The Financial Agency, which was launched Saturday in a major move to integrate the operating and planning roles of financial policymaking bodies, started actual operations on Monday. The new financial-watchdog body combines the Financial Supervisory Agency and the Finance Ministry’s Financial Planning Bureau, drawing a line between financial and fiscal-policy functions. This effectively limits the Finance Ministry’s powers to tax and spending policies.

The new agency, a part of the comprehensive government reorganization that will take full-scale effect next January, faces tough challenges. Its main task is to stabilize the financial system and make it internationally competitive through stepped-up liquidation of nonperforming loans held by banks and other financial institutions. That is an essential condition for the sustainable recovery of the Japanese economy.

At the same time, there are concerns about how it will perform. Chief among these is the worry that it may abuse its comprehensive regulatory powers — a worry that was very much evident in the past when the Finance Ministry maintained a broad grip on the private financial sector. Another is over possible political intervention in, or pressure on, the agency’s process of drafting financial rules and regulations. Keeping a safe distance from political influences is essential to securing transparency in the conduct of financial policy.

Banks’ bad-debt woes are likely to continue for some time, although the feared financial panic has been averted, thanks mainly to a massive infusion of public money into capital-short banks. Despite significant reduction of the debt overhang, however, it remains a big obstacle to banking revival.

The 16 leading banks that closed their books at the end of March had cleared some 4.6 trillion yen in bad loans, or three times as much as planned. Continuously falling land prices, diminishing collateral values and debtors’ falling profits — all these forced the banks to jack up their loan-loss provisions. But they still have nearly 18 trillion yen in noncollectible loans. Including similar loans held by regional banks, the total amount of bad debts is still estimated at more than 27 trillion yen.

In the year to March 2000, the 16 banks produced about 3 trillion yen in net profits from their lending operations. That figure, however, is dwarfed by their combined bad-debt burden. It is hard to believe that debt disposal is “over the hump,” as the banks say it is. They still have a long way to go before the debt problem is fixed once and for all.

Many of their long-standing clients, such as major constructors and retailers, are in trouble and are finding it difficult, even impossible, to pay off their huge debts. In fact, a growing number of distressed borrowers are asking creditor banks to forgive some of their debts. For instance, Sogo Co., a troubled department store chain, is requesting a debt waiver in an effort to restructure.

Debt forgiveness is no panacea, however. If it is really necessary, the borrower involved must first map out a credible recovery program. The creditor bank may find it less expensive to grant a debt writeoff than to go through protracted legal proceedings. But creditor banks may also have a different motive for not wanting to follow the legal route: putting off the hard decisions by giving ailing clients temporary relief instead of seeking legal solutions, which would expose their loose lending practices.

Over the past several years, the government has injected 8 trillion yen in public funds into major banks to help bolster their capital and boost business lending. This money is also intended to encourage bank mergers. In fact, several major banks have joined forces or decided to set up holding companies. These megamergers and business tieups, however, are aimed primarily at winning the competition in the domestic market. It may be a long time yet before Japanese banks become competitive with foreign megabanks in the international market.

The Financial Agency must help Japanese banks achieve global competitiveness by reinforcing the banking system as well as by improving its inspection and oversight functions. It also must help consolidate credit associations, thereby stabilizing regional banking. Beginning in April, the regulatory authority over these community banks shifted from prefectural governments to the central government.

Finally, the Financial Agency needs to maintain strict self-discipline, not only in dealing with political parties or individual politicians but also in exercising its discretionary powers. For that, information disclosure is essential. It will enhance administrative transparency and accountability.

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