Significance of LTCB in Japanese financial system.Long Term Credit Bank is the first bank that changed traditional way of banking business, which is focusing relationship, into market oriented business style. And the bank was first one that was owned by foreigners. And also, LTCB is a new trial of the escape from lost decade of Japanese financial trouble.If LTCB restructuring had failed, Japanese financial restructuring might have been delayed much longer. Watching LTCB’s success, international investors started to believe in the possibility of success in Japanese financial market. Japanese financial authorities could decide to take the money from abroad, based on the success of LTCB.Most of all, LTCB was the first mover of restructuring banking business as market oriented. And through the process of reform the bank affected other banks to follow its business style. In other words, LTCB was a catalyst of financial reform in Japan financial system. Or at least, the bank was flagship for international investors. And the bank was test bed too.Main issues and problems of LTCB case.Huge size of bad loans, which could not write off just only based on their profitability was big problem for LTCB and Japan’s financial market too. Because Japanese financial tradition was relationship focused. And Ministry of Finance in Japan wanted to keep that loans until the economy recover by itself and bad loans disappear automatically without any pain.During 1980s, there was a so called asset price bubble. The equity and real estate prices skyrocketed. But, when 1990s come, the bubble burst. The Nikkei index fell from its high of 38,917 in December 1989 to 14,309 in August 1992. (Reszat, 2003) The land price of Japan started to tumble from 1991 for 11 years in a row. (Choi, HeeGap, 2003),None performing loans (NPLs) was becoming bigger and bigger along with the economic recession. Collateral in the form of equity or real estate also lost their value. It worsened the NPLs problem.By December 1991, bad debts of LTCB reached to ￥2.4trillion. There was no improvement of bad debts problem until late 1990s, in spite of internal reform trials.What all banks did during 1990s was cover-up of bad debts in various ways. These are rolling over bad debts, indirect lending through small institutions such as credit unions, removing of bad debts to subsidiary’s balance sheet, removal of problematic papers, and using derivatives devised by a foreign bank.LTCB used subsidiaries to hide bad balance sheet. Even the bank created subsidiaries of subsidiaries, so more firmly hide bad debts’ existence. This could be possible due to the loose accounting standard of Japan’s authority.In the case of EIE, LTCB stop supporting EIE publicly, but LTCB supported Tokyo Kyowa Credit Union, Tokyo Kyowa Credit Union supported EIE. In other words, LTCB supported EIE in disguise.Bad loan by loose definition of Japanese government was one of hiding. Financial authority did not face the true, thus effort to resolve the problem was weak.By December 1994, LTCB’s bad and potentially risky loans reached to ￥3.4trillion or a fifth of all its loans. By 1995, LTCB’s real bad loans rose above ￥2trillion.Close relationship with dying franchise was one of main problems in Japan’s banks. If LTCB cut off the relationship and clear off the bad loan, it would disturb total financial system and made child company default. It could impact Japanese economy in bad direction.Authority’s inability to reform and discretionary attitude was serious problem in Japan’s financial hard time. Conservative bureaucrats just waited for economic recover to come, letting LTCB, including other banks, do not reform financial system and deals with bad debts.Ministry of Finance and LDP was saying that the downturn in stock price and land price were just temporary and would turn up soon. There is tendency for government and financial companies to have strong optimism about economy. It seems true in anytime, anywhere.When there was inspection by the authority, inspectors even did not want to peek a basement, where young bankers hiding critical document boxes.Conservative Japanese culture delayed financial reform too much. For one thing, there is ‘wa’ in Japan. It is the meaning of harmony among society. So, nobody wants to say ‘no’ directly, and nobody likes revolutionary reform.Resolution process of LTCB.Internal reform trial in the form of new business strategy, focusing on investment banking, failed due to the traditionalist’s rejection in 1985.In November 1996, Ryutaro Hasimoto, the Japanese prime minister, released a document entitled ‘Structural Reform of the Japanese Financial Market; toward the Revival of the Tokyo Market by the year 2001’. It