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Japan's Nonperforming Loan Problem

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Some editorial revisions have been made to the English translation since it was initially released on October 11, 2002.
The original Japanese text, however, remains entirely unchanged.

October 11, 2002
Bank of Japan

Summary

Japan's nonperforming loan (NPL) problem should be regarded as being inextricably linked with structural changes both in the financial sector and corporate sector. While the problem was previously characterized primarily as the negative legacy from the bursting of asset price bubbles, recently it has increasingly become more a question of the disposal1 of NPLs newly generated in the transformation of industry and individual businesses.

  1. Disposal of NPLs includes loan write-offs and loan-loss provisions.

During the past ten years, Japanese banks have made progress in addressing the problem by disposing of more than 90 trillion yen in NPLs. Nevertheless, they now face a more severe challenge than ever, given the decline in their financial strength and earning power against the following background. First, a substantial amount of new NPLs is continuously being generated as structural changes progress. Second, the lending margins of banks remain low. And, third, unrealized gains on bank shareholdings, which used to serve as a buffer, have been exhausted.

A comprehensive approach is required to resolve the NPL problem, the principal components of which should include a more appropriate evaluation of NPLs, the promotion of their quick disposal based on such evaluation, and the enhancement of earning power on the part of both firms and banks. At the same time, the government and the central bank should preemptively seek to prevent a financial crisis from arising, and prepare an environment which is conducive to the steadfast resolution of the NPL problem.

A. Appropriate Evaluation and Quick Disposal of NPLs

An appropriate evaluation of the reduced economic value of NPLs and concomitant provisioning for the potential losses are prerequisites for the quick disposal of NPLs. In light of recent rapid changes in the economic structure and the sophistication of credit risk management, opportunities to improve current provisioning methods should be explored. In this regard, the Bank of Japan, through its on-site examination and off-site monitoring, intends to encourage major banks, in particular, to strengthen their own efforts toward more appropriate provisioning. Furthermore, it is essential to expand the secondary market for loan assets through such measures as the active use of the Resolution and Collection Corporation (RCC), thereby preparing an environment in which NPLs are priced on a market basis, and to urge banks to remove these loans from their balance sheets.

B. Improving the Competitiveness of Both Banks and Firms

From the viewpoint of promoting the efforts of bank management to improve earning power and restore financial soundness, the financial system, banking regulations, and the tax system should be constantly reviewed.

To resolve the NPL problem, we need a comprehensive approach toward improving competitiveness and promoting rehabilitation of the corporate sector by incorporating the viewpoints of both industrial and regional development policy. At the same time, to secure smooth corporate financing activities, we should nurture new markets for securitization, with credit enhancement devices provided by the government as appropriate.

C. Securing Financial System Stability

If faced with the risk of a financial crisis, we should respond to the situation in an appropriate and flexible manner with the government invoking Article 102 of the Deposit Insurance Law and the Bank of Japan acting as lender of last resort.

While staving off a financial crisis, we need to prepare an environment which is conducive to the steadfast resolution of the NPL problem. In this regard, we should encourage banks to reduce their shareholdings. Furthermore, we should consider an option to inject public funds into banks at risk of becoming undercapitalized in the process of the quick disposal of NPLs. Injection should be conducted in such a way as not to undermine the incentives to improve competitiveness.