No. 12 — March 24, 2000


Weekly Review

--- by Douglas Ostrom

Less than 10 years ago, Japan was home to 13 of the biggest commercial banks anywhere. With the merger that Sanwa Bank, Ltd., Tokai Bank, Ltd. and Asahi Bank, Ltd. announced March 14, the ranks of top commercial banks headquartered in the world's second-largest economy will be reduced to five in the next two years. The banking industry has taken giant strides toward consolidation over the past decade, including tie-ups of regional banks, trust banks and still-smaller depository institutions as well as mergers among commercial banks. Although the weaknesses exposed during the protracted financial crisis of the 1990s provided a strong impetus for the restructuring, analysts are not convinced that the changes will leave the industry stronger or better able to withstand future difficulties.

The latest combination involves descendants of four of the 13 so-called city or nationwide commercial banks that were in operation at the start of the 1990s. In April 1991, two smaller city banks, Kyowa Bank, Ltd. and Saitama Bank, Ltd., merged to form what became Asahi Bank. In September 1998, Asahi Bank announced plans to join forces with another relatively small member of the top tier, Tokai Bank, by October 2001, a deadline later moved up by a year. The March 14 announcement added the much-larger Sanwa Bank to that partnership, which now is expected to be finalized by April 2001.

Taiyo Kobe Bank, Ltd. and Mitsui Bank, Ltd. combined in April 1990 to form what was named Sakura Bank, Ltd. two years later. Bank of Tokyo, Ltd. and Mitsubishi Bank, Ltd. teamed up effective April 1, 1996 to create today's largest commercial bank, Bank of Tokyo-Mitsubishi, Ltd. In November 1997, another city bank, Hokkaido Takushoku Bank, Ltd., was declared bankrupt (see JEI Report No. 44B, November 21, 1997). It eventually was absorbed by North Pacific Bank, Ltd., a second-tier regional bank, and Chuo Trust & Banking Co., Ltd. Last August, Dai-Ichi Kangyo Bank, Ltd., Fuji Bank, Ltd. and Industrial Bank of Japan, Ltd. announced a megamerger (see JEI Report No. 33B, August 27, 1999). The three-way tie-up will result in the establishment of a holding company this fall that will operate as Mizuho Financial Group. A merger deal between Sakura Bank and Sumitomo Bank, Ltd. followed in October (see JEI Report No. 39B, October 15, 1999). It is set to close by March 2002.

When the dust settles, four huge groups created through mergers and Daiwa Bank, Ltd., the only one of the 13 1990-era nationwide commercial banks not to have unveiled a merger arrangement or to have gone out of business, will be left standing. Daiwa Bank's prospects are problematic because of its unceremonious forced exit from the U.S. market in 1996 following its failure to disclose pertinent information regarding huge trading losses (see JEI Report No. 47B, December 22, 1995). The Osaka-headquartered bank's poor financial health and its unique role as the only city bank traditionally allowed to offer trust services also limit the number of potential partners. A merger risks the loss of the trust business it now conducts with rival banks. Nonetheless, most observers do not expect Daiwa Bank to remain independent for long. It eventually may join crosstown rival Sanwa Bank and its partners.

Japan's three long-term credit banks, historically comparable in size to the nation's city banks, also have been transformed in recent years. Following its late 1998 collapse, Long-Term Credit Bank of Japan, Ltd. was nationalized. In early March, LTCB was purchased by a foreign consortium led by New York City's Ripplewood Holdings LLC; it will operate as Shinsei Bank. Nippon Credit Bank, Ltd. failed later the same year and also was nationalized. NCB is likely to be sold in late spring to a group organized by Softbank Corp. (see JEI Report No. 8B, February 25, 2000). Industrial Bank of Japan, as noted, will become part of Mizuho Financial.

Analysts have focused their forecasts of the near-term international standing of Japan's commercial banking business on the four big groups to emerge from this process — Sanwa Bank/Tokai Bank/Asahi Bank, Mizuho Financial, Sakura Bank/Sumitomo Bank and Bank of Tokyo-Mitsubishi. They are comparable in size, with assets varying from the equivalent of $1.5 trillion for Mizuho Financial (which is on track to be the world's largest bank measured by assets when completely merged in 2002) to $968 billion in the case of Bank of Tokyo-Mitsubishi. However, the four differ in structure. The Sanwa Bank/Tokai Bank/Asahi Bank group is expected to emphasize retail banking over the wide, generally discrete geographic areas in which the three now are strong. In contrast, Bank of Tokyo-Mitsubishi still reflects the strengths of its big business, internationally oriented forerunners. Sakura Bank/Sumitomo Bank and Mizuho Financial fall between these extremes.

