Takenaka's appointment as head of Japan's banking watchdog was widely read by investors as a signal that Prime Minister Junichiro Koizumi now intends to unleash a new wave of public money toward fixing the banks; forcing some to shutdown or to submit to government control. Will he be able to reform the ailing banking system?

The world's second largest economy, once well known as the largest creditor country, has entangled herself in a severe whirlpool. Today, Japan seems to be utterly helpless in combating the deepening deflationary pressures that are intensifying the economic crisis that began more than a decade ago, when the stock market and real estate bubbles burst. The sorry state of Japan's economy is partly due to the ailing banks. Meanwhile, the bad news seems to keep getting worse. The Japanese banking system seems to be totally paralyzed. It has so many bad loans on its books; it cannot make loans to new businesses or existing ones that need capital for expansion. Politicians ask banks to finance Japan's massive construction industry and dying corporations. The Japanese money supply is exploding, but none of the money is heading to where it is needed. Despite years of high-profile actions by the Japanese Government, the banking system's bad-loan problem arguably is worse today than ever before. Due to the growing burden of bad loans and the economy's intensifying deflationary and recessionary pressures, many of the banks are already on the verge of collapse.

Banks are still at the heart of the Japanese economy and the loans account for nearly 60% of all corporate debt. In the US, by contrast, 61% is capital-market debt. However, in 1990, after a decade in which companies in Japan routinely borrowed against inflated real estate holdings and in turn poured money into the stock market, Japan's ratio of total corporate debt to GDP was high at 225%. The comparable figure in the US today is only 95%. Besides, most of the Japanese banks are still desperately dependent on government for survival. The government is the single largest shareholder in most of the major Japanese bank groups (34.35% ownership of the top seven groups). This increased rapidly when banks were being nationalized and then sold to investors including foreigners. The problem is simple. Most banks cannot make enough money (defined as capital) to pay their bills. They lent money to companies which are not in a position to repay. The banks now carry $1.25 tn in bad loans and ¥40 tn ($342 bn) in interest-rate swaps; they have turned risk-averse while pressuring depositors to bail them out or by selling shares illegally. Over the past decade, Japanese banks are estimated to have written off ¥90 tn ($725 bn) in bad loans. Bank experts say that the estimates for what they still have to write off are unreliable because of how they have been calculated. The number could be anything from ¥50 tn to three times that of the amount.

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