What is the Truth About the Scale of Japanese Banks' Bad Debts? Is the Situation Manageable?

Byline: Maximilian J.B. Hall (1) Keywords: Japan; banks; bad debts Abstract: In January 1998, the Japanese Ministry of Finance (MoF, 1998) released figures which suggested that the Japanese banking industry' s 'bad' debts might be as high as AY=77 trillion (since revised upward to AY=87.5 trillion, if cooperative-type institutions are included Financial Supervisory Agency (FSA), 1998). This compared with the previous official estimate of AY=28 trillion. The 'revelation' was designed to do three things: (1) to convince investors, at home and abroad, who had long suspected that the 'true' level of bad debts was much higher than the authorities (and the banks) were willing to admit to, that the authorities were sincere in their quest to enhance disclosure by local financial intermediaries (2) to stifle opposition to the government's plans to use up to AY=30 trillion (since increased to AY=60 trillion) of public funds to stabilize the financial system.sup.1 by underlining the gravity of the situation facing the Japanese economy and (3) to pave the way for the introduction of more 'transparent' reporting by the banks in April 1998 when a regime of 'prompt corrective action' (PCA).sup.2 was scheduled to commence. This article explains the evolution of bad debt disclosure by the Japanese banking industry and assesses the significance of the latest figures. In particular, it highlights the extent to which 'accounting forbearance' has been, and continues to be, used to mask the true level of the banks' bad debts and refutes the claim that the industry's bad debt burden peaked in 1995. The banking industry's ability to handle the continuing bad debt problem, in the face of a significant impairment of economic capital and the market's relentless drive for full disclosure and transparency, also is assessed. Author Affiliation: (1) Banking and Financial Regulations, Loughborough University, Japan Article History: Registration Date: 09/10/2004