Resona bailout: Nationalization is only the beginning

Kazuhito IKEO (Professor, Keio University)

The government has decided to inject new capital into Resona Group to eliminate cumulative loss of its subsidiary, Resona Bank, which will effectively be nationalized. However, this is not a real solution to the problem. If the bank is not revitalized quickly to the levels where the bank could be operated independently without government support, it would only be the beginning of endless and fruitless infusion of capital. The rescue operation needs to be a short-term exercise, and effective infusion of human resources, including those from the private sector, is one of the keys to expedite the process.

Quick recovery of self-sustainability is the key

Infusion of public money into Resona Bank is in accordance with the new scheme set last fall. This is, however, not a solution but only the beginning of a process to revive the bank. To leave the bank under government control for a lengthy period of time is against the larger policy framework of financial revitalization. It is when the bank is relieved of regulatory control and regains the ability to act independently that the problem could be considered closed.

There have been many discussions along the lines of how public money could be used to solve the issue of non-performing assets at financial institutions. It must be recognized, however, that injecting public money into an ailing bank merely means that the responsibility to deal with the problem is transferred from the managers to the government, requiring the government itself to step in a resolve the issue. This also means that the bank must be run by the government, succeeding former managers of the bank. But is the government qualified to operate a commercial bank? If not, it would only result in an endless loop of poor performance and further injection of public funds.

In effect, nationalizing a bank means creating a new, money-losing, state-managed corporation. The problem will not be resolved, then, until this entity is rebuilt to the stage where it would be able to stand on its own.

There have been opinions proposing that the government would not need any expertise to manage a bank; and all that the government needs to do is to bring in a manager assigned to realize a profit who would either be fired or given a bonus at the end of some originally set deadline. If the world were really this simple, however, there would be no investors troubled with such matters as corporate governance. Investors' responsibility, for their own sake and necessity, is to evaluate a manager in terms of his or her competence from various aspects, and it has been documented that assigning a simple profit target would rather have a negative impact on the manager's performance.

There is another point especially with regard to Japan's bank managers. Is the banking sector problem merely a result of incompetence or imbecility of the managers? Is it not too naive to expect that someone else, if urged strongly to make profits, would perform significantly better than the previous managers would?

In other words, Japan's banking problem must be treated as a whole industry issue as well as at the individual bank level. It is true that Japan's banks have weaknesses in management and corporate governance, which must be corrected, but that would not suffice.

Excess banking capacity needs to be rectified

It would be a futile effort to tell banks to keep a sufficient margin to cover the risks in lending money when there are too many banks competing in the market. Banks would lend without profit rather than lose customers to competitors. If this were to occur in an ordinary industry, losers had to be exited so that the number of firms would become fewer eventually. For banks, however, it was customary for the government to step in to avoid insolvency, which has resulted in preserving excessive banking capacity in the market.

Within such an environment the assumption that the issues could be resolved if capable managers were installed seems too naive. It is somewhat disturbing as government officials have apparently not realized this point, among which Prime Minister Koizumi made a remark that Resona's performance should recover through capital infusion and managerial reform.

The special assistance scheme being employed by the government in conjunction with capital infusion has no substance other than to monitor the behaviors of the bank. A team will be set up from the staff at the Financial Service Agency, but their job is to only watch and check management and to attend directors' meetings. This means the bank will be under closer scrutiny by authorities, but would this in any way assure improvement of the bank's performance?

Experts from private sector needed on the monitoring team

The monitoring team would consist of government officials with no experience in the banking business. Although Japan's public servants are supposed to be very talented, it is probably too much to expect them to be able to run a bank properly, especially where the predecessors have failed. If there is no viable reason to assume that bureaucrats could run a commercial bank better than business people, then the arrangement under the scheme should be considered a temporary measure, which should end as soon as it becomes practical for business people to take over.

Dissolutions of the defunct Long Term Credit Bank and The Nippon Credit Bank a few years ago could be good examples for comparison. Those transactions sucked huge amounts of public money and levied heavy responsibilities on the regulators, but the problems were quickly settled through sales of the banks to private investors. The current scheme applied to Resona would be less burdensome to the authorities but could distract their attention from seeking a true and effective solution.

Capable personnel need to be commissioned from the private sector as well in creating an effective monitoring team. It remains to be seen and must be watched closely whether the government is truly aware of the real issues, and whether it is prepared to take positive and effective measures.

(The original Japanese paper appeared in the May 20, 2003 issue of Nikkei Shinbun)