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OPINION: Roses Among The Thorns Of Japan's Banking System

By Scott B. MacDonald and Keith W. Rabin

The Example Of The Shinkin Central Banks Shows That Ideas Of Transparency And Disclosure Are Slowly Taking Root

STAMFORD, Conn.--Japanese banks have had many problems over the past decade--including non-performing loans, a slowness to consolidate mergers, poor disclosure and rising foreign competition.

Public money has been used to pay for banking mistakes. This was the case with the Jusen banks, which crashed in the mid-1990s costing Japanese taxpayers billions of dollars. More money was recently used to recapitalize some of Japan's largest banks and the latest information shows bad loans to be on the rise again.

However, not all Japanese banks are deeply troubled. The regional institution, Shizuoka Bank, is doing relatively well, maintaining one of the few AA ratings in the country.

Among the major Japanese banks, a handful of financial institutions are moving in the right direction, including the Shinsei Bank (formerly the Long-Term Credit Bank), the finance company Takefuji and two institutions established by government act, Norinchukin and the Shinkin Central Bank (SCB).

What is important about these examples is that they reflect a serious and largely underreported development in Japanese banking: A shift to a more proactive management style that deals with problems in a top-down fashion in a manner that does not stick the taxpayer with a huge tax bill.

The Shinkin Central Bank, for example, possesses $202 billion in assets. This makes it comparable in size with FleetBoston, the 5th largest bank in the United States. Possessing one of the highest ratings among Japanese banks, it has been praised by Moody's (A1) and Standard & Poor's (AA-) for its asset quality, high liquidity and strong capitalization.

With only a small portion of its portfolio allocated to corporate bonds, it does not suffer from large cross-share holdings, which many claim to be one of the main problems facing Japanese financial institutions.

Some readers will be surprised to learn that SCB's ratings are equal to leading U.S. banks, such as Bank of America, Citigroup and Bank One. SCB is the central bank for 369 shinkin institutions, which serve 8.5 million medium-sized and small businesses as well as individuals throughout Japan. Its major functions are to manage the excess reserve liquidity of shinkin banks and to safeguard against solvency problems.

Shinkin banks are akin to credit unions, though their operations are increasingly akin to commercial banks. SCB is funded by its members, mostly through time deposits and capital markets activities. Its position in this U.S. $1 trillion-plus cooperative system provides its members with a large and stable funding base.

Shinkin banks generally operate at comparatively low expense ratios, with a capital adequacy level of close to 16 percent, well ahead of most Japanese banks. At the same time, shinkin banks face pressure from Japan's lengthy recession, upheaval in local economies and industrial restructuring.

Considering the multiple challenges facing Japanese banks, SCB has provided strong leadership to its members, some of which have had problems.

For example, in 1999, two member banks--the Kyoto Miyako and Minami Kyoto--had grave problems related to bad loans in the real estate, construction and textile sectors. Kyoto Miyako had also inherited a number of bad loans from an earlier merger. Examinations by governmental regulators reinforced concerns over the looming failure of these institutions.

Instead of letting the problem fester, SCB management acted quickly. It recognized if both banks failed there could be substantial damage to the local economy, which was heavily dependent on shinkins.

Other considerations included potential fallout to other shinkin and banks and the need to protect depositors and healthy borrowers. It was also acknowledged that to delay would only make the problem worse, tarnishing the reputation of all shinkin banks.

Consequently, SCB, together with Kyoto Chuo Shinkin, the largest shinkin in Kyoto, intervened. With the blessing of the government, which provided insurance support, the Kyoto Chuo Shinkin assumed control of the two smaller shinkin in January.

At the same time, SCB provided a loan of around $400 million to the Kyoto Chuo Shinkin. This helped it balance the hit it assumed through the bad loans of these banks.

As a result, Moody's, which had given SCB a financial strength rating of D+, (the current rating of many major Japanese banks) upgraded SCB to C+ in March, one of the strongest ratings in Japan.

Although Moody's had previously raised concerns about the stand-alone ability of the SCB to develop business and improve profitability, this new financial strength upgrade reflects the progress that SCB has made, at a time when many other Japanese financial institutions have been downgraded.

The Organization for Economic Cooperation and Development in its May 2001 biannual economic report called for Japan to have a more detailed appraisal of the quality of banks' loan portfolios, a realistic assessment of bank capital and debt forgiveness or repossession of collateral. The international organization also indicated a need to liquidate insolvent banks, replace failed management and use public funds to cover losses of depositors. While many Japanese banks are still anguishing over these issues, SCB is seeking to follow through with much of what the OECD is advocating.

While Japanese banking continues to wrestle with implementing workable credit cultures based on the concepts of transparency and disclosure, the SCB experience indicates these ideas are slowly taking root and that some hope remains for the Japanese banking system at large.

Scott B. MacDonald is director of research for Aladdin Capital, a Stamford, Conn.-based hedge fund and Keith W. Rabin is president of KWR International, a New York-based consulting firm. Their views are not necessarily those of BridgeNews.

© 2001