Time of repentance for Japan: Tokyo's stock market dive has left many domestic banks in need of government support to survive

JAPANESE bankers are atoning for their bad debts. Last week, Dai-Ichi Kangyo, the biggest bank in the world, banned its top executives from flying first class, cut back their use of limousines and reduced their pay by 5 per cent. A rash of similar announcements is expected from other banks in the coming weeks.

The public display of guilt is not an arcane Shinto ritual but a piece of calculated public relations. It is designed to win the Japanese taxpayer over to the idea that government money may be needed to prop up the crisis-torn banking system, whose precarious state could undermine the Y10,700bn (pounds 43.6bn) economic recovery package announced last month.

As the banks campaign quietly for direct financial help, the government has begun to signal its agreement. But there has been a barrage of attacks from economists, businessmen, the press and ordinary taxpayers, who have been outraged at the idea of paying for the banks' bad lending and unimpressed by shows of repentance from senior executives. On Friday, Ryuzaburo Kaku, chairman of Canon, accused the government of being 'hand in glove' with the banks and said it was 'using the possibility of bank failures and the ensuing financial panic as a blackmail'.

Other businessmen and politicians, who accept the need to prop up the banks, are campaigning for them at least to come clean on their problems and end the obsessive secrecy behind which they hide the full extent of their bad debts and property holdings.

The government's concern is that banks have been one of the powerhouses of economic expansion in Japan, offering generous loans to industry at low margins. If they are brought low by failures or become so weak that they cannot expand their lending, attempts to kickstart the economy will be doomed.

The banks' financial power has more than domestic significance. During the 1980s, they became big lenders to industry and property companies in Europe and the US. Nowadays, a sneeze from Japanese banks can give the rest of the world pneumonia.

The virus that hit Japanese banks is closely related to European and US strains of the same disease: heavy lending to property companies at a time of rapid economic expansion was followed by enormous bad debts when the economy turned down and property companies went to the wall.

A substantial part of the banks' lending was indirect through financial companies, which were not banks but which specialised in lending to property companies. Much the same happened in the fringe banking crisis in Britain in 1974.

Estimates of the size of the banks' problem loans range from Y29,400bn to Y56,350bn. The banks' portfolios now include a huge range of foreclosed properties they cannot sell, from offices to golf courses and luxury penthouses. If the highest figures are correct, the Japanese banking losses could be comparable with the savings and loans crisis that has ravaged US savings banks.

Less than three weeks ago, Kiichi Miyazawa, the prime minister, unveiled a special package of tax and accounting measures designed to help the banks over their problems. This included permission to delay reporting losses on enormous holdings of shares - due to have been published in the half- year accounts at the end of this month - and a relaxation of rules that would have forced dividend cuts as profits dived.

But last week, Mr Miyazawa made it clear that he is now prepared to go much further and use government money to bail out the banks.

The government's change of heart may signal that it sees the banks' problems getting worse, not better, forcing it to brave the wrath of businessmen and voters.

The prime minister's promise was played down by the ministry of finance, which is worried about the public reaction. It insisted that only a small amount of public money would be needed. However, analysts believe that many billions of pounds of support will be required to have any effect.

David Marshall, a Tokyo-based analyst for IBCA, the London credit rating agency, warns in a report this morning that despite the new measures, the economic slowdown is likely to lead to a further deterioration in the banks' loan books over the coming year. IBCA believes the bad debts could spread from property to retailing and industrial loans, a pattern already seen in the UK and US recessions.

The various bank rescue plans are all based on an autonomous agency to buy land currently held by banks as security, building some form of subsidy into the deal. One way would be to buy the land at above current market rates, though this would involve keeping Tokyo land prices artificially high, breaking Mr Miyazawa's promise to bring prices down to within reach of home buyers. Brian Waterhouse, of James Capel Pacific in Tokyo, said: 'It's not possible to keep his promise to people and rescue banks.'

Some banks doubt the wisdom of accepting government money. 'Those with foresight know the danger of being held under obligation to the LDP (the ruling Liberal Democratic Party),' said a bank economist. But most now believe government action is urgent, and there are precedents to back it up. In 1964, when the Tokyo stock market collapsed, the Bank of Japan provided Y300bn to an independent agency to support the market.

There is one aspect of the Japanese banking system that is unique, and which some analysts believe brings a far greater danger of instability and collapse. This is the extraordinary reliance of banks on profits made in the stock market.

Unlike most other central banks, the Bank of Japan allows banks to count unrealised profits on shareholdings towards their hidden reserves, which are a part of their capital. When the stock market collapses, as it has done this summer, bank capital is eroded.

Internationally agreed rules allow banks to lend up to a fixed multiple of their capital. When it is eaten away, lending is restricted; if too much capital is lost and cannot be replaced, a bank's very existence may be threatened.

As the chart shows, the stock market low last month wiped out the hidden reserves of three big banks. If shares had fallen a little further, 12 more would have been hit.

Mr Marshall says if a recovery programme for the Japanese banks is to lead to long- term health, it must tackle their 'extreme vulnerability' to the stock market. That would mean reducing their shareholdings, however, which would have gloomy implications for other stock market investors.

In the short term, the massive effort to restore economic confidence, culminating in the government's Y10,700bn expansion package, pulled the stock market away from its August lows. Indirectly, it was also the first stage in the rescue of the banking system.

----------------------------------------------------------------- CREDIT RATINGS ----------------------------------------------------------------- Bank of Tokyo AA- Dai-Ichi Kangyo Bank AA+ Daiwa Bank AA- Fuji Bank AA- Industrial Bank Japan AA+ Kyowa Saitama Bank AA- Long-Term Credit Bank A+ Mitsubishi Bank AA Mitsubishi Trust/Banking A+ Mitsui Trust & Banking A Nippon Credit Bank A- Sakura Bank AA- Sanwa Bank AA Sumitomo Bank AA Sumitomo Trust/Banking A+ Tokai Bank AA- Toyo Trust & Banking A Yasuda Trust & Banking A ----------------------------------------------------------------- Source: IBCA -----------------------------------------------------------------

(Photographs and graph omitted)