Optimists see glimmers of hope. Big banks seem to be well provisioned against the risk of more corporate failures following the bankruptcy of retailer Sogo in July, and the volume of property transactions is picking up as more and more investors finally swallow hard and accept write-offs. But economists and analysts say Japan still has a long way to go before the dead wood left over from wasteful speculation in the 1980s is cleared away, allowing green shoots to push through.

Credit Suisse First Boston said pressure from a falling stock market and from the Bank of Japan, which is hankering to raise interest rates, had begun to drive home the message to politicians that they must halt the use of cheap money and wasteful government spending to prop up unviable firms. "Completing the process of liquidating bad private-sector assets and dealing with the impact on banking-sector capital are essential to sustainable economic recovery and indeed government solvency," the bank's global strategists said in a report. Unlike their counterparts in the West, Japanese banks have been reluctant to own up to past lending mistakes by calling in bad loans and selling the collateral - usually property - or forcing walking-dead companies to declare bankruptcy.

"With Sogo going bankrupt, it exposes the fallacy that all the debt problems are through the system, which is the story the government was trying to tell," said Graeme Knowd of Standard and Poor's rating agency in Tokyo.

That indulgence was reflected in recent figures showing 81.8 trillion yen ($748 billion) in problem loans in the banking system at the end of March, up 1.45 per cent from a year earlier and accounting for 12.1 per cent of total loans.

The Sogo saga, and the political confusion that surrounded it, have depressed banking stocks of late, but Darrel Whitten, Chief strategist at ABN AMRO in Tokyo, said the banks had only themselves to blame.

"The banks' downfall has been their own intransigence in writing off and liquidating bad credits," he said. Whitten, and many others, believe politicians and banks will be reluctant to let heavily indebted construction firms with ties to the ruling Liberal Democratic Party follow Sogo to the wall. "You get this image of a bunch of old guys desperately trying to keep the status quo and stay in power as long as they can," he said of the LDP. "All of that is not conducive towards an image of an accelerated clearance mechanism," he said.

Restructuring by corporations and financial service firms, by contrast, has led to a jump in property liquidations.

-- (Reuters)