Bank consolidation to increase profitability

Fund managers are remaining cautious over the future of Japanese banks. Many are underweight in the sector or, in extreme cases, have a zero weighting in bank stocks, even though the Topix Banks sub-index has risen by 59% to the year. During the same period the Topix Index has increased by 35%. The rise of banking stocks is partly due to the consolidation activity taking place in the sector

Although it is expected that consolidation activity will enable banks in the future to reduce costs, the sector still carries the heavy burden of bad debt. This problem has intensified with falling property and land prices. An index measuring property prices in Tokyo peaked at 106.7 in September 1997. It is now around 23.4

Keith Donaldson, fund manager at Martin Currie, says: "The bad debt problem is increasing. A lot of banks were offered land and property as collateral on borrowing. As land prices fall the value of the borrower's collateral will also fall

Martin Currie has around a 4% weighting in banks compared to an index exposure of 13%. Though the group is not bullish about the medium term future of the sector it prefers to have some exposure

Donaldson said: "Basically banks form a large part of the index and we prefer not to underweight a sector by more than 10%. The holdings we do have are in convertibles, such as Sanwa bank, Tokai bank and Toyo Trust bank. All three banks offer relatively limited downside

Schroders has recently gone from a underweight position in the sector to one of zero exposure. Denis Clough, fund manager at the group, explained that Schroder Japan unit trust had exposure to Fuji bank but he decided sell the stock after shares rose sharply following consolidation activity. In August Dai-Ichi Kangyo Bank, Fuji Bank and Industrial Bank of Japan announced they were to merge, creating the world's largest bank, with assets of nearly £1,000bn

Clough believes the increasing consolidation activity in the sector will in the end reduce costs but he is unsure whether revenues will increase. He says: "As a two year forecast we do not believe banks are charging enough for loans (1.8%) in relation to credit risks

Though their lending charges are low, the banking sector's loan business is contracting. Donaldson says: "The banks are weary of lending to smaller companies which form the largest part of the corporate sector. These companies are choosing to issue bonds or receive government money. The government is committed to lending ¥20 trillion to help the corporate sector recover

Clough points out consolidation is beginning to take place in other parts of the financial industry. Recently two of the top five insurance companies announced merger plans with smaller firms. He says: "Consolidation activity is a bonus

There is also a growing demand for mutual funds in the country. Schroders holds Tokyo Fire & Marine, an insurance company which has a small fund management arm but the group are not expecting domestic companies to benefit much from the increase demand for mutual funds

James Thorneley

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