Revamped DBJ will take more risk

Yo Takeuchi, CFO of the Development Bank of Japan, discusses privatisation, shareholder culture and taking advantage of the turmoil in the global financial markets.

Can you give a snapshot of the bank?
We were founded to re-develop the Japanese economy, and we helped make it the second largest in the world. But the deregulation promised by former Prime Minister Koizumi means we have to change. I am a public finance expert and was engaged in the privatisation of Japan Post Bank. My last project is to privatise DBJ. We plan to become a unique type of investment bank in Japan.

What do you mean?
There is a separation between securities and banking activities in Japan. However, we will be the pioneer in combining both activities, at least until we are completely sold to the public in the next five-to-seven years. We are long-term investors in the power and infrastructure sectors. We continue to re-develop this country. We take middle-risk for middle returns. As you know, we have three mega-banks in Japan. Compared to the US and the UK, therefore, I admit that the ôBig Bangö [financial deregulation] in Japan is pretty weak in Tokyo. Therefore, in order to bring the economy to new growth, somebody needs to take more risk, by using more sophisticated financing techniques.

So the law separating securities from banking activities be relaxed?
Yes, itÆs being considered. And we will be the pioneer. We are not big. Our total assets are just one tenth of big banks like Mitsubishi or Mizuho. But the integrated model will hopefully give us an advantage. In addition, since 100% of the stock is currently owned by the government, we will get government support during the transition period.

Do you want to attract retail money?
ItÆs not quite decided yet what our business model will be. Currently, taking deposits is physically difficult. We only have 500 professionals. Some kinds of commercial banking businesses are not necessarily profitable, given that we are probably over-banked in Japan.

WhatÆs your view on consolidation in the banking sector?
I think deals such as the Nomura acquisition of Ashikaga are indispensable to revitalising the Japanese financing model, based on my experience being in charge of a local finance bureau. In the US, there is a diverse range of business models in the financing sector. But here in Japan, regional banks in Tokyo or Hokkaido all have the same business models.

Why is that?
Japanese regional banks enjoy the status of Daimyo (samurai lords). ItÆs a bit provocative. But I mean they need more competition to stimulate the local economies.

How can the local banks be made to improve?
The core of their business is all right. But how can they engage in doing something more risky? Nobody wants to take any risks, so all the banks are doing the same thing. ThatÆs the main difference between the US and Japan. We can help them do that, because we have a wide variety of networks with the local community. We want to encourage them to take a slightly more adventurous attitude to helping their customers. ThatÆs why banks like Macquarie in Australia are interested in working with us.

What relationship do you have with local governments?
We have known them for the past 60 years. We are public minded and trustworthy, so they like working with us.

Which Western bank would DBJ model itself on?
We are going to be unique. We want to absorb the best parts of all the banks. And we are a marathon runner not a sprinter. We will not focus on short-term gain. Clearly, ôshort termismö has cost a lot to those banks caught in the subprime crisis.

Many parts of the Western model are now under review, donÆt you think?
Well, IÆm very keen on the partnership model at Goldman Sachs. We are small and quality-oriented, like them. We are going to create our corporate structure starting from this coming October. We need to think how to establish a balance between risk taking and the back and middle offices. In order to take risk, we need to have a very strong back office and risk functionality.

How about the privatisation? Will it proceed by IPO?
ItÆs not sure yet. That will be decided by the Ministry of Finance. There are many financial IPOs û Post Bank, Dai-Ichi Insurance and so on. We are not sure if we will become like one of those groups. We concluded Japan Post had to IPO. But we are a unique institution. The government will discuss what kind of scenario is best fit to us. Frankly, our net assets are around $20 billion. So selling a portion of that to the market will probably require an IPO, but itÆs not decided.

Where do you see the big opportunities, once you are restructured? Might you underwrite the privatisation of state assets at local government level?
I think so. But we also have 3,500 good clients all over Japan, whom we will continue to work with. We want to emphasize more sophisticated lending, more unconventional financing. This is a different niche to the regional and mega banks. We are going to engage in a seamless range of financial businesses from senior loans to equity. Especially, in so-called mezzanine financing we have acknowledged expertise. We can also cooperate with the regional banks, since they lack technology and knowledge. So they can learn from us and work with us.

