Walls Come Tumbling Down in Japanese Banking

Back to Contents of Issue: June 2002

Economic strictures put the squeeze on not only profits and staff, but also time-honored Japanese traditions of obsessive, obsequious customer service. When it's a foreigner directing the squeezing, the pain is harder still to take. Alex Stewart reports from Kansai on takeover guru Wilbur Ross's grand ambitions.

by Alex Stewart

THE FORMULA FOR A traditional Japanese banking service could be expressed as Time + Ceremony = Service. In other words, give the impression that a lot of staff are giving their all to cater to the customer's every whim, while maintaining excessive levels of humility and old-fashioned respect, and you'll keep them happy forever thanks to the winning power of obligation. On the other hand, Kansai Sawayaka Bank -- literally 'Freshness Bank of Kansai' -- is intending to breathe new life into these stuffy conventions, by using banking models largely developed not in Japan, but -- horror of horrors -- in the US.

Before the 'Big Bang' financial deregulation of 1999, the banking system operated under the so-called convoy system, by which banks followed instructions handed down from the Ministry of Finance and maintained their relative position within a defined pecking order. The Big Bang introduced choice and competition. It also weeded out weaker banks. One of these was Kofuku Bank (literally 'Happy Bank'), which was reincarnated as Kansai Sawayaka Bank, or KSB as the bank refers to itself.

Kofuku gained notoriety for lending with unusual abandon, even by bubble standards, to real estate developers during the 1980s, firstly in Osaka, then in Tokyo and then anywhere (including New York). The bank started out in 1926 in the boondocks of Wakayama Prefecture (south of Osaka) at a time when local banking consisted of passing a collection chest from household to household, from which loans were then parceled out. The owners of the bank were the Egawa family. Unusually, the Egawa family still owned the bank right up to its bankruptcy after the war -- unusual because the US occupation ordered the closure of all such community banks. One of the few other banks to avoid the occupation order was Tokyo Sowa, which was the only other regional bank to date to be sold to foreign investors.

Fast forward to 1999 and Kofuku Bank became the first acquisition target for all-American takeover guru Wilbur Ross when he took over management of a private equity fund from Rothschild Inc. To Rothschild bankers, the prospect of a high-profile investment, with the risk of things going politically wrong, seemed unattractive. Due to this opposition, Ross offered to take over management directly. It was Big Bang time and the Japanese government was willing, for the first time, to allow foreign investors to shake up the industry. Kofuku Bank was a good target, as it was family-owned (no ties to bank-centered keiretsu groups), and not in Tokyo, so it faced less intense competition. To purchase the bank, the newly established WL Ross & Co. raised a total of JPY24 billion from investors. By all accounts, the fund was welcomed with open arms by the government, with personal contacts at Daiwa Securities and Sumitomo Bank playing a role in smoothing negotiations. The new bank was formally established on February 26, 2001.

For the investors, Kofuku was an ideal turnaround situation, with the prospect of an IPO and a profitable exit. For the government, it was an experiment tucked away in the corner of the banking field, in which foreign investors would have an opportunity to prove whether they had a better model. The government later injected JPY12 billion of public money to give the experiment a better chance of success. The new owners had a clear view of what was needed to make the bank profitable and their priority was to condense the number of branches and staff to an essential core before introducing a new model that focused lending on high return consumer credit and short-term credit markets for small and midsize companies. Half the 2,000 Kofuku Bank staff found jobs with help from customers of the bank and local government. The number of bank branches was cut from 123 to 81 (and since then reduced to 73 in order to cut costs). The most radical change occurred in higher management, where the senior managers were unceremoniously replaced by a team of specialists comprising ex-managers of GE Capital, Nippon Credit Bank (bought by Softbank and reborn as Aozora Bank), Sanwa Bank, Citibank (Singapore) and Tokai Bank. KSB president Shuichi Takahashi was with Tokyo Mitsubishi and has five years' experience working overseas, mostly in Sydney. Takahashi keeps in close contact with Ross, who is said to send many emails to bank executives; Ross also joins board meetings by video link from New York each month.

The revamped bank's motto is: 'Speed, Challenge and Always Customer First.' Chief operating officer Kenji Hitoshi puts it more succinctly: "Mr. Ross is very clear about what he wants and he's always telling us: 'If this is profitable, why aren't we doing it faster, and if it's unprofitable, why are we doing it at all!'"

