TOKYO -- The Japanese banking system was already viewed as one of the weakest links in the global economy, even before the attack on the World Trade Center stunned the world. Now, the health of many lenders could depend more than ever on how well Japanese and world stock markets hold up once U.S. share trading resumes, bankers and market-watchers say.
Share prices in Tokyo leveled off on Thursday, after plunging 6.6% the day before, after a terrorist attack on the financial heart of Manhattan. The benchmark Nikkei 225 Stock Average ended the day nearly flat at 9613.09, while the broader Topix Index rose 1.3% to 1003.51. The number of shares changing hands in Tokyo was low because many investors waited for direction from the U.S. markets, which have had been closed since Tuesday and will stay shut at least until Monday.
See full coverage of the attack.
Stock levels are a critical concern to large Japanese banks, which hold massive portfolios of shares that -- this year for the first time -- they will have to value on their books at current market prices. Any losses will partially erode the banks' capital, the financial bedrock on which they base their lending. At today's levels, most big banks already have potential losses on their share portfolios, analysts say. If Japanese stocks plunge further -- pulled down, for instance, by weakness in the U.S. -- the losses could grow into serious liabilities for the banking system, which is already hobbled by bad loans, depreciating assets and razor-thin profit margins.
"I thought if we take time, we can" fix the banking problem with Japan's existing policies, said Asahiko Isobe, a member of an advisory group to Financial Affairs Minister Hakuo Yanagisawa. "But now I don't know. Just as we were hitting the bottom, came additional worries."
Further stock-market falls could help force the Japanese government to take stronger action to resolve problems at its banks than it has proposed so far, traders say. Such action could include having the state inject more money into struggling banks to recapitalize them, or force lenders to sell off bad assets more quickly. Other possibilities include having the government take over banks or order banks to replace their senior executives. Calls for more aggressive action to support banks are already on the rise.
"Personally speaking, I think public funds should be injected into banks that need them," said Toshio Miki, a member of the Bank of Japan's policy board, which sets the nation's monetary policy and helps supervise the financial system. "That would strengthen their capital and allow them to take more risks."
Japan's banks haven't fallen back into a crisis like the one they experienced from late 1997 to early 1999, when they faced severe shortages of capital and loss of confidence among investors and depositors. In 1997, a credit crunch brought down Hokkaido Takushoku Bank Ltd., when confidence in the lender eroded so far that no other bank was willing to lend it money.
Bank treasury officers say that the Bank of Japan's ultra-loose monetary policy, which is keeping the overnight bank lending markets overflowing with cash, has minimized the likelihood of a credit crunch slamming a major Japanese bank. The system worked well on the day after the U.S. attacks, when the potential for funding crunches was at its highest. The Bank of Japan quickly pumped two trillion yen into the money markets and managed to keep overnight lending rates close to zero, an indication that no banks were starving for funds.
Another problem Japanese banks could face is a serious shortfall in capital, such as occurred during the country's 1998-1999 financial panic. In early 1999, the Japanese government responded by injecting 7.5 trillion yen in capital into the largest banks. The banks' capital is now being eroded by unrelenting bad-loan write-offs, as bankruptcies among borrowers cause new bad loans to pop up as fast as old ones are written off. Another threat to capital is the implementation of mark-to-market accounting for securities this year, which will force banks to post valuation losses on their massive shareholdings.
But most of the major lenders still have capital ratios well above required minimums, even at current stock levels. "That's why we put so much public money into banks -- to prepare for this kind of moment," said Mr. Isobe, who was on the government panel that approved the injection. "Otherwise those banks might have died, almost."
Yet a declining stock market presents other hazards for Japanese banks, which had long used capital gains from sales of stock to fund their bad-loan write-offs. With stock prices so low, it is now more likely that many banks will see losses on their portfolios rather than gains. Merrill Lynch in Tokyo estimates that at current stock levels, Japan's major lenders have about 4.5 trillion yen in potential stock losses.
Those stock losses, combined with losses from writing off bad loans, could push some lenders to post losses for the fiscal half-year that ends this month. If Japanese share prices fall more and the losses grow, that could undermine market confidence in banks perceived as weak. In turn, the share prices of weaker banks themselves could fall so sharply that financial regulators might be forced to take action to support them. A similar dynamic is what brought down the Long-Term Credit Bank of Japan Ltd. in 1998.
That disaster scenario might not materialize. Many Tokyo traders and investors are optimistic about the chances for a recovery in Japan's markets, saying Tuesday's big decline in share prices was a knee-jerk reaction to the uncertain situation in U.S. markets.
Investors and traders say one reason for the downturn was a drop in buying by foreign investors. Foreign investment had been one of the main sources of support for Japanese shares recently, as many troubled domestic investors, particularly banks, have been under pressure to unload shareholdings to raise cash in the face of growing bad-loan losses. And while selling from domestic investors continues, many potential foreign buyers are waiting to see how U.S. markets behave when trading in New York resumes, before making investment decisions, they said.
"We weren't doing a lot of trading," said Marc Desmidt, a director at Merrill Lynch Investment Managers Co. in Tokyo. "No one in America, I doubt, was thinking about trading shares in Japan."
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