Auditors were at the end of May preparing to approve the annual results of Japan’s four mega-banks, including Mizuho, nominally the largest bank in the world by assets. The consensus was that all four banks would make it through the auditing process.
But when it comes to poring over the books next time round, auditors may find it almost impossible to approve the accounts. If they cannot, that could set in train the long-awaited nationalisation – or at least recapitalisation – of Japan’s banking system.
The reason is Resona. On May 17, when auditors of Japan’s fifth-biggest bank said that, in all conscience, they could not approve Resona’s accounts, the government was forced to inject $17bn of public funds into the bank.
Shin Nihon, Resona’s auditors, had found themselves unable to accept the bank’s rosy profits forecasts for coming years, largely because the recently merged regional bank had been dripping red ink for years. As a result, the deferred tax assets (DTA), which made up 77% of Resona’s core capital, were drastically reduced, bringing its capital adequacy down to just above 2%, well below the 4% legal minimum for a domestic bank.
Robert Feldman, chief economist at Morgan Stanley in Tokyo and an intellectual ally of Heizo Takenaka, the economy and financial services minister, says the writing has been on the wall since last October. Then, Mr Takenaka, brought in to shake up the banks, made it publicly known that auditors would be held responsible for their audits. “It was there for anybody to see in black and white,” says Mr Feldman. “Nobody believed Takenaka at the time, but the writing was on the wall.”
If that is true, and presuming that Mr Takenaka can stay in his job long enough, then time is up for many of Japan’s other big banks as well. These banks do not rely quite as heavily on DTAs as did Resona, but only just. As a percentage of Tier 1 capital, DTA’s account for 51% of Mizuho’s capital, 58% for Sumitomo Mitsui and 54% for UFJ. For Mitsui Trust, DTAs account for a staggering 88.6% of core capital.
“I think a precedent has been set,” said one auditor who declined to be named. “After Shin Nihon did that to Resona, we are all going to have to look at this issue more carefully.”
The issue of DTAs could become particularly acute since all four of Japan’s big banking groups have made losses for the past two years. Unless they can do so again next year, auditors may be forced by the Resona precedent to drastically write down their DTA assumptions.
That presents banks with a stark choice. Some may try to raise more capital, as they did in the run-up to book closing at the end of March. Mizuho, for example, tapped its own borrowers for Ą1,100bn in fresh equity. As part of its capital raising, Sumitomo Mitsui got Ą150bn from Goldman Sachs.
That trick, enough to stave off nationalisation this time around, could be hard to repeat next time round, particularly as bank shares have tanked since those deals were concluded, punishing the new shareholders.
A second alternative would be to reduce assets by aggressively calling in loans. Because banks have been doing just that bank lending has fallen for 64 months in a row. But again, there is a limit to what banks can do.
The third choice is the most obvious, though the hardest to take. Japan’s big banks could do what Resona has just done. Admit that they cannot make it on their own and ask the government for funds.
