Banking Industry Overview
11, 01. 2004
Japanese City Banks Will Be Reorganized into Three Megabanks
Ministry of Finance Japan
The Japanese financial services industry is in the midst of a reorganization of unprecedented scale. The Japanese banking industry is currently centralized into four megabanks. They are The Bank of Tokyo-Mitsubishi, Ltd. (formed through a merger of The Mitsubishi Bank, Ltd. and The Bank of Tokyo, Ltd.), Sumitomo Mitsui Banking Corporation (SMBC; formed through a merger of The Sumitomo Bank, Ltd. and the former Mitsui Bank Ltd.), Mizuho Bank, Ltd. (formed through a merger of the Industrial Bank of Japan, Ltd., Dai-Ichi Kangyo Bank, Ltd., and Fuji Bank, Ltd.), and UFJ Bank Limited (formed through a merger of Sanwa Bank, Ltd. and Tokai Bank, Ltd.).
However, disposal of nonperforming loans is not progressing at UFJ Bank, and the bank is facing difficulties securing an adequate equity ratio on its own. For this reason, UFJ Bank is trying to advance a merger with The Bank of Tokyo-Mitsubishi. Meanwhile, SMBC is also exploring the acquisition of UFJ Bank, and it has announced a policy to block a merger between UFJ Bank and The Bank of Tokyo-Mitsubishi. Regardless of which financial group UFJ Bank will ultimately align with, it is for sure that Japanese banks will be reorganized into three megabanks.
The Rapid Advance of Bank Reorganizations, Inclusive of Regional Banks, Is Taking Place
Reorganizations are not limited to major banks, such as city banks. There is large-scale consolidation taking place that involves small- and medium-sized banks, such as regional banks, as well. Full bank deposit protection will come to a complete end in 2005. This includes bank accounts used for settlement purposes, such as ordinary deposits. Once the government guarantee of 100% of bank deposits comes to an end, the upper ceiling on deposit refunds will become limited to 10 million yen per depositor.
It is expected that this will make the selection of banks an even more difficult decision for customers. There is also the possibility that there will be a massive outpouring of deposits from banks that have unfavorable compositions of finances, and there is concern that this may cause chaos in the financial industry. The consolidation of small- and medium-sized financial institutions, such as regional banks, is rapidly advancing with such circumstances in the background. The Japanese government is requesting that banks aggressively dispose of their bad loans and restore the soundness of the compositions of their finances. The government is taking the policy of giving operational guidance to banks that are unable to meet an equity ratio of 6 percent, which is the standard of the Bank for International Settlements (BIS) for domestic business operations, and in some cases, ordering the suspension of business.
Policy Measures Taken to Prevent Bank Bankruptcies
The rapid reconstruction and development of the Japanese economy after World War II was supported by industrial groups that centered on banks. The Japanese government's financial administration, dubbed the "convoy system," provided banks with utmost protection. Under this system, banks backed corporate business activities by actively providing loans to group industries in line with the government's industrial policy. This system created a uniquely Japanese financial practice called the "main bank system," a system that supported Japan's high economic growth.
The convoy system represented the basic policy of the Japanese financial authorities to keep banks from going into bankruptcies. Under the convoy system, banking policy administration kept in pace with the "slowest ship;" in other words, banks with the least profitability. This meant that even the least efficient bank was able to survive.
A Unique System for the Flow of Funds Created Under Government Guidance
The government also controlled the flow of funds by clarifying the roles to be played by different types of banks, such as city banks, long-term credit banks, trust banks, regional banks and mutual banks. For example, the three long-term credit banks in Japan had restrictions on the number of branches they could open, but they were given the special privilege of being allowed to issue bank debentures. Long-term credit banks used the long-term funds collected through bank debentures to take on the role supplying companies with long-term funds for use in capital investments. Meanwhile, banks such as regional banks, which had a vast amount of excess cash, used their funds to purchase bank debentures, etc., and helped to create the unique system under government guidance for the flow of funds.
Headquarters of Mizuho Financial Group, Inc.
