, the Financial Reconstruction Commission sought to prop them up, most notably in the case of the LongTerm Credit Bank of Japan (LTCB), which had a capital deficit of nearly US$32.7 billion. In line with then-Prime Minister Keizo Obuchi's vows, greatly criticized by the opposition Democratic Company, the government-run Deposit Insurance Corporation helped clear LTCB's capital deficit, absorbing US$37 billion in bad loans. …

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