Nervous eyes watch Japan's debt-laden banks

By Michael Millett, Herald Correspondent in Tokyo

Even by the wretched standards of Japanese banking, these are not good times for Daiwa.

Ejected from the United States in the mid-1990s because of an errant local employee's fraudulent trading, and snubbed by bigger rivals in the merger mania of recent years, Daiwa has tried to reinvent itself as a regional giant in its native Osaka region.

But the small and medium-sized companies that are its main borrowers are doing it tough in Japan's prolonged economic downturn.

While it runs a profitable pension trust operation, Daiwa is finding it hard to make money out of its mainstream banking business. Its image was mauled by a landmark court decision last year that its executives were personally liable, to the tune of 83billion yen ($1.37billion), for shareholder losses suffered in the New York debacle.

Meanwhile, its costs and its debts are piling up.

It has had to help bail out Tokyo Mutual, its close ally in Japan's debt-laden life insurance sector, and buy two smaller, struggling local rivals to broaden its regional reach.

Like most of its competitors, its management grossly underestimated the non-performing loans swamping its books, many stemming from deals done in Japan's bubble era of the late 1980s.

Australia - and Asia - have much to fear if Japan's regulators are serious about forcing the nation's banks, like Daiwa, to rid their balance sheets of bad debts. The task could be accomplished only by forcing debt-laden companies to the wall, eroding already fragile business confidence and giving consumers less reason to spend.

If Japan heads backwards, so too will exporters that rely heavily on its markets. The world's second-biggest economy is by far Australia's main export destination, taking up to 20per cent of total exports.

But the alternative to this drastic measure is not much better.

Japan has recorded minimal economic growth over the past decade, largely because its corporate sector remains burdened by debts incurred a decade ago.

Daiwa originally set aside 45billion yen this year for debt debt write-offs, but in November the bank was forced to raise that to 81billion yen.

Even that left it with problem loans officially listed at 1trillion yen. While Japanese regulators insist that all city banks have adequate capital ratios, as stipulated by international banking law, analysts query Daiwa's bad-debt figures and the ability of the company to come up with sufficient collateral to cover it.

Daiwa has a 32billion yen exposure to Tokyo Mutual alone, a firm the ratings agency Moody's terms "under severe stress". It has voiced fears it may lose more than 16billion yen extended to an insolvent local leasing company.

Now the bank's extensive share portfolio, its main source of capital in these troubled times, is being flooded with red ink.

Most experts say Daiwa is posting huge latent losses on its share portfolio, making it impossible for it to tackle its debt problem - just as rapid economic deterioration pitches more of its Osaka clients into financial difficulty.

Vague rumours of Daiwa's impending collapse regularly sweep the Tokyo financial markets. This week they spread further afield, contributing to a huge sell-off on Wall Street on Wednesday as New York finally awoke to the systemic flaws still plaguing Japan's financial system.

The bank dismisses the speculation as groundless, insisting it has made full provision for its share losses.

But the assurances do not convince Moody's. "The bank's economic capitalisation is not sufficient to cover possible future credit losses," it concluded this month. Its economic performance is listed as E-, the lowest possible rating. This is a junk bond status normally afforded deadbeat banks in banana republics. Mind you, Daiwa is in good company. Only the staid Bank of Tokyo Mitsubishi escapes an E rating on Moody's books.

Japan's bad debt mess was supposed to have been fixed two years ago when the Obuchi administration, fearing a financial meltdown, redirected 7.5 trillion yen into bank coffers to enable management to clean up their balance sheets.

Daiwa was one of the beneficiaries. In exchange for the state largesse, the bank was supposed to write off its debts, rationalise its activities and put its business on a sound financial footing.

The public bail-out, detested by voters who felt the banks were being rewarded for their own stupidity, was only a half-success. It stabilised the system, halting a run of banking failures that had threatened to pitch Japan into complete financial turmoil. But it failed to remove the bad debt problem that has been acting as an anchor on the banking sector and the overall economy ever since the asset bubble burst in 1990-91.

