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Asia-PacificJanuary 5 2004

Japan: not yet out of the woods

The government’s rescue of Ashikaga regional bank illustrates that, while Japan’s economic outlook has improved, there are still areas of concern.
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A rising Nikkei index may have helped the major Japanese banks produce favourable first-half financial results but while optimists can claim some progress, the overall banking sector remains highly vulnerable. This was underlined by prime minister Jurichiro Koizumi’s recent decision to nationalise temporarily the troubled regional bank Ashikaga Financial Group, at an estimated cost of Ą1,000bn ($9.1bn). It was the second bank to be bailed out by the government in 2003, after Resona Group received a massive Ą2,000bn capital injection in June. “We decided to nationalise (Ashikaga) temporarily in order to prevent confusion,” Mr Koizumi said. “It was the responsible move.”

Probable support

Ashikaga reported a negative net worth of $857m and a capital ratio of minus 3.7% as of end-September 2003. A medium-sized bank, it enjoys a 50% share in both the local loan and deposit markets in its home prefecture of Tochigi and, as a result, the high probability of government support had helped it maintain its investment grade despite severe asset quality problems.

Ashikaga will become a 100% subsidiary of the Deposit Insurance Corporation, and the regulator, the Financial Services Agency (FSA), will send in new management while a new owner is sought. The bank’s failure also highlights the growing differences between the regional and major banks.

Bad loan problems

“Japan’s regional banks remain slow in writing off bad loans,” says Ryoji Yoshizawa at rating agency Standard & Poor’s. “As of the end of September 2003, the regional banks’ non-performing loans (NPLs) after deducting loan loss reserves, on a consolidated basis (based on risk monitored loans), accounted for 4.6% of total loans. This was an improvement of only 0.3 percentage points from six months ago. During the same period the major banks succeeded in reducing their net NPL ratios by an average of 0.7 percentage points.” He believes that asset quality problems at regional banks may not have peaked out yet.

Meanwhile, the top six Japanese banks, excluding Resona Holdings, reported a combined net profit of Ą944bn for the first half (April-September), a significant increase over the Ą24.7bn achieved a year earlier. Brett Hemsley at Fitch Ratings in Tokyo describes the 28% rise in the Nikkei over the period as the biggest factor behind the change. “The banks incurred huge losses last year as a result of the equity markets; this year has been a big positive,” he says. But while a drop in devaluation losses on equity holdings has helped all banks, some analysts remain bearish over whether the improvement can continue and whether banks can count on stock sales for profits.

Of the majors, Mitsubishi Tokyo (MTFG) led the pack, turning a Ą188.1bn loss last year into a Ą301.9bn net profit in this latest period. Mizuho, UFJ and Sumitomo Mitsui all produced significant profit increases and all four have raised their income forecasts for the full year.

Currency shifts

Analysts, however, remain wary that banks have turned the corner, given the difficulties of operating in a 0% interest rate environment, the annual bank lending shrinkage of around 2% during the past few years and the low structural profitability of the sector. And while the economy shows some promise, with recent economic growth proving solid at an annualised 2.2%, the strengthening of the yen against the US dollar is a concern. Japanese exporters are the main force behind any apparent economic recovery and the currency shift makes exports more expensive.

In expressing considerable uncertainty over Japan’s economic outlook, the latest OECD report on Japan noted last month: “Achieving a robust, sustained expansion will depend on overcoming serious structural problems, which will limit Japan’s growth potential and weaken demand. Resolving such problems requires greater resolve in pursuing a broad-based policy that features structural reforms to improve resource allocation, revitalise business sector activity and restore the soundness of the banking sector.”

It adds: “Given the close linkage between the weakness in the banking sector and deflation, these two problems must be solved simultaneously.” The banks and the government may be heading in the right direction but there is still a long, long way to go.

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Read more about:  Asia-Pacific , Japan