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ArchiveJanuary 2 2000

Japan : Financial services come of age

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Anthony Rowley reports from Tokyo on why Japanese banks are looking ahead with optimism.

The curtain has finally come down on what has been a lost decade for Japanese banks, during which they have slid ignominiously from global supremacy (in terms of asset size at least) to the verge of bankruptcy, under the weight of bad debts - and in some cases have gone over the edge.

If the banks have appeared to move with caterpillar-like speed towards reforming their outdated structures, they now resemble a chrysalis, from which should emerge giant butterflies that can slough off the legacy of poor management that has held back their progress. It promises to be a spectacular transformation.

The past year has been marked by a series of dramatic announcements of mergers and alliances between leading domestic banks - in some cases involving tie-ups with, or takeovers by, foreign institutions. The mergers have fairly long lead times but, when they finally come to fruition, Japan should once again be able to boast of having the first and second largest banks in the world (again in asset terms).

More important, it should have a modern, more efficient and globally competitive banking industry. There are probably one or two more mega-alliances yet to be disclosed but as analyst James Fiorillo at ING Barings in Tokyo says: "Major bank match-making [in Japan] is nearing the end game - a few more big announcements and it will be over." After the drama of these announcements, however, comes the hard part: merging traditionally different cultures among leading banks; learning new management techniques, and absorbing modern banking technologies.

Three banking alliances announced in recent months have, in effect, reduced the number of "city" or money-centre banks in Japan from nine to six, and at the same time have spelled the end of Industrial Bank of Japan (the last remaining, viable long-term credit bank) as an independent entity. Meanwhile, the seven trust banks making up the remainder of Japan's formerly 21 major banks appear likely to merge or to be reabsorbed within the city banks that spun them off.

The stage is being set for the emergence of just three types of bank in Japan: three or four mega-banks with a wide functional and geographical span; several so-called super-regional banks that will combine domestic lending functions of current city and regional banks; and a host of niche or boutique banks. At the same time, a kind of two-tier banking and financial system is developing - one tier consisting of alliances between foreign and Japanese institutions and the other of mega-groupings formed from proposed mergers among domestic institutions.

Examples of the first category include: an investment banking operation being established in Japan by Merrill Lynch, using large parts of the failed Yamaichi Securities that the US group acquired: the investment banking operation that a group led by Ripplewood Holdings hopes to establish via acquisition of the nationalised Long Term Credit Bank of Japan (LTCB): and a mooted investment banking alliance between Lehman Brothers Holdings and Bank of Tokyo- Mitsubishi.

The foreign partners in these alliances are acknowledged industry leaders and are also acknowledged to have much more sophistication than their Japanese counterparts in investment banking, asset management, trading in derivatives and other instruments, electronic banking and operating automated teller networks. Until recently, it appeared that the foreign joint ventures would quickly come to dominate such areas, leaving Japanese banks almost completely dependent on retail banking operations, where their dominance cannot so easily be challenged by foreign competitors. (Although Citibank has made considerable inroads in Japanese retail banking, it has taken the US group well over a decade to achieve this.)

The recent wave of proposed mergers among Japanese banks has challenged the assumptions that a neatly delineated, two-tier market can persist for long, however. Banks involved in these mergers have declared their intention to compete fully with foreign institutions, both in the Japanese domestic market and, eventually, on a global basis. The principal mergers so far announced have been those between Industrial Bank of Japan (IBJ), Fuji Bank and Dai-Ichi Kangyo Bank (DKB), which will be the world's largest in asset terms; between Tokai Bank and Asahi Bank; and between Sumitomo Bank and Sakura Bank, the world's second largest in asset terms.

Last November, Daiwa Bank and Sumitomo Trust Bank announced their intention to form a joint venture in the pension fund management business, which may create a closer alliance later between these two institutions, possibly involving the addition of Mitsui Trust. Meanwhile, Softbank (not a bank, but an Internet financing and publishing group headed by Masayoshi Son) is leading a syndicate of Japanese investors bidding to take over the failed Nippon Credit Bank (NCB). The consortium also includes Tokio Marine and Fire Insurance Company, leasing company Orix and Ito Yokado, owner of Japan's 7-Eleven shop chain.

