All-out competition will break out among Japan’s four major banking groups next month in an arena that will host some of the world’s largest banks in terms of aggregate assets.

Three megamergers will give birth to banking giant Sumitomo Mitsui Banking Corp. on April 1, and the United Financial of Japan and Mitsubishi Tokyo Financial groups on April 2. These three will join the Mizuho Financial Group, which began operating in September.

Their size alone, however, does not automatically make them top-tier banks, because all four share the same set of problems: massive bad loans and dwindling profitability.

Bank of Tokyo-Mitsubishi President Shigemitsu Miki has acknowledged the problem.

“(Japanese banks) are extremely large in size . . . but what still needs to be done is to improve their earnings future,” Miki said in September when he announced a detailed plan for his bank’s merger with Nippon Trust Bank and Mitsubishi Trust & Banking Corp.

Many bank analysts have taken a harsher view, calling the decisions to merge less than strategic.

“Mergers don’t occur to increase profits. Mergers happen because banks need to survive,” said Brian Waterhouse, senior analyst at HSBC Securities.

Indeed, the need to strengthen balance sheets, tackle mountains of debt and invest in emerging technologies has made mergers an attractive alternative to going it alone, especially at a time when foreign banks are acquiring footholds and retailers and other nonfinancial companies are trying to enter the field.

Of the four, only the Mitsubishi Tokyo Financial group has repaid the public for its capital injection, leaving the other three reliant on taxpayers’ money to shore up their capital bases.

Return on equity ratios, a key indicator of a firm’s earning power, have ranged from Sumitomo Mitsui’s 7.4 percent to Mitsubishi Tokyo’s 3.2 percent in the first half of fiscal 2000, hardly in the league of the 20 percent to 25 percent ROEs exhibited by the world’s top foreign banks.

The Big Four’s combined outstanding bad loans totaled

13.3 trillion yen as of the end of September, and the Mizuho group, uniting Dai-Ichi Kangyo Bank, Fuji Bank and Industrial Bank of Japan, is lagging in its cleanup efforts.

During the first half of fiscal 2000, the group — at 151 trillion yen in assets the world’s largest — wrote off bad loans worth a combined 246.9 billion yen, the least of the four. It had 4.13 trillion yen in outstanding bad loans, the most of the four groups, as of Sept. 30.

In comparison, the UFJ group, which will consist of Sanwa Bank, Tokai Bank and Toyo Trust Bank, wrote off 337.2 billion yen in bad loans, bringing its nonperforming assets to 2.41 trillion yen, the least of the four, as of Sept. 30.

Unlike the others, the UFJ group announced last week that it was going to take more aggressive action to clean up its balance sheets before the merger. Thanks to writeoffs of 1.13 trillion yen, UFJ said it expected to post pretax losses of 289 billion yen for fiscal 2000.

Although this was generally welcomed as a positive step, it does not end the problem.

A more pressing matter facing the banking groups is the latent losses caused by a falling stock market. The recent steady decline in share prices is damaging banks’ ability to write off bad loans as the March 31 fiscal yearend approaches.

The nation’s 16 major banks, which held securities worth 37.3 trillion yen as of Sept. 30, will suffer latent losses of between 5 trillion yen and 9 trillion yen if stock prices end 20 percent to 30 percent below September’s level, according to the Financial Services Agency.

Meanwhile, as a longer-term problem, each bank in the four groups holds an array of risky borrowers in three problematic sectors: general contractors, real estate firms, and the retailing and wholesaling businesses.

The first half of fiscal 2000 witnessed some 3,000 corporate failures in the heavily indebted construction sector and another 3,000 in the retailing and wholesaling sector, according to Teikoku Databank, a private credit research agency. In the real estate sector, the number of bankruptcies, 300, was relatively small for the six-month period, but the scale of liabilities left behind in each case was quite big, an agency official said.

Within the Mizuho group, for instance, Fuji Bank made 22.2 billion yen in long-term loans to Tobishima Corp., an ailing contractor, while DKB made 106.4 billion yen in loans to Hazama Corp. The list goes on.

As they gear up for global competition, however, each of the four groups has been trying to sever relations with problem borrowers.

Tokai Bank virtually cut off Chiyoda Mutual Life Insurance in September by refusing to give it more funds. A similar decision by DKB resulted in the embarrassing failure of the Phoenix Resort Corp., the third-sector operator that runs the loss-making Seagaia seaside resort complex in Miyazaki Prefecture.

Along with efforts to deal with nonperforming loans, the four financial groups are also trying to build a sound customer base to increase profitability and competitiveness.

The Mizuho group, for instance, is trying to press ahead with its deep and extensive customer bases in corporate and retail banking.

Of the 2,800 nonfinancial companies listed on the Tokyo Stock Exchange, 81 percent have business ties with the Mizuho group, while DKB and Fuji Bank have brought together some 30 million individual customers in the retail field, the largest by far in Japan, according to a Fuji Bank official.

Meanwhile, in an attempt to maximize the synergies of their integration, each has been exploring ways to strengthen cooperation within their greater corporate groups, typically through business tieups with their friendly life and nonlife insurers.

Sumitomo Mitsui Banking, which is closely tied with the Sumitomo and Mitsubishi corporate groups, for instance, will develop a system with Sumitomo Life Insurance Co. to sell each other’s products, taking advantage of ongoing deregulation in finance.

The four banking groups are also striving to prepare for the planned introduction in 2004 of the so-called risk-weighed standards for capital adequacy requirement by the Bank for International Settlement, another future challenge for Japanese money center banks.

In addition to the current requirement to maintain a capital adequacy ratio of at least 8 percent, regardless of a borrowers’ financial health, the new rules will require banks to adopt proper credit rating systems in accordance with the creditworthiness of its borrowers.

To cope with this, the UFJ group, for example, will create a standardized credit rating system as early as next month, dividing its borrowers into 10 to 20 levels of creditworthiness.

Even with all those efforts, however, many analysts remain skeptical of Japanese banks’ international competitiveness, citing their near-zero interest rates, the presence of major clients in ailing industrial sectors, and falling revenue from equity and bond portfolios hamstrung by an ailing stock market.

Earlier this month, rating agency Fitch placed the financial strength ratings of 19 Japanese banks — including most of those making up the four giant banking groups — under negative review.

“Can they compete? Yes. But profitably? I doubt it,” analyst Waterhouse said.

Citing Japanese banks’ inability to change the interest rates they charge their customers because industries have grown dependent on cheap funding, Waterhouse said that if banks tried to increase their loan rates to bring returns to the levels of top Western banks, the impact on the economy “would be disastrous.”

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