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Another Japanese megabank is in the making. Sumitomo Bank and Sakura Bank have just agreed to merge by April 2002, which will create the world’s second-largest banking group, with assets of about 99 trillion yen. Earlier this year, Dai-Ichi Kangyo Bank, Fuji Bank and the Industrial Bank of Japan announced a tieup deal that will make them the world’s largest financial conglomerate.

The significance of the Sumitomo-Sakura deal is that it cuts across traditional zaibatsu borders. Sumitomo Bank, of course, is the main bank for Sumitomo group companies, while Sakura Bank, formerly Mitsui Bank, serves the Mitsui group. This tieup highlights the fundamental changes that Japan’s banking industry is now undergoing.

With financial institutions scrambling for cover amid the Big Bang of financial deregulation, it is certain that the planned merger between Sumitomo and Sakura will add fuel to realignments in the private financial sector, involving not just banks but other finance houses, such as brokerages and insurers.

The Sumitomo and Mitsui groups include many companies that represent corporate Japan. So it is likely that the bank merger will lead to the birth of a financial and industrial colossus embracing two former zaibatsu groups. Perhaps it will also trigger tieups, even mergers, among group companies themselves. If that happens, it will also lead to realignments and structural reforms in a broad spectrum of Japanese industries.

Moves toward bank consolidation have picked up momentum since DKB, Fuji and the IBJ unveiled their integration plans. The announcement was followed by a similar agreement between Tokai and Asahi banks to set up a joint holding company. With Tokai serving central Japan and Asahi the greater Tokyo area, the two banks chose the route to a mega-regional bank.

These developments put Sakura Bank under the spotlight, not because of its strength but rather because of its inherent weakness — symbolized by its bad-debt overhang. The consensus view was that, acting alone, it might not be able to survive. Sakura, created through the merger of Mitsui and Taiyo Kobe banks, is seen as a marriage gone sour: It is plagued by internal disharmony — a problem not uncommon in merged banks — and is unable to reap the benefits of economies of scale.

During the bubble period of the late 1980s, Sakura Bank stepped up lending to real-estate firms, general construction contractors and nonbank finance companies. After the bubble burst, many of those loans proved uncollectible. With its financial health deteriorating, the bank found it difficult to meet the borrowing needs of Mitsui group companies.

Sumitomo Bank, on the other hand, has done a relatively good job clearing its bad loans, and its earnings power is said to be more or less stable. In fact, it is ranked as a “good bank,” along with Bank of Tokyo-Mitsubishi. So, unlike Sakura, Sumitomo is seen to be in a good position to survive on its own. Why, then, is it joining hands with Sakura? The plausible answer is that it is seeking to boost its competitiveness through economies of scale and build a universal bank providing a broad range of services at home and abroad. In the background, obviously, is the prospect of the three-way megamerger of DKB, Fuji and IBJ.

One of the greatest concerns of financial institutions here is how to tap an estimated 120 trillion yen in personal financial assets. For Osaka-based Sumitomo, teaming up with Sakura, which has more deposit accounts than any other domestic bank, makes good business sense.

In an age of global competition, there is no bucking the trend toward bank consolidation. A word of caution, however, is in order. Big may be beautiful, but it is no guarantee of success. To succeed, big banks must generate big profits. This is particularly true for Japanese banks whose earnings power is decidedly weak compared with that of U.S. and European banks.

The three banks are no exception. They are, to be sure, tops in the world in terms of combined assets, but admittedly their profit-making capacity is believed to be too weak in terms of global competition. Much the same thing can be said for both Sumitomo and Sakura.

All these banks are reportedly planning major payroll cuts. Employees are said to be unhappy and even angry that executives are trying to achieve efficiency at the expense of the rank and file. That could be the Achilles’ heel of mergers and tieups, for it is impossible to build strong and attractive banks if employee morale is depressed. A megabank, like any other organization, must have a motivated workforce if it is to succeed.

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