The blockbuster deal to combine Dai-Ichi Kangyo Bank, Fuji Bank and the Industrial Bank of Japan may be compared to an epic drama. Act one has opened with fanfare. But what if discord develops between the director and playwright? What if the actors turn out to be hams? What if the stage settings are not attractive? The audience would be disappointed and leave their seats. The “financial shakeup” drama would end as a “financial disaster” drama, causing a further erosion of the competitive base of Japan’s private financial sector.

The planned union of the three banks under a holding company would create the world’s largest financial group in terms of assets. The megadeal involves the whole range of financial services, such as retail and wholesale banking, investment banking, trust banking, portfolio management and insurance. In this regard, it is essentially different from past bank mergers and tieups and from partial alliances with foreign financial institutions.

If the deal succeeds, it will likely pave the way for the building of a new financial system in 21st-century Japan. Success depends on the leadership of the “directors,” the quality of the “scenario” and the performance of the “actors.” That is why the “audience” is watching the drama with a mix of hope and fear.

The tripartite union is designed to achieve both economies of scale and “economies of scope” by increasing the scale and diversity of production. By doing so, the three banks want to regain lost ground in the world financial market and compete with foreign megabanks on equal terms. Having been driven into a corner, so to speak, they are trying to ensure their survival in the increasingly competitive world of global finance.

The question is whether they will be able to create the kind of bank they are aiming for — one that is powerful enough in terms of earnings, capital and services to join the ranks the world’s big five. Their CEOs deserve credit for launching this monumental undertaking. The difficulty is that they have to accomplish so much in so short a period, perhaps a year or two.

Bigness is no guarantee of success. But in the global financial market, the chief playing field for the megabanks, the idea that “small is beautiful” is fantasy. Even in the retail market, moves to create “domestic megabanks” are underway, as between Tokai and Asahi banks. These moves, also involving smaller banks, are likely to touch off a major shakeup of the finance industry. Hopefully, that will also help spur lending to those that badly need capital: startup companies.

A big challenge for the three banks is improving their earnings power, which is much lower than that of Bank of Tokyo-Mitsubishi. Doing so means winning the competition in sophisticated financial transactions. For that, they must restructure boldly to trim fat and increase efficiency. They must also make strategic decisions to make the most of their resources and to develop the kind of services that meet the diversifying needs of customers at home and abroad. And they must get ready for all this in one or two years.

The three banks’ total assets are valued at 141 trillion yen, a sum that far exceeds those of other megabanks, such as Deutsche Bank Group, Citigroup of the United States, BNP Group of France and UBS of Switzerland. The question is how to boost the earnings power through integration to a level comparable to that of the megabanks — more specifically, to between 200 billion yen and 650 billion yen or more in after-tax profits. Currently, the three banks have a combined net deficit of nearly 1 trillion yen. Delays in the disposal of bad debts continue to depress their balance sheets.

The global megabanks have high returns on equity ranging from nearly 20 percent to a little over 10 percent. By contrast, the three banks’ returns on equity after tax are nothing to speak of. Their capital stock, loans and deposits combined greatly exceed those of Bank of Tokyo-Mitsubishi, now the largest bank in Japan. But their business profits for the year to last March totaled under 600 billion yen, almost the same as the figure for BTM. Moreover, as noted above, they have a large combined net deficit. That is in sharp contrast to the strong showing of BTM, which has received a relatively small amount of public money to clear its bad debts and yet has generated a net profit of 45.3 billion yen.

Nevertheless, the three-way alliance may have come as a shock not only to BTM, but also to other major commercial banks, such as Sumitomo. They will all try to improve their own earning power while exploring possibilities for mergers and tieups. Meanwhile, new realignments will likely take shape among such institutions as Sanwa, Nomura Securities and Nippon Life Insurance. The financial services industry here, according to many experts, will consolidate into four or five groups capable of surviving global competition. Eventually, they say, the number will be reduced to just two or three.

The tripartite deal will test the mettle of the three partners particularly in the areas of brokerage and information technology. The IBJ has a skilled staff in investment banking, while DKB and Fuji are strong in retail and wholesale banking. In the realm of high-tech financial transactions, however, the three banks as they stand now are no match for the megabanks. This is likely to be the most competitive sector in financial markets. But these banks, which, like other Japanese banks, have long lived in a cozy world of protection and regulation, seem to be ill-prepared for the rough and tumble of international competition.

Another concern is that life and death decisions might be dodged or postponed under the collective leadership. Strong leadership is needed to make such decisions. All three banks have many skilled people in traditional business lines, but very few in the new areas of international banking. Therefore, with courage and insight they need to hire talented people from foreign financial institutions, as well as from nonfinancial sectors at home, and use their expertise not only in their operating divisions but also at the decision-making level of the holding company.

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