Japan bank tsar finds he needs a few good friends

With his plan to fix Japan's dismal banking industry hitting a wall of political resistance, economics tsar Heizo Takenaka raced around Tokyo on Wednesday attempting the once unthinkable: building consensus for radical change.

The odds are stacked against him. Economists expect his brand of reform to a banking system choking on at least $416 billion in bad loans to undergo some key changes to stop any major bank from being nationalised.

They also expect Takenaka to abandon a restriction on the use of future tax credits as capital, currently forming about 40 percent of banks' core capital. Leaked reports suggested Takenaka wanted to impose a 10 per cent cap on the use of such assets in bank capital.

Frightened at the prospect of bankruptcies in the retail, construction and real estate industries that form a powerbase of Prime Minister Junichiro Koizumi's ruling Liberal Democratic Party, senior LDP officials likely shot it down, analysts said.

One possible outcome is what economists call a "back-door" bailout for the banking system.

This centres on pouring taxpayer money into the current vehicle for buying bad debts, the Resolution and Collection Corp (RCC), possibly allowing it to buy non-performing assets at face value rather than market rates.

Taxpayer money could be channelled into the banking system without declaring a banking crisis. Bank executives would likely keep their jobs. There would be no nationalisations of banks. But bad loans would be taken off their books.

But there are pitfalls to this approach. By not holding bank executives accountable, voters would essentially be asked to pay for their mistakes and shoulder the cost of years of mis-management at banks.

"They looked at this a year ago and decided it was so blatant, the taxpayers wouldn't let them get away with it," said ING economist Richard Jerram.

"But maybe having taken the system to the brink, they can now get away with it," he added.

The RCC approach might be done in conjunction with a stricter approach for measuring the banks' loans, using the cash flow generated.

There are other risks to beefing up the seven-year-old RCC, which is currently barred by law from selling non-performing loans bought from the banks at a loss, rendering it more of a warehouse than a clearing house for the loans.

For this to work, the RCC would need an overhaul so it could quickly sell assets with promise to private investors.

Managers capable of reviving good parts of bad companies would be needed, along with dozens of lawyers to untangle often archaic land tax laws while helping the RCC transfer ownership of a possible flood of assets.

When Japan last bailed out its banks, in the late 1990s, critics say the effort was half-hearted. Distressed businesses weren't restructured. Land, factories and other assets weren't auctioned off.

The net result was that many companies stayed alive that should have failed, sucking even more blood from the banks and preventing a much-needed re-allocation of capital into fresher industries with more efficient management and greater potential.

Economists said Takenaka, an ardent reformer and former Harvard University professor, may also adamantly oppose the idea of pouring public money into the banking system without holding senior bank executives accountable.

"Ultimately, (the opponents to reform) don't want to see a lot of companies going bankrupt because that is where a lot of the political support comes from," said Peter Morgan, chief economist at HSBC Securities.

"At the end of the day, the package will be watered down somewhat," he added. "There is probably going to be some acceleration of the bad loan write offs and there may be some large victims coming out of that. At least the risk of nationalisation has gone up."

Still, some were reluctant to write off the bad debt workout, even if it does succumb to change.

The reform blueprint is now expected by the end of month to coincide with the government's "anti-deflation" package. By delaying the reforms, the government has more time to come up with offsetting "safety net" measures, some economists said.

"What you're getting here is not a compromise but policy coordination," said Jesper Koll, chief economist at Merrill Lynch in Tokyo. "The fact of the matter is that there will inevitably be a short-term negative impact. But at the end of the day, what you are going to get is an anti-deflation policy."

He added that the net result will be a long-overdue crackdown on inefficient companies that have stifled growth for a decade.