An $8 Billion Write Off And A Celebration

To hear Sumitomo Bank Ltd. board member Masayuki Oku tell it, the latest announcement to rock Japan's beleaguered banking world took shape over the four-day New Year's holiday. While most of the country celebrated, his bank's top managers hunkered down to map out a strategy for the next fiscal year. Their concern: how to deal with $15.8 billion in bad loans burdening their books since Japan's economic bubble burst in 1990. Says Oku: "They wanted to find a breakthrough."

It seems they did. On Jan. 27, only two months after forecasting a $600 million operating profit for the fiscal year ending in March, Sumitomo announced it would write down $8 billion in bad loans and take a $2.8 billion loss for the same period. The crunching loss is the biggest by a Japanese company in memory and the first by a major Japanese bank since World War II. More important, it is the most open admission yet of bank-loan problems in Japan, where disclosure standards pale by comparison with those in the U.S. and Europe.

Rarely does a monumental loss trigger a celebration. But on the next day of trading, the Nikkei stock index rose by 3.6%, and several top banks' shares--including Sumitomo's---soared by more than 15%. Investors and analysts alike hail Sumitomo's move as a sign that Japan's banks are starting to climb out of the bad-loan morass that has gripped them since 1990. Japan's leading banks hold an estimated $133 billion in nonperforming loans (table)--a third of the perhaps $400 billion in bad loans burdening Japan's financial system. Now, observers believe, Sumitomo's decision could hasten a much-needed restructuring. Says Yoshinobu Yamada, an analyst at CS First Boston (Japan) Ltd. in Tokyo:

"This is very good news for the financial industry."

Other major banks may follow Sumitomo's footsteps. Its decision "shows that banks can deal with their problems by themselves and that there's no need for public funds to support them," Yamada notes. Likewise, Alicia Ogawa, an analyst at Salomon Brothers Asia Ltd., believes that pressure for an industry restructuring may now mount. While she thinks few major banks are strong enough to absorb big write-offs this year, she names Bank of Tokyo, Mitsubishi Bank, Industrial Bank of Japan, Sanwa Bank, and Fuji Bank among those that probably can.

FILTER DOWN. So far, no other major banks have announced write-offs. They may hesitate to imitate Sumitomo because Japanese mores could impel a bank chairman to resign after reporting a loss. Sumitomo finessed this issue because its former chairman resigned in 1993 to take responsibility for loans to scandal-fraught trader Itoman Corp., a major source of the bank's bad debt.

Nevertheless, Sumitomo's move suggests that the regulators now feel comfortable enough with banks' reserves and profitability--and with Japan's recovery--to let the bad news filter down to the bottom line. Until now, bureaucrats at the Ministry of Finance and the Bank of Japan forbade major banks to report losses for fear of undercutting confidence in the financial system. To cover losses, banks sold off pools of equity as the fiscal yearend approached.

Bureaucrats deny they sanctioned the reporting of a loss. "We don't have the power to stop them from reporting what they want," says Toshio Muraki, a director of the Ministry of Finance Banking Bureau. But Sumitomo's Oku says that for the past year, retired "old boys" from the Ministry and the Bank of Japan have been calling for banks to start taking losses. This was a classic ploy for the agencies to signal their wishes. Oku says Sumitomo's decision was helped along by the recent "confirmation" of Japan's economic recovery, which should spark new demand for loans, and by the bank's cost-cutting, which freed up funds to cover losses.

So, for Japan, Sumitomo's start is important. If other banks now pick up the signal, it could pave the way for more aggressive lending to creditworthy customers, which could boost profits and further aid Japan's recovery. "This will be the year in which dramatic strategies are unveiled to solve the financial system's problems," predicts CS First Boston's Yamada. If so, Sumitomo Bank richly deserves kudos for getting the ball rolling.

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