The Big Bang, Japanese Style

Better late than never. Years after the U.S. relaxed the Glass-Steagall Act --the legal wall between commercial and investment banking--and Britain deregulated its financial industry in the Big Bang, Japan's byzantine financial system is finally starting to loosen up.

The transformation is happening Tokyo-style, in a series of baby steps rather than a giant leap. But for Japan, still suffering a hangover from the collapse of the "bubble economy" of the 1980s, the change is profound. At stake is the global competitiveness of Japan's financial industry. Unless the country can restore the health of its banks and brokers, they will be hard-pressed to do battle with U.S. and European rivals that have been expanding around the globe at a furious clip.

Pressure to modernize is coming from within, too. Japan's financial structure, imposed on its banks and brokers by the postwar U.S. occupation and upheld by turf-protecting bureaucrats, created a plethora of specialized institutions that channeled capital to industry. The system worked fine when Japan was a developing nation. But now that it's the world's No.2 economy, its financial needs mirror those of other industrial countries. And the financial crash of the early 1990s has made the system's inefficiencies even more apparent.

STAY AFLOAT. Regulators can afford to focus on industry restructuring now because the financial system no longer seems in imminent danger of imploding. Although banks still have about $300 billion in nonperforming assets, lower interest rates and a recovering economy are helping them stay afloat. "The rise in nonperforming assets seems to have peaked," said Bank of Japan Governor Yasushi Mieno at a conference on Oct. 31, "and we probably don't have to worry anymore."

So, for starters, the Ministry of Finance is allowing commercial banks to ease into the securities business and securities firms to dabble in trust banking. In addition, rather than using taxpayer money to bail out institutions drowning in bad real estate loans, it's encouraging stronger banks to take over weaker ones. For instance, in return for shouldering Nippon Trust's $5 billion portfolio of nonperforming assets, financial heavyweight Mitsubishi Bank Ltd. can expand into the trust business, which involves fund management and custodial accounts.

Initially, the biggest beneficiaries of financial restructuring are likely to be Japan's corporate borrowers. Since World War II, they have relied disproportionately on bank loans for their funding. MOF regulations stifled the kind of flourishing corporate-bond markets found in most other industrialized economies. Now, MOF realizes it can't deprive Japanese industry of modern, low-cost financing. Nor can it deprive its financial firms of the tools they need to remain globally competitive. Japanese financial groups must have freedom to offer the same spectrum of financial instruments and services that Western groups such as Barclays Bank PLC and J.P Morgan & Co. do--including wholesale and retail banking, sales and underwriting of securities and derivatives, and fund management.

NEW OPPORTUNITIES. But by the rules of its classic paternalism, the Ministry also can't leave banks uncompensated for the loss of corporate lending. So by allowing banks into the securities business but limiting them to bond underwriting, MOF is killing two birds with one stone: It gives banks new opportunities, while nurturing a bond market.

By last summer, six banks had established securities subsidiaries, two more had received trust-banking licenses, and all of the four biggest securities firms had launched trust banks. And by the end of this year, several more banks are expected to get securities licenses.

Eventually, the big players hope to become world-class providers of financial services that crash through all the old regulatory barriers, perhaps following the German model. "In the future, we're aiming to become a universal bank," says Norio Kato, a director at Sakura Securities Co., Sakura Bank Ltd.'s new brokerage subsidiary. "Our bank has 600 branches, and a million people visit them a day. We'd like to meet all their needs."

Despite such visions, financial bureaucrats are keen to preserve their own power. That's why they're promoting reform at a measured pace. The banks' new securities subsidiaries can only underwrite bonds and are limited to one office. They cannot sell, trade, or underwrite shares. The brokers' trust-banking activities are also limited--for instance, they can't operate pension trusts, and they can't join any nationwide networks of automatic teller machines. "Deregulation is happening in a very regulated way," says Yuichi Shono, a general manager at Bank of Tokyo Ltd.

New players are making inroads in spite of the restrictions. Yoshihide Kimura, a director in MOF's Securities Bureau, attributes an 8.8% jump in corporate bond issues during the first half of this fiscal year largely to the debut of the first three bank-owned securities firms. One of these, IBJ Securities Co., now ranks sixth, behind five traditional brokers, in corporate bond issuance. But because of MOF's restrictions, says IBJ President Atsuyoshi Yatsunami, "we're like an airplane flying with one wing."

MOF has promised to review the regulations as soon as next April, although fierce opposition from the struggling brokerage industry might delay further loosening for another year. The brokers feel they're getting the short end of deregulation's stick. Meantime, they're trying to defend their corporate-bond business from the bank interlopers by pushing the bonds on individual investors. Their huge nationwide networks of offices, which the banks are denied, give them an edge. "There's $5 trillion in private savings accounts here," says Akira Ogino, a managing director at Nomura Securities Co. "We want to induce more of it into capital markets." He says Nomura recently has successfully sold bonds from the likes of Toshiba Corp. and Tokyu Department Store Co. to consumers.

MOF could be forced to move faster if a lot more brokers and trusts look shaky. In August, 1993, the Ministry allowed Daiwa Bank Ltd. to buy more than 50% of Cosmo Securities Co., the first time a bank was allowed to own more than 5% of a full-fledged securities firm. Then last month, Mitsubishi Bank was permitted to take over teetering Nippon Trust Bank Ltd.

MOUNTING PRESSURE. Such rescue missions are costly in the short run, but many analysts believe they move the banks toward universal banking more quickly and cheaply than if consolidation were done from scratch. With speculation rising that Yasuda Trust & Banking Co. and Chuo Trust & Banking Co. may also be merger candidates, pressure could mount for the Ministry to give everyone an equal shot at new business.

Ultimately, keeping up with the global financial markets, not internal pressure, may be what forces Japan into faster deregulation. "It's the worldwide trend," says IBJ's Yatsunami. "If Japan is the exception, our financial industry will decline and lose worldwide competitiveness. This would be to the detriment of our country." Even the gnomes at MOF seem to be getting that message.

                Let the Turf Wars Begin
                           NEW FREEDOMS
      A dozen major commercial banks may now sell securities, and more will follow. Securities houses, in turn, can enter the trust business.
                         TOUGH RESTRICTIONS
      Banks doing securities underwriting must stick to bonds; they can't trade or float stock issues. No more than 50% of the new securities operations' revenue may come from bank customers.
                        MORE EFFICIENT MARKET
      The cost of capital should come down for corporate borrowers, and investors may shift some of their savings into bonds.
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