Three driving forces were behind the trio of consolidations announced in the last eight months. Most obviously, the severe bad-loan problems faced by nearly every bank in Japan regardless of size called into question the industry's business methods. The banks involved in the pending mergers were not alone in discovering that they badly lagged their American and European counterparts in many respects, not the least of which were advanced credit analyses that might have headed off some of the worst abuses. Moreover, Tokyo's relaxation of its long-standing prohibition on holding companies (see JEI Report No. 9B, March 7, 1997, and No. 24B, June 27, 1997) has permitted banks to move quickly to form such hybrid organizations as typified by Mizuho Financial and the Sanwa Bank/Tokai Bank/ Asahi Bank merger, where a holding company also will be established.

Arguably, however, the most important motivation has been fear. As the banks most active in the international arena, Japan's nationwide commercial banks are well aware of all the high-profile combinations among their overseas rivals and worry, perhaps irrationally, that they must grow in order to compete. Such European partnerships as that also announced in mid-March between German banking giants Deutsche Bank AG and Dresdner Bank AG as well as American linkups like that between NationsBank Corp. and BankAmerica Corp. in 1998 to form Bank of America Corp., the number-two U.S. commercial banking giant, and the combination of Citicorp, the parent of number-one Citibank N.A., and Travelers Group Inc. the same year into Citigroup Inc. have not gone unnoticed.

Banking industry analysts have not evaluated the planned Japanese mergers as favorably as these and other American and European tie-ups. Most obviously, the economies of scale and scope that often provide the motivation for U.S. banks to combine are not as compelling in Japan. There, nationwide commercial banks, as measured by assets, were so large a decade ago that they regularly were the subject of alarmist reporting in the American media, which pointed out that even Citibank and BankAmerica were puny in comparison with Japan's midtier city banks. Yet despite their size — or perhaps because of it — big Japanese banks ran into many more difficulties in the 1990s than their counterparts elsewhere. Meanwhile, they invested far less in information technology. For Japanese banks to claim, as they do now, that they need to grow in order to afford the technology that American banks acquired years ago raises the question of why they missed the boat in the first place.

Japanese banks are even less likely to capture additional economies of scope. Only in the past year have traveling Americans found the Bank of America name coast to coast and even then, not necessarily in-between. By contrast, the largest Japanese commercial banks for decades have operated a nationwide network of branches, however thin. In any event, with the advent of Internet banking, spreading automated teller machine networks and other technologies, geographic considerations rapidly are becoming irrelevant in both countries.

Moreover, Japanese banks have not yet taken the plunge that might trigger a real revolution in how business is conducted. None has combined with a foreign bank, as Bankers Trust Corp. did last year when it was absorbed by Deutsche Bank, unless one counts Ripplewood Holdings' acquisition of LTCB. Equally important, big banks in Japan have yet to merge with nonbank financial companies, the prototype being Citigroup, which brought under one roof retail and investment banking, securities and insurance.

In lieu of outright combination, major Japanese financial institutions are exploring how their keiretsu (corporate grouping) connections might be exploited to create a cafeteria-style collection of financial services. In this respect, the three recently announced mergers actually may create roadblocks since most city banks already have ties of varying strength with both life and nonlife keiretsu insurers. Fuji Bank and Dai-Ichi Kangyo Bank may see eye-to-eye on the banking business, but their respective keiretsu nonlife insurance partners, Yasuda Fire & Marine Insurance Co., Ltd. and Nissan Fire & Marine Insurance Co., Ltd., may not.

The holding companies planned also may find it hard to reap the efficiencies that such combinations should generate. At the time of the April 1990 merger between Taiyo Kobe Bank and Mitsui Bank, veterans of the former complained about another merger hard on the heels of the Taiyo Bank, Ltd.-Kobe Bank, Ltd. linkup — which had happened 17 years earlier. Other merged banks have operated three personnel departments for years: one legacy office for each predecessor bank and one for the combined entity.

The problems with Japanese bank mergers reflect more than just unusually stubborn employees. As in other large Japanese companies, a career employee often has, if not lifetime employment, at least an exceptionally long tenure with one bank. A 20-year banking veteran may have no professional experience other than working for his or her current employer. With little personnel movement between banks — let alone among industries — banking practices are more likely to become firm-specific and employee loyalty fierce. A merger, while having the potential benefit of bringing in new ideas, also easily can sow discord.

These issues may be one reason why the Sanwa Bank/Tokai Bank/Asahi Bank merger is expected to be the last big combination among leading Japanese banks to be announced for a while, apart from possibilities involving Daiwa Bank or one of the remaining trust banks. Indeed, officials of the banks involved in the pending mergers say that integrating operations will take at least three years.

Any further mergers, should they happen, will bring together banks still trying to complete a previous tie-up. Such a combination would be gargantuan. Subsequent linkages may well involve partnerships that allow now-distinct financial services to be offered under one roof. By that time, Japanese banks probably will be able to benefit from the years of experience of American and European banks that already have been there and done that.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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