The government on Thursday formally approved a “bridge bank” plan to take over banks that fail and extend loans to their sound borrowers.

The plan was based on a draft approved and announced by the ruling Liberal Democratic Party earlier in the day. The government hopes to submit bills to implement the plan during an extraordinary Diet session to be convened later this month and pass them as early as September.

As the centerpiece of the package for resuscitating the ailing financial system, the bridge bank scheme is expected to help expedite the cleanup of problem loans; sour loans are the primary drag on the Japanese economy that is threatening to dampen the global economy as well.

Key policymakers involved in the plan’s construction expressed confidence that it would be accepted both at home and abroad as proof that Japan is serious about cleaning up its crumbling banking sector.

The plan, modeled after a U.S. system created in the late 1980s, involves creation of a state-run holding company, which in turn will set up subsidiary bridge banks to take over failed banks. The scheme sets a maximum five years for bad loans to be resolved and will apply to bank failures that occur within that time frame, Finance Minister Hikaru Matsunaga told a news conference. A bridge bank that cannot find a private receiver bank within the window will be liquidated. In the first stage of the plan, failed banks will be immediately placed under government control, if judged appropriate by the Financial Supervisory Agency.

Bank management will be replaced by a new team of state-appointed managers and the bank will continue to extend loans to “sound and good-faith” borrowers. These new managers will be appointed by the FSA.

The managers will then search for other financial institutions to take over the failed bank’s operations. Legal changes will be made to smooth such transfers and to cope with cases in which stockholders’ meetings cannot be held to approve the transfer.

The failed bank’s nonperforming loans meanwhile will be transferred to the Resolution and Collection Bank, an existing public entity. If no bank agrees to take over the operations, the plan will move into its second stage, where a new national bank will be created under the state-run holding company, subject to approval by the screening panel of the government-backed Deposit Insurance Corp.

In creating national bridge banks, the holding company will use public funds from the 13 trillion yen package adopted by the government earlier this year to stabilize the financial system. About 2 trillion yen of the 13 trillion yen was injected into 21 banks in March to reinforce their capital bases.

Following the release of the plan Thursday evening, Taku Yamasaki, the LDP’s policy affairs chief, said he believes the scheme will be accepted by the international community. “We put a lot of effort into drawing up the plan as fast as we could to respond to calls from the international community. I think the international community will understand our efforts to stabilize Japan’s financial system,” he said.

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