The convoy system, however, began to crumble in the 1990s. The myth that banks would never go under came to a complete end with the collapse of Hokkaido Takushoku Bank, Ltd. This was followed by the bankruptcies of two of the three long-term credit banks - the Long-term Credit Bank of Japan, Ltd. and Nippon Credit Bank, Ltd. - and they were placed under state control. Major reorganizations took place in the Japanese financial services industry triggered by the failure of these three banks. In 1998, public funds were poured into banks that could not meet an adequate equity ratio, and banks used the funding to advance their disposal of bad loans. Measures were taken to restore fiscal soundness and improve operations.
Damage Caused by the Liberalization of Interest Rates
Why, then, did such large-scale reorganization of the banking industry take place?
Matters Made Worse by the Bank of International Settlement's Regulation on Equity Capital
Tokyo Main Office of Sumitomo Mitsui Banking Corporation
As if to make matters worse, the Bank of International Settlement (BIS) decided to introduce a regulation related to the equity capital of banks. Through this regulation, an equity ratio of 8 percent needed to be maintained in order for banks to continue international operations. Furthermore, even domestic operations would not be permitted if a bank did not meet an equity ratio standard of 6 percent. Japanese banks, which are generally undercapitalized, met such standards by adding on the unrealized capital gains of the client shares they owned, as main banks, in great amounts. Changes in the business environment, which took the form of reductions in profit margins and declines in financing demand by companies, compounded by the introduction of the equity capital regulation by BIS became the driving forces that accelerated the reorganization of the Japanese financial services industry.
Major Financial Deregulation brings about a Bubble Economy
After the Plaza Accord, the Japanese government implemented major credit relaxation in order to counteract the deflationary effects of the stronger value of the yen. This brought about an economic bubble in Japan, and land and share prices rose abruptly. With the increase in the latent value of stocks through the rise in share prices, new demand for bank loans, such as loans for use in land speculation, increased. Banks also aggressively began investing in real estate in order to compensate for the lowered demand in companies' normal funding needs. However, the Bank of Japan shifted to a tightening of Japan's money policy, and share and land prices went on a downspin. As a result, Japanese banks were saddled with vast amounts of nonperforming loans in the 1990s. Furthermore, the fall in share prices brought down the equity ratio of banks and had a critical influence on the management of banks. Another factor that placed an enormous burden on the operation of banks was the need to set aside great amounts of reserves in preparation of a state in which nonperforming loans became irrecoverable.
Credit Crunch Brought About by Banks' Need to Achieve an Adequate Equity Ratio
Banks that could no longer meet the equity ratio standard endeavored to maintain the ratio through such measures as counting in taxable loan-loss reserves that had been set aside. However, differences in interpretation with finance authorities over its authorization, etc. also arose, and many banks were placed in a predicament. Banks were forced to scale back assets in order to achieve the equity ratio standard, and they began taking measures such as curbing new loans and making recovery of loans from companies.
Headquarters of Mitsubishi Tokyo Financial Group, Inc.
This brought about a credit crunch in the Japanese economy and had the aspect of inhibiting general business activities of Japanese companies. Banks that were unable to meet the equity ratio standard despite such measures were forced to either seek public funding or face government takeover. Financially unstable banks and banks with massive amounts of nonperforming loans explored mergers with banks that had sound financial content, while financially stable banks acquired such problem banks.
Japan's Big Bang Financial Reforms Implemented in the Late 90s
After World War II, the Securities and Exchange Law prohibited a financial institution from conducting banking activities and securities services together. A feature of Japan's post war financial system was that there was a double "fence" placed around its financial institutions. As mentioned earlier, segmentation was created between banks. At the same time, a barrier was also built to separate banking and securities. This was possible because of the existence of financial administration that restricted competition between financial institutions. However, while such a uniquely Japanese financial system was permissible during Japan's development, it already started showing signs of being inconsistent by the time Japan's economic restoration was completed.
Financial deregulation took place in the United States in the 1970s and in the United Kingdom in the 1980s. In addition to the liberalization of interest rates, liberalization of the operations of financial institutions as well as deregulation of foreign exchange regulations, etc. also advanced in Japan. The fence that separated banking and securities operations was also lowered, and banks and securities companies could enter the other's field by creating a subsidiary. Furthermore, Japan's Big Bang financial reforms, which followed the example of financial liberalization in the U.K., were also implemented in the late 1990s. The liberalization of the Japanese financial industry was virtually completed from the viewpoint of the financial system.
Three Key Points towards the Future