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Update on Japan's Debt Repayment Moratorium

January 1, 0001

 

  • No mandatory moratorium - Lender’s consent will be required.
  • Debt subject to moratorium will be guaranteed by the government.

A moratorium on debt repayments by individuals and small business owners has been advocated by Shizuka Kamei, Japan’s financial services minister, since he took office in mid-September. Kamei’s proposal to exempt debtors from repaying the principal and accrued interest on loans sent shockwaves through Japan’s financial services sectors. According to the press reports on October 9, 2009, however, the moratorium will likely be legislated in a more modest form and will not be mandatory. The debt moratorium, however, is expected to put additional burden on Japan’s already heavily indebted government and may create moral hazard problems.

According to the press, on October 8th, the Democratic Party of Japan and the Hatoyama administration agreed that the government will guarantee the debt placed in moratorium. Under the terms of the proposed legislation, the debt of individuals and small companies may be placed into moratorium during the one-year period after the legislation’s enactment. The moratorium may postpone debt repayments for up to 3 years. The agreement of the lender financial institution and the borrower is required and there will be no mandatory moratoriums. Because the program will require lender consent, the government’s guarantee is essential to getting lenders to agree to defer loan payments.

Under the proposed program, the lender and the borrower will refinance the existing debt and the government will guarantee the new loan utilizing an existing government guarantee program. However, the guarantee program has already consumed half of its 30 trillion yen (US$340 billion) budget. The government says that it has no plan to increase the guarantee program’s budget. But if there are significant defaults on the debts in moratorium, the government will likely be forced to inject more capital into the guarantee program and worsen the government’s financial condition.

In connection with the moratorium, the Financial Services Agency will revise its inspection manual for financial institutions and exclude debts under moratorium from the "bad debts" category. This rule change may effectively conceal bad debts held by Japanese financial institutions for the next 3 years until these bad debts have to be written off after the 3 year moratorium expires. This is reminiscent of the financial crisis in late 1990's and banks may yet again experience financial difficulty when they have to write off bad debt. It is likely that public money will be infused to these struggling banks under the amended Financial Functions Enhancement Act, and whether or not the government can afford to these costs may become an issue.

One negative consequence of the moratorium is the moral hazard problems associated with it. While it will be beneficial to consumers and small businesses to be released from the stress of debts for 3 years, many debtors may not be able to or may not make the effort to successfully restructure their personal finances businesses. Unless there is a significant economic upturn in the next the 3 years, the moratorium may only delay the inevitable reality of failed businesses for another 3 years. Also, it is not clear how lenders will react to the program and they may not agree to the moratorium at all. The program may also create confusion on the part of borrowers as they may not understand the rule and think that they are exempt from all repayments, regardless of the lenders' consent.

The status and details of the moratorium legislation are still fluid, but we expect to see developments in the next few weeks. We will monitor the situation and keep you informed.