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Japan Takes A Broom To The Banking System (Int'l Edition)

International -- Cover Story: Special Report


Japan's once mighty banks don't inspire much awe nowadays. Since 1993, they have had the dubious distinction of being among the least profitable in the industrialized world. Recent financial collapses at home have humiliated big banks into paying a premium to borrow in global money markets. The U.S. is even taking steps to limit federally backed American lenders' exposure in Japan--a major comedown on the global stage. "This is a sad story," says International Trade & Industry Minister Ryutaro Hashimoto.

Sad, perhaps, but not as terrifying as it seemed only a few months ago. After years of masking Japan's banking problems with stopgap measures, the Ministry of Finance (MOF) has finally decided to clean things up. MOF has outlined a plan to use public money to manage future bank failures, consolidate weaker players, and sell off nonperforming bank assets. The goal: to transform the sprawling, inefficient, and overprotected banking system into a lean and competitive industry. In the new landscape, dozens of competing institutions might give way to four or five $1 trillion monoliths that would lead Japan back into the global banking race and dominate its push into Asia's booming markets.

Getting there, of course, will be neither easy nor swift. Japanese banks will be lucky to achieve a return on equity of 6.5% this year--a third of what Citicorp earned in the second quarter. One reason: the bad-debt crisis. Private analysts estimate nonperforming loans at $800 billion, or 16% of Japan's gross domestic product. Banks and corporations already dumped $6.6 billion worth of U.S. real estate in 1994 and could unload $10 billion more this year. But billions in sour property loans at home still weigh down their books.

MANAGED PANICS. In his efforts to fix the mess, Finance Minister Masayoshi Takemura has gotten a big assist from central bank governor Yasuo Matsushita. The Bank of Japan has lowered interest rates nine times since July, 1991, including a half-point cut in the benchmark discount rate, to 0.5%, on Sept. 8. With short-term rates at historic lows, lenders can borrow money nearly without cost to buy government bonds yielding 2.8%. As loan demand revives, banks may get some relief from the gap between the 2% interest rates paid to depositors and the 3% they command on corporate loans of more than a year. The central bank also "is committed to provide all the support possible" to big banks as they restructure their portfolios, a well-placed financial source insists.

But the banks have a long way to go before they look anywhere near healthy. MOF has already put out some big fires--the worst being a $1 billion deposit run on Tokyo's Cosmo Credit Union in July and the collapse of the Kizu Credit Union and Hyogo Bank Ltd. in Osaka a month later. By committing more than $11 billion to cover deposits, MOF calmed fears of a financial meltdown. Perhaps more important, these managed panics softened public resistance to using taxpayer money to help solve the banking system's problem once and for all.

For example, MOF is seeking approval from the Diet for a plan to refloat Japan's Deposit Insurance Corp., whose $10 billion reserves were wiped out by recent runs. The ministry would replenish the coffers with public money, then guard against future shortfalls by requiring member banks to contribute 0.04% of total deposits, up from 0.01% now.

The ministry is also trying to bail out Japan's insolvent housing loan corporations, or jusen, which are saddled with some $81.5 billion in problem loans. Refloating them will require public money and contributions from big banks with longstanding ties to the housing lenders. After that, "a Resolution Trust [type] vehicle may become necessary" to sell off assets, figures Sei Nakai, deputy director of MOF's banking bureau. The jusen might be dissolved gradually, with their more promising assets force-fed to the money-center banks that are shareholders. Uncollectible loans might be written off or forgiven.

Not all the solutions will come out of taxpayers' hides. MOF is also weighing issuing bonds to capitalize new "workout" banks, such as the one created to take on Hyogo's $14.5 billion in problem loans. Hyogo and its 20-odd nonbank affiliates will be liquidated in early 1996, and a new bank--with entirely new management--will take over their loans. Losses will be covered by Bank of Japan loans, deposit insurance funds, and additional capital from neighboring banks. As part of a $135 billion economic stimulus plan announced Sept. 20, MOF will also earmark $30 billion to buy land, a move that will help banks by propping up real estate values.

MERGER FEVER. MOF is also likely to speed the consolidation that has already begun in the overcrowded industry. In April, Mitsubishi Bank Ltd. and Bank of Tokyo Ltd. joined to form the world's biggest bank, with roughly $700 billion in assets. The new bank will have fewer bad debts as a proportion of total loans than any of its nine biggest competitors. Similarly, 29 credit unions in the Tokyo area may be merged into three, each with deposits of $5 billion and fresh capital. With 21 major commercial banks chasing the same corporate clients--not to mention 129 regional banks banging heads--even bigger mergers are sure to follow.

A leaner banking system would surely enhance Japan's expansion into Asian markets. The banks already have a big edge in lending to Japanese multinationals, which invested nearly $65 billion in the region last year. Sanwa Bank Ltd., for instance, has made major inroads into China and Hong Kong and is the No.1 bank in Asian project financing. "These guys are definitely not out of the game," says BZW Ltd. analyst David Threadgold.

But competition is heating up. The megamerger between Chase Manhattan Corp. and Chemical Banking Corp. will be felt in Asia. Chase has made big strides in the syndicated loan business and also snagged a piece of the Paiton financing. Cost-cutting from the merger will only strengthen its presence. To hang on to market share as competition grows, the Japanese are cutting prices abroad despite dismal results at home. "Loan spreads have fallen by as much as 50% in Thailand," thanks to Japanese discounting, says Arun Duggal, Bank of America's Japan country manager.

Japanese banks also have some catching up to do with Western rivals in businesses that do not involve lending. Executives often grouse about the big edge that U.S. rivals such as J.P. Morgan, Salomon Brothers, and Goldman Sachs have in offering swaps and other derivative products to lure clients. "Their skill in derivatives is still much better than ours," says Nagayoshi Kudoh, managing director at Sakura.

You wouldn't have heard that kind of an admission back in the 1980s, when the Japanese were riding high. "Japanese banks believed we were almighty, that we had enough capital to compete in every business," muses Kaneo Muromachi, Sanwa's managing director of international operations. Now, as Japan emerges from the post-bubble wreckage, banks are setting more realistic goals. And if MOF can bring a decisive end to the bad-debt crisis at home, odds are that Japanese lenders will reemerge a little wiser--and a lot more profitable.

Cleanup Measures for Japan's Banking Mess

How Tokyo officials hope to relieve the estimated $800 billion in bad loans burdening the banks:

-- The Bank of Japan is cutting short-term interest rates to the bone, so banks can borrow from each other more cheaply than they lend to the


-- The $10 billion Deposit Insurance Corp. may be expanded, with members paying higher premiums

-- New workout banks, capitalized with deposit insurance funds, will begin absorbing weak credit unions and banks

-- MOF may create a vehicle like Resolution Trust in the U.S. to sell off bad housing debts

-- Large banks and credit unions will have to disclose risky loans and show their books to the public

-- MOF will stage-manage more consolidation among financial institutions--strong as well as weak

DATA: BUSINESS WEEKBy Brian Bremner in Tokyo

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