A growing scandal involving two securities company and a bank in Japan has raised a new challenge to the Japanese government's decision to deregulate the country's financial sector.
As a centrepiece of Japanese prime minister Ryutaro Hashimoto's policy, financial deregulation is aimed at removing regulations that are widely blamed for Tokyo's decline as a financial hub. Hashimoto's proposal, to be fully implemented by 2001, calls for the removal of restrictions on financial products and services, and breaking down barriers that segregate commercial banks, trust banking, stockbrokers, insurance companies and other types of institutions.
In doing so, Hashimoto hopes to reverse Tokyo's decline as a financial hub and put it on a par with London and New York. The buzzwords, Hashimoto declared last November when he announced the plan, were: 'free, fair and global' business dealings.
But the recent unfolding of scandals at one of Japan's leading commercial banks and two securities companies in connection with alleged illicit ties and payments to a sokaiya extortionist has undermined the validity and effectiveness of the upcoming Big Bang reforms.
A sokaiya is a specialist - someone who extorts money from companies in exchange for not revealing sensitive information about the firm or ask embarrassing questions at shareholders' meetings. Conversely, sokaiya may offer to intimidate others, including rival sokaiya, into silence.
Prosecutors recently charged four Nomura Securities executives and 11 Daiichi Kangyo Bank (DKB) executives with conspiracy and violating both the Commercial Code, which bans dealing with sokaiya, and the Securities and Exchange Act, which prohibits compensating clients for investment losses.
Just how far Hashimoto will go in implementing his reforms remains uncertain. To date, he has been unable or unwilling even to carry out the relatively insignificant step of lifting limits on foreign ownership of stocks in Japan's two largest telephone operators, Nihon Telegraph and Telephone Co and Kokusai Denshin Denwa. Nor have any reforms been proposed to privatise or break up the government's postal savings system under which post offices throughout the country accept savings deposits. It is the largest 'bank' in the country with 226 trillion Japanese yen (about US$1.9 trillion) in deposits - yet, unlike private banks, it pays neither income tax nor fees to support the deposit insurance system, one which guarantees deposits in case a bank goes bankrupt.
The Big Bang's stated goals pose 'a formidable and far-reaching agenda', says J.Kirby, a former minister in charge of finance at the British Embassy in Tokyo.
Critics, says Kirby, have faulted Hashimoto for not going far enough or fast enough and for emphasising the profits of existing institutions rather than new products for customers. Regulation of brokers' commissions, for example, will not end until October 1999.
'I'm not sure whether there is a consensus on how much pain is acceptable,' says Kirby.
Taggart Murphy, a financial analyst and author of The Weight of the Yen says the reforms will not provide the transparency and fairness needed to turn Tokyo into a major financial centre and will turn out to be 'just tinkering'.
Right now, the still widening scandal that brought one of the nation's most influential sokaiya out of the shadows and on to centre stage is providing an unexpected yardstick by which to gauge the prospects for transparency, fairness and enforcement of rules in the future of Japan's financial system.
To develop confidence in the financial system, regulators must 'make clear not only that measures to enforce fair and honest procedures are in place, but also that they are willing to use them', says Alicia Ogawa, a managing director of Salomon Brothers in Japan. That's why the punishment of offenders in the current scandal is 'very important', she says.
At the end of July, the Ministry of Finance (MoF) suspended Nomura, Japan's largest broking firm, from several key areas of the domestic financial markets until the end of the year for providing and conducting illegal stock trades in 1995 for a sokaiya called Ryuichi Koike. DKB, the country's second largest bank, was also hit with penalties for 'lending' Koike money to buy shares in Nomura and other securities firms.
Nomura is barred from stock dealing and all stock-related business operations and has been ordered not to underwrite public bond issues or take part in their auctions. DKB has also been ordered not to give credit to new corporate clients, nor underwrite public bond issues or establish new business bases in Japan or aboard until the end of the year.
