Commentary: A Finance Bonanza In Japan? Forget It

When Merrill Lynch & Co. acquired parts of the ailing Yamaichi Securities earlier this year, the move was heralded as a foretaste of the future of Japanese finance. With 33 of Yamaichi's branches and the best 2,000 of its personnel, Merrill Lynch Japan Securities Ltd., a separate operating unit, was instantly counted among the brave new firms that would decisively open the potentially huge market to foreign participants.

Now, things look a little less grand. Merrill's breakeven target has been bumped up from three years to five, Tokyo analysts say. For Merrill and other crusaders, things will only get tougher. "These firms are investing here on the basis of experience elsewhere, and that doesn't necessarily count for much," says Stephen Church, who runs Analytica Japan, a Tokyo consultancy. "You get the feeling they don't really know what they're in for."

GERMAN MODEL. Merrill, UBS, Fidelity Investments, Citigroup, and others all expect Tokyo's "Big Bang" reforms will yield unfettered access, open competition, and transparency--in other words, a level playing field. Some will do all right--even prosper for the next 5 to 10 years--until Tokyo finishes reshaping the sector. After that, wish them luck, for by then it will be clear: Japan, while slowly accepting the competitive principle, is far from embracing the liberal capitalism of Adam Smith. Instead, Japan's new financial sector will more closely resemble Germany's financial services industry.

Tokyo's most hidebound bureaucrats know the banks and brokerages need an overhaul. But however dire things look from the U.S. side of the Pacific, Japan views the massive balance-sheet problems of its banks not as a crisis so much as a bump on the road to strengthening finance as a strategic industry. Indeed, the Finance Ministry has quietly mulled banking reform for almost 20 years--and settled some years ago on Germany's banking system as a model. The "Allfinanz" model turns a core of powerful banks into one-stop financial supermarkets. MOF believes this model is the fastest way to dismantle one of the key reforms of the postwar period: the highly compartmentalized financial system the American occupiers helped create.

Skeptics might assert that after decades of success, Germany's banks are now their own worst enemy: slow, incapable of competing in global investment banking, and unsuccessful at attracting new customers. And MOF has not covered itself with glory lately, either. Its tax policies helped drive Japan into its current recession, and its inspectors did a terrible job policing the reckless loan policies of Japan's banks.

This is all true, and the risks of a misfire are there. But MOF has survived rough times before. And there's nothing to say Japan cannot import the German model while anticipating its problems and reshaping it to suit the Japanese context. Clearly MOF now believes that building large universal banks with immense marketing reach is the best way to meet foreign competition. Decades from now, Japa-nese balance sheets are likely to look a lot cleaner, MOF will have a new regulatory framework, and Japan's most prominent banks--the best of the keiretsu banks plus the Industrial Bank of Japan--will offer everything from underwriting and new issues to retail equities and insurance.

That's the plan, discernible in outline. If it succeeds it is likely to prove a fateful choice for those Western firms now spreading themselves across Japan's financial landscape. They can stay and fight--or they can prosper for a few years, then sell their operations back to the Japa-nese. For as Ja-pan's domestic financial players marshal their forces, today's aggressive foreign investors will see their market shares slowly decline. They will have done much to upgrade the local pool of banking personnel, and they'll have imported products that the recast Japanese institutions can, in effect, adapt and improve for their own ends. Then Japan's universal banks will market the same products foreigners are introducing--but with more reach and a better grasp of Japanese sensibilities.

Policymakers have toyed with the idea of universal banking off and on since the 1880s when Japan first started borrowing liberally from Germany's economic model. Even now, the Teutonic strategy will take years to unfold. But U.S. finance companies ignore it at their peril.

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