The balance of outstanding loans held by Japan's four main categories of banks fell 0.6 percent from a year earlier last month, compared with drops of 1.6 percent in September and 1.9 percent in August, Bank of Japan data showed on Wednesday.
The data has logged year-on-year falls every month since comparable figures for the category became available in January 2001, but October's decline was the smallest during that period.
Stripping out special factors, such as write-offs of non-performing loans, bank loans excluding those by "shinkin" credit unions were up 0.9 percent from year-ago levels, the third straight month of annual growth after turning up in August for the first time since October 1998.
Mamoru Yamazaki, senior economist at HSBC Securities, said demand for loans was picking up as the economy improved and companies looked to increase capital spending.
"A lot of companies do not have enough cash at hand to spend, and it seems like loan demand is picking up mainly from small and medium-sized companies," he said.
Loans held by regional banks, which cater mainly to smaller companies, were up 1.8 percent from a year earlier while those held by shinkin banks were up 0.2 percent, even before stripping out special factors.
"Conditions for lending are improving," a BOJ official told reporters. "But we can't say yet whether the decline in loans will continue to slow at the pace we saw in October."
Until this year, Japanese companies had shied away from borrowing as they rationalised their businesses amid deflation, while banks also concentrated on disposing of bad loans.
But companies are slowly warming to the idea of borrowing as the economy recovers and banks are becoming more willing to lend to companies as they are less worried about the risk of firms being unable to repay.
Under calculations from the Japan Bankers Association, the country's main bank lobby, outstanding Japanese bank loans were already up from year-ago levels in October for the first time since March 1999.
Loans were up 0.2 percent according to the group's data released on Tuesday, which differs from the BOJ in that it includes loans to financial institutions and is based on banks' end-month loan balance as opposed to an average figure.
MONEY SUPPLY DULL Still, Japan's most widely watched measure of money supply, M2 plus certificates of deposit (CDs), grew by only 2.0 percent from a year earlier in October, a small setback from a 2.1 percent gain in September.
Growth in money supply - a gauge of how much money the banking system is supplying to the rest of the economy - is seen as key for Japan shake off seven years of deflation.
Seiji Adachi, senior economist at Deutsche Securities, said while money supply growth remained anaemic, a breakdown showed the flow of money was improving between banks and individuals.
"The data shows individuals converting more of their savings into assets such as bonds, stocks and investment trusts as they grow confident that deflation is coming to an end," he said.
A government survey on Wednesday showed Japanese service sector workers less optimistic about business conditions, but a recovery in incomes is expected to continue supporting consumer spending and help the economy overcome seven years of deflation. The survey's diffusion index (DI) was at 50.7 in October, down from 51.7 in September but still above 50 which suggests more workers are optimistic than pessimistic.
Gross domestic product data on Friday is expected to underscore the view that the economy is in a steady recovery.
A survey of 38 private-sector economists by the government-affiliated Economic Planning Association produced an average forecast of 1.07 percent annualised GDP growth in the July-September quarter after 3.3 percent growth in April-June.