The Impack of World's Second Largest Bank Merger on "Japan, Inc."

The Impact of World's Second Largest Bank Merger on "Japan, Inc."

Jin CHEN

Introduction

In mid-October, Sumitomo Bank and Sakura Bank announced that they would merge in April 2002 to form the world's second largest bank, precipitating wide-ranging discussions about the current restructuring of Japanese industry. Many observers in the press have written that this merger, crossing as it does the once-sacred lines between corporate groups, will have a profound impact on the Japanese corporate landscape.

In this article, I argue that the impact of this particular merger is not as dramatic as the media have reported. It is an event that must be interpreted against the backdrop of the Japanese economic slowdown, increasing globalization, and intensifying mega-competition in the 1990s. The merger is also a necessary step in the restructuring of the Japanese economy, a process which is evolving very gradually. In this article, I first provide background information about the merger, then present the argument that the impacts are profound, and finally substantiate my argument that the merger does not herald a dramatic change in the Japanese economy. In the course of my argument, I consider the merger in the larger economic context and analyze the corporate relationships embedded in the concept of "Japan, Inc."

The Merger

Sumitomo Bank is the fourth largest commercial bank in Japan and the main bank of the Sumitomo groups of companies. Sakura Bank is the sixth largest bank in Japan and the main bank of the Mitsui groups of companies. A merger between them means not only a combination of bank assets and banking expertise as it does in the US context, but also a more complex and entangled financing scheme across the two large Japanese corporate complexes - as of 1995, Sumitomo Co. and Mitsui & Co. have 583 and 742 subsidiaries and affiliates, respectively (The Fair Trade Committee, "The Report on the Economic Concentration," 1994).

Sumitomo and Mitsui have been part of Japan's economy since the 17th century, forming into powerful corporate groups known as zaibatsu in the late 19th century. They were among the targets of the zaibatsu dissolution process started in November 1945, when the General Headquarters of the Occupation Forces issued a "Memorandum Concerning the Dissolution of Holding Companies." Although a total of 83 major holding companies were named in five initiatives undertaken from September 1946 to September 1947, the actual number of zaibatsu that were abolished was very limited, partially due to MacArthur's "reverse course" in order to build American alliances in Asia in the beginning of the cold war against the Communist countries. Thus many major companies kept their zaibatsu affiliations despite the Anti-Monopoly Law of 1947, which prohibited the establishment of pure holding companies and forced parent companies to undertake business operations themselves. These post-war laws and regulations nevertheless broke down the exclusive family ownership of large zaibatsu, loosened the relationships between individual companies under the same parent company, and thereby significantly reshaped Japanese corporate structure.

Some background information regarding the Japanese main bank system is due here. Traditionally, large firms in Japan rely heavily on direct bank finance rather than equity or bond issues, and maintain a close relationship with a particular bank known as the firm's "main bank." The main bank has several important functions in Japanese industrial financing. First, it provides finance to manufacturing companies in the absence of effective equity and bond markets. The average main bank provides about 25% of all credit to the borrowing company. The main bank is also a principal shareholder and may own up to 5% of the equity of the borrowing company.

Second, main banks have monitoring and control functions which the hostile takeover and credit-rating institutions provide in the United States. By seating a bank representative on the board of directors of the borrowing company, the main bank is closely involved in the business and financial plans of the firm. The main bank's easy access to inside information and internal decision-making is particularly important as Japanese standards of corporate accounting and disclosure are poor by international standards.

Third, the main bank provides financial stability to the borrowing company. The main bank is expected to look after the borrowing company should it encounter financial difficulties. A sound main bank relationship is thus seen as a kind of bankruptcy insurance. (See, for example, Sheard, 1989.)

With the above background, let us return to the Sumitomo-Sakura merger. Sumitomo Bank and Sakura Bank announced that as a part of the merger, they plan to slash their joint work force of 31,000 by some 9,300 in five years - a 30% reduction. They plan to make a 20% reduction by March 2002, and the final 10% will take place by 2004.

This work force reduction is much more severe than the reduction in the largest Japanese bank merger ever. Announced in August, that merger will combine Dai-Ichi Kangyo Bank (DKB), Fuji Bank (Fuji) and Industrial Bank of Japan (IBJ), and involves plans to cut 6,000 jobs in five years.

The new bank will have a strong retail network, combining Sumitomo's strengths in the Kansai area (Nara, Kyoto and Osaka) with Sakura's strengths in the Tokyo metropolitan and Kobe areas.