Last month the sokaiya scandal spread to Yamaichi Securities, the smallest of the country's 'big four' broking firms, with raids by the Tokyo Public Prosecutor's Office on the homes of top executives. The securities firm is suspected of using its Singapore office, Yamaichi Futures, to pass on illicit trading profits amounting to ¥79 billion to Koike in Tokyo. Yamaichi executives - including the chairman Tsugio Yukihira and president Atsuo Miki - announced their resignation last month to 'clear up the negative legacy of the past'. They denied personal involvement in the suspected payoffs.
This was the second time in six years that Nomura had been punished for making illicit payments to gangsters and for compensating clients for losses in stock trading. Adding to the shock was the arrest and indictment of Hideo Sakamaki, who took over as president in 1991, vowing to clean up Nomura.
Analysts say the penalties could slash Nomura's revenues by one-third and reduce DKB's operating profit by 5% this year.
Raisuke Miyawaki, a retired National Police Agency official, says Hashimoto's reforms provide 'a golden opportunity' to break ties with the underworld by making financial transactions transparent.
But the big prize for the economy will come from cracking open the 'golden egg' - Japan's ¥1,200 trillion (about US$10 trillion) in household savings, one third of all the savings in the world.
Reforms to break off segmentation
Since World War II, Japan's financial system has been segmented. For instance, banks may not trade equities. But much of this is about to change thanks to the reforms.
A new law will largely repeal the Foreign Exchange and Foreign Trade Control Act that currently bars domestic investors from holding overseas bank accounts and restricts the dealing in foreign money with any firms but 'foreign-exchange banks'. The Act has made it difficult for Japanese investors to buy foreign assets.
According to Robin Radin, a financial consultant and member of Harvard University's law faculty, the new ruling will allow investors for the first time to employ overseas brokers, bankers and advisers to manage their savings, undermining the position of Japanese banks.
Other changes include:
* Commissions on share trading will mostly be deregulated. At the moment, only trades of ¥1 billion or more may attract variable commissions; from next April this bar will be lowered to cover trades of more than ¥50 million, and from 1999 brokers will be free to set commissions on all trades as they see fit.
* The ban on over-the-counter (OTC) derivatives will be lifted. Currently, OTC equity derivatives such as swaps and options are banned in principle. From next April they will be allowed, bringing them into line with interest-rate derivatives.
* From April 1999, banks will be able to sell investment trusts, Japan's version of mutual funds. At the moment, only securities firms may sell them directly; the 'big four' securities firms control three-quarters of the distribution.
Overall, says Radin, the Big Bang represents a complete reversal of the MoF's traditional discretionary, non-transparent regulations that aimed 'not to promote open, free and fair markets but rather to cultivate and manage orderly cartels'.
Lester Thurow, a professor at the Massachusetts Institute of Technology, fears the government will implement only piecemeal reforms that will 'make the system worse'.
Glen Fukushima, a former deputy US trade representative who is now vice-president of AT&T in Japan, says the Japanese focus discussions among themselves on 'easing' - rather than removing - restrictions. He warns that the real aim of the reforms is not to open the market to foreigners but 'to enhance Japan's international competitiveness'.
Ogawa of Salomon Brothers predicts the Big Bang will not come in a single jolt but rather, like everything in Japan, will unfold over a long period. Depositors are unlikely to abandon the familiar names of Japanese banks they have come to trust over the years.
Takashi Hosomi, a former vice-finance minister and now chairman of the Nihon Life Insurance Research Institute predicts, however, that the reforms will deal far more devastating blows to Japan's banks and securities firms than Hashimoto imagines. Already, he says, 'the dam' has sprung a leak and the outflow of money has started. 'Hashimoto hasn't yet started thinking about how to prevent that from becoming a flood.'
Hosomi believes securities firms face 'devastation'. He foresees some big Japanese banks coming under foreign control and predicts that many banks and nearly all securities firms will be forced to shut their overseas operations.
