The importance of focusing on loans and projects on a stand-alone basis has since been learnt by major banks, but itÆs still an unpopular concept. ôThere is a culture in Japan that expects cheap money. But capital needs to be priced correctly if itÆs not to be misused,ö says Graeme Knowd, a banking analyst at CLSA in Tokyo.
The latest proof that companies need to learn to price and exploit capital better is the fate of Shinginko Tokyo, of which the Tokyo Metropolitan government is the major shareholder. The bank is drastically cutting back its staff and branch numbers following a major pile up of non-performing loans.
Shinginko was set up to help the struggling small enterprise sector in Japan, after Tokyo governor Shintaro Ishihara declared his support for the sector during his 2003 gubernatorial re-election campaign and became the main sponsor for the idea. His goal was laudable, certainly: to help the small business sector in Tokyo. Nationwide, small businesses are suffering from a variety of ailments such as sluggish GDP growth, difficulty in accessing loans and, perhaps most damagingly, a dearth of profitable projects.
Crucially, Shinginko, which means ônew bankö in Japanese, departed both from the traditional method of requesting collateral and the more modern method of making a decision by looking at the financials and the business plan. According to CLSA, the bank simply used a computer scoring system. These computer models are anything but perfect, as US lenders have recently found when faced with high-scoring customers defaulting on their loans, and to compensate for the frailties of the model, lenders need to charge a risk premium.
ôIf you have a credit scoring computer model, you need higher rates. Or, you introduce tough loan officers who know their clients û but thatÆs also expensive,ö says Knowd from CLSA.
Shinginko took the opposite tack, making cheap loans with no collateral. It also had to pay more than its rivals to attract deposits, given its lack of a franchise. The result, perhaps predictably, was disastrous.
But the problem goes deeper than the credit scoring. ôIf SMEs are defaulting on loans which carry such low interest rates, it shows the projects they are investing in are generating too little profit,ö Knowd points out. ôCompanies need to find high-margin projects to invest in. If they canÆt pay 5% a year on a loan, they shouldnÆt be in business, frankly.ö
IshiharaÆs well-intentioned efforts to prop up the SME sector have resulted in a major burden for the taxpayer, with the Tokyo Metropolitan government planning to bail out the bank with an additional $400 million (on top of the $1 billion the bank was initially capitalised with). In return, Shinginko will slash its number of branches from six to one, and lay off hundreds of staff. The bankÆs accumulated losses come to a staggering $900 million, but following the promise of a capital injection it has declared an intention to be profitable by 2012.
This is far too long, and the bank should be closed down, argues CLSAÆs Knowd. The bank has reportedly passed the hat around the financial community for additional capital, perhaps in the form of a buyout, but so far there have been no takers.
In June 2007, Standard & PoorÆs downgraded the bank to BBB+/A-2 with a negative outlook. In the report on the downgrade, the ratings agency noted that the business model based on lending assets consisting of ôloans to SMEs, including nonprofitable businesses with poor creditö needed to be revised. Indeed so.
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