Japan has a perennial capacity to surprise and the sudden surge in banking mergers this year almost certainly indicates another unexpected leap forward, both for the domestic banking industry and for the international capability of Japanese banks.
As a result of the respective tie-ups agreed in August among Industrial Bank of Japan, Fuji Bank and Dai-Ichi Kangyo Bank, and now between Sumitomo and Sakura banks, Japan will have the first and second largest banks in the world in terms of assets. The significance of these moves extends well beyond just size.
They indicate, say some analysts, that Japan is beginning to focus on banking and financial sector reform with the same kind of intensity that it applied earlier to building super-efficient export industries. The banking alliances are defensive in nature but they point to the emergence of more aggressive attitudes among Japanese bankers towards investing in technology, and raising the sophistication of their operations to world-class levels.
Banking mergers in Japan have often been seen as a way of dealing with non-performing loans (NPLs). Some have argued that merging weak banks does not create a strong one. But the bad debt problem is already being eroded by a strengthening in Japan's economy and by a steady decline in the rate of new corporate bankruptcies. Mergers appear to be more about creating new strengths than dealing with old weaknesses.
They also indicate fundamental changes in corporate and shareholding structures as well as further realignments within Japan's banking sector. The mergers do not suggest that what are likely to be the remaining four or five leading Japanese banks after the merger wave ends will reverse the dramatic retreat they have made in recent years from international lending. Toru Hashimoto, chairman of Fuji Bank, says it could be up to two years before Japanese banks make a convincing reappearance on the international stage.
But when they do, it is likely to be from a springboard of genuine competence rather than on the basis of asset inflation induced by a bubble economy as in the past. Sumitomo and Sakura, two leading 'city' or money-centre banks, revealed in October that they are in talks with a view to merging completely by April 2002, although they plan to begin exchanging shares in each other by the end of the fiscal year in March, and to integrate certain operations before the merger date.
Sumitomo, part of what was one of Japan's leading zaibatsu groups (bank-centred holding companies) had been widely expected to seek a merger partner in order to maintain a dominant position. The choice of Sakura, part of the rival Mitsui business and banking empire was unexpected, and the move appears to have major implications for corporate sector restructuring.
Although the zaibatsu were abolished by occupying US forces after World War II, somewhat looser-knit keiretsu groupings replaced them. Sumitomo and Mitsui have their own keiretsu groups but Sumitomo Bank president Yoshifumi Nishikawa says these groupings will be affected significantly by the proposed merger with Sakura. Their keiretsu structures will be integrated to some extent but there are also likely to be disposals of shareholdings by both banks in numerous business interests.
Current law stipulates that Japanese banks may not hold more than a 5 per cent stake in any company and there are overlapping shareholdings in some cases, as between Sumitomo and Sakura. Divestiture of shares will accelerate the process of unwinding that is already under way in the extensive web of cross-shareholdings among Japanese companies and financial institutions in general. A number of factors appear to have influenced the decision by Sumitomo and Sakura to announce their prospective merger at this point in time.
These include: l IBJ, Fuji and DKB's announcement that they intend to merge their activities to form what will become the world's largest bank, and moves by Tokai and Asahi city banks to advance their planned merger to October 2000. The decision by Japan's Financial Reconstruction Commission to negotiate a purchase of the nationalised Long-Term Credit Bank of Japan by a group led by Ripplewood Holdings of the US has also been an important factor. l Another is the approach of April 2001, when full protection of bank deposits ends, as is the need to accelerate provisioning by banks against NPLs. The recent change in leadership of Japan's official Financial Reconstruction Commission (which some believe may herald a less enthusiastic official approach toward banking mergers), may also have played a part.
The combined assets of Sumitomo and Sakura banks will be 99 trillion yen ($934bn), which will make it the world's second largest bank. Recent banking mergers within Japan have completely upset the global rankings table with Fuji/IBJ/DKB now occupying prospective first place and Sumitomo/Sakura in second place. Deutsche Bank (currently the world's largest in asset terms) faces being demoted to third place.
Bank of Tokyo-Mitsubishi (BoTM), which was the world's largest bank following the merger of Bank of Tokyo and Mitsubishi Bank several years ago, will move from fifth to seventh place as a result of newly announced Japanese bank mergers. Unlike IBJ, Fuji and DKB, Sumitomo and Sakura will not use a bank holding company as the vehicle for effecting their merger but to go instead for a more conventional exchange of shares in which one entity (probably Sumitomo) will completely absorb the other, although the new name has yet to be decided.
The merger is likely to be a more complete one than that among the other three banks but at the same time it may pose more problems in consummating. The marriage between Bank of Tokyo and Mitsubishi led to considerable problems in merging identities, management styles and activities. Bank holding companies were newly legalised in Japan with effect from last year as a means of facilitating easier amalgamations.
Tokai and Asahi plan to take this route and other banking mergers may be effected before long using the holding company route. Sumitomo and Sakura will begin by co-operating in various areas of retail banking such as providing joint services at retail outlets, through automated teller machines and via Internet banking services. Later they will unify investment banking operations such as merger and acquisition (M&A) activities.
A new operation that Sumitomo has formed with Daiwa Securities will be merged with Sakura's securities subsidiary. Integration will be carried out of trust banking and insurance operations within the merged entity (as in the case of the IBJ/Fuji/DKB merger). The merger will give both banks access to a wide base of corporate clients and make it more difficult for rival domestic banks and foreign entities to break into this client group. This is a critical factor behind the current wave of bank mergers in Japan. The banks recognise that they must reduce costs significantly through mergers (Sumitomo and Sakura plan to shed roughly one-third of their combined workforce over time) but they must also invest much more heavily in computerisation and in other areas so as to upgrade their overall competence.
The FRC's decision to choose Ripplewood over a domestic banking consortium to acquire LTCB has also acted as a catalyst in this respect. Japanese domestic banks fear that the Ripplewood-led group of institutions will use LTCB as a springboard for forcing a major entry into Japanese banking and securities industries, by investing heavily in sophisticated techniques such as derivatives management and related skills. This is likely to galvanise further Japanese banks into defensive mergers.
