Japanese banks suffering after decade of bounty


In future histories of international high finance, September 1990 is entitled to a footnote as the month when Japanese banks looked to the United States as a possible source of capital.

After a decade of shopping their huge rolls of cash around the world, often undercutting competitors to get huge chunks of the "junk" bond issues that paid for the U.S. corporate takeovers of the 1980s, Japan's banks are themselves hunting for ways to borrow money.

They are not always finding it.

For the first time in a decade, key international rating houses have repeatedly downgraded major Japanese banks and put others on their "watch" lists for possible downgradings.

Ripples from the mounting problems of Japanese banks have reached far overseas. They range from the drying up of an important capital source for corporate takeovers to interest-rate worries for U.S. states and cities that rely on Tokyo-based letters of credit to help hold down interest rates on government-backed bonds.

The sources of Japanese banks' troubles this year are the mirror images of their two greatest strengths through the late 1970s and the 1980s: a strong stock market and low interest rates.

After a boom of more than a decade, the Tokyo Stock Exchange went into free fall through the late winter and early spring of 1990. It was just beginning a lackluster recovery when Iraq's Aug. 2 invasion of Kuwait sent prices through the floor again. By the end of September, the exchange's leading index, the Nikkei 225, was down by nearly half from last winter's high.

Japan's main banks all are members of keiretsu, groups of companies that hold large amounts of each other's common stock. For a decade, the immense inflation of price-to-earnings multiples on the Tokyo exchange, which reached 50 and 60 by late 1989, made expansion easy and profits in the banks' own operations less important.

With the exchange's successive crashes this year, banks estimated that the book value of their assets had dived by more than $116 billion from the end of March to the end of August. In a system that has emphasized banks' growth more than their profitability, that is equal to four years' pretax profits.

Japan's Finance Ministry Monday unveiled an emergency plan Monday to support the stock market. The ministry said it would allow investors more leverage in their stock market accounts, and raised the portion of insurance company assets that could go into stocks.

The rescue plan helped. After falling 761 points Monday, the 225-stock Nikkei index made its largest-even one-day gain Tuesday, climbing 2,676.55 points or about 13 percent to 22,898.41. The market then rebounded after a two-day halt in the rally. On Wednesday, the index fell 49 and on Thursday it fell 571 points. On Friday, it rose 549 points to close at 22,827.65.

Low interest rates lent additional power to the Japanese bank boom of the 1980s, but inflationary pressures have prompted the Bank of Japan, the nation's central bank, to more than double its benchmark rate -- from 2.5 percent to 6 percent -- in less than half a year.

The result of those twin reversals has been that some of the dour men who run Japan's collection of the world's biggest banks have begun to raise capital through innovations not usually associated with Otemachi, Tokyo's financial headquarters.

At least two big mainstream banks have issued subordinated debt instruments through subsidiaries in the Caribbean.

Last month, the Asian Wall Street Journal reported that Mitsubishi Bank, the world's fourth largest, was looking at the prospects of raising capital through a sale of stock in a U.S. subsidiary, San Francisco-based Bank of California.

Not all of the banks have reached so far afield, but the problems of Japan's biggest commercial banks led the Ministry of Finance to grant them permission last June to raise capital through subordinated debt schemes usually reserved for the country's long-term credit banks.

That set off such a flood of new subordinated debt issues that the ministry set up a queue to assure the big commercial banks "orderly access" to London and other big international capital markets.

Still, many of Japan's top 12 banks reportedly are finding takers for fewer than half of the billions of dollars in subordinated paper they are offering.

That is not because anyone doubts the banks' ability to pay their debts. It is because the instruments themselves -- obligations that put the lender in line behind several other categories of creditors -- can provide the bank's benefactor only a razor-thin margin if the bank is to keep interest on money it borrows lower than interest on money it lends.

Nobody in Japan is predicting a long string of bank failures or rescues comparable to those the United States has faced, or even mass layoffs such as those New York banks have begun to announce.

Most analysts in Japan say that Japanese banks, though undercapitalized by world standards, have strengths that banks elsewhere cannot call on, especially those in the United States.

Those strengths include both a government that does not hesitate to bend policy in times of trouble and the corporate relationships created by the keiretsu.

Some Japanese banks already have drawn on these corporate connections to borrow money, especially through subordinated debt.

When that prospect is discussed, the names that come up as potential allies of the banks are formidable -- Toyota, Mitsubishi, Sony and Toshiba have been mentioned as likely candidates in recent Japanese newspaper articles.

Still, the reversals of 1990 have been swift and substantial.

One measure of their pace and depth has been in the prospects of Japan's 12 biggest banks to meet international capital requirements.

When the Bank for International Settlements set March 1993 for the big Japanese commercial banks to match the rest of the industrial world's capital standards, nobody saw a problem.

The rules allow banks to count 45 percent of unrealized gains on their stock portfolios as capital. With that much of their paper stock profits counted as capital, Japan's biggest banks were so rich that all but one of the country's top 12 were reported to have met the standard by March, a year after it was set and a comfortable three years ahead of schedule.

Half a year later, only three of the 12 are said to exceed the standard, -- capitalization equal to 8 percent of assets -- and those three are said to be on or near the borderline. No longer is anyone willing to predict how many of Japan's banks, if any, will meet the standard 2 1/2 years from now, when the deadline arrives.

For many Japanese bankers, the huge drop in stock prices has sounded like the first shoe dropping.

The other shoe is the equally hyperinflated market in real estate, which always responds to tight money more slowly than stocks because real estate takes longer to sell.

It was overexposure to hyperinflated real estate, not to stocks, that Moody's investment rating service cited in August when it downgraded Japan's Dai-ichi Kangyo Bank, the world's biggest, and Fuji Bank.

The Bank of Japan is not likely to relax interest rates until it sees a drop in land prices and stock prices, Nobuyuki Ueda, senior economist and associate general manager of the economics division of the Long Term Credit Bank of Japan, has said.

"Asset price inflation is to be corrected. Even sticky land prices will finally come down," Mr. Ueda said.

The troubles of Japan's banks, though far from threatening their survival, will play into the economies of Japan and the rest of the world in the form of a gigantic addition to what most analysts see as a relentlessly mounting international liquidity problem.

Recent surveys of Japanese bankers have begun to show that for the first time in more than a decade they are planning to rein in -- or already have begun to trim back -- their plans for growth in lending.

Many say the main reason is that they are determined to beat or at least meet the deadline set by the Bank for International Settlements for bringing capital holdings up to 8 percent of assets.

Most analysts in Japan think Japan's cash-rich corporations are well positioned to ride out a period of tighter money, especially since most have been investing heavily in new plants, equipment and technology for more than a decade.

But the new reticence of banks to expand their lending, combined with the virtual elimination of the Tokyo Stock Exchange as a place to raise investment funds, seems to be having its first effects on Japanese companies' ability to spend.

New orders for capital goods began to decline in September surveys, and many analysts say that was the first sign of a cooling economy.

The stock market's drop and the tighter money at home has reversed more than half a decade of capital flows from Japan to other countries, especially the United States.

Billions of dollars have flowed back to Japan this year, and the Japanese have staked out far smaller positions at debt sales by the U.S. Treasury.

Mr. Ueda said he saw no reason to predict an early change in that trend.

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