New supervisory rules trigger alarm in Japanese banking system

The impact of a rigorous new Japanese bank inspection system is causing alarm at the country's banks, with many scrambling to shore-up fragile financial reserves ahead of its implementation in the next couple of months.

In the past, Japanese banks were not obliged to accept the findings of the Financial Service Agency's (FSA) inspectors or to reflect their results in account settlements. Authority to force compliance with findings was limited to the supervisory bureau of the Japanese watchdog, which often overlooked its inspectors’ own reports, Tokyo analysts said.

As a result, banks were able to deal with bad loans according to their own standards, rather than on the basis of actual needs.

Three new FSA approaches have triggered concern: special inspections, a new loan assessment method - based on a discounted cashflow technique - and tougher assessment of real estate taken as collateral. The latter represents a particular problem, as many banks are rumoured to use friendly appraisals that inflate the value of collateral.

The reaction of Japanese banks to these changes remains, for the present, controlled. This is partly because the new measures are unlikely to affect 2002 financial results, and because impending elections mean Prime Minister Junichiro Koizumi is unlikely to take immediate steps that risk forcing a banking crisis.

But, with equity markets performing poorly, bankers remain under threat, with stock valuation losses now directly offset against capital. As a result, many are now actively attempting to address capitalisation issues rather than delaying action until later in the year.