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Shinsei Bank and Aozora Bank are in talks about merging and are looking to establish a joint holding company in summer 2010, which would create Japan’s sixth-biggest bank in terms of assets, sources close to the matter said Saturday.

The two banks, which were formerly providers of long-term credit to businesses, are owned chiefly by U.S. hedge funds J.C. Flowers & Co., which has a stake of about 33 percent in Shinsei, and Cerberus Capital Management L.P., which has an interest of some 45 percent in Aozora.

Given that both banks are said to be considering linking up with other financial institutions, what the U.S. shareholders decide is expected to determine the outcome of the talks.

Both banks are strong in corporate financing and corporate rehabilitation operations. A merger will likely help them create economies of scale and therefore reinforce their competitive edge.

Combining the two would create an institution with over ¥18 trillion in assets, sixth among Japanese commercial banks and larger than Chuo Mitsui Trust Holdings Inc.

Shinsei and Aozora were both nationalized in 1998. After they were brought largely under private ownership in 2000, they revamped their operations under the guidance of their U.S. shareholders and others but remained under partial ownership by the Japanese government.

Both banks anticipate net losses in the year ended in March after suffering huge losses on risky overseas investments that went south when the global financial crisis exploded and the recession ensued.

The Financial Services Agency has been paying close attention to the banks’ earnings and asset status and is believed to be calling on them to take radical steps to improve operations, including the option of industry restructuring.

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