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Japan's Banking Crisis

Jon Herskovitz

Japan boasts some of the world's largest banks, but they are staggering under a mountain of bad debt. These non-performing loans are loans that were made to companies who now don’t have the money to repay the banks. The government estimates that the banking system is burdened by up to $300 billion dollars of non-performing loans. Some analysts put the total much higher, at $680 billion. Some estimate the total amount of bad debt is about one-quarter of Japan’s total gross domestic product (GDP) -- greater than the GDP of many nations in the world.

In theory, Japanese banks need to write off the bad loans and regain some of their money by taking over the collateral they accepted as a security for the loans when they were first made. Many businesses offer their property, for example, as collateral for a loan. If the business can’t repay the loan, the bank has the right to take over the property and to sell it, if it wishes. However, manyJapanese small and medium enterprises are estimated to be struggling with loan repayments. If the banks stop lending to them, and take over the collateral backing those loans, it could trigger a tsunami of failures that will flood companies up and down the archipelago.

In addition, since the 1980s, asset values in Japan have dramatically declined. That means the collateral backing the loans is not worth very much any more. A bank that gave up hope of being repaid for the money it loaned, and instead took over a property that was worth less than the amount of the loan, could go bankrupt itself. If a large number of banks fail, there would be few banks around to supply credit to businesses that need to borrow money to operate or expand. That would hurt the economy and make it even harder to encourage the kind of profitable companies that banks need in order to make money.

Japan is already facing its highest unemployment rate since the post World War II period. A wave of companies going under would exacerbate the problem and boost the jobless rate to a level that could case social unrest.

To make things harder for the banks, most hold massive amounts of shares in Japan’s stock market, something that used to be a valuable source of income for the banks. But now those shares are trading at some of the lowest levels in 19 years.

On the plus side, Japan has the luxury of being home to some of the greatest savers in the world. Japanese have about $12 trillion in savings in banks. There is no dire need for outside help to get Japan out of its banking mess. What is needed is resolve on the part of the government and businesses to make the hard decisions needed.


How did Japan’s banking sector get into such a mess? The troubles that launched the current problem were mostly born of the go-go days of the 1980s when Japan's economy was growing at a red hot pace and credit was easy to come by. The Tokyo Stock Exchange zoomed to the forefront of the world with some estimates putting the value of Tokyo shares at 49% of all the world's stock markets combined. Banks flooded the market with loans for mortgages, construction projects and business expansion. Land prices skyrocketed. Just to give an example, at one point in the 1980s the Imperial Palace grounds in downtown Tokyo, smaller in area than Disneyland, were valued at more than the entire state of California.

Once the bubble burst in the early 1990s, land started to plunge in value. Consumer confidence eroded as a deflationary spiral set in. With prices going down, purchases would be cheaper in the future. So people continued to wait before making purchases, believing prices would continue to fall. And without the Japanese people going out to spend, it has been very difficult to get the economy to grow.

The roots of Japan's banking crisis are also deeply ingrained in a system where companies and banks are allowed to hold each others’ shares. They allowed these ties to dictate their business policy instead of following rational business procedures. Enormous amounts of loans were made for projects that were questionable at best and often times economically unfeasible.

In the late 1990's, the Japanese government injected $56 billion in the banking sector to try to help it get back on its feet. However, the money seemed to be of little use, mostly because the banks took the money but didn’t try to clean up their books. For example, collateral for bad loans -- such as land and real estate- were not sold off. Once burned by a capital injection that seemingly accomplished little, the public is twice shy when politicians mention dipping into public coffers again to help banks.

The credit ratings agency Standard and Poor's has cut Japan's sovereign debt to the lowest standing among the Group of Seven industrialized nations - saying they are not satisfied with Japan's assessment of its own problems or its ability to tackle the non-performing loan issue. Analysts say Japan has yet to make transparent the extent of the problems at its bank as it tries to save face about the malaise in the sector. Forcing bankruptcy for troubled firms, they say, is the only way to remove the dead wood from the system.