was the start of Japanese version of financial ‘Big Bang’. It was the plan for deregulation reform of financial market in Tokyo.The President of LTCB, Onogi, tried reform by alliance with Swiss Bank Corporation (SBC; now it is called UBS). The CEO of SBC was a friend of Onogi, when he was a young banker in London.The alliance plan included setting up 3 joint ventures of investment banking, asset management, and private banking. By these joint ventures, LTCB could have reformed into new business style to earn net income. And there was a plan of $2billion fund raising to increase capital base and cross-shareholding of 3 percent in each other.In 1997, Asian financial crisis came. One of the Japan’s largest banks, Hokkaido Takushoku, collapsed as first collapse in sixty year of Japan’s history. It was followed by Sanyo Securities, a second tier broker and Yamaichi Securities, the fourth largest broker in Japan. That was really bad time for alliance.Alliance trial with SBC was ended in vain in 1997, mainly due to the conservative Japanese bureaucrats, who liked more Japanese style resolution.Japanese authority wanted merger between Japanese banks, so tried to make LTCB merge with Sumitomo Trust and Banking. But it ended in vain either. Sumitomo Trust requested for more public fund to pour in LTCB, but financial authority could not accept it.The Japanese authority decided to nationalize LTCB and tried to find new buyer. It was the time in the middle of Asian crisis. Russia defaulted on its debt in 1998 and there was a rumor that Long Term Capital Management was on the verge of collapse.Ripplewood, a vulture fund from the New York, started negotiation with financial authority to invest in LTCB, using consortium of western financial institutions such as AIG, Citigroup, GE Capital, Mellon and Paine Webber. In the negotiation, Ripplewood got a ‘put’ option, which is right to return newly founded bad debts to the authority and a public fund injection tooLTCB renamed as Shinsei Bank, it means new life, under management of western senior manager and board members. The Bank started treating banking as a business, not a public service. Shinsei Bank stated operation in 2000. The new bank changed its IT system totally with very low cost relative to other Japan’s banks and in a surprisingly short time horizon.The president of new bank, Masamoto Yashiro, set up retail banking, in a way that had never been in old LTCB. Four new themes were accepted for retail business. These were Empowerment, A Unique Identity, Accessibility, and Fun.They started make a profit in corporate banking division, by the coordination of product professionals and relationship managers, cleaning off old bad debts, changing to adequate collaterals, selling corporate bonds.Step by step, Shinsei bank recovered from bad debts and made net profits.Cultural issue & Efficiency in restructuringMaintaining consensus and harmony is the key cultural factor in Japan society, which made revolutionary restructuring difficult in Japanese bank. And nobody wanted to say ‘no’ directly. They preferred evolution to revolution.Even when it is M&A between companies of same country, there are huge differences and conflicts between two companies, so it takes a few years to become one company in a cultural sense. If it is the case of western people and Japanese, it is quite natural that there must be big conflicts.In the Japanese culture, ‘wa’ is important tradition. It means harmony in society. It can be an obstacle to reform process or all kinds of changes in corporation.There is ‘nemawashi’ in Japan’s culture too. This means that Japanese should create consensus before implementing. It delays implementation process. Thus, it could weaken the competitiveness of corporation. In speedy business environment of 21C, fast implementation is crucial for a success. So, Shinsei bank used top-down approach. At first, this approach invoked resistance from middle class managers. As time passed, each side could understand each other more than before.Traditional payment system in Japan was based on only age. It was not efficient for a foreigner’s eye. And there was conflict of payment level between foreigners and old LTCB employees. To solve this problem, the new management team developed two different payment systems, which were applied to foreigners and old LTCB members respectively.In Japanese financial company’s culture, women had only clerical job. New foreign managers gave her a chance to be a manager based on her ability.A retailer Sogo asked Shinsei for a debt forgiveness of $980mllion. So the bank tried to use ‘put’ option for the government to take the bad debt. Traditionally, Japanese trust words more than written contract. And