Financial Times, Friday, August 12 1994

By Gerard Baker


Japan's Credit Crunch Threatens Anaemic Recovery

For the first time on record the economy has suffered a contraction in lending

If Japan's anaemic recovery shows any sign of strengthening in the next year, it will not be thanks to the country's banks.

Figures published this week by the Bank of Japan show the economy is suffering from a severe credit crunch. Credit creation has been on a steeply declining path since the end of 1990, when the economy began its long recession, but in June and July, for the first time on record, the economy suffered credit contraction.

In June lending by domestic banks contracted by 0.1 per cent over the same month a year ago; for July the contraction was 0.4 per cent.

"Instead of injecting purchasing power into the economy, the major banks are actually withdrawing money," said Mr Richard Werner, chief economist with Jardine Fleming in Tokyo.

The figures have renewed concerns that financial institutions, weighed down by their own bad debt burden, are increasingly reluctant to lend even to financially secure prospects.

The banks' defence is that they are simply helpless spectators at a beggars' banquet. The problem is not shortage of supply, they argue, but a lack of demand, as companies express little interest in borrowing to finance new investment.

Indeed, they point out, so severe is the dearth of demand for bank lending that they have in recent weeks pared interest rates to the bone for their larger corporate customers to entice them back, even at the risk of cutting further their slim profit margins.

But critics of the banks say their willingness to lend is increasingly selective. The prodigality that characterised the late 1980s so-called 'bubble economy', when asset prices surged, has given way to a hyper-conservatism that is stifling investment and recovery.


The reason, said Mr Werner, is that the collapse in property prices in the last few years transformed banks from aggressive lenders into models of parsimony.

"The assessment of credit risk is largely based on the archaic method of assessment of the value of collateral, mainly land," he said. While large companies, sitting on substantial land holdings, have no difficulty borrowing, small businesses are unable to convince banks that their collateral will hold its value, even if their cash flow and other business indicators are healthy.

Several banks have already had their own near-death experiences as a consequence of and expanding non-performing loan portfolio and are anxious not to repeat them.

Apportioning blame for the implosion of credit is ultimately an unproductive exercise. What matters is that money is now being drained from the economy. At the same time, public sector liquidity is also parched. Since credit creation represents purchasing power, the implications for the economy are disturbing. Without an early upturn in lending, whether supply- or demand-led, Japan's nascent recovery may prove short-lived.