Total of bad loans understated by Y13,000bn - FSA

The decision to release the figures is the latest step to strengthen banking supervision in Japan by Heizo Takenaka, the former academic and reformist cabinet minister who took charge of the FSA last month, the Financial Times reported.

It follows the release of a package of banking reforms late last month by the FSA, the country's main financial regulator, that requires bad loans fall by half by March 2005.

The publication of the FSA's estimate rides roughshod over the sensitivities of senior executives at the country's largest banks and is likely to further sour relations between Mr Takenaka and the banks' boards of directors.

In the FSA's assessment, Mr Takenaka said bad loans were Y47,000bn compared with the banks' figure of Y34,000bn.

The 36 per cent difference was attributed to the banks' failure to classify their loan portfolios accurately.

It confirms long-held fears that the lenders have been deliberately understating the size of the problem to avoid having to make provisions and to keep favoured borrowers alive.

Japan's bankers threatened to sue Mr Takenaka earlier this month if he pressed ahead with plans to revise the way they use deferred tax assets to calculate their capital.

Mr Takenaka withdrew the proposal.

As part of its assessment, the FSA also revealed that the banks had made insufficient provisions for bad-loan losses.

The regulator said Y15,300bn in write-offs was required, 47 per cent higher than the banks' estimate of Y10,400.

The extent of bad loans and loan losses could grow further after the FSA completes another set of inspections of the banks - likely to begin in February - during which it will apply even stricter criteria.

The figures released at the weekend were based on the FSA's latest inspection for April 2001 to March 20002. At that time the regulator was run by Hakuo Yanagisawa, who was sacked and replaced by Mr Takenaka.

Banks review non-performing loans and loan-loss reserves twice a year. The FSA's February audit will help ensure the banks are accurately conducting their own reviews.