Bank, securities tie-ups complex

TOKYO, May 04, 2009 (The Yomiuri Shimbun - McClatchy-Tribune Information Services via COMTEX) -- SMFJY | Quote | Chart | News | PowerRating -- Sumitomo Mitsui Financial Group reached a basic agreement last week to acquire two financial businesses from U.S. banking giant Citigroup Inc. -- Nikko Cordial Securities Inc. and Nikko Citigroup Ltd., Citi's investment banking unit.

SMFG also has been eyeing further strengthening its already potent alliance with Daiwa Securities Group.

The deal between SMFG and Citigroup will mark the birth of Japan's first comprehensive financial group as one of the nation's banking giants takes control of one of the country's largest brokerage houses.

It also is expected to have a major impact on the future actions of the nation's two other mega banks and could lead to a further realignment of the nation's financial sector.

Reports about the deal reminded me of what a senior official at a major securities company told me when I was still a fledgling economic news reporter.

He said that, essentially, bankers lend money they collect from depositors and wait patiently for the interest rate spread to be realized -- much like farmers waiting for a crop yield.

He compared this with the securities business, which is more aggressive in a wide range of areas deemed profitable, an approach he said was more like hunting.

This difference in corporate cultures between the banking and securities business sectors, would, he said, make it almost impossible for bankers to run a brokerage.

Back then, the banking and securities sectors bickered fiercely over what was referred to as the "boundary issue," or the problem of how to enable entities in the banking and securities sectors to operate on each other's turf.

The debate took place against the backdrop of a shift in emphasis in the financial sector away from "indirect financing" toward "direct financing" following changes in the nation's securities market as the economy rapidly matured after a period of high growth.

Banks at that time were eyeing the possibility of engaging in operations that had traditionally been considered the exclusive turf of securities firms.

The views of the senior securities official I mentioned might therefore have reflected the sense of competition between banks and securities firms.

The issue was eventually resolved when the two sides reached an agreement on a formula that allowed them to establish subsidiaries in each other's operations.

The move toward fusing banking and securities operations has continued as Japan has followed on the United States' heels in financial reforms.

In addition, as a result of the financial turbulence following the bursting of the bubble economy, there has been far-reaching realignment in both the banking and securities fields, reducing the number of major players to three mega banks and three huge brokerages.

The latest deal involving SMFG and the two Nikko firms is a landmark in the consolidation of the financial industry.

The two other mega banks -- Mitsubishi UFJ Financial Group Inc. and Mizuho Financial Group Inc. -- may feel for now they have been bested by SMFG and will likely be eager to beef up their securities-related operations in response.

But what is particularly interesting is how banks, having operated so long with a "farmer's" mentality, are absorbing the mind-set of a "hunter."

This is happening at a time when the business model typical of U.S. brokerages, which have made a furious dash for profits, is seen by many as being at the root of the current financial crisis that originated with subprime loan problems in the United States.

Major U.S. securities firms made huge profits by describing themselves as "investment banks" and took advantage of highly leveraged capital to make the most of relatively small amounts of cash.

However, they eventually ended up failing or being purchased by other firms that acquired them to become holding companies, undermining the very business model of the investment banks.

It also has been said that banks' excessive forays into securitized financial products in pursuit of bigger profits, despite their "farmer" roots, also contributed to the current global financial crisis.

This being the case, many in the financial world are now questioning the wisdom of banks imitating the brokerage business model rather than continuing with their traditional background role of providing different sectors of the economy with the cash they need to operate.

With the current international trend toward favoring tougher financial service regulations, there are growing indications that securities firms might become subject to net worth requirement rules similar to banking institutions.

If this happens, it could put significant restraints on the hunter approach of brokerages.

This leaves open the question of how banking firms can best integrate the know-how of securities firms to improve the efficiency of their operations.

In order words, what should banks, with their different business mind-set, do to ensure the securities businesses they operate are successful?

This may turn out to be the toughest challenge facing banking executives wanting to create truly effective, comprehensive financial service entities.

Masuda is economic news editor of The Yomiuri Shimbun.

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