In Japan, Ties Meant to Bind Now Strangle
Powerful Keiretsu System Stalls Nation's Recovery
by Sandra Sugawara
Washington Post Foreign Service
Friday, October 16, 1998; Page A01

TOKYO—Not so very long ago, when Japanese companies were steamrolling into America, muscling aside U.S. car companies, winning huge banking deals and buying up Hollywood, the keiretsu was viewed as Japan Inc.'s powerful secret weapon.

The keiretsu groups were an awesome sight -- industrial and trading powerhouses clustered around core mega-banks, all cooperating with one another and wreaking havoc on their U.S. competitors. They looked invincible, bound together by stock holdings, cozy relationships among top officials and preferential business deals.

Now the keiretsu system is a nightmare for those desperate for Japan to reinvigorate its economy and help fend off a worldwide slowdown. The keiretsu ties that bind can also strangle The culture of mutual protection makes it hard for strong companies to break free and grow, and forces weak companies to bail out even weaker ones.

"Japan is like a big pond. It has plugged all the outlets -- that is, it has blocked all attempts to restructure," said James McGinnis, a Tokyo-based banking analyst with Dresdner Kleinwort Benson. "So the pond is stagnating, and even the strongest fish in the pond have started to suffocate." It is Japan's keiretsu system that helps make it almost impossible to reform Japan's banks. The keiretsu economy is organized on the concept of business groups anchored by a major bank. Thus, the survival of its largest banks is central to the survival of Japan's keiretsu groups. That's one reason why analysts remain skeptical that Japan's plan to inject more than $500 billion into its banking system will bring about major reforms or economic growth.

Efforts to close weak banks, cut off shaky borrowers and boost the stronger ones could be a serious threat to keiretsu members. Some of the weak banks might be the main banks of major business groups. Some shaky borrowers appear to be core keiretsu members that the bank has pledged to support. In an environment where financial disclosure is weak, business executives look to the guarantee of a company's main bank to judge a company's dependability.

"If the confidence in a group's main banks is shaky, the confidence in the companies who use the banks as their main banks gets affected," said Rinichi Kozaki, an economic consultant.

So it is that banks like Fuji Bank and Sakura Bank insist they will not take any public funds, despite struggling with massive levels of bad debts. Instead, the financially ailing Fuyo group keiretsu is trying to bail out its Fuji Bank and the struggling Mitsui group is trying to bail out its Sakura Bank. Many of the companies being asked to ante up are themselves losing money. But analysts here said the companies believe the alternative -- no group bank -- is worse.

The Fuyo group companies "couldn't afford to let Fuji Bank fail and lose their main, nucleus bank. That may essentially cost them more. Some companies might actually have a hard time finding a new funding source," said James Fiorillo, a banking analyst with ING Barings. "The group's firms would be damaged considerably, with some of them fatally wounded."

The protracted debate in Japan over its banking bailout legislation has been a battle between Japan's unique system of business groups and efforts to force a more U.S.-style form of free markets on Japan.

For several weeks, the Democratic Party of Japan, the largest opposition group, was able to rally other opposition parties around its plan to erect a Western-style bank regulatory scheme that would force banks to fess up to their problems and would only bail out banks that had a plan for becoming profitable. Such a plan would probably have forced banks to cut off support for weak keiretsu group companies.

The Democratic Party said many banks might be liquidated or temporarily nationalized, possibly including those main banks of keiretsu groups. It embraced the concept of "creative destruction" whereby bankruptcies are supposed to free up funds for more profitable firms and job creation.

But ultimately other opposition groups grew uncomfortable with the potential of widespread bankruptcies and layoffs, so they decided to side with the ruling Liberal Democratic Party's plan to put money into the major banks to stabilize them.

The result is that the collapse of any major banks probably has been averted, but the "creative destruction" that might have spurred the rebirth of healthy, growing companies is nowhere in sight. Kozaki said the keiretsu group system works for companies that merely want to stay alive, but "if a company really wants to grow, it has become a barrier."

Industrial Roots

Japan's keiretsu business groups have their roots in extremely tight industrial groups, known as zaibatsu, that dominated the economy prior to World War II. During its military occupation, the U.S. dismantled those groups, but gradually the more loosely run keiretsu rose up to replace them. They include some of the oldest and most admired names in the Japanese corporate world -- Mitsubishi, Sumitomo and Mitsui. These groups generally included a main bank, a trading company that acted as the distribution arm of the group, and a host of industrial companies. These companies tend to buy products and services from one another -- though not exclusively -- and loyalties run deep.

Manufacturers such as Toyota or Nissan also have vertical keiretsu groups made up of their suppliers and distributors.

To solidify their relationships, members of keiretsu groups generally become one another's major shareholders, customers and lenders.

"What you had evolve was a culture of mutual protection. Banks lent money on the basis of corporate connections, and if they did their jobs properly -- which meant keeping their groups going and making sure that funds went to the proper industrial sectors -- they were fine," said R. Taggert Murphy, a former investment banker in Tokyo and author of "The Real Price of Japanese Money."

If the banks got into trouble, the government backed them up. The Finance Ministry tried to ensure bank stability and profitability through regulations meant to keep out competition. And Japan's central bank made up the difference when large banks ran short of cash. "It was the responsibility of the government to ensure that banks always had adequate resources," Murphy said. "Banks didn't have to worry about their capital ratio or their credit quality."

