The government’s emergency economic package released April 6 featured steps to promote bad-loan disposal in the banking industry. The specific targets involved a two-year deadline for major banks to remove some 12.7 trillion yen in outstanding loans to borrowers either bankrupt or on the brink of collapse, and a three-year deadline to take care of new nonperforming loans.

The bad-loan mess was the biggest factor behind the decade-long slump of the Japanese economy. While it is of course welcome that the government has drafted plans to solve the problem once and for all, there still remains much to be done.

First, the plan to dispose of those bad loans within two years is not unreasonable, if it means writing off 6 trillion yen to 7 trillion yen a year. In fact, the major Japanese banks combined have been disposing some 10 trillion yen in sour loans each year.

The real problem, however, is that despite these efforts, the amount of outstanding bad loans has not declined because more and more of them are turning sour. As the value of assets held by banks deteriorated while their borrowers’ earnings slumped, real estate and stock prices continued to fall. What matters now is whether the nation can put and end to this process.

Banks must dispose of their bad loans at a speed faster than the pace at which new loans turn sour or the problem will never be fixed. To do this, the banks will need to earn enough profit so they can take care of the mess. Recent years, however, have seen a structural decline in the profitability of Japanese banks.

Ever since interest rates on deposits were liberalized in the 1980s, Japanese banks have been unable to secure a profit margin big enough to match their lending risk.

According to recent studies, banks are increasing their loans to small and medium-size firms as major companies shift more and more to direct financing. However, the average profit margin on those loans, which involve more risk than lending to major firms, remains on the same level.

A structural problem like this cannot be reversed, even with an improvement in business conditions. Banks must carry out fundamental reforms to improve their profitability.

Earlier this month, several major banking groups were officially launched. Whether the regroupings represent a sheer quest for size or a real effort to realign the industry toward greater competitiveness and profitability remains to be seen.

In a time of both misinformation and too much information, quality journalism is more crucial than ever.
By subscribing, you can help us get the story right.