While another 1998-style financial crisis is unlikely - there are no signs of a credit crunch here or abroad - the debt burden prevents the banks performing any multiplier role in economic activity. In fact, they act as a serious impediment to reform.

The banks have consistently refused to acknowledge the size of the debt problem. Cosy links between the banks, the bureaucracy, the ruling Liberal Democratic Party (LDP) and the corporate sector have undermined efforts to force them to do something about it.

Instead of directly writing off debts, accepting that the zombie companies to which loans were recklessly extended in the bubble era had no hope of repaying them, or that the collateral used to back them (invariably real estate) was worth a minute percentage of its book value, the banks simply parked them in their accounts. Loan-loss reserves were theoretically set aside to cover the non-performing loans. These have proven grossly inadequate.

The collateral that Japanese banks hold for dud loans includes golf courses, cemeteries and other property that is almost impossible to shift in a climate of plunging prices. Many of these properties were bought by the bloated construction sector at highly inflated prices during the bubble era. Because of their strong links with the LDP, the Government has been reluctant to push them to the wall.

By refusing to deal with the problem, the banks have allowed it to get worse.

The industry has spent more than 70trillion yen since 1992 disposing of bad debts. Yet, the 18 main banks, including Daiwa, have admitted carrying another 40.9trillion yen. Analysts say it may take double that to really wipe out the mess.

This week three banks - Sanwa, Tokai and Toyo Trust - said they would collectively write off more than 1trillion yen in bad debts this year - almost double their original provisions. This will force the three, which will merge next month to become UFJ Holdings, heavily into the red.

But it is at least a sign that the banks are finally biting the bullet.

One driving force has been accountancy changes that come into effect next financial year, starting on April1, requiring the corporate sector to list holdings at market rather than book value.

This will prevent the banks masking their bad loans with unrealistic valuations.

So the banks have been dumping large swathes of their share cross-holdings over recent weeks. This has created a vicious circle, with the frenzied selling pushing down overall equity values and leaving the banks even more vulnerable to the worsening economy.

The Yoshiro Mori Administration, in its death throes, has been forced into action.

Its first response was trademark LDP, adopting measures to push share prices up, even if that involved more public funds.

But reformers, including the feisty head of the Financial Services Agency, Mr Hakuo Yanagisawa, are insisting that the banks end their procrastination and move the bad debts off their books completely.

http://www.smh.com.au/news/0103/17/pageone/pageone8.html

-- Martin Thompson (mthom1927@aol.com), March 16, 2001

Answers

Its the best article I've read, explaining the Japanese bank crisis. Thanks Martin

-- Guy Daley (guydaley@altavista.com), March 17, 2001.

Pre-rollover, there was considerable concern that financial institutions in Asia in general and in Japan specifically, had gotten a late start with remediation efforts. Does anyone have know the extent to which remediation efforts were completed in Japan or elsewhere in Asia pre-rollover? If any one has any references on this topic, I hope you will post them.

-- Paula Gordon (pgordon@erols.com), March 17, 2001.

Saturday March 17, 4:33 pm Eastern Time Global Markets Spooked by Japan's Banks By Daniel Sternoff

NEW YORK (Reuters) - It all comes out in the wash.

And as crumbling global stock markets take investors to the cleaners, financial markets are targeting Japan's sickly banking system as the most likely potential systemic risk to the world economy.

``Watch Japan. Japan is a particular tinderbox at the moment,'' Bill Gross, managing director of Pacific Investment Management Company, the world's biggest bond fund, told CNBC.

Japan's banks have been saddled with a mountain of bad loans for much of the last decade, and investors have for years been carping about ineffective government efforts to tackle the problem.

``There are embedded losses of at least 5 to 10 percent of GDP (gross domestic product),'' said Vincent Truglia, managing director of sovereign risk at Moody's Investors Service.

``Anyone who is surprised about problems in the banking system would have had to have had their heads in the sand for quite some time,'' he said.

But a potent cocktail of severe stock carnage, a darker global growth outlook and new Japanese accounting rules that may expose the extent of the banking system's troubles have now sparked fears that the rot could infect overseas markets.

