JAPAN BANK CAPITAL: NOW YOU SEE ME NOW YOU DON'T

Japan's Asahi Shimbun has this inteesting piece about the capitalisation situation of Japanese banks. According to this Japanese daily the major banks still have capital adequacy ratios of 10 percent or higher, meeting the internationally accepted minimum of 8 percent. But much of this capital consists of previous government bailouts and deferred tax assets, posted in anticipation of tax refunds. Accumulated profits are apparently near zero, following numerous bad debt write-offs. The question to ask then is major banks really as healthy as they claim they are?

Capital contributed by shareholders, accumulated profits, shareholdings, gains on real estate and other items are considered the tangible capital that constitutes shareholder equity and can be used to cover losses. The last two injections of public funds, in 1998 and 1999, are supposed to be paid back, and deferred tax assets are also considered artificial capital.

Each banking group's capital-adequacy ratio was raised by 2-3 percentage points through the previous injections of public funds, and only Mitsubishi Tokyo Financial Group has repaid that assistance. Although public funds are considered part of shareholder equity under Bank for International Settlements standards, they are not true equity in that they are debts that must be paid back to the government. Banks have almost no surplus cash after writing off bad debts, and they may not be able to pay back the government.The banks, however, counter that the purpose of the public funds was to boost their equity to begin with, and ease their reluctance to lend money. They say it's irrational to claim their capital is weak because it includes public funds.

Real estate property assessments also pose a problem. Since March 1998, banks have been allowed to top up their capital by booking any increase in a property's assessment over its acquisition price as an unrealized gain. Now that major banks are facing unrealized losses on their commercial real estate holdings, however, their equity will likewise have to be revised downward. Banks haven't reappraised their real estate since before its market value fell below its book value, so unrealized losses due to falling land prices remain hidden. The banks say they have disclosed their latent losses in their financial statements, and do not intend to hide them. Land prices, meanwhile, continue to crater.

The use of deferred tax assets-expected future tax refunds-is another questionable technique the banks use to pad their capital. It was introduced in March 1999 to encourage banks to set aside taxable reserves against bad debts. The BOJ says banks' combined deferred tax assets totaled 10.6 trillion yen in March 2002, up 3.5 trillion yen from the previous year. Over the same period they rose to account for 36.5 percent of shareholder equity, from some 20 percent. Deferred tax assets have swelled in tandem with the increase in tax credits the banks are receiving for disposing of bad loans.The maximum amount of deferred tax assets a bank can post is based on its future profit projections. Some analysts want closer scrutiny of banks' profit projections, lest an overly rosy outlook allows a bank to pad its capital too much. Banks can also include up to five years' worth of expected taxes in their shareholder equity. In the United States, on the other hand, they can only post deferred tax assets for the coming year.
Source: Asahi Shimbun
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