Japan's economy looks to be approaching a key milestone in its long climb out of an extended slump: After years of tightfisted policies, Japanese banks are starting to expand lending again.

After nearly a decade of decline, Japan bank loans could be growing again soon. The total amount of credit extended by Japan's national and regional banks in July shrank just 0.1 percent from a year earlier, the smallest decline since the data series was started in June 2004, according to the Japanese central bank. A broader measure of bank lending has been shrinking since 1997.

Encouragingly, lending is on the rise in some regions of Japan. On the southern island of Kyushu, for instance, loan growth turned positive last month for the first time in nearly six years.

Economists say overall bank lending will probably turn positive toward the end of 2005, given the healthy economic indicators and corporate earnings reported in recent months. On Friday, the government said the Japanese economy grew 0.3 percent in the April-to-June quarter from the previous three months.

The potential increase in lending comes as Japan's big banks reach the end of a decade-long struggle with bad loans, and it should eventually strengthen their bottom lines. But it is also another important sign that after years of credit contraction and falling prices, Japan could again be entering a cycle of expansion, with banks again playing a pivotal role.

"It's simply another step along the path of emerging from the misery of the past 15 years," said Richard Jerram, Japan economist for Macquarie Securities. A pickup in total loans, he said, would be "very positive from the macroeconomic perspective."

The strengthening economic optimism is buoying Japan's stock market. The Nikkei 225 Stock Average climbed to a four-year high of 12,263.32 on Thursday, and ended Monday at 12,256.55, up about 6.7 percent for the year.

Leading the rally were the nation's top banks, whose strong earnings for the latest quarter had pleasantly surprised the market. Among them, Mizuho Financial Group Inc. saw its shares climb to $5,044.17 on Monday, up 12 percent from a month ago. Shares of rival Sumitomo Mitsui Financial Group Inc. gained $201.40, or 2.6 percent, Monday to close at $7,863.78 -- 15 percent higher than on July 15. Aiding the banks' earnings recovery was a sharp decline in costs associated with disposing of bad loans, which earlier had eaten away much of their profits.

Credit Suisse First Boston LLC strategist Shinichi Ichikawa last week recommended that investors have more Japanese bank shares in their portfolios, saying the growing momentum for economic recovery -- which gives companies more impetus to borrow -- will help lenders' bottom lines even more.

For years, Japan's banks were so weighed down by bad loans that they couldn't afford to lend aggressively. As the economy slumped, many companies were too wary to borrow money to invest in new plants, machinery or stores. The resulting credit contraction further choked economic growth and left interest rates languishing at rock bottom.

That is all showing signs of changing. At the end of March, bad loans held by banks were down 33 percent from a year earlier, to $167.15 billion, and roughly half of the March 2003 levels, according to the Financial Services Agency. Machinery orders jumped 11.1 percent in June from May, suggesting companies are investing again.

Some economists say the increases in lending so far are being driven more by aggressive banks than by real demand for funding. In the year that ended March 31, the total amount of funds raised by corporations grew for the first time in nine years, according to the central bank. But the increase came primarily from fundraising in the equity and bond markets, while bank lending actually contracted.

Against this background, interest charged by banks on new loans is still falling, and aggressive lending in the real estate market is causing mini-bubbles in the prices of high-end properties in big cities, said Morgan Stanley economist Takehiro Sato. "The increase in [loan] quantity has not necessarily resulted in improvement in quality" of lending, he said.

A Japanese businessman stands by a display of stock prices. After years of decline, Japan's economy is heading toward growth.