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