"Now you have an entire system under extreme pressure," Murphy added. "The strains on the current system are great, and I don't think it's going to survive."

The signs of stress occur daily. When the Fuyo group allowed Yamaichi Securities Co. to collapse last November, stock market traders interpreted that as a sign of the weakness of Fuji Bank, despite repeated assurances from bank officials. When another Fuyo member, Yasuda Trust, faced serious troubles a few weeks later, Fuji Bank arranged a $847 million (100 billion yen) rescue.

"If they had had two failures as a group, it could have led to the breakdown of the Fuyo group itself," said Tomokazu Ohsono, an author of several books on keiretsu groups. The stronger Fuyo group companies might have left the group to look for main banks that they could depend on for funding in tough times. Companies that stayed with Fuji Bank might have had problems dealing with other companies that might view Fuji's guarantees as tenuous.

The keiretsu system is "suffering from system fatigue," Ohsono added. Originally the system made sense, but it didn't change with the times, he said.

The LDP and the Finance Ministry believe they have a way to update and strengthen the keiretsu system. In addition to stabilizing the main banks, they are deregulating the financial system to encourage the keiretsu companies not to break up but to meld closer together. The government this year ended the 50-year ban on holding companies, which was enacted after World War II to prevent the reemergence of the zaibatsu. The deregulation of financial industries here, known as Big Bang, will enable keiretsu to form holding companies that merge their banks, brokerages and insurance companies.

Already the key financial companies in the Mitsubishi group -- Bank of Tokyo-Mitsubishi, Mitsubishi Trust and Banking, Meiji Mutual Life Insurance Co., and Tokio Marine and Fire Insurance Co. -- have announced plans to form a partnership to explore ways of operating jointly in various areas such as investment banking.

Mitsubishi Corp. Chairman Minoru Makihara sees this consolidation as Japan's logical response to the mega-mergers taking place in the United States and Europe. "I think due to global competition and the credit crunch, the ties will get stronger" among keiretsu, he said. "I've been saying in this time of global competition and economic difficulties, we should look again at the various companies within our own group, first of all, because it's the easiest way to do it, and see if we can join forces, provided it's not an exclusive kind of thing."

Indeed, recent events show that the keiretsu groups will not go down without a tough fight. When Nikko Securities announced a partnership with Travelers Group Inc., the U.S. financial powerhouse that is now part of Citigroup as a result of its merger with Citicorp, Moody's Investors Service said the deal is "likely to have a material positive impact on Nikko Securities." But Japanese in the banking and securities companies weren't so sure. The answer to that, they said, would rest with the Mitsubishi keiretsu group.

Although Nikko Securities is not a core member, it was close to the Mitsubishi group, which held 12 percent of its stock. Nikko Securities was supposed to play a central role in Mitsubishi's holding company. But when the deal with Nikko Securities was announced, officials of Bank of Tokyo-Mitsubishi were angry, according to Japanese news media. A good deal of Nikko Securities' stock and bond underwriting business came from Mitsubishi group companies. The media quoted bank executives as saying Nikko Securities could kiss that business goodbye and that at some point the group might dump its Nikko shareholdings.

Officials of Nikko Securities and Travelers have said they want to continue to do business with the Mitsubishi group. But when the new alliance was formed, there was no mention of Nikko Securities. "We don't plan to have a tie-up with Nikko and Travelers, but we can't say never," said a spokesman from Bank of Tokyo-Mitsubishi.

Analysts say that keiretsu groups certainly have the resources to punish those companies that jump at better opportunities. But such thinking will only delay the recovery of Japan's economy. Hiroshi Okumura, a professor who has written numerous books on keiretsu, said the business groups need "to let weak companies go under and new ones emerge. Instead the groups are not letting the market mechanism function."

"I think the role of the corporate group system -- to provide funds for rapid growth of industrial companies -- is gone," said Okumura. There is now an oversupply of automobile, chemical, steel and other industrial companies in Japan. Meanwhile companies in industries where Japan lags, such as software development, rarely benefit from such relationships.

Still, several Japanese officials question whether this is the time to experiment with U.S.-style free markets, given the global economic turmoil. "So many corporations are supported by the main bank system, that when a main bank fails, the effects easily spill over into the real industry," said a Finance Ministry official.

"We just don't know what would happen," said another Finance Ministry official.

Ties That Bind

A keiretsu is a group of Japanese companies whose financial fates are closely linked They buy one another's stock, make loans to one another and give priority to one another in business dealings. Keiretsu business groups are formed around large banks.

Here is one of the best known of these, Fuyo group, with Fuji Bank at the center, and some of its core members:

Yasuda Trust & Banking Co. (asset management)

Yasuda Mutual Life Insurance Co. Tokyo Tatemono Co. (real estate)

Oki Electric Industry Co. (electronics)

Nissan Motor Co. (auto)

Hitachi Ltd. (electronics, capital goods)

NKK Corp. (steel)

Marubeni Corp. (trading company)

Canon (cameras, copiers, printers)

Sapporo Breweries (beer)

SOURCE Corporate Keiretsu and Industry Map by Tomokazu Ohsono

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