By Sandra Sugawara
Washington Post Foreign Service
Monday, May 4, 1998; Page A01

NAHA, Japan—To grasp the financial crisis that has Japan's economy in long-term paralysis, look no further than Shinei Teruya, a tanned and smartly tailored man who from an office overlooking Okinawa's capital built a mini-empire of shopping malls and office buildings.

To shoppers and tenants, all looked well. In fact, from the early 1990s Teruya's company was teetering on financial collapse. It remained open, he now says, only through a web of loans funnelled secretly through third parties and the shuttling of bad debt between the books of affiliated firms. His bank, knowing full well that his firm was bankrupt, did everything possible to avoid foreclosing on it, following the country's dictum that the pain of unemployment must be delayed as long as possible.

His house of cards finally came tumbling down in March. It was all based, Teruya said, on practices that "I'm afraid Americans will find strange," but are common and legal in Japan.

If the financial books were opened up, tales like Teruya's would be found in many places in Japan, banking analysts said. Banks, developers and other companies use similar practices to hide the true level of their financial distress.

By keeping open companies that in the United States would be quickly declared insolvent and closed, the system in Japan has kept a lid on unemployment, but also has hindered the nation's economic revival by channeling scarce money into enterprises that don't produce real wealth.

Bit by bit, Japan is moving to shutter some of these operations. But the dictum of Japan Inc. that no one can get hurt remains very much alive. For example, an official from Teruya's bank, the Bank of Ryukyus, said the bank did nothing wrong in Teruya's case, except perhaps to stick too long by a company because it had faith in its founder. The official spoke on condition of anonymity.

The financial shenanigans between banks, affiliates and customers generally occur behind closed doors. In this case Teruya's company, Teruya Sogyo, got into a fight with its bank and details emerged in court proceedings. He agreed to be interviewed because, he said, he thinks his story might trigger reform.

"The system is wrong," he said. "I don't think we should have done what we did. But back then, we were all foolish, not just the banks. The system should be changed so that this kind of financial manuevering won't be allowed. Otherwise the Japanese financial system won't improve, because under the current system, even with disclosure, you can hide things."

Teruya established his company two decades ago in Okinawa, a chain of tropical, palm-tree studded islands in far-southern Japan where economic life is dominated by tourism, construction, agriculture and large U.S. military bases. During the "bubble economy" of rising prices in the late 1980s, he rode the tide, developing shopping malls, buying and selling commercial properties on speculation.

The bubble burst in 1990 and many development companies found themselves in deep trouble as the value of their property contracted. By 1991 Teruya Sogyo had hit the official limit of how much money his bank would lend him, but its boss still wanted money to invest in another large property.

A new loan to an over-borrowed company like Teruya Sogyo might have had to appear on the bank's books as a problem loan. So a ruse common in Japan was worked out, Teruya said: Instead of lending money to Teruya Sogyo, the bank lent $27 million to a financially stronger construction company named Konoike Construction, which was working on one of Teruya Sogyo's projects. That would show on the bank's books as a "good" loan.

Konoike then passed the money on to Teruya. There was a private understanding among all three parties, Teruya said, that whatever was documented in the official papers the loan was really his company's obligation. He was confident that after two years he'd be able to pay off enough of his other loans from the bank to enable it to transfer the $27 million load officially to his company.

A Konoike Construction spokesman confirmed that the company borrowed the money, but had no further details.

Two years later, Teruya hadn't been able to clear his other debts and Konoike Construction wanted the $27 million loan off its books. The bank then transfered the obligation to a subsidiary of Teruya Sogyo, where again it would not show up as part of the debts of the parent company, which was growing ever-shakier financially. The situation was so bad that the bank eventually sent over one of its executives to, in essence, run Teruya Sogyo. Japanese banks often make such a move when an important customer gets into trouble, rather than cut off the customer.

In a confidental assessment that Teruya showed a reporter, Bank of Ryukyus stated that Teruya Sogyo "is actually bankrupt." The bank added, "If Teruya Sogyo goes bankrupt now, the impact on Ryukyus bank and its affiliate companies would be enormous."

In return for the bank's support, Teruya said, he got a request for help from it. He said bank officials concerned about an upcoming inspection by government auditors asked to borrow $1.5 million of stocks he owned personally, a 10 percent share of a golf course, which the auditors would count as the bank's own assets.

Teruya said he agreed to the arrrangement because it was "commonly done" and he expected the stock would be returned promptly. But the bank never returned the stocks, saying they were holding it as collateral against the money his company owed the bank.

