Commentary: Why Failures Spell Success For Japan's Reforms

Japan's financial industry is in the final rounds of a multitrillion-dollar game of musical chairs. On Oct. 20, Kyoei Life Insurance Co., Japan's 11th-largest insurance firm, collapsed, winning the dubious title of Japan's biggest-ever corporate failure. In spite of Kyoei's grim numbers--a colossal $42 billion in debts--the stock market barely flinched. The bankruptcy, which comes less than two weeks after the failure of Chiyoda Mutual Life Insurance Co., did push financial stocks lower. But it failed to trigger a market stampede. Investors, it seems, are growing inured to the implosion of Japanese companies.

Maybe Japan's investors and regulators are finally realizing that the system cannot support companies like Kyoei indefinitely. Kyoei, like three other Japanese life insurers that folded this year, had promised policyholders returns several percentage points higher than what it could earn in interest. At the same time, sales were declining and losses were mounting. Without strong merger prospects or a big bank to save it, Kyoei finally buckled. "Kyoei's failure was inevitable and another sign that Japan is no longer isolated from the rules that govern global markets," says Akio Makabe, a markets analyst at Dai-Ichi Kangyo Research Institute.

Kyoei's fall is the logical--and necessary--outcome of the Big Bang reforms of the financial industry that the government unveiled in 1996. The measures, which have been phased in over four years, culminate next April in the lifting of the fire walls that have separated banking, insurance, and brokerage firms. In anticipation, the country's 17 "city" banks, along with its life and casualty insurers, have rushed into each others' arms in hopes of forming financial supermarkets. Some tie-ups are along old keiretsu lines--such as those between Bank of Tokyo-Mitsubishi Ltd. and Mitsubishi Trust & Banking Corp. Others are marriages of convenience, such as the agreement between Nippon Life Insurance Co. and three nonlife insurers.

The Big Bang, however, spells doom for weaker players. That's why Kyoei lost its seat at the table. It spent its final months seeking an alliance with Prudential Insurance Co. of America. But when the full extent of Kyoei's bad debts became known in September, Prudential pulled out.

BETTER POLICING. Kyoei must now come up with a restructuring plan under a new law that protects debtors. Prudential may buy Kyoei's policies while Kyoei sells off the remainder of the company. A government bailout fund will cover some of the remaining shortfalls.

The worst outcome would be for the government to get cold feet and throw other weak insurers a lifeline in the form of accounting exemptions. At the same time, it should take care not to trigger panic by assuring policyholders that they won't lose their accumulated premiums. The government also can't drag its feet on deregulation of the property market; otherwise bad debts will never get flushed from companies' books.

The best thing that could happen is for the shakeout to continue, so that a small group of healthy financial players can finally emerge. Most analysts say Japan's life insurance market--the world's largest and 40% bigger than that of the U.S.--faces further bankruptcies. While it's difficult to know how many more insurers are in trouble because the companies are not publicly listed, analysts say the top 10 insurers will likely survive, while several additional smaller players are likely to fail.

That they will be allowed to do so is part of the new realism. One-fifth of the 9,473 Japanese companies that went bankrupt from April to September this year had been propped up by government guarantees dating to the credit crunch of 1998-99--guarantees that Tokyo is rightly allowing to expire.

In contrast to the handwringing after the collapse of Long-Term Credit Bank of Japan Ltd. in 1998 and the Sogo Department Store earlier this year, the government did not try to patch over Kyoei's shortcomings with taxpayer money. Just the opposite. After Kyoei folded, the Financial Supervisory Agency said it might tighten rules for calculating solvency margins that show the degree to which insurers can repay their policy holders. That would help the FSA police weak insurers and force laggards to strengthen their balance sheets. For once, the government is not trying to turn back the clock. That can only mean a healthier financial future for Japan.

Before it's here, it's on the Bloomberg Terminal.