"We don't see any problem in the practice of replacing part of a portfolio in JGBs (Japanese government bonds) with less liquid municipal bonds under current accounting standards," a senior MOF official said on Wednesday. "As long as those transactions are made at market value."

The Financial Times newspaper reported on Wednesday that some Japanese banks have been pretending to sell JGBs at artificially high prices to large Tokyo brokers, in exchange for low liquidity bonds bought at artificially low prices.

The newspaper said such deals -- called "tobashi," or "pitching" -- allow investors to conceal losses temporarily because losses on JGBs need to be reported regularly, while losses on other securities, such as municipal bonds, do not.

The MOF official said such moves would becomea legal issue only if the seller promises to a third party to buy back securities at a price not reflecting the prevailing market value.

They would violate the Securities Exchange Law as an illegal transfer of profits as well as the Commercial Law governing management responsibility, the official said.

Tobashi deals involve banks or brokerages selling their or their customers' bad loans or loss-ridden securities to non-consolidated affiliates or other traders. In exchange, they receive loans or other financial favours to make their or their customers' balance sheets look better in the eyes of investors.

"But such transactions could cause significant losses on the side of the seller, depending on the market conditions," the official noted. "There is nothing to suggest they would be motivated to take that sort of risk."

The FT said it was easier to engage in tobashi deals after a recent move by the Japan Securities Dealers' Association (JSDA) to abolish its transaction rule that all bond trades need tobe conducted within two per cent of the market price.

However, traders here said they doubted a JSDA regulation change alone would be enough reason to spur banks to take the risk of illegal transactions.

Japanese and Western traders said they found it hard to believe such deals were still popular, in light of the 1997 collapse of Yamaichi Securities -- then the nation's fourth largest brokerage -- and the resulting stepped-up supervision by the Financial Supervisory Agency (FSA).

Yamaichi's failure was blamed largely on their secretive tobashi transactions.

"If (anyone is) still involved in these practices now, they must be either desperate or ignorant," said one senior Japanese banker.

A JSDA official said the group is investigating the impact of the rule change to determine whether it makes it easier for its member brokerages and banks to engage in improper transactions.

The FSA on Wednesday declined to comment on the allegations.

"I believe the article may simply have confused it withportfolio reshuffles, which have become more active here," said a senior trader at a European bank.

"Bankers reshuffling their portfolios to improve short-term performance, including duration changes, have become popular here against a backdrop of lean dealing profits," he added.

The FSA has recently started investigating whether banks and brokerages operating here have hidden bad loans by transferring them to affiliates.

"Not just the Japanese (banks), but foreign brokers here as well are very nervous about being inspected by the FSA," said the Japanese banker.

Agency inspectors last week were in the Tokyo offices of Credit Suisse First Boston to begin an inspection into the group's businesses, including its securities arm and their trust bank and financial products branches.

The FSA did not explain why it had decided to inspect units of CSFB, but Japanese media reported that the probe was focused on its risk management and compliance with legal requirements.