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All eyes are on how the government will try to prop up the nation’s banks and get them to shed their nonperforming loans. With many experts viewing capital injections as a key step in this regard, we take a closer look at the issue:

Didn’t the government inject banks with capital a couple of years ago?

The government injected a total of 10.4 trillion yen into 32 banks between 1998 and March, as displayed on the accompanying chart.

These injections, carried out under the Financial Reconstruction Law and related legislation, were made via purchases of preferred stocks and subordinated bonds. In exchange, the banks were ordered to submit restructuring plans that included pledges to reduce their bad loans, increase their lending activity and boost their earnings.

Do the banks really need more capital?

Bank capital-to-asset ratios remain high, but they’ve been boosted by past capital injections and deferred tax-effect assets, while retained earnings have been depleted by years of bad-loan disposal and the slumping value of their equity holdings.

On the whole, banks remain vulnerable to increases in cases of bankruptcies or stock market tumbles. Major banks’ capital totaled 16 trillion yen as of the end of March. Compare that to the 20 trillion yen that analysts estimate the banks will need to deal with their bad loans in the next two years, and an estimated 2.1 trillion yen in latent equity losses as of the end of the month.

Why is the government considering another round of injections now?

Banks have been accelerating their disposal of bad loans — setting aside more reserves against loan losses or collecting what they can and selling off their soured loans.

But with the economy still sluggish, each year sees more reports of soured loans. As of the end of March, nonperforming loans held by the nation’s banks had risen 9.6 percent from the previous year to 43.2 trillion yen. Loans worth another 100 trillion yen are currently under special watch, although payments are not in arrears.

The BOJ, which unveiled a radical plan last week to purchase banks’ stockholdings, has shifted market expectations toward the government and whether it can come up with a similarly daring plan to make good on Prime Minister Junichiro Koizumi’s banking reform pledges.

How would new injections be carried out?

One new proposal would see the money pumped in indirectly via the government’s debt collector, Resolution and Collection Corp.

Under this proposal, the RCC would buy up banks’ delinquent loans at above-market prices and sell them on the secondary debt market.

Should no one purchase the loans, the RCC would shoulder the resultant losses, ultimately using public money to make up the difference.

The RCC, which was founded on a pledge to keep taxpayers’ losses at a minimum, will have purchased some 914 billion yen in of loans by the end of the month for what it deems fair market value — roughly 104 billion yen.

What would be the implications of the RCC paying the book-value of the loans minus banks’ loan-loss reserves?

This would shelter the banks from further losses but would also certainly raise the burden of losses for the RCC. The secondary debt market in Japan is still developing, with few players. Moreover, the RCC is limited to buying loans extended to borrowers that banks categorize as having either gone bankrupt or are effectively bankrupt.

RCC President Akio Kioi also points out that, if the entity were to buy loans at higher prices, it would deal a demoralizing blow to the handful of banks that have shouldered losses by aggressively working to clean up their bad loans until now.

Why are banks and regulators against another direct capital injection?

Currently, banks can receive an injection through two routes — by failing, or by having the prime minister declare that the financial system is in crisis. Deposit Insurance Corp. can use a maximum of 15 trillion yen in the event of either scenario. But banks have pointed out that their capital-to-asset ratios are above regulation levels, stating that they don’t need more funds.

On a political level, Financial Services Minister Hakuo Yanagisawa, who spearheaded the first capital injection and pushed through the nationalization of two long-term credit banks, pledged in 1999 that Japan’s financial system was safe from further large disturbances and that no further injections were needed.

He has said that further use of public funds would dull the incentive for banks to push ahead with reforms.

Another reason is that banks do not want the government holding any more of their preferred stocks, which could potentially be exchanged for common stocks and lead to government control of the banks.

Will a fresh capital injection really help the banks?

They may help banks survive, but are unlikely to make them profitable.

Past injections have not led to a marked improvement in banks’ earnings or a rise in the volume of their loans. Low credit demand continues to plague bank earnings, and the volume of bad loans continues to outweigh earnings on their core operations.

Standard and Poor’s, a U.S. credit rating agency, has said that a capital injection will not lead to an improvement of its ratings on Japanese banks, since strong government support is already included in the current ratings.

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