Japan’s second largest bank, Mitsubishi Tokyo Financial Group (MTFG) and the fourth largest bank, UFJ Holdings (UFJ) are planning to merge by September 2005 to form the world’s biggest bank in terms of assets. The proposed merger will bring together total assets of ¥188 tn ($1.7 tn), which is one and a half times the total assets of the presently largest financial services company, the Citigroup with $1.19 tn. Despite the risk of erosion of MTFG’s capital base after writing down of the non-performing loans of UFJ, the merger is in tune with the ongoing consolidation process in the Japanese banking industry, which is trying to tackle the problem of non-performing loans. The merger has the potential to address the problem of bad loans in the Japanese banking sector, which has pushed the entire industry into trouble
since the mid-1990s.
The troubled Japanese banking industry and the rationale behind the merger The problems in the Japanese banking industry started in 1995 when the Bank of Japan reported the failure of two credit unions—Tokyo Kyowa Credit Association and Anzen Credit Bank—which failed to recover loans worth ¥110 bn. Following this, a large number of depositors withdrew ¥63 bn from the fourth largest credit union of Japan—the Cosmo Credit Corporation. In August 1995, Kizu Shinyo Kumiai, the biggest credit union of Japan, was reported to have an unrecoverable loan of ¥600 bn, which coupled with the failure of Hyogo Bank, a commercial bank, further eroded the faith of the depositors in Japanese banks. The crisis aggravated with the Daiwa Bank scandal, which surfaced in September 1995. Daiwa, then Japan’s 12th largest bank, reported a cumulative loss of $1 bn over an 11-year period. The same year, the Jusen crisis also came to the fore. Jusen companies were formed in 1970s with the help of the Japanese Ministry of Finance to cater to the increasing demand for housing loans in Japan. It had started giving loans to real estate companies during the real estate bubble when land prices significantly increased. When the real estate bubble burst in the late 1980s, the company was hit hard due to a rapid decline in real estate prices. It continued operations in spite of accumulating huge non-recoverable loans. In 1995, the Japanese Ministry of Finance discovered that Jusen had non-performing loans of ¥9.6 tn, out of which ¥6.4 tn was unrecoverable and ¥1.2 tn was a possible loss. All these events resulted in the declining prices of banking stocks, and degraded credit ratings of Japanese banks.
In 1998, Japan’s seventh largest securities firm, Sanyo Securities, defaulted. The next ones to fail were the largest bank in Hokkaido, Hokkaido Takushoku Bank (bad loans amounting to a total of ¥934.9 bn) and the fourth largest securities firm of Japan, Yamaichi Securities. It led to the increase in Japan premium and in 1997-98 the Japanese banks had to pay 100 basis points above the London Inter Bank Offered Rates (LIBOR), in case they wanted to borrow US dollars in the interbank market.
As of 2004, MTFG has total assets of ¥106 tn and UFJ has assets worth ¥82 tn. However, UFJ suffered from bad loans of ¥3.95 tn by the year ending March 31, 2004. Resolving the bad loans problem is difficult as large chunk of such loans are concentrated with a few clients making the recovery very difficult. Moreover, UFJ has been reporting net loss since 2002. In June 2004, the Financial Services Agency in Japan issued an order to UFJ to review its operations and submit business improvement plans as it had tried to evade full disclosure of its bad loans and operational problems. The bad loan ratio of UFJ is 8.5% compared to 2.9% of that of MTFG. As part of its recovery plan and to regain profitability, UFJ has decided to merge with MTFG as it would bring the required financial muscle to bury a lot of bad debts.