'The Big Bang will be faster, deeper, more powerful and dynamic than is yet widely understood,' says Kenneth Courtis, Tokyo-based chief economist and strategist for Deutsche Bank Group, Asia Pacific.
The current scandal, however, has underscored the difficulties that Japan faces in moving from a financial world burdened with underworld ties to a modern system capable of winning international trust.
Sokaiya activities range from the petty to the princely, and their targets include at least a third of all large corporations in Japan. Indeed, threats of harassment have become so common that corporations maintain 'general affairs departments' to deal with them, and make payments routinely. In June, Tokyo police arrested two sokaiya impostors who sent out bills to 442 companies for subscription payments to a non-existent magazine and managed to swindle ¥31,550,000 out of the firms.
Koike, 54, is clearly a prince among sokaiya. DKB executives have been accused of 'loaning' Koike ¥11.7 billion (about US$97.5 million). Prosecutors say Nomura paid him ¥370 million to ensure that he would not cause trouble at their stockholders' meetings.
Claiming concern over 'trouble' at stockholders' meetings, however, is a tactic to divert attention from deeper scandals, say critics. Figuring that successful sokaiya constrain meetings to about 30 minutes compared with two hours for a rambunctious free-for-all, just the money the DKB is accused of 'lending' Koike (about US$97.5 million) works out to more than US$1 million for each minute shaved off a stockholders meeting. No one believes that even the harmony-obsessed Japanese need harmony that badly.
Koike was quoted by police as admitting that he used the money he 'borrowed' from DKB to purchase 300,000 shares each in Nomura, Daiwa, Nikko, and Yamaichi, the big four securities firms in Japan.
The Asahi Shimbun newspaper identified Koike as a disciple of the late Rikiya Kijima, a sokaiya with talents that gave him influence among both leftists and rightists in Japan.
Koike, the publisher of Gendai no Me, a respected monthly magazine that established itself as a theoretical journal for 'new left' thought also served as a lieutenant to the late Yoshio Kodama, a rightist who was one of the business world's most influential 'fixers'.
Kodama had extensive dealings with elite politicians and bureaucrats until well into the 1970s. Documents released by a US Senate sub-committee in 1976 identified him as a secret agent for Lockheed Aircraft Corp in its successful bribe-ridden campaign to sell the Lockheed TriStar aircraft to All Nippon Airways of Japan.
Koike, the Asahi Shimbun reported, was introduced to executives of Nomura and DKB by Kijima while Kodama was still alive.
How sokaiya gain their foothold
Partly as a result of speculative investments in real estate that swept Japan during the 'Bubble Economy' years of the late 1980s, gangsters gained a foothold in mainstream businesses by providing services such as intimidating recalcitrant landlords into selling their buildings, clearing the way for private developments, according to Miyawaki, the retired police agency official. Gangsters were also employed to settle insurance claims through threats and intimidation.
Sokaiya equip themselves for extortion by collecting information about illicit payments that businesses make to politicians and bureaucrats, says Miyawaki.
He blames bureaucrats at the finance, construction and welfare ministries for intentionally overlooking favours, bribes and other abuses.
Gangland ties with construction companies, he says, have grown so widespread that contractors pay the gangsters sums equivalent to between 1% and 3% of the value of every significant construction contract throughout Japan as 'security money' to avert harassment and sabotage.
Gangsters are also becoming increasingly violent in resisting attempts to collect loans made to them during the 'Bubble Era,' he says.
In 1993 and 1994, two bank executives and a director of Fuji Film Co were gunned down in gang-style assassinations that police have not been able to solve.
Recently, the chairman of a large corporation received an envelope containing only a street map marked with the route his grandson walked to school. The threat was explicit enough to frighten him but not explicit enough to obtain any help from the police, the Asahi Shimbun reported.
Despite such clouds over Japanese businessmen, Merrill Lynch, a large New York-based stock broking firm, declared that the current scandal 'is spurring the reform process'.