The government views the merger positively. Katsusada Hirose, Administrative Vice Minister of International Trade and Industry (MITI) has said that the merger will play a positive role in industrial reorganization ("Bank Merger to Blur Old Zaibatsu Lines." The Nikkei Weekly, October 18, 1999). International financial analysts have also generally praised the plan. They take the merger as an indication that the Japanese financial industry's Big Bang reform, which refers to the massive mergers and acquisitions as a result of deregulation, is entering its final stages.

While the Bank of Tokyo-Mitsubishi seeks to operate globally, and the integration of the three banks (DKB, Fuji and IBJ) constitutes an attempt to create a comprehensive financial group, the Sumitomo-Sakura merger fills the gap in the retail sector. The stock market welcomed the plan. When news of the merger appeared in the press, the stock prices of both banks rose rapidly.

The Argument that the Sumitomo-Sakura Merger Will Have a Profound Impact

One direct implication of the Sumitomo-Sakura merger is that rivals in key industries, from trading houses to auto makers, will soon share the same main bank. In the short term, if two rivals share the same main bank, they are no longer rivals as the main bank has the same interest as each one of these two companies, and the intensity of market competition is reduced. In the long term, however, if the two companies are seen as joining forces in the market, they may be more able to survive competition against larger companies or foreign companies bound to enter the Japanese market as Japan continues its financial reforms, and continuing competition is thus preserved. It is difficult, therefore, to predict whether the net result will be increased or reduced competition.

Another ramification of the Sumitomo-Sakura merger is that it increases the likelihood that another round of industry realignment will occur. Some even think that for a Japanese bank to reject a merger, even when the other bank is a main bank of another corporate group, would no longer be logical in the Big Bang era. Under global mega-competition, the executives of big banks, despite the size of the banks, feel that they must cooperate across traditional zaibatsu groupings to be competitive. Thus, mergers like the Sumitomo-Sakura merger cast increasing doubt on the old loyalties to traditional relationships.

Last but not the least, the Sumitomo-Sakura merger will create the second largest bank in the world, smaller in asset size than only the recently announced merger among DKB, Fuji and IBJ. The presidents of Sumitomo Bank and Sakura Bank admitted that the three-way merger among DKB, Fuji and IBJ had accelerated their decision to merge.

Why Isn't the Sumitomo-Sakura Merger a Dramatic Change?

First, let us consider the merger in the context of the ongoing restructuring of the Japanese banking industry which began two years ago. Intensifying competition in the global financial market, increasing emphasis on economies of scale, as well as the new rules in the financial sector brought about by deregulation have made mergers like the Sumitomo-Sakura merger inevitable. A couple of years ago, Japan had ten commercial banks, seven trust banks and three long-term credit banks. Now, after the collapse of Hokkaido Takushoku Bank in 1997, the regionalization of Daiwa Bank in 1998, and mergers reducing four other commercial banks to two entities, there are only five commercial banks in Japan. All three long-term credit banks have disappeared, and most trust banks are now allied with major bank groups. It would not be surprising if the wave of realignment moved beyond the banking sector to securities and insurance industries.

Second, let us consider the argument that bank mergers will change inter-company relations in Japan. The two mergers announced in August and October make large Japanese banks even larger. The new holding bank consisting of IBJ (the twentieth largest in the world), Dai-Ichi Kangyo Bank (the eleventh largest) and Fuji Bank (the fifth largest) will exceed Deutsche Bank in size to become the largest bank in the world with total assets of 141 trillion yen. The merged Sumitomo and Sakura will become the second largest bank in the world, with 98.7 trillion yen ($931.1 billion) in assets. These changes will relegate Deutsche Bank to third place and UBS to fourth place.

What does the change in rank mean in the real world of corporate operations and corporate governance in Japan? Professor Masahiro Shimotani of Kyoto University offers some helpful insight for us to answer this question. Professor Shimotani distinguishes corporate group (kigyo keiretsu) from corporate complex (rokudai kigyo shudan). A corporate group consists of a parent company at the head of a large number of supporting subsidiaries. These subsidiaries were formed either through the parent's internalization of existing companies or through its spinning off of operating divisions in the context of diversification, vertical expansion, or management decentralization. In these cases the subsidiaries remain organically connected with the parent company, and the parent company is slimmed down into mere corporate headquarters. Thus companies in a corporate group typically belong to the same industry. Business groups or keiretsu are bound together by capital ties or regular transactions, and these bonds are reinforced by the cross-ownership of stock and the sharing of top management personnel. These ties may also be formed through long-term continuous transactions, technology transfer, or lending.