``It has reached the point where things go bust,'' said Carl Weinberg, chief global economist at High Frequency Economics in Valhalla, NY.

CONTAGION EFFECT?

Japan, the world's second largest economy, is again teetering on the brink of recession after a decade of stagnant growth. Political confusion is adding to a crisis atmosphere.

The collapse in the benchmark Nikkei stock index to 16-year lows has heightened worries over Japan's banks, which possess huge equity holdings.

Japanese institutions have been forced to sell assets invested overseas ahead of the end of the fiscal year on March 31 to shore up their books, which have been battered by stock losses.

And to make things worse, the global equity sell-off coincides with accounting rules introduced for the new fiscal year, which require Japanese banks for the first time to report the actual market values of their now-depleted equity holdings.

Tony Crescenzi, chief bond market strategist at Miller Tabak & Co., said that present Nikkei stock index levels ``would essentially render many Japanese banks insolvent under the new accounting rules.''

``The spreading of Japan's problems has increased the systemic risks posed to the world financial system,'' he said.

On Wednesday, shares of global financial services firms, including U.S. giants like Citibank (NYSE:C - news), Bank of America (NYSE:BAC - news) and J.P. Morgan Chase (NYSE:JPM - news), were hammered as ratings agency Fitch placed 19 Japanese banks under negative review.

Japanese institutions own a massive $2.2 trillion in foreign stocks and bonds, and a credit crunch in Japan could hurt North American and European asset markets.

``If the Nikkei continues to fall, that means the banks are in trouble, and that means the Japanese may repatriate securities in order to shore up their economy,'' said PIMCO's Gross.

Weinberg said given Japan's tight links to the world financial system, a ``disorderly shutdown'' of a major bank or trust fund could ripple into world markets by disrupting credit and trading relationships with foreign institutions.

``We have seen banking systems fail, but never a banking system with huge cross-relationships in the world financial system. Any one major Japanese bank will be a much more important shock,'' Weinberg said.

HOLD THE CRISIS TALK

But other analysts say fears of a systemic banking crisis in Japan and ``contagion'' of foreign markets are misplaced.

``Financial markets are undergoing a great deal of stress around the world, so people are looking at what may be the weak link in that system. Therefore eyes are focusing on Japan and Japanese banks,'' said Moody's Truglia.

But he said the Japanese government would ultimately use taxpayer cash to bail out troubled banks should the system be threatened with insolvency.

And given the well-advertised problems of Japan's banks, any crunch should not blindside financial markets.

``By definition, a crisis has to be unexpected. Otherwise it is simply a problem,'' he said. ``If you adequately price in all the risk and have identified where the risks are, you won't get a crisis out of it.''

http://biz.yahoo.com/rb/010317/business_global_risk_dc_2.html

-- Martin Thompson (mthom1927@aol.com), March 17, 2001.

INVESTIGATING THE IMPACT OF THE YEAR 2000 PROBLEM
Country	Repair Cost	Total Cost % GDP	% Systems	Schedule Indicator
USA	$187,921,430,000	2.5%	0.83	0.87
Japan	$105,964,254,000	2.3%	0.78	0.85

-- spider (spider0@usa.net), March 17, 2001.

That was from the Senate's 100 Day Report.
They further concluded: Despite significant improvement in the past year, Japan may have underestimated the scope of the Y2K problem. According to a Bank of Ja-pan survey, the majority of Japanese banks have neither engaged in contingency planning, nor checked the Y2K exposure of customers and counterparties. Since banking has proved to be one of the most aggressive sectors in addressing the Y2K problem around the globe, underestimation on the part of the Japanese banking sector may indicate even less awareness in other sectors.

The Gartner Group rated Japan in level 2 in
March of 1999. Later they downgraded them to
level 3 in the Senate's 100 Day Report. That
was a rating from 1 to 4, 4 being the worst.

-- spider (spider0@usa.net), March 17, 2001.

Top List Of Countries To Watch

TB 2000 Archive

-- spider (spider0@usa.net), March 17, 2001.

Thanks, Spider. Very interesting indeed....

-- Paula Gordon (pgordon@erols.com), March 17, 2001.