Japan's banks rebound to lead the pack

"The fiscal year ended March 2005 marks the end of Japan's financial crisis."

Brett Hemsley, senior director for Japanese financial institutions at Fitch Ratings

Buying scandal-tainted bank plagued by four straight years of red ink hardly seems like an auspicious way to cement a turnaround.

But when Mitsubishi Tokyo Financial Group Inc takes over money-loser UFJ Holdings Inc tomorrow, the new bank will not only emerge as the world's biggest bank -- surpassing Citigroup in terms of assets -- but it will also symbolize the rebirth of a Japanese banking industry once buried in bad debt.

Named Mitsubishi UFJ Financial Group Inc, the new giant will lead an industry that has undergone years of consolidation, largely freed itself from the onerous bad loans and is now helping underpin the nation's economic resurgence.

"The banks are back," said Jesper Koll, chief economist at Merrill Lynch & Co. "A normal economy where you've got not just growth in employment and wages, but also growth in credit is likely to become more pronounced."

Just few years ago, Japanese banks were saddled with massive debts that had piled up over a decade-long slowdown in the world's second-largest economy after the stock and property price bubble burst in the early 1990s.

At their peak in March 2002, major Japanese banks' loans to troubled borrowers totaled ¥43.2 trillion (US$383 billion). The total dropped to 17.9 trillion yen by the end of March, according to the latest data from Japan's Financial Services Agency.

In May, Bank Minister Tatsuya Ito declared that seven top Japanese banks had reached a "turning point" in reducing by half the proportion of their bad loans to overall lending -- a government target for moving banks toward financial health.

To get there, the banks reduced loans, wrote off nonperforming debts and gobbled up weaker lenders. Japan's "Big Four" -- Mizuho Financial Group, Mitsubishi Tokyo, Sumitomo Mitsui Financial Group and UFJ -- didn't even exist 15 years ago. All were formed in recent years through mergers with smaller banks.

Come tomorrow, that will shrink to the "Big Three."

Now, the banks' earnings are rebounding, their stocks are gaining, and -- in a sign of Japan's economic recovery -- overall bank lending rose year-on-year last month for the first time since 1998, when the central bank began keeping statistics.

"The fiscal year ended March 2005 marks the end of Japan's financial crisis, with improvement in the banks' asset and capital quality," said Brett Hemsley, senior director for Japanese financial institutions at Fitch Ratings, said in a July report.

He predicts that the industry could report its highest net income ever in the current year, exceeding the previous record of ¥1.7 trillion in 1989.

But to achieve global competitiveness, Japanese banks still need to boost their profitability. Interest margins for Japan's big players are about 1 percent, about four or five times lower than that booked by US rivals, Koll said.

The problems that faced Osaka-based UFJ, the smallest of the "Big Four," provide a glimpse of the industry's ills.

It was the last of Japan's big banks to meet the government's target of halving the proportion of bad loans, only after posting a fourth straight annual loss in the year through March this year.

The company's troubled clients included retailer Daiei, which is now undergoing a government bailout, while three former executives at its banking unit were arrested last December over allegations the bank lied to government authorities about its bad debts.

The new Mitsubishi UFJ Financial Group Inc will have total assets of around ¥190 trillion (US$1.68 trillion), topping US-based Citigroup Inc's US$1.55 trillion, based on most recent company figures.

Mitsubishi Tokyo and UFJ posted a combined net loss of ¥139.3 billion in the year through March.

But adding individual outlooks would give the new company a joint profit of ¥735 billion in the current fiscal year through March next year, while together they are forecasting net income of ¥1.1 trillion for the year through March 2009.

However, a three-month delay to Jan. 3 in the merger of the commercial banking units of UFJ and Mitsubishi Tokyo because of worries about computer integration has raised concern about whether the companies are too optimistic about cost savings.

Mitsubishi UFJ may not be even Japan's biggest bank for long.

Prime Minister Junichiro Koizumi plans to privatize the nation's postal system, which has ¥330 trillion in savings and insurance deposits and 24,700 offices around the country.

That process, if approved by parliament, would begin in 2007 and could pose a retail banking threat to the likes of Mitsubishi UFJ.