Ever since Junichiro Koizumi became prime minister of Japan, in 2001, he has argued that structural reform of the country's financial system is vital for long-term national economic growth. His approach seems to contrast favorably with that of past administrations, which failed to tackle this issue in earnest, fearing the political consequences of the pain brought about by change. Koizumi is absolutely right to seek new directions in fiscal policy, the privatization of state-owned entities, and regulatory reform, but he has gone neither fast nor far enough. Indeed, structural changes have yet to get under way, and now the question is whether the momentum for reform will continue.

Some progress has been made. Big Japanese banks are at last shedding bad loans, and the balance of nonperforming ones is down by 13 percent compared with March 2003. All of the major banks, with the exception of Resona, posted positive interim results on a consolidated basis last September, and the share prices of some big banks are recovering. The government has stiffened the accounting requirements for calculating deferred tax assets, making it harder for Japanese banks to book them as equity capital. And banks have reduced their holdings of these questionable...