Is Revitalizing the Banks Enough?

Kazuhito IKEO (Professor, Keio University)

It is important to formulate effective tactics. But as the proverb says, "Wrong strategy cannot be saved through good tactics." So long as there is an error in the basic strategy, tactics, however refined, cannot bring about a solution to the issue. In this context, the currently popular thesis that "banks should restructure management and seek profitability" should be viewed with skepticism.

There is no ambiguity in the fact that Japanese banks still have managerial problems, such as in the area of corporate governance, which need to be corrected. But it is utterly wrong to assume that all of the financial difficulties Japan is experiencing can be reduced to the issue of running a bank. The question is, while banks must definitely regain their strengths, would it be enough to resolve all the problems?

In my view, Japan's financial problems are unfortunately not something resolvable by simply restoring sound management of commercial banks. The core of the problems is that the fundamental architecture of the financial system has become obsolete.

The financial system placing commercial banks at the center was appropriate and effective during the catch-up stage of economic development when fund starvation was the norm. But since the economy has matured to the current stage where fund is not necessarily scarce, the bank-centered financial system has become inadequate.

Thus, a reform of financial system architecture has become necessary. It was proposed in the Overview of the Medium-term Vision for the Future of the Japanese Financial System by the Financial Service Council reported last year that reform should aim to establish a channel for fund flow through market-based financing while streamlining the traditional type of relationship-based financing through banks. This is indeed a proper strategy to approach the imminent problem.

However, the current approach adopted by the government, which asks banks to expedite reforming their management to increase their profitability, lacks the fundamental notion that the traditional type of bank-centered financing system needs to be streamlined, or more specifically, that the present state of over-banking needs to be dissolved. Perhaps there is a misapprehended optimism among people involved that through efforts by managers of banks, commercial banking could become a growing industry.

It would, of course, be a different story if means were in place where banks compete for profitability and losers would be shaken out of the market. But in reality, the government so far has chosen an avenue to avoid bank failures, and banks are actually being bailed-out with public money in accordance with procedures dubbed as pre-bankruptcy measures.

It is inconceivable that most of the banks could recover health and profitability while preserving the volume of banking industry at present levels. Ignoring industry level reforms where commercial banks themselves should be the object of scrutiny and at the same time requiring bank managers to work hard to make profits is indeed a good example of the proverb: trying to save a wrong strategy with a good tactics.

What is needed is to ask some banks to stop exerting fruitless efforts to remain in the industry and to pull out of the business. Then plans should be devised to transfer human and other resources released by the shut down into building a new market-based channel for flow of funds.

(The original Japanese article appeared in the October 4, 2003 issue of Weekly Toyo Keizai)