Banking is still problematic

Japan's ebbing banking sector remains under siege by international investors and Japanese authoritie...

Japan's ebbing banking sector remains under siege by international investors and Japanese authorities. Almost 10 months after Koizumi's appointment as prime minister, the banking sector continues to be the economy's major problem.

'When Koizumi came into power he was supposed to force through more reforms, but this did not happen,' says Adrian Hickey, Japanese investment manager at Edinburgh Fund Managers. 'The reforms were stalled. The key change we want to see is on the banking side.'

However, Japan is talking of structural reforms after the Bank of Japan refused to follow government requests to increase the purchase of bonds from investors each month by ¥1tr. There is expectation of structural reform before March, the end of the financial year.

If banking reforms go through, the government will have to inject money in the system to make sure some credible banks are able to pull through. 'The government needs to inject money,' says John Greenhill, director of Japanese equities at Royal & SunAlliance. 'Banks are increasingly seeing new bad debt generation.'

So far any actions that have been taken to improve the situation with the banks have not been totally successful.

Hickey explains: 'The Financial Reconstruction Commission (FSC), an inspecting agency, was set up to carry inspections on banks. It created categories of non-performing loans and set minimum reserve levels. But the categories proved too lenient and the FSC lost credibility.'

The one major problem of the banks is their large equity holdings rendering them vulnerable to losses on equity. Greenhill says: 'New legislation is in place to set up an institution to buy the equity of these banks. But the money attributed is ¥2tr ' this sum is not big enough to create a sizeable impact.'

With the BOJ's reluctance to implement further monetary policy, there are fears that deflationary pressures of the economy might get out of hand. This might pose a significant difficulty for the reforms.

Greenhill says: 'Monetary policy is not proving successful. The country has a zero interest rate policy and BOJ is tired of waiting for structural reform. It will be harder for banks to restructure if there is a downward spiral of deflation as overall value will drop.'

Hickey adds: 'The low yen should help deflationary pressures. So Japan should have experienced a spread of prices from imported inflation. But this has been dampened by the knock-on effect of the domestic economy. The economy is still operating with overcapacity and is not benefiting from the weak yen.'

Anusha Roy