Economic crisis: Japan bites the banking bullet

Economic crisis: Japan bites the banking bullet

By Alex Brummer

TOKYO: The signs are that the Japanese government is finally
facing up to the reality of its financial crisis. Unless it fixes
banking -- as it promised its partners in the Group of Seven
industrialized nations -- the threat posed to the real economy is
almost too ghastly to contemplate.

The proposed merger between the troubled Long Term Credit Bank
of Japan and Sumitomo Trust & Banking, regarded as one of the
healthier banking groups, represents a step along the learning
curve.

The government of Ryatoro Hashimoto, which has wrestled
control of the banking crisis away from the once-omnipotent
ministry of finance, seems to have a sensible strategy in its
grasp.

It knows that simply to allow the LTCB to fail would be a
mistake. So it has conducted talks with potential partners behind
the scenes with the aim of preserving LTCB's good business but
shedding its bad loans.

What it has been anxious to avoid is the mess that followed
the earlier decisions to allow securities firm Yamaimichi and the
city bank, Hokkaido, to go to the wall.

In both cases, the effects on the real economy were severe:
Yamaimichi produced a shock to consumer confidence last November
from which it has still to recover. The Hokkaido collapse sent
dozens of firms into bankcruptcy in the region it served, pushing
the area into a downward financial spiral.

Central banks talk endlessly about the dangers of "moral
hazard", arguing that no institution is too important to fail.
But the reality is different, especially when the system is so
vulnerable to shock. One consequence of the weakened yen is that
every time it slips, it puts more pressure on the banks' approved
capital ratios.

In the case of LTCB, which is a vital lender to medium-sized
enterprises, the risk of spreading damage to the manufacturing
bedrock of the economy is severe.

As far as Sumitomo is concerned, if it does become the white
knight, it does so with a sound reputation. Among other things,
it is the largest investor in the world's strongest bank, Goldman
Sachs -- a potentially useful tie-in for all parties, especially
as the "big bang" reforms in Japan almost make it inevitable the
large global battalions will become dominant.

The LTCB situation has been seen in Tokyo and elsewhere as the
first test of the Hashimoto approach.

During recent week, the Prime Minister has conducted a series
of meetings with cabinet and monetary officials to hammer out a
"total plan" to resolve the crisis.

The Bank of Japan and new regulator the Financial Supervisory
Authority are insisting on an approach based on the American
model of full disclosure, with traditional forces within the
discredited ministry of finance advocating a more cautious
method.

The ruling Liberal Democratic Party has promised to bring
forward the plan by July 8. There has been much speculation that
if and when disclosure is enforced, it might provide a rare
chance for foreign financial operations to become a significant
presence in Tokyo. Investment bank Merrill Lynch has already
blazed a trail, buying the assets and business of Yamaimichi
Securities.

Other U.S. financial groups have also seen a chance. America's
most aggressive financial conglomerate, Travelers -- now merging
with Citibank -- has bought into Nikko Securities, and chairman
Sandy Weill believes there will be a Japanese appetite for U.S.
savings and insurance products.

In the insurance area, the American Insurance Group has
launched a bold attempt to join Japan's largest insurers with an
offer for Aoba, which could be worth as much as US$1 billion.
Aoba itself has absorbed the Nissan Mutual Life Insurance
Company, which failed in October 1997. The insurance sector, like
banking, has been seriously affected by slumping asset values in
commercial property and equities.

Large parts of the Japanese life assurance business have
become uneconomic. The industry has been paying out higher
bonuses on policies than poor investment returns hit by low bond
yields and poor dividends would justify. AIG is already a
significant presence in Japan's insurance industry through
subsidiaries AIU Assurance, American Home Assurance and Alico
Japan.

The U.S. banking sector appears able to accumulate deposits
from Japanese investors through its modest branch outlets with
alacrity.

An almost permanent queue waits outside Citibank's main branch
in central Tokyo, with savers preferring the safety of a US
banking institution -- even if it means selling yen for dollars
-- to the precarious state of Japanese banking. It is estimated
that Japan's banking system is carrying bad loans of $559.51
billion, but the figures remain cloudy because of poor disclosure
rules.

The Bank of Japan, which until now has not been aggressively
involved in efforts to sort out the system, is apparently ready
to force greater disclosure and take disciplinary action against
directors failing to come clean on their accounts.

Under the wider plan being pushed by senior Liberal Democratic
Party apparatchiks and by financial officials, the concept of a
"bridge bank" -- taking over the bad loans -- is to go ahead. But
for it to work, a further raft of measures will have to be
resolved.

These include defining the tax status for the bank loans that
have been disposed of, the creation of a middleman to auction
loans, and a process for settling the legal status of collateral.

It had been thought that the first case for the bridge bank
procedure would be LTCB, but a Sumitomo deal might make it
unnecessary. The government is flirting with other options for
dealing with bad loans, including absorbing them through
government-controlled financial groups such as the Japan Finance
Corporation for Small Business.

But as seen in the securities and insurance sector, overseas
groups -- with the Americans blazing the way -- will have a
critical role to play.

-- Guardian News Service