A key area where Ross believes much greater efficiencies and returns on capital are possible is in the use of IT. He makes the point that the lifetime employment system prevented companies from enjoying higher productivity returns because the system did not allow IT to replace people. KSB is free from all such constraints. It is developing a new money settlement system so that it can concentrate processing in one or two centers instead of employing people at each branch. It is also developing its own credit evaluation system. Unlike other small-size regional banks, KSB was able to recruit an ex-GE Capital manager, Koichi Ishibashi, as director of IT. He brings skills from a company with the reputation of offering the fastest approval time for consumer loans in Japan. KSB also offers a credit card that doubles as an ATM card with instant access to an unarranged overdraft. There is an impressive new Web site, although no plans to offer Web banking just yet.

The results are showing up in the financials. After seven months of operation (as of Sept 2001), return on assets was 0.33 percent; not much below Aozora Bank's 0.38 percent after 13 months of operation. More impressive, its return on equity stood at 23.1 percent compared to 3.7 percent at Aozora and 11.2 percent at Shinsei. The operating overheads ratio (general operating expenses divided by gross operating profit) still needs improving. KSB's ratio was only 88 percent after its first year of operation, but this was an improvement from 98 percent at acquisition. Anything below 50 percent for a bank is "extremely positive," says banking analyst James Fiorillo of ING Securities in Tokyo. "It is declining slowly," commented David Peters, a young American lawyer who works in president Takahashi's office. "But it's obviously too high." On the other hand, the bank stands up well in the rankings table, snaring the 19th slot in a survey of 126 banks in Toyo Keizai magazine in February. According to Peters though, the bank was disappointed: "It did not take into account sufficiently our superior stability."

Such decisive changes are sending seismic tremors through the traditional banks of Osaka, especially since there are still enough of them to stretch end to end round Osaka Bay. When KSB launched its collateral-free loan service called Quick (maximum loan JPY5 million), the Daiwa Bank group quickly followed with a similar service (maximum JPY10 million). Asked to comment, Daiwa told us that KSB's style of lending, which focuses on individuals, is unconventional because of difficulties in assessing creditworthiness. However, KSB COO Hitoshi points out that in the US, regional banks have a much higher ratio of personal loans to business loans. KSB, he says, has simply followed the US model. It means that credit evaluation is much more important. The bank is still preparing its own evaluation system, but in the meantime is collaborating with Aiful, a major consumer finance company, to offer a joint small business loan for which customers pay an annual rate of 14 percent. Customers pay 7 percent interest directly to Aiful, which is the guarantor of the loan, and 7 percent separately to KSB.

Despite its novel business approach, KSB still isn't making waves on the street, judging from a meeting with Dr. Takashi Kazusaka, an expert on regional banking at Osaka City University. Before our meeting he carried out a random test on three of his grad students. None of them knew the name, Kansai Sawayaka. This is doubly strange since the bank's traditional base is in southern Osaka where the university is located. It led Kazusaka to question whether KSB had done enough to project its image.

Kofuku Bank's customer base was concentrated in the scruffier, more industrial parts of Osaka. But what KSB is doing now is likely to appeal to the more sophisticated kind -- offering foreign currency deposits, mutual funds and advanced credit cards. Furthermore, after closing half its branches, the bank has focused on the better-heeled parts of town.

Acquisition is one way to strengthen brand recognition. KSB says it has looked at credit union banks in Osaka and actually bid for Eidai, a credit bank in Tokyo, earlier in the year. Ross says he is keen to duplicate the KSB experience in Tokyo and could gain some economies of scale from expansion, such as funneling deposits collected in Osaka into more bankable loans in Tokyo. Even so, according to Fiorillo, there is a body of opinion which states that as banks expand they incur diseconomies of scale. Many point now to small, community banks in the US with a sharp retail focus as models of profitability. This is the same model that KSB is aiming to replicate should it move into Tokyo.

The major test of KSB's resilience will be how well it emerges from the ending of insurance on time deposits, which had been guaranteed by the government until this April. Ross sees the ending of deposit insurance as a positive step, since more depositors will start to evaluate banks on their performance and underlying strengths rather than non-economic factors.

The Japanese government may be satisfied that KSB passes the test with flying colors, proving that a small bank can survive and prosper when barriers to competition are lifted. The problem is that Kofuku may be a one-off. Most other banks are part of tight keiretsu groupings, and are not so amenable to drastic change. However, KSB could just possibly be a model for much larger banks to spin off their retail operations. For example, the success of KSB should stimulate some homegrown thinking by competitors on how to avoid being all things to all customers. And its focused approach should resonate with an industry which is desperately trying to get back to basics. @

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