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Stock prices for Japan’s top banks have been rising lately despite the huge deficits they have suffered in the business year that ended March 31. Increases in loan losses are good news in the sense that they reflect progress in bad-debt write-offs. In the same year, the nation’s seven banking groups took a record 7.57 trillion yen in loan-loss charges, posting a combined net loss of 4 trillion yen, according to their full-year earnings reports released Friday.

The big deficit mirrors the banks’ resolve to clean up the mess as soon as possible. But it also reflects the tough posture of the Financial Services Agency, the bank regulatory body, which conducted special bank inspections in the second half of fiscal 2001. The official audits prompted lenders to list more loans as nonperforming.

It may be premature to conclude, however, that the worst is over. At the end of March, 13 top banks held a record 27 trillion yen in nonperforming loans, an increase of about 40 percent from a year earlier. Despite the high-profile moves to build banking prowess, notably the birth of four megabank groups, prospects for debt cleanup remain cloudy.

Although the economy is showing signs of a modest recovery, there is deep concern about bank profitability and asset quality. There is also persistent doubt about some of the predicted benefits of bank mergers. For example, the extensive computer glitches that occurred at the Mizuho group right after its debut in April — and continued over an extended period despite a crash program of damage control — raised fresh questions about the presumed beauty of megabanking.

Big banks appear confident about the future, however. “The worst is over for debt write-offs,” says a top executive. “From here on, we will be able to shed bad loans within the limits of net operating profits. There will be no further deterioration in shareholder capital.” As an FSA official puts it, “bank capital remains healthy.”

However, these comments need to be taken with a grain of salt. The reason is that confidence in banks remains weak; it appears to have further declined since the full-deposit guarantee was lifted in April. That is attributable to two factors: larger-than-expected amounts of bad loans outstanding and the demerits, real or imagined, of bank mergers.

It is not only the volume of dud loans that matters, but also the reason they have ballooned in spite of continuous write-offs. The protracted recession, the third in a decade, is partly to blame. But the main reason is that the FSA inspections drove the banks to assess loan risks by stricter standards. In other words, the ad hoc audits inspired them to be more honest about the quality of their loan assets. The fact is that banks in general are still seen to be less than positive about disclosure.

Accelerated write-offs require that the banks boost their core business profits, the main source of funds for debt disposal. About the only way to do so is to raise rock-bottom lending rates by a notch or two, depending on the borrower’s performance. That won’t be easy given the still severe business environment. What’s more, changing the lock-step mentality in this most traditional area of banking will likely take time.

To be sure, all of the top lenders maintain much higher capital-to-asset ratios than the minimum required under the international bank-capital regime. But whether they truly meet the international standards of capital adequacy seems to be another matter. For one thing, analysts point out that new accounting rules tend to make capital look larger than what it really is.

Successive downgrades of Japan’s government bonds by international rating agencies are another cause for concern. Ratings for these IOUs, held in large numbers by the banks, are now the lowest of the major industrialized countries. Should bond prices drop as a result of further downgrades, or for other reasons, their capital position would further deteriorate.

Doubts about bank consolidations also overshadow the future of banking giants. The prevailing perception appears to be that some of the much-heralded merits of megamergers, such as lower operating costs and computer system integration, are difficult to achieve. In other words, the megabanks’ performance so far have fallen far short of expectations.

It is true, as bankers are at pains to point out, that economic recovery and banking revival are closely intertwined. But it is not sound policy, as experience shows, to base write-off programs on an economic upturn that may or may not last long. Basically, there is only one way for banks to clear their debt burdens: putting their own house in order. That is the minimum responsibility of loss-making companies.

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