The new chairman of Japan's Financial Reconstruction Commission, Michio Ochi, is thought to want a domestic bid for NCB. Sanwa Bank, the only one of the principal city banks yet to declare an alliance, is reportedly considering a tie-up of some kind with Bank of Tokyo-Mitsubishi. (BTM is itself a product of an earlier merger between the Bank of Tokyo and Mitsubishi Bank and has now been pushed well down in the ratings by other Japanese mega-mergers).

These amalgamations promise to produce new banking entities with huge assets - US$1,300bn equivalent in the case of IBJ, Fuji and DKB, and $940bn for the Sumitomo/Sakura grouping - but some analysts question whether their dominance will extend beyond asset size. They argue that, in the rush to form defensive alliances in the aftermath of the prospective takeover of LTCB by Ripplewood Holdings being announced, Japanese banks have failed to focus on their inherent strengths and to select merger partners accordingly. (The Ripplewood takeover has yet to be finalised.)

The Japanese authorities' desire to build national champions in the banking arena is held to be partly responsible for the sudden rush of mergers. Japanese banks are said by some critics to be pursuing unfocused universal banking strategies, which will result in merged groups having to sell off significant portions of their assets and operations to avoid overlaps and to achieve rational integration of operations. Given their relative lack of expertise in other areas, such groups will be forced to concentrate on domestic retail banking, they say. Such arguments appear to state the position too simplistically, however.

A large capital base is essential for banks aspiring to be global players in areas such as underwriting financial securities and lending to corporate clients and other entities. Japanese banking mergers will produce entities with a strong global competence in term of capital. Also, by reducing staff numbers and cutting branch networks, the merged banks should be able not only to improve operating margins but also to make good the deficiencies in investment that have caused them to lag in terms of computerisation and technology.

Holding company structures allow banks more flexibility to merge and rationalise their activities without having to submerge their corporate identities first. Mergers so far announced offer a liberal time frame in which to make such adjustments, pending full integration. Moreover, while Japanese banks were anxious to avoid wholesale takeover by foreign institutions, they appear more willing now to contemplate absorption of banking techniques from abroad, and to consider employing foreign nationals in key positions (so long as the Japanese identity of the institution is preserved).

Such flexibility has become key to the survival of Japanese financial institutions. Perhaps most important is that banking in Japan is being viewed as an important generator of economic activity and of employment rather than merely as being the handmaid of industry. The necessity to expand investment banking and capital market activity has also been recognised at national and individual bank level, while the importance of asset management has also been recognised.

It will be some time yet, however, before Japanese banks are ready to make a re-appearance as aggressive players on the international scene. Toro Hashimoto, president of Fuji Bank, says it will take a "considerable" time for this to happen, while Tasuku Takagaki, chairman of Bank of Tokyo-Mitsubishi, puts it at "at least two years". The region suffering most, meanwhile, from the Japanese banks' international retreat, is Asia. The banks are "surrendering market share" and "giving up good lending opportunities", argues ING Barings' James Fiorillo. Their reticence, he suggests, reflects not so much the Asian contagion as the "inability by Japanese banks to risk-base price their loans".

Japanese banks had around $124bn of lending in Asia (excluding the offshore banking centres of Hong Kong and Singapore) at the peak in 1997, but this has now fallen to around $7bn. This represents an "unprecedented withdrawal" from Asia, he adds. It is not only overseas that Japanese banks are contracting their lending. Overall, loans by Japanese banks in the domestic system fell for a twenty-third consecutive month in November, while foreign banks continue to take up some of the slack. This process of consolidation - both at home and overseas - is likely to continue for some time yet as the banks regroup, in a structural as well as strategic sense, ready for their next assault.

The time-frame for disposing of NPLs and for consolidating mergers suggests that it could be two to three more years before this assault comes.

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