I associate mezzanine financing with growth, but Japan is growing so slowly.
Yes, at 5% economic growth, mezzanine financing would be in demand, but we are only growing at 2%. There are not many companies which are willing to take risk. Companies can borrow from regional banks, but sometimes itÆs not enough. As you know, most bank lending is tightly tied to real estate collateral. There is little non-recourse lending at the regional bank level. So some companies tend to suffer. We can work with the regional banks to help them develop that expertise and thereby help the local community.

ItÆs very difficult to get a return on the credit side in Japan, because of the liquidity. Do you think the regional banks are sitting on a lot of toxic products they have bought off the US investment banks while chasing yield? There seems to be a systemic problem when excess capital leads to these problems. What do you think?
Yes, add moral hazard to the mix, and you do get a problem.

Do you think we are looking at the end of an era in finance?
ThereÆs always good times and bad times. We have to restructure the overall financial system. I guess the Europeans are taking an aggressive line against the US and the UK investment banking model now. IÆd like to add that good finance is a public good. Like good infrastructure, itÆs an indispensable part of the economy.

The problem of this crisis is too much emphasis on banks as a money-making machine. The efficient markets hypothesis is fine, but it needs a minimum standard of regulation. ItÆs time for the US or European governments to inject public money to stabilise the financial system, as Japan did in the 1990s. This would be much better than cutting taxes, but a Republican president in the US will probably disagree. We had a very intense debate on these lines in the 1990s, and we eventually had to inject public money. That was the point made by Finance Minister Watanabe to former treasury secretary Larry Summer last month.

Do you think US growth rates could suffer like Japan in the 1990s for several years?
This is a serious recession, but I donÆt think US will suffer for the next 10 years. The US economy has a strong dynamism. But it could take two years to recover.

Maybe itÆs a good time for DBJ to buy a US investment bank?
Yes, maybe.

ItÆs just unclear if there is any healthy investment bank, currently.
Yes, thatÆs the problem! But if there is a once in a lifetime opportunity to buy an investment bank, we would be interested. Think of Deutsche BankÆs acquisition of BankerÆs Trust, which turbo-charged their return on equity.

What will be your philosophy at the newly privatised DBJ? Will you be responsive to shareholder pressure? Or do you feel that itÆs responding to shareholders in overzealous ways which lead to the problems in the US?
We want to become a public-minded, long-term investor, like Warren Buffet.

Is Warren Buffett public minded?
Yes, I see him in that way.

But whatÆs the point of being public minded if you are being privatised?
Think of it this way: there is a lack of confidence in Japan relating to the securities houses here. ThatÆs why investors keep their money in banks, collecting very small amounts of interest. We believe we can change that perception by becoming the top financial adviser and coordinator in Japan. If, for example, you get attacked by Steel Partners, you will feel scared. But if you get a visit from the man from DBJ, you will open the door and serve tea to him!

So you would be going back to the old-fashioned ætrusted advisorÆ role, as recommended by Jonathan Knee in his book The Accidental Banker.
Yes, itÆs an appropriate time to go back to that model.

Do you think shareholder culture is desirable currently, and do you think the Japanese are accepting this culture?
A 100% shareholder culture is the US model, but in Japan, sticking to a 100% shareholder culture would make you a sprinter not a marathon runner. I think Japanese investorsÆ view is to look at long-term returns. We already have more assets than any other country in the world. So tomorrowÆs profitability is less important to us. The other point about shareholders is that they should be good. Some Japanese refer to foreign shareholders as barbarians. I think both foreigners and the Japanese have got a bit too heated.

From the low shareholdings amongst the Japanese, it seems they have given up on their own companies, because they feel they are treated badly. Do you agree?
But lots of Japanese invest via the foreign funds. And we hope we can encourage higher equity ownership.

Yes, that would be great. Currently, it seems to me there is little incentive in Japan to improve the equity market because itÆs seen as primarily benefiting foreigners.
Yes. In the 1990s, we were behind globalisation, and we suffered. Now, this is a great chance to catch up with the rest of the world. There are typhoons outside, but the Japanese are accustomed to typhoons and earthquakes. ItÆs like the Meiji Restoration û when the samurai abandoned their swords and top knots and became managers.

How about the rest of Asia? Any opportunities there?
Well, we are mostly engaged in domestic activities. But if companies in Japan want to invest in abroad, we can help them after the privatisation process takes place this coming October. We will be able to emphasise the Asia cross-border business, in Vietnam and China for example.

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