Japan's debt tidal wave

Tokyo's financial system is under water, and a restructuring looks too little, too late

Leading Tokyo analysts are warning that Japan's bad debt mountain and banking crisis are a tidal wave big enough to completely engulf the world economy before it has even had a chance to recover from its current woes.

The comments come as the Japanese government remains locked in talks over how best to cope with the dire problems faced by the banks, which are currently burdened with trillions of yen's worth of bad debts arising from the lending frenzy of the 1980s bubble economy.

But the issue has become more difficult to solve following the deep slump on the Japanese stock market, which hit a 17-year low earlier this year. That has delivered a massive blow to the life insurance industry, whose biggest companies have invested heavily in equities. Analysts and fund managers are warning that two of the biggest players, Asahi Life and Mitsui Life, could be facing collapse.

That would in turn expose big problems with the Japanese government's approach to dealing with the bad loan issue. The strategy favoured by the Japanese government is to use the publicly-funded Resolution Collection Corporation (RCC) to buy some of the problem loans from the banks. But the strategy, says James McGinnis of Commerzbank, has exposed a massive gap in Japanese economic thinking.

The RCC is only set up to deal with problem loans arising from companies that have gone bankrupt. But behind the scenes are an estimated ¥150 trillion (£870bn) of "category 2" loans – money owed by companies on the critical list. But the conversion rate from critical to bankruptcy is very high – bankruptcies for this financial year will total 18,000.

That problem has been exacerbated by the collapse of several big companies such as the Sogo department store chain, followed by Mycal – a major chain of supermarkets. Worries now centre on Daiei, another big retailer with gargantuan debts.

The nightmare scenario, painted by a number of analysts, is that if the category 2 loans were reclassified as officially bad debts, the banks would not be able to take the strain and even the biggest ones could risk collapse.