WASHINGTON (Kyodo) The International Monetary Fund on Tuesday singled out Japanese regional banks’ failure to dispose of bad loans as one of the risks remaining in Japan’s banking system.

In its semiannual Global Financial Stability Report, the IMF also warned that a fall in asset prices resulting from a U.S. interest rate increase and a decline in the dollar as the U.S. current account deficit swells may impinge on financial market stability.

The Washington-based institution said major Japanese banks’ balance sheets have improved significantly thanks to a strengthening economic recovery and a rise in stock prices.

“However, reductions in nonperforming loans by regional banks have lagged behind the major banks,” it said.

During the six months to Sept. 30, regional banks reduced their bad loans by only 5 percent, compared with major banks’ 14 percent. Regional banks now account for 44 percent of nonperforming loans in the Japanese banking system, the IMF said.

“The nationalization of Ashikaga Bank, the 11th-largest regional bank, in December 2003 drove home the magnitude of the nonperforming loans problem of regional banks,” the report says.

Ashikaga Bank, based in Utsunomiya, Tochigi Prefecture, was placed under state control after the government found it insolvent with a negative net worth of 102.3 billion yen as of Sept. 30.

The IMF said Japanese banks need to accelerate the restructuring of subperforming loans. “The slow restructuring of the stock of subperforming loans” continues to leave bank balance sheets fragile, it says.

Regarding the global financial markets, the IMF said “exceptionally low short-term interest rates” in major financial centers such as the United States and Japan contributed to resurgent economic growth and rising corporate earnings.

But there is “a real risk of investor complacency” in such a low interest rate environment, it says, urging the U.S. Federal Reserve to communicate better with the markets about a rate increase.

“If asset valuations become based on excess liquidity rather than fundamentals, the withdrawal of monetary stimulus could trigger a widespread reassessment of asset valuations,” it says. “To limit this risk, the transition to tightening needs to be carefully managed and clearly communicated to markets.”

Since June, the U.S. central bank has been pegging its closely watched target for the federal funds overnight bank lending rate at a 46-year low of 1 percent.

The IMF said the dollar is under downward pressure against other major currencies because the U.S. current account deficit hit a record high of $541.8 billion in 2003.

It said the deficit has been financed by investment by Japanese and other Asian governments in U.S. Treasury securities as well as renewed purchases of U.S. corporate bonds and equities by international private investors.

Asian central banks, including the Bank of Japan, have been conducting massive currency-market intervention to stem their currencies’ appreciation against the dollar. They have been investing the dollars gained through the intervention in U.S. Treasury securities.

The IMF said currency markets do not appear overly concerned that the dollar’s decline will either accelerate or have a disruptive impact on other asset markets.

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