A bank spokesman said that the stocks were requested as collateral from the very start, not for deceiving bank inspectors.

A fight ensued over the stock. Teruya said he went to court to try to get it back. The strategy backfired -- last year Bank of Ryukyus asked the court to liquidate Teruya Sogyo; a few weeks ago it complied.

The bank in some ways resembles its former client, Teruya Sogyo, in looking good from the outside. The bank, with headquarters in a pleasant white five-floor building in Naha, it is a mainstay of the island's economy, accounting for about 48 percent of all loans. In the year that ended March 31, 1997, it reported total banking and trust assets of about $13 billion, net income of $17 million and revenue of $446 million.

Bank Chairman Akira Sakima is a silver-haired man who also chairs the Okinawa Chamber of Commerce and the Okinawa public safety commission, which oversees police activities. His bank was the first Okinawan firm to be listed on the Tokyo Stock Exchange.

But for some time now Okinawans have feared for the bank's stability. Last January a rumor hit Okinawa that the bank was about to go under. The government and officials promptly denied it, but were not able to stop a temporary run on the bank.

Then last year someone put confidential documents from the bank into the hands of Yukihisa Fujita, a social activist turned member of parliament.

In an interview, Fujita said the documents showed that problem loans at Bank of Ryukyus totalled $2.8 billion as of last September -- equal to 30.7 percent of all its loans and 6.9 times higher than the level of bad loans the bank publically disclosed.

In parliament Fujita initially got no praise for bringing to public attention what was clearly a serious financial problem. Instead, colleagues warned him that he could trigger a bankruptcy. When he rose last month to question government and bank officials during a legislative committee meeting, he was booed by legislators, with some shouting that his public revelations could destroy the economy of Okinawa.

Eventually he was allowed to ask his questions. Among them: Why were the public statements of bad loans so at odds with the private ones? Bank officials replied that many of the problem loans listed in the internal document were not disclosed because the bank expected them to be repaid.

About a week later, however, Bank of Ryukyus said it was formally restating its bad loan level to about four times the previous level "to win trust." The bank said it expected to report a loss for the fiscal year ending March 31 because it planned to dispose of all its bad loans.

It remains unclear how much of that disposal will truly liquidate a bad loan and move on from it, and how much will be a paper shuffle.

The bank has 12 affiliates, some with dozens of employees and some smaller, Fujita said. One of the affiliates was established in 1995 to help the bank get rid of bad loans that were piling up after Japan's "bubble economy" burst in 1991. Numerous banks and other types of companies use affiliates to hide bad debts and other financial transactions from public disclosure.

For the bank, it worked like this: The bank lent money to the affiliate, which used the money to buy financially troubled property on which the bank had forclosed, a bank spokesman said. Although the bank was in essence lending itself money to buy bad loans from itself, the problem loans magically disappeared from its books. They would show that the bank had conducted an auction for the loan, and bid it good-bye.

This is within the rules in Japan. A Finance Ministry official said that the Bank of Ryukyus does not have to report the finances of any affiliates it consider "unimportant."

Analysts said that financial sickness is particularly bad among Japan's 128 regional banks, of which Bank of Ryukyus is one. These institutions operate outside Tokyo, catering to parts of the country ignored by the big banks based in Tokyo and Osaka. They are often the lifeline of small and medium-sized companies and thus critical to regional economies.

About one-sixth of the regional banks "should be closed because they are near bankruptcy," said Yushiro Ikuyo, an analyst at Commerz Securities, the brokerage arm of Commerz Bank of Germany. The only reason these banks have not collapsed is because of Finance Ministry support and funds from the central bank, said Ikuyo. A ministry spokesman denied that any bank stays open solely because of ministry support.

Banking analysts in Tokyo said that when regional banks are ranked from strongest to weakest, Bank of Ryukyus falls around the middle.

But that's low enough so that many people in Okinawa remain worried. Kazuji Agarie, a 34-year-old entreprenuer who runs a marine products company, still thinks the bank is shaky. He hasn't returned money he withdrew last January. Seizo Marumo, a 64-year-old businessman, also is skeptical about the bank's health, but figures the government will protect his money, which he has kept there.

And sitting in his 9th floor office with windows overlooking the ocean on one side and Naha city on the other, Teruya remains skeptical too. He gestures out the window: "There are many companies in worse shape than us out there."

"Banks used to support them, but they can no longer do that. The debts are too huge," he said. "But they have to allow companies to go under gradually. Because if all of them fail at once, the banks would go under."

Special correspondent Akiko Kashiwagi contributed to this report.