Each spring in recent years, people have started talking about a financial crisis in Japan as the month of March draws near. In about five weeks, most Japanese firms will be closing their books for fiscal 2002, and I would like to discuss this year’s situation from several perspectives.
The first major factor to consider is the Financial Services Agency’s special inspections of banks’ assets, the results of which will have a major impact on asset revaluation. In the FSA inspection last year, 34 of the banks’ 149 struggling major corporate borrowers were put in the category “borrowers with bankruptcy risk” or even lower creditworthiness. Of the 34 firms, 26 were in four notorious sectors — construction, real estate, retail and nonbank moneylenders, and some of them have since gone bust.
One major reason that major banks are expected to suffer huge losses is that, in addition to the continuing downtrend in the stock market and land prices, companies in those four problem sectors are still grim performers and are requesting loan forgiveness in the range of hundreds of billions of yen. The government has set a timetable for banks to dispose of their nonperforming loans, and the FSA’s inspection stance is being closely watched as a gauge of how serious the government is about attaining that goal.
In their attempt to forestall further deterioration in financial health, the major banks have announced plans to boost their capital bases by issuing new shares. Some of the plans involve partnerships with foreign financial firms, and the amount of one of those deals is set to reach 1 trillion yen. However, it is not clear if such huge numbers of new shares can be smoothly absorbed by the market. And the result for each bank — how smoothly its shares are absorbed by the market — will be closely monitored as a factor toward future evaluation.
If the newly issued shares are to be acquired by companies in the habit of maintaining traditional business links with the banks, the practice will simply run counter to the efforts being made by banks and companies to unwind the web of cross-shareholding relationships. At a time when accounting rules are based increasingly on market value of assets, banks’ plans to increase capital may be sowing the seeds of future uncertainty.
Seen from a longer-term perspective, we have to realize that an increase in bank capital means an increase in share supply. The market will be watching to see if the banks will be able to gain sufficient profits to match the costs of these efforts. The risk that capital increases might push down share prices cannot be ruled out. Media reports say that the dividend costs of having foreign capitals acquire the newly issued shares could hit 4.5 percent. At a time when government bond yields stand below 1 percent, it will not be easy for banks to achieve the profit needed to cover such high costs. In addition to efforts to boost their capital bases, the banks will need to reorganize their assets.
With the government mired in debt, many expect the financial sectors to play a greater role in boosting the nation’s economy, but we have to realize that this process will not lead to salvaging all companies or individuals unable to adapt to the changing business environment. We must not forget that the source of bank lending is the funds provided by shareholders and depositors.
Another factor that should be monitored is how the situations in Iraq and North Korea will evolve. Crude oil prices have already risen by about $10 per barrel compared with a year ago, and that is naturally pushing up the cost of industrial production and daily living. The problem, as pointed out by U.S. Federal Reserve Board Chairman Allan Greenspan, is that manufacturers are unable to pass on these additional costs via prices because deflationary pressures and overproduction woes are sweeping through the global economy. The rising costs simply eat into corporate earnings, threatening to lower share prices further.
Last, let me mention some positive elements. Both small and large companies are accelerating efforts to streamline unprofitable segments of their business through mergers and integrations. This shows the reforms advocated by Prime Minister Junichiro Koizumi, while slow in implementation, are bearing some fruit. If the main players of the economy — the government, companies and individuals — fail to take the initiative on structural reform, the market will bring pressure to bear to accelerate the process. Reforms do lead to economic recovery, albeit after a certain time lag, and recent developments could be signs of a future upturn.
To sum up, I would say that a major financial crisis is unlikely in March unless Japan is attacked by a Nodong missile.
In Japan, where indirect financing is still the main means for corporate fundraising, resolving the bad-loan problem will require rebuilding the health of not only financial institutions, but their borrowers as well. Macroeconomic and fiscal policy tools have already been stretched to the limit, and microeconomic reforms in each bank and corporation will hold the key to recovery. Banks and corporations that are unable to do so are destined to be liquidated from market pressure. In that process, signs of a recovery are already emerging.
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