UFJ bank prepared to write-off 1trillion yen in bad loans

"We're extremely sorry we have to skip interim dividend payouts, but we had to make this decision to show that the new UFJ group will be more forward-looking," Sanwa vice president Hiroya Nobuhara told a news conference.

Pressure on the yen

It is hardly good news, but is the first sign that Japan's four mega banking groups are tackling their debt mountain.

The news was the lifeline traders had been looking for and the Nikkei stock market index rose.

But concerns surrounding the weak economy overshadowed the rise in the Nikkei, with the yen falling to a 20-month low against the dollar for a second consecutive day.

For the banks it means their foreign denominated assets gain value back home - giving them a further boost.

But the weak yen, although it could help Japanese exporters, has echoes of the 1998 crisis, when the yen rose to 148 to the dollar before the US Treasury intervened.

Then, as now, it was fears of a banking collapse that precipitated the fall.

And just as before, the losses made by the banks who hold huge share portfolios - whose value has been shrinking - was a key factor in their distress.

Working the system

Most Japanese banks have preferred to set aside provisions to cover bad loans rather than writing them off.

This practice, and extension of more loans to risky borrowers has pushed the financial system to the brink of collapse.

The finger that pulled the trigger was ratings agency Fitch, which placed 19 Japanese banks under a negative review in anticipation of new accounting rules coming in next month.

In the past, banks could hide losses on their share portfolios - valued by some analysts at 34 trillion yen ($280bn).

The debt-laden banks are already saddled with insufficient reserves to cover 63.9 trillion yen ($530bn) in bad loans.

Caution urged

Following UFJ Group's announcement analysts were quick to point out that it was too early to let the banks off the hook.

Government policy is still unclear on how banks should deal with their bad debts.

The Financial Services Agency still has to deliver a package of measures by the end of March to help banks cut their bad debts.

Miyazawa: Might set up fund to absorb stock market falls

But the markets were desperately looking for any good news and the UFJ's action was followed by Financial Minister Kiichi Miyazawa saying that he might set up a special private fund to absorb stock sales.

The central bank is evaluating the impact structural reforms could have on the economy, including the possibly negative side-effects of writing off bad loans, which could result in some banks becoming bankrupt.

"Disposing of bad loans could have a positive effect in the long term," said the Bank of Japan Governor Masaru Hayami on Thursday, "But there could also be some temporary, negative effects such as unemployment."

Central bank turn-around

The Bank of Japan meanwhile rekindled rumours of a return to a zero interest rate policy after he said the bank would listen to government.

Many economists are betting on a return to the free money policy when the BOJ's Policy Board members meet on Monday in a climate where shares are near a 16-year low and the economy barely scraping above a recession.

His remarks, unlike those of the banks, had little impact on the markets, because few believe a return to zero rates will do too much to boost the economy or the yen.

The Bank of Japan introduced its zero-interest policy in February 1999, when the country was deep in a financial crisis after two large banks had gone bust.

It stuck with the policy until last August when, convinced the economy was rebounding, but then it raised overnight rates to 0.25% to the fury of the government.

Last month the BOJ cut the overnight money market rate to just 0.15% and lowered the discount rate, for the second time in three weeks, to 0.25%.

The bank may also consider targeting reserves held by commercial banks which would ensure greater financial system stability and cut the amount of money in circulation.

It would be a radical turnaround in policy from targeting the inflation rate and is reported to have the support of some board members.