No. 33 — August 25, 2000

 

Weekly Review

JAPAN'S NONPERFORMING-LOAN PROBLEM REFUSES TO GO AWAY
--- by Jon Choy

The government's recently formed Financial Services Agency has calculated that the total value of problem loans on the books of Japanese banks and related institutions was slightly higher at the end of FY 1999 than it had been the year before (see JEI Report No. 36B, September 24, 1999). Although the amount of the lowest-quality loans dropped, the figure for notes that carry some risk of default rose far more. However, not all types of lenders experienced an increase in problem loans in the year through March 31, 2000. Banks, in fact, made headway in whittling down their mountain of questionable loans, but bad loans continued to pile up at cooperative financial institutions. The progress achieved by banks, especially the 17 biggest ones, is reassuring. Nonetheless, a cloud of uncertainty still hangs over Japan's lending business.

According to the official compilation of lenders' self-assessments of their loan portfolios, problem loans (Classes II through IV) reported by all types of banking institutions equaled ¥81.8 trillion ($743.6 billion at ¥110=$1.00) as of March 31, 2000 compared with ¥80.6 trillion ($732.7 billion) at the end of FY 1998 (see Table 1). The key to this deterioration was the 2.1 percent rise in Class II notes, which are described as loans with some risk of default that require monitoring. At the same time, though, the banking industry trimmed its most problematic assets — loans classified as unlikely to be repaid or recovered. In short, lenders successfully reduced the worst of their nonperforming loans but failed to get a handle on the far larger pool of loans with potential problems. Moreover, with the volume of lending off 3 percent in FY 1999, questionable loans represented 12.1 percent of the outstanding total versus 11.6 percent a year earlier.

Table 1: Lenders' Internal Assessments of Their Loan Portfolios,
March 31, 1999 and March 31, 2000

(in billions of yen)

March 31, 1999

Class I

Class II

Class III

Class IV

Total

All Banks

¥487,545

¥61,024

¥3,160

¥74

¥551,803

Top 17 Banks

316,814

39,209

2,296

71

358,391

First-Tier Regional Banks

127,669

15,442

582

3

143,695

Second-Tier Regional Banks

43,062

6,373

282

0

49,717


All Credit Cooperative Institutions


126,174


15,608


700


2


142,483

Credit Associations

70,144

10,209

358

1

80,711

Credit Cooperatives

13,723

2,278

234

1

16,237

Agricultural Institutions

24,911

1,583

67

0

26,561


All Financial Institutions


613,719


76,632


3,860


76


694,286

March 31, 2000

Class I

Class II

Class III

Class IV

Total

All Banks

¥472,388

¥60,539

¥2,835

¥12

¥535,774

Top 17 Banks

308,857

38,879

2,017

12

349,765

First-Tier Regional Banks

122,935

15,609

590

0

139,134

Second-Tier Regional Banks

40,596

6,051

228

0

46,875


All Credit Cooperative Institutions


119,177


17,681


706


0


137,564

Credit Associations

64,371

10,527

304

0

75,202

Credit Cooperatives

12,334

2,877

266

0

15,477

Agricultural Institutions

26,203

1,995

82

0

28,280


All Financial Institutions


591,565


78,220


3,541


12


673,338

Notes: Class I: Loans with no or little risk of default

aaa aa Class II: Loans with some risk of default that require monitoring

aaa aa Class III: Loans that are unlikely to be repaid

aaa aa Class IV: Loans that are unrecoverable

aaa aa "All Cooperative Institutions" includes other lenders besides the three subcategories listed.

Source: Financial Supervisory Agency (http://www.fsa.go.jp/news/newse/e20000728-1b.html).

Although their bad-loan numbers are smaller, cooperative financial institutions increasingly are at the heart of Japan's lending woes. Among banks, only first-tier regional banks posted higher nonperforming-loan figures at the close of FY 1999 than the year before and the rise was a marginal 1.1 percent. In contrast, cooperative institutions as a group reported a 12.7 percent jump to ¥18.4 trillion ($167.3 billion) in questionable loans. These results highlight where the Financial Services Agency and other financial regulatory agencies will be focusing their attention in the near future.

Along with the reports prepared by lenders, the Financial Services Agency released its own evaluation of the loan portfolio of the banking industry more narrowly defined (see Table 2). This information is not directly comparable to the data from banks because a slightly different classification system is used. However, with its detailed look at nonperforming loans, the survey is revealing. As before, the total value of nonperforming and restructured loans was higher at the end of FY 1999 than 12 months before. That increase, though, was due solely to a surge in loans on which interest payments were in arrears by six months or more (the PDL category). Loans to bankrupt borrowers (LBB), past-due loans on which neither principal nor interest had been paid for three to six months (3PDL) and restructured loans all were down as of this past March. Banks, especially nationwide commercial banks, appear increasingly confident that they are over the hump — at least going by the sharp drop in the amount of money set aside in loan-loss reserves.

Click Here for Table 2

Like the industry-generated information as well, the Financial Services Agency assessment indicates that banks are doing a better job of handling their soured loans than other types of financial institutions. Consequently, Japan's bad-loan picture looked brighter at the end of FY 1999 if banks are the source of the data and worse if all types of lenders are thrown together.

The tally of losses on bad-loan disposals (see Table 3) underscores the fact that banks have been more successful in getting their finances back in shape than rival lenders. The FY 1999 figure not only was down sharply from the record reported the year before but also was at its lowest level since FY 1994. This drop, plus fatter latent stock portfolio profits (Table 2), should help bottom lines.

Click Here for Table 3

 The FY 1999 rise in potentially troublesome (Class II) loans likely muted any boardroom celebrations, however. Bank are required to set aside reserves equal to the amount of loans in question in case borrowers fail, but many observers think that this cushion is inadequate. Arguing that Class II notes are of poorer quality than the "doubtful" category used by U.S. financial regulators, these analysts suggest that reserve requirements for Class II loans be raised as high as 80 percent. The sudden and costly bankruptcy of retailer Sogo Co., Ltd. (see JEI Report No. 28B, July 21, 2000) demonstrated once more that the banking industry remains vulnerable to unexpected loan problems and, consequently, that reserves may be too skimpy. The same experts point to many other potential sources of trouble — most prominently, construction companies, real estate firms and golf course operators — in cautioning that as far as bad loans go, Japanese banks are not yet out of the woods.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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