Japan's benchmark share index spiralled to 16-year lows yesterday, threatening a cycle of harm in the banking industry and drawing ever more desperate calls for calm from officials.
The baleful influence of the banks extended to the government JGB market. Falling shares can be a boon for bonds since investors seek the safety of fixed income debt, but here there is no place to hide since Japanese banks may have to unload JGBs to cover their equity losses.
The malaise spread to the yen which retreated to ?123.50 per dollar from Friday's one-month highs around ?122.70, though dealers said uncertainty over US commitment to a strong dollar was still the overriding concern in the forex market.
"The conventional wisdom is that with the Nikkei at these sort of levels the average bank is looking at a loss on its stock holdings," said Chris Walker, strategist at CSFB.
Such losses threatened the asset quality of banks' balance sheets and led to further selling of bank shares, so leading the Nikkei yet lower. The Nikkei average shed 2.51 percent or 298.76 points to 11,609.63, its lowest close since Jan. 7, 1985.
The rout was led by the banking sector IBNKS, which alone fell almost five percent on the day bringing its losses in the past two months to no less than 30 percent.
Heavyweights such as as UFJ Holdings and Mitsubishi Financial Group were not spared, with both losing around eight percent of their value on the day.
Such was the strain that Japanese Finance Minister Masajuro Shiokawa abandoned his usual nonchalance and admitted to being very worried by the falls in share prices. So worried that he asked the brokerage industry for help in boosting the market through mutual funds, though he added that this was not an administrative order.
However, many analysts lay part of the blame for the latest equity slump at the door of the government.
"The market is clearly disappointed at a lack of concrete steps from the administration for the cleanup of the bad loan mess," said Zenshiro Mizuno, general manager of equity trading at Marusan Securities.
The reformist administration of Prime Minister Junichiro Koizumi has proposed banks scrub certain bad loans off their balance sheets in two to three years. As ever, analysts fear the changes do not go far enough.
"Most of the disappointment is centred on the bad loan issue, Kozumi's people have focused on the very smallest possible definition of bad loans, just the tip of the iceberg," Walker said.
With banks struggling to write off even the narrowest slice of bad debt, the last thing they need is falling equity prices eating into their ability to offset loan provisions with profits from stocks.
Indeed, traders fret that the banks will have no recourse but to realise profits on their bond holdings, and these have grown truly massive in the recent period of super-loose liquidity.
Furthermore, the deeper the dive in shares, the more bond investors worry that the government will fall back on the tried, and failed, response of fiscal spending.
All of which was enough to see the key 232nd 10-year JGB yield briefly climb to three-month highs at 1.390 percent, before slowly edging down to 1.375 percent on last-minute adjustments ahead of a 10-year JGB auction on Tuesday.
September 10-year JGB futures closed at 139.25, up 0.09 point from Thursday's Tokyo session close.
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