In a July report, Merrill Lynch said prospects for the Big Bang made the Japanese equities market 'the most impressive investment opportunity among the world's major markets'.
It said it expected that financial and economic deregulation 'will ultimately contribute to positive corporate earnings'. Investment banking, brokerage and investment management business should 'enjoy rapid growth', it added, concluding that 'a rush of new foreign investment in the financial sector seems likely'.
Big Bang aims to encourage savings
Revitalising the management of Japan's huge household savings is at the core of the Big Bang. With the rapid ageing of Japan's society, Hashimoto hopes increased competition among financial institutions will raise the quality of investor services and induce households to shift some of their savings into stocks, foreign bonds and trust funds to reap higher returns. Right now, a 30-year US Treasury bond offers about 6.5% return a year compared with about 2% for an equivalent Japanese note.
Providing higher returns to savers worried about retirement could reduce 'the diabolical pressure to save more and more', says Courtis of Deutsche Bank Group. This would tend to boost consumption, which in turn would increase economic growth. At present, 60% of household savings are stuffed away in ordinary bank deposit accounts or in saving accounts at post offices, drawing virtually nothing in interest payments, according to the Economic Planning Agency (EPA). Only 6.5% of the savings are invested in such products as stocks and mutual funds.
By comparison, the EPA notes, Americans keep only 16% of their savings in bank deposits and invest 23% of their savings in stocks.
Author Murphy faults the reform plans for overlooking needed tax innovations, for failing to spell out rules for disclosure of information about corporations' financial standing and for lacking guarantees that rules will be enforced and that unfair advantages won't be given to insiders.
Big Bang assigns the task of interpreting all the key issues to the bureaucracy, 'which will of course resolve them in [such a way as] to preserve its institutional prerogatives', says Murphy. Without 'political direction over the bureaucracy, everything else is tinkering', he adds.
Ronald Bevacqua, a senior research economist at Merrill Lynch in Japan, argues along similar lines. In a paper for the Japan Policy Research Institute, he wrote: 'It is very likely that any change which does occur will be at a pace set by the ministries and aimed at goals determined by them. Hashimoto's strong public stance on reform is largely for show.' Even cultural handicaps stand in the way of reform, says Ogawa of Saloman Brothers.
The country's egalitarian cultural standard may make a good society, she says, but it doesn't make for good banking. 'Some clients will fail to repay their loans', she says, so banks must reflect that fact in different rates of interest for different risks to ensure profitability.
Former vice-finance minister Hosomi says that in the face of global changes, government protection is no longer as effective as it used to be. As a result, Japan has no choice but to reform. In 1987 the Tokyo Stock Exchange surpassed Wall Street in the value of its transactions.
By 1989 they had reached US$2.4 trillion. But six years later they had shrunk to US$889 billion, leaving Tokyo trailing both New York and London, which had seen trading double over the same period.
Technology is compounding Japan's troubles, says Courtis.
Today, investors can buy shares through an Internet broker who will charge a commission of US2 cents a share, compared with the US$5 a share that investors must pay Japan's established brokers.
Regulations can no longer prevent a flight of capital in the face of that kind of cost differential, he says. Courtis and Ogawa agree the major change that must occur is a reduction in both the size and the number of financial institutions.
Thirteen of Japan's 20 largest banks, which control 44% of bank assets, and which rank among the healthiest banks in Japan are incapable of earning what she calls: 'an economic return on their capital'.
She claims that bad loans left by the bursting of the 'Bubble Economy' are now equivalent to 60% of bank capital. This, Ogawa say: 'will become a serious problem as interest rates rise, threatening the existence of some banks'.
Other banks that remain inefficient or fail to develop a speciality may also fall by the wayside, she says, yet no solution has been mapped out for the debt problem.
Courtis sums up the bad loan issue bluntly: 'Many institutions will have to disappear - by merger or takeover.' New competition will squeeze profits so tightly 'that a vast, profound and explosive structural change will begin. It is then that the "Big Bang" will really become a "Big Bang'',' he says.