Abstract

In the first half of the 1990s, Japan’s financial system experienced a disturbance of a magnitude not experienced since the prewar financial crisis almost half a century ago. Financial institutions came to be burdened with substantial nonperforming loans, most of which were related to real estate, and the resulting loss of interest income and charge-off costs seriously impaired their financial condition. At the peak, the total amount of nonperforming loans was, on a gross basis, equivalent to 8.5 percent of nominal GDP. As a result of concerted efforts by both the public and private sector, however, this figure has been reduced to 6.0 percent, as of the end of September 1996 (Figure 1). On a net basis—after deducting the portion covered by collateral or loan loss provisions—the figure stands at 1.5 percent, a reduction of 2.4 percentage points in 12 months (Table 1). Moreover, legislative action taken in June 1996 has provided an institutional framework within which remaining issues can be smoothly resolved. Thus, although the problem lingers, steady progress has been made toward its solution. The next challenge is to reconstruct an efficient and stable financial system without delay, taking account of the lessons learned from the nonperforming loan problem. This paper examines, from the central bank’s point of view, how it has coped with the problem, what it has learned, and how such lessons should be incorporated into construction of a new financial system for Japan.