Sumitomo masks reality of bad debt: Outlook

If Sumitomo were a bank from any other country, it would be tempting to see its decision to declare a thumping loss against bad loans as a straightforward piece of balance-sheet management. But in Japan, decisions of this magnitude are really that simple. In a system as tightly controlled as that of Japanese banking, Sumitomo's decision to post a Y280bn loss in its 1994/5 financial year will, ultimately, have been taken by the Ministry of Finance. It is an event with implications far beyond the bank itself. It is no coincidence that the loss was announced by one of Japan's strongest banks. A few years back, such a loss because of bad debts risked provoking panic, and possibly a run on the banks. Now, there is a sense that even if the loan problem is still there, the public perception of it has calmed, and the stability of the system is no longer at risk. This is an important message, especially after the trauma of the Kobe earthquake and the renewed doubts it provoked.

But the finance ministry's shift, after many years of denying banks permission to declare a loss, is also a liberating stroke - one reason why banking shares jumped by nearly 17 per cent in Tokyo yesterday. For the authorities have in effect announced atax holiday. In Japan, losses that occur in one year can be deducted from taxable income for the next five years.

Having kept liquidity very tight in recent years to accelerate corporate restructuring in Japan Inc, the men from the ministry are now saying, via Sumitomo, that banks can restructure their balance sheets without jeopardising their ability to finance thegathering economic recovery.

This change of policy does nothing to diminish the dimensions of the bad-loan problem, which may be as high as Y17,000bn - one reason why there may not be a rush of banks following Sumitomo's example. Many do not have the capital strength to absorb losses on this scale: and allowing some presentational truth into the balance sheet will not change that wider reality.