In mid-April 2002, Japan's government released its own analysis of the bad loan mess at its banks. "There is no problem with the health of banks," the Financial Services Agency said in its report. The report said Japan's top seven banks had to write off $14.5 billion in bad loans for the business year ended March 31, 2002 and it said the total amount of bad debt on the books of Japan's banks stood at $282 billion. But later in 2002, the government became more aggressive, announcing a broad banking sector reform program, under which it is pushing banks to get rid of bad loans and replenish their weak capital bases. The plan includes an option to use public funds to boost the capital of some banks. That would probably mean having the government buy shares in the bank, thus it is an implicit threat to nationalize any lenders that don’t take action and clean up their books. This has prompted some banks to announce plans to speed up bad loan write-offs and to raise money by issuing new shares.

Lessons Learned

1) Regulation: Banks need to make their bad loans transparent, even though doing so would likely expose the cozy relations they had with affiliated businesses and interest groups that were able to secure loans for dicey investments. The government has begun to demand that major banks tighten the rules by which they classify loans and account for capital. It is carrying out special inspections of major banks to confirm that the lenders have been strictly classifying their loans.

2) Share ownership: Unlike banks in the United States, Japanese banks are allowed to own stock. As Japan's stock market staggers to find its footing after being walloped from the early 1990s through the first years of this century, Japan's banks have seen their capital base eroded as the value of their stock portfolios decline. In addition, as stock prices have fallen, banks cannot take gains from their investments and use them to help write off their bad debts.

3) Profitability: With so many companies struggling to stay afloat in Japan's anemic economy, finding credit-worthy borrowers has become one of the hardest challenges faced by banks. But the issue of cross-shareholding has also been a problem. Some say the fact that Japanese banks can hold shares in companies makes them less likely to make the tough decisions about who to loan to and when to foreclose on bad loans that would make them more profitable.

4) Zombie companies: For example, one way banks tried to get around the problem of writing off bad loans was by providing troubled companies with debt waivers or swapping their debt for equity. This method has been used to help the country's largest supermarket chain Daiei Corp., and the construction company Haseko Corp. Analysts say this type of support is risky because it simply disguises the problem by shifting it from the company to the bank, keeping dying companies alive on minimal nourishment, and ultimately hurting Japan's competitiveness. Daiei is now called a "zombie company" in the Japanese press as it muddles along in its operations without any vigor or aim.

5) Court-ordered restructuring: This is when the court appoints administrators to take over a troubled company, pay off or write off its loans, and then seek a buyer for the failing firm. Shinsei Bank, bought by U.S. investment firm Ripplewood, is an example of an institution that went through this process. Some analysts believe more restructuring needs to be carried out than is currently taking place.


Over the past 10 years, Japanese banks have written off about $500 billion in bad loans on their books, but they still have a long way to go. Some changes were made in the law to allow banks to merge in the hopes that getting bigger might make the banks more efficient. Now, the Big Four, Sumitomo Mitsui Banking Corp., the Mitsubishi Tokyo Financial Group, the UFJ Group and Mizuho Financial Group, hold about $4 trillion in assets and account for about 50% of the nation's commercial lending to individuals and companies, according to industry estimates. They also have about 47% of the nation's non-performing loans. The Big Four banks can offer better efficiencies for making loans to large and small businesses and they have an extensive network built in Japan. But analysts have yet to be convinced that the banks are taking the aggressive steps that are needed to get rid of bad debts and clean up their weak capital bases.

There are calls for the government to take over troubled banks and force them into restructuring. In times of trouble for some of the country's blue-chip behemoths, bureaucrats and politicians often echo the phrase "too big to fail" as they explain the need to prop up a falling company. But public opinion is against dipping into public coffers to support companies that have made their own problems through mismanagement. The Japanese people are still waiting to see some real signs that the nation’s banking system is getting back on track.

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