Tokyo May Be Getting The Message: Pull The Plug

It let Hokkaido Takushoku Bank go under, and up to a dozen others may follow

When Hokkaido Takushoku Bank Ltd., one of Japan's largest lenders, found itself unable to raise cash on Nov. 17, you might have expected regulators to swoop in and bail it out. Instead, the Bank of Japan stepped aside and let Takugin, as it is commonly known, go bust. Many investors see the government's willingness to let the long troubled bank collapse as anything but an omen of a coming financial panic. Instead, it may be a signal that after eight years of denial, Japan is finally getting serious about addressing the $800 billion in bad loans in its banking system before its economy suffers even more harm. "The key issue is to get the banking system into shape where banks feel comfortable issuing new credit," says Credit Suisse First Boston chief economist Neal M. Soss.

The new, tougher approach--perhaps symbolized by a Nov. 17 press conference at which Takugin President Sadamasa Kawatani announced his bank was going out of business-- marks a sea change in attitudes that could bring about a wholesale restructuring of Japanese finance. Instead of pressuring stronger competitors to help keep badly injured banks alive, regulators may now simply let them go under if they can't raise funds on the markets. As many as a dozen more banks could be closed before the end of the year "if the Bank of Japan is really committed to attacking the [country's] financial problems," says ING Baring Securities (Japan) Ltd. analyst Richard Jerram.

Already, write-offs of bad loans are mounting so rapidly that most major lenders are expected to declare losses in the fiscal year ending Mar. 31. Those with bigger losses could suffer Takugin's fate. "Weaker institutions are being picked on. This is snowballing," says one senior banking industry insider.

Speculation over how Japanese authorities will confront the banking crisis is causing violent mood swings on the Tokyo stock exchange (chart). Reports that Prime Minister Ryutaro Hashimoto might be willing to pump public cash into a bank rescue program caused the Nikkei stock average to shoot up 11% on Nov. 17 and 18, only to fall 5% a day later when Hashimoto claimed he had been misquoted.

But many observers continue to believe that if they are going to let the weakest banks fail, the government will have little choice but to put some public money toward protecting their depositors and stabilizing healthier lenders. Indeed, only hours after Hashimoto roiled the stock market, Bank of Japan Governor Yasuo Matsushita said he'd like to see a "broad-based discussion" of the use of public money.

Japanese banks, whether or not they approve the Takugin shutdown as a model for other troubled institutions, are reluctant to admit they might need public cash. Years of loan losses and corruption scandals have already damaged their image and standing. Still, some senior bankers seem to be willing to take the heat if that brings about needed reforms. "It is now necessary to inject large amounts of public funds into the financial system and to build a public consensus for doing so," says Hideo Ishihara, chairman of Goldman Sachs Japan and a former top executive at Industrial Bank of Japan Ltd.

It is not just the sagging Nikkei that is pressuring bankers and regulators toward a shift in attitudes. Hashimoto's Big Bang plan to liberalize financial markets starts to kick in next year. Banks and brokers are already under intense pressure to shape up or face destructive competitive attacks from domestic and global rivals. Extensive wreckage in Big Bang's wake could leave Japan with a banking system too weak to lend and a securities industry too feeble to raise money for business, cutting off liquidity the country needs to pull out of its economic slump. Even worse, corporate bankruptcies have reached a record high, just when East Asia's financial woes threaten to leave lenders with up to $90 billion in new losses.

On top of that, the sagging stock market--down 59% since 1989--has eaten into banks' capital. They count some of their unrealized gains on stock portfolios as equity. But by the time the Nikkei hit 16,000 Nov. 14, those unrealized gains had turned into a paper loss of $12 billion for the country's 20 big banks, estimates ING Baring analyst James P. Fiorillo. If Japanese regulators became as strict as their U.S. colleagues during America's banking clean-up of the 1990s, Salomon Brothers Inc. believes Japan's 20 biggest lenders would need as much as $80 billion to bring their capital up to the standards set by the Bank for International Settlements. "For a long time," says Jardine Fleming Securities Ltd. banking analyst Walter Altherr, "we have had brain-dead institutions and relatively little hope of anyone's having the courage to pull the plug. Now, the market has forced the regulators' hands."

Analysts expect Japan to cobble together a plan similar to Resolution Trust Corp.'s rescue of the U.S. savings and loan industry in the early 1990s. Regulators at the Ministry of Finance, presided over by Hiroshi Mitsuzuka, have been preparing behind the scenes. Over the past two years, they have been in close touch with counterparts at Washington's Office of Thrift Supervision and Federal Deposit Insurance Corp., quizzing them by fax and in person on bank bailouts and other issues.

But Japan's rescue plan likely will be carried out on a case-by-case basis, rather than as a wholesale assault, as was the case in America. The Liberal Democratic Party plans next month to release a host of measures aimed at the financial system. That has raised speculation that the LDP will push state pension funds into buying new issues of bank preferred stock to bolster their equity base.

CS First Boston's Soss notes that the U.S. resorted to similar purchases to keep Continental Illinois National Bank, Lockheed, and Chrysler, alive during financial crises. Some U.S. industry sources think banks could also gain liquidity by borrowing from the Bank of Japan or the Federal Reserve, using their $60 billion in U.S. Treasury securities as collateral.

In fixing the banking system, Tokyo's first line of defense is its Deposit Insurance Corp., supported by premiums paid by banks. The DIC's assets and powers are nowhere near as large as its American counterpart, the Federal Deposit Insurance Corp. Analysts estimate that the DIC has a yearly premium income of roughly only $3.7 billion, enough to liquidate no more than one or two midsize regional banks per year. Nonetheless, the Japanese corporation assumed control of the problem assets of Takugin and plans to sell them. Bank of Japan officials maintain that they are willing to lend DIC whatever it needs, while also pledging $7.8 billion in credits to Takugin for short-term liquidity to protect depositors as it shuts down.


Takugin was allowed to fold after the East Asian crisis and the failure of Sanyo Securities Co. Nov. 4 put Japanese financial institutions under new scrutiny. In Takugin's case, the market didn't like what it saw. Although it was planning to merge with another bank to survive, Takugin found itself unable to raise funds on money markets. The big issue now is whether the weak lenders can be closed, merged, or otherwise taken care of before investors get jittery again. For the first time in memory, says Moody's Investors Service analyst Rieko McCarthy, "market forces are taking over." Put to good use, those forces could be a vital agent for efficiency and economic growth.

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