TOKYO - JAPAN outlined steps to ease strains on its banks, as Tokyo stocks hit a 26-year low on fears that lenders will need billions of dollars to boost capital, and as the yen rose despite a G7 warning of excess volatility.

Investors dumped Mitsubishi UFJ Financial Group and other major Japanese banks, on concern that their heavy exposure to domestic equities could trigger the kind of massive losses that tore through Wall Street but have so far skirted Japan.

Prime Minister Taro Aso said the government would expand a scheme that gives banks access to public funds and also strengthen regulation on the short-selling of shares.

Mr Aso has also said a state body should be used to buy shares from banks, and that limits on bank recapitalisations should be raised, Economics Minister Kaoru Yosano told reporters.

The prime minister also called for extending tax relief on income from stocks and dividends, Mr Yosano said.

On Sunday, Mr Yosano said that a newly announced bank bailout scheme should be increased several-fold to nearly US$110 billon (S$166 billion).

The measures underscore the difficulties now facing lenders in the world's No.2 economy, which at first appeared to have avoided the credit crisis, allowing them to invest in overseas rivals.

'The government will have to do something for banks', said Mr Koichi Ogawa, chief portfolio manager at Daiwa SB Investments.

'The problem here is that the stock market has fallen, it has nothing to do with derivatives or anything like that. As stocks have dropped, banks are faced with rising paper losses'.

Tokyo's benchmark Nikkei share average briefly dropped as low as 7,141 on Monday, its lowest since 1982.

The benchmark has lost about half of its value so far this year - falling by nearly a third this month alone - as a rise in the yen and a weakening outlook for the economy has curbed appetite for Japanese stocks.

The losses, which drove more risk-averse investors away from currencies such as Australian dollar and back into the yen, overshadowed Group of Seven warnings on Monday that the yen's sharp swings posed a threat to financial and economic stability.

Traditional Japan
Although Japanese banks have had little exposure to the risky credit instruments that crippled Wall Street, investors now fear that lenders' extensive shareholdings and rising bad-loan costs will unravel profits this year.

Traditionally, Japanese lenders hold large stakes in their corporate clients as a means to cement business ties.

The value of those stocks totalled more than US$250 billion at the end of March, data from the Japan Bankers Association shows.

Small, local banks, which are also tied to Japan's dwindling regional economies have also been hit hard.

In response, the government recently announced a plan to make up to 2 trillion yen in public funds available to the country's lenders.

Yet that scheme should be increased to around 10 trillion yen (S$160 billion) from 2 trillion yen, Mr Yosano said on Sunday.

Mr Aso is also planning to announce an economic stimulus package later this week to support the economy.

That package, Japan's second in just a few months, is expected to include a total of 5 trillion yen in new spending, including 2 trillion yen in temporary income tax cuts.

Capital raising
Mitsubishi UFJ Financial Group, Japan's top lender, is considering raising up 1 trillion yen to shore up its capital, people familiar with the matter have said.

Mizuho Financial Group, Japan's second-largest bank, and third-ranked Sumitomo Mitsui Financial Group, are both looking to raise as much as 500 billion yen, newspapers reported on Monday.

All three lenders said in statements on Monday that they had made no decisions regarding their capital plans.

MUFG, which recently invested US$9 billion in US investment bank Morgan Stanley, has also this year paid US$3.5 billion to take full control of California lender UnionBanCal and spent about 150 billion yen to raise its stake in consumer finance affiliate Acom Shares of Japan's top three banks fell by their maximum limit allowed on the Tokyo Stock Exchange.

Mitsubishi UFJ was down 14.6 per cent, to 583 yen as of 0520 GMT (1.20pm Singapore time).

Mizuho tumbled 14.8 per cent to 230,000 yen while Sumitomo Mitsui dropped 11.5 per cent.

The Nikkei closed 6.4 per cent down, hitting its lowest closing level since October 1982. -- REUTERS