the authority did not expect that the put option actually exercised. The Japan’s bureaucrats were furious about Onogi and western investors, so were Collins and Flowers. They did not understand each other. But, by the contract, Shinsei had the right to use ‘put’ option legally.Tension between ‘relationship banking & market oriented approach’In Japan, there was a unique concept, called ‘keiretsu’. It is kind of ‘family’ or ‘tribes’ that linked each other with cross-shareholding and mutual support. The relationship between the companies within same kereitsu is really tight so the value of relationship is more important than temporary profits. It was possible to maintain that concept through the rapid growth era, until bubble burst in early 1990.When LTCB tried to decrease old bad debts announcing suspend of support to risky and hopeless companies, financial authority intervened to keep supporting for the stability of financial system and economy. The authority’s conservative status had had an anti-effect for financial reform in Japan.If LTCB decreased bad debts by cutting support, the loss from the bad debts might transfer to other banks and government. It could affect whole financial system.In 2001, Shinsei started radically change their lending policy and notice it to all clients. Instantly, some clients complained to politicians about Shinsei’s lending policy, and politicians talked to bureaucrats about it.The Financial Service Agency (FSA) ordered Shinsei to support ‘category two’ companies, which were categorized by Japan’s authority as healthy but treated as ‘Zombie’ by Wall Street investor’s view.Japan’s bureaucrats insisted Japanese way of solution that would not breaking ‘wa’.Restructuring LTCB and move toward market oriented financial systemIn Japan, corporate governance was balanced between the banks, their clients, and the Ministry of Finance. After Ripplewood buy the share of LTCB, Wall Street investors strongly argued their rights on the banks business, operation, and earning. It was cutting the old tradition of Japan’s financial system, the cross-shareholding.At first, this changes made Japanese bureaucrat upset. Through the negotiation and many talks, the mood was changed inch by inch.Main clients of the bank acted like a family of the bank, Shinsei treated them on the base of profitability. It also provoked argument between Yashiro and financial bureaucrat. At last, FSA changed their status toward reform.In old LTCB, the man who was charged of lending business had a decision right whether to lend or not, but after Shinsei reopen business, employees of lending division follow the guideline about suitability of lending. The guideline was made mainly base one market principle.Contribution of the restructuring within the LTCB to the move toward market oriented financial system in Japan.Through many cases, such as Sogo shock in 2000, First Credit, consumer credit group, in 2002, and the Daiei, supermarket chain, debate. Shinsei got a little cooperation from the rest of the system.For Wall Street investors, LTCB case was one of the best deals ever. “In 2000, the consortium spent $1.2bn to buy the bank.” After successful initial public offering, the investors sold a third of their shares for $2.4bn, and remaining stake has a value of $10bn. (Tett, Gillian and Peter Smith, 2004)The other Wall Street private equity investors are really wanted to follow similar success saga. But, for the Japanese government’s eye, the deal was viewed as kind of losing a game. Japanese government spent about $36bn of taxpayers’ money to clean up the bank’s balance sheet. And it take over ￥1,100bn of bad loans, provided ￥850bn of reserves, and injected ￥240bn to improve capital base. So, Japanese authority will never mistake same thing again. It can be a bad news for potential investors from Wall Street.The effect of Wall Street investors investing in Asian financial company, Shinsei and other many similar cases, left western style efficient way of business which is market oriented in Asian financial market. That might be good experience for Japan but adequacy of the huge benefit of the Hedge Fund remained controversial.Similar cases happened in other developing counties, such as Korea. Some cases are going on right now. The authority should deal with the case wisely.ReferencesChoi, HeeGap (2003), ‘The lesson from Japanese bubble economy’, in Issue Paper May 24th, 2003, Samsung Economic Research Institute.Reszat, Beate (2003) Japan’s Financial Market : The Lost Decade, HWWA discussion paper 231, June 2003Tett ,Gillian (2004) ‘Saving the Sun’, London : Random House Business BooksTett, Gillian and Peter Smith (2004) ‘Shinsei investors clean-up’, Financial Times 15 March