A corporate complex is made up of a number of corporate groups. Corporate groups are linked together to form one corporate complex through the cross-shareholding and presidential meetings characteristic of Japanese corporate governance. Cross-shareholding provides financial stability to corporate groups. The regular meetings of the presidents of complex companies, known as presidents' council meetings (shacho kai), are informal monthly luncheons. These meetings provide a forum for social interaction and the exchange of information between the presidents, reinforcing their friendly relationships. The individual member companies maintain their own independent powers of decision. The pre-war "control tower" organizations that guided the overall actions of the zaibatsu no longer exist, and have been supplanted by loose complexes.

Professor Shimotani argues that "Japan's corporate groups have been proven to be quite flexible, contributing to the avoidance of what might be called big company disease" (Shimotani, 1997, p. 24). Large Japanese enterprises have actively sought to quasi-externalize internal units into subsidiaries, while simultaneously quasi-internalizing numerous outside smaller companies and subcontractors. By taking advantage of these processes of quasi-externalization and quasi-internalization, Japan's large enterprises have been able to expand their boundaries beyond the limits of the firm and have created more flexible organizational structures. This flexibility creates adaptability, which can make the impact of the merger of the main banks of different corporate complexes less dramatic. Professor Shimotani also points out that, although "de-keiretsufication," or weakening ties between subcontractor firms and the central parent, has been a phenomenon for several years, and the old problem of balancing decentralization and vertical integration has resurfaced in the form of post-bubble recession restructuring strategy, the "fundamental nature of Japanese corporate groups is likely to continue as it is for the foreseeable future" (Shimotani, 1997, p. 25).

What will happen to the rate of cross-shareholding and the traditional relationships between corporate complexes after two main banks of two corporate complexes merge? I do not expect considerable changes because the intra-complex stock holdings among the six largest corporate complexes are thin. In 1997, the rates of cross-shareholding within the Mitsui complex and the Sumitomo complex were 15.1% and 22.2%, respectively. With the exception of Mitsubishi (38%), the average intra-complex cross-holdings of the other four complexes is about 19%. Average intra-complex transactions (excluding financial institutions) are less than 10% of total transactions (The Fair Trade Committee, "The Report on the Economic Concentration," 1994). The argument that this merger will hurt traditional relationships between corporate complexes may be countered with the argument that Sakura will be able to retain the business of Mitsui group member companies, which have recently strayed from their longtime main bank, while Sumitomo can enhance its wholesale business by adding Sakura's customers to its base.

Furthermore, as discussed above, although the short-term impact of the Sumitomo-Sakura merger is to reduce competition, its long-term effect is hard to predict. What would happen if the Sumitomo-Sakura merger did not take place? Given the trend of the Japanese "Big Bang," Sumitomo and Sakura could each be taken over by other banks, in which case the competition would be reduced even further than the current scenario. The long-term impact of the proposed merger is influenced by, among other things, the degree to which the Japanese markets are open to foreign firms.

Finally, Japanese corporate structure compliments two other unique features of the Japanese economy: lifetime employment and long-term trading relationships. Paul Sheard explains in his paper why the main bank system makes sense in the Japanese context (Sheard, 1989). For instance, he reasons that lifetime employment makes external monitoring costly. Sending a representative of the main bank to the board of a borrowing company can essentially eliminate monitoring costs. Thus for a merger of main banks across corporate complexes to have a profound impact, it would have to alter other aspects of the Japanese system. These other aspects of Japanese corporate governance will take a long time to change. In his talk entitled "Is Japanese capitalism ending?" Professor Ronald Dore of Cambridge University concluded that Japan's moves toward capitalism (as that term is understood in the US and the UK) are taking place extremely slowly, and that firm structure, employee promotion schemes, and relationships among firms will remain as they have been in the past.

In conclusion, the proposed merger between Sumitomo Bank and Sakura Bank, by itself, is unlikely to cause any fundamental change in the Japanese corporate landscape. The proposed merger is merely one of the many mergers and acquisitions in Japan's economic restructuring since the end of the 1980s when the economic bubble bursted.

(The author is a candidate for the degree of Master of Arts in Regional Studies/East Asia at Harvard University.)

References:

1. Sheard, Paul. "The Main Bank System and Corporate Monitoring and Control in Japan." Journal of Economic Behavior and Organization 11 (1989): 399-422.

2. Shimotani, Masahiro. "The History and Structure of Business Groups in Japan." In Beyond the Firm: Business Groups in International and Historical Perspective, ed. Takao Shiba and Masahiro Shimotami. Cambridge: Oxford University Press, 1997.