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How to tackle Japan's bad-loan
problem
By Keiichiro Kobayashi
TOKYO - From a macroeconomic point of view, to
dispose of bad loans is to reduce excessive private debt
and convert it into government debt. Since the presence
of bad assets within the private sector is causing
inefficiencies in the entire economy, converting
private-sector debt into government debt will have a
significant impact on the real economy, in addition to
cleaning up the balance sheets of banks and firms.
Solving the bad-loan problem is indispensable to
the recovery of the Japanese economy. Yet inspections by
the government based on stricter loan assessment
criteria alone cannot solve the problem. It is important
to create a macroeconomic environment that encourages
business entities to accelerate bad-loan disposal.
One option is to provide banks with
opportunities to earn higher profits, thereby
encouraging them to terminate loans to bad borrowers.
For instance, higher long-term interest rates would
create an environment in which banks can secure a
certain amount of profits by purchasing long-term
government bonds. Should this happen, the amount of
outstanding loans to inefficient corporate borrowers
would fall.
For this scheme to work, however,
banks must be prevented from suffering appraisal losses
brought by falling bond prices. Specifically, banks need
to be able to book the value of government bonds based
on acquisition cost under the condition of holding them
until maturity. Another prerequisite is not to allow
banks to continue "forbearance lending" to non-viable
borrowers, or rollovers of bad loans. To fulfill these
conditions, the responsibility of banks' past management
teams must be fully accounted for. Both shareholders and
supervisory authorities must keep a careful eye on bank
management to ensure that banks realize high
profitability.
If long-term interest rates are kept
high and banks accelerate bad-loan disposal, more
companies will go under, more people will lose jobs, and
corporate liquidity crises will become more frequent. To
cope with these situations, the government would have to
implement fiscal measures and the central Bank of Japan
(BOJ) pump more money into the call market.
So
if the government is to help banks earn profits in the
form of higher interest rates on government bonds held
by the banks, at the same time, it would have to
increase fiscal expenditures to tackle unemployment,
help rehabilitate small and midsize companies, and
alleviate other shocks caused by the bad-loan disposal.
Should the government inject public funds into banks, it
would be another form of fiscal expenditure.
Therefore, in the process of reducing the
banking sector's bad loans and re-stabilizing the
private-sector economy, government debt will inevitably
increase. This means private-sector debt will be
transferred to the government. Once the bad-loan problem
of the private sector settles, the real economy will
gradually regain strength and return to a path of
sustainable growth. It then becomes a question of how to
manage a soft landing of the public-debt problem.
Concerted efforts by all concerned government
agencies are vital to realize a combination of two
policies: transferring excessive private-sector debt to
the government (bad-loan disposal), and reducing
government debt over a long period of time (government
bond management policy).
First, the Financial
Services Agency should maintain strict administrative
inspections and urge banks to speed up their disposal of
bad loans while looking into their management
responsibility. Setting improved bank profitability as
its policy goal, the FSA should reform the financial
system and reinforce supervision over bank management.
Meanwhile, it should allow banks to use acquisition
costs to book the value of their hold-to-maturity
government bonds, granting the opportunity for banks to
improve profitability.
Second, the Ministry of
Finance should diversify the timing of government bond
maturity and ensure market stability. To maintain
confidence in fiscal discipline, the ministry should
revive the Fiscal Structural Reform Law with an
amendment to add an elastic clause to counter cyclical
fluctuations, and present a long-term vision for fiscal
reform. At the same time, the ministry should tolerate a
temporary expansion of fiscal expenditures to prop up
overall demand and facilitate structural reform, taking
necessary measures to cope with increasing unemployment
and bankruptcies, an unavoidable result of bad-loan
disposal.
Third, the BOJ should keep short-term
interest rates at or near zero and guide long-term
interest rates upward to stabilize at a relatively high
level, thus better facilitating banks' bad-loan
disposal. To cope with the liquidity crises of corporate
borrowers, the central bank must be agile and flexible
in boosting short-term money supply to prop up overall
demand. Once the private-sector economy is back on its
feet, the BOJ should embark on price-support buying of
government bonds, guide long-term interest rates lower
and prevent a plunge in government bond prices.
Fourth, it has been noted that the virtual
disrespect of debt claim priority in bankruptcy cases
explains banks' inefficient lending activities, such as
forbearance lending to non-viable borrowers and
unnecessary credit squeezes on small and midsize
companies. The judicial authorities should reform
bankruptcy proceedings to enable quick and efficient
corporate reorganization and prevent inefficient lending
activities by banks. This would help reduce excessive
private-sector debts and minimize the financial burden
on taxpayers.
Finally, government agencies
should facilitate companies' entry to and exit from the
market by promoting deregulation and reinforcing
competition policies. They should also help the
formation of potential growth industries, such as
information technology, financial engineering, and
biotechnology, etc, by providing support for
technological development. With bad-loan disposal in the
private sector on course, the real economy should regain
strength and long-awaited sustainable recovery should
arrive. This growth will also help reduce public debt.
Moreover, appropriate monetary policies amid massive
outstanding government bonds could induce modest
inflation, effectively reducing the government's burden
of debt repayment.
Keiichiro Kobayashi
is a fellow at the Research Institute of Economy, Trade and
Industry (RIETI) in Japan
(The
opinions expressed or implied in this paper are solely
those of the author, and do not necessarily represent
the views of the Japanese Ministry of Economy, Trade and
Industry or of RIETI.)
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