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Will Japan emerge from crisis as a real financial center?

by Jochen Legewie

The events of the past weeks and days have dominated headlines and are threatening the world economy. Like so many dominoes, share prices and banks, big and small, have fallen in the United States and Europe, wiping out massive amounts of capital — about $21 trillion as of the end of September.

At first, the European banks looked as if they would escape the downturn. But as the crisis worsened, the piecemeal, country-by-country approach to dealing with the problem became more and more inadequate. Even countries like Iceland, which had virtually no exposure to subprime loans, found themselves teetering on the brink of absolute bankruptcy.

Many other financial institutions in Europe were being nationalized or facing the possibility of insolvency when this article went to print, and the G7 was hashing out measures at an emergency meeting in Washington to fix the crisis.

The crisis has hit Europe as hard as the U.S., and is in the process of spreading to the rest of the world, including Asia. As the Economist said in a recent headline: “The financial crisis belongs to everyone, not just the U.S.”

Japan’s banks seem less affected by all the havoc. But the waves of bad news will eventually impact overall economic activity, and it seems a full blown recession is unavoidable. From a purely financial viewpoint, however, Japan appears to be weathering the storm and even profiting from the upheavals.

The Mitsubishi UFJ Financial Group took an estimated 20 percent stake in Morgan Stanley, which may prove to be a major coup. This followed its takeover of UnionBanCal in California in August for an estimated $3.5 billion. These have been aggressive moves for a previously conservative institution.

Likewise, Nomura Holdings bought up the Asian and European divisions of failed investment bank Lehman Brothers along with its back office and IT functions in India.

Other bold moves included the Sumitomo Mitsui Financial Group’s investment in Barclays bank, and Mizuho Corporate Bank’s purchase of a stake in Merrill Lynch.

It cannot be stressed enough that these deals represent more than just a lot of money changing hands. It is no less than a dramatic redrawing of the world’s financial map. Tokyo, which had nearly given up on claiming a place on the global financial stage, might actually achieve this goal now that the landscape has shifted.

This swing in power was illustrated by a quiet announcement last month, a tidbit of news that may have been lost in the noise: the City of London’s semiannual report on the world’s financial centers.

The report declared that Tokyo had jumped two places on the list from ninth to seventh, while Frankfurt had fallen three spots from sixth to ninth.

In fact, the Lord Mayor of London David Lewis made a tour of Asia, including a visit to the Tokyo Stock Exchange, last week to discuss Tokyo’s new position, underlining its relative ascendancy as a hub of international banking.

And now that even more capital control has shifted to Tokyo, it will be interesting to see where the city ranks next time this report is issued. The fall of Frankfurt will also be a topic to revisit, as it might indicate a relative decline of continental Europe.

This vote of confidence in Tokyo prompts another examination of the context of these maneuvers. It was just 10 years ago that Japanese banks faced a similar situation, with stacks of bad loans and no available credit to sustain them. Now, years later and on an even keel, these same banks have reformed and emerged as global players. But will they be able to live up to the challenges of the new banking world?

The truth of the matter is that although Japan’s megabanks may have the upper hand at the moment, to a large extent it is more out of circumstance than by design. The subprime fiasco was a creation of U.S. origins, one that many European banks were quick to buy into at first. Would Japanese banks have avoided the mess if they had been more international in their operations? Probably not.

Regarding the future of Japan’s financial sector there are basically two issues. The first is a micro-economic one: Will Japanese banks and securities firms be able to manage the cultural challenges of integrating not only Western, but also Anglo-Saxon, peers and develop the forces into new strong international players? This won’t be easy, since traditionally risk-averse banks will have to reconsider their basic investment — and management — strategies.

Second, will the various financial players, including regulators and the stock exchange, be able to grab this opportunity and execute a balanced deregulation and internationalization of Japan’s financial center?

Here is where the real challenge lies. Blind trust in the markets is not an option, but neither is an unquestioning faith in rules and regulations.

If history is any guide, one could be excused for being skeptical. But history also made us believe that Wall Street’s investment banks would be around forever. So let us hope that the Japanese players get their act together and find the right balance between openness and internationalization on one hand, and Japanese strengths and virtues on the other.

Jochen Legewie is president of German communications consultancy CNC Japan K.K.