Daiwa stares into the abyss

DAIWA BANK's international operations hang in the balance this weekend after the shock decision by American regulators to close down its branches in the US, following the disclosure of a $1.1bn (pounds 700m) fraud at its New York office.

Sumitomo Bank is considering a rescue takeover of the stricken bank. The two sides have talked, although Sumitomo said that detailed discussions were not currently in progress.

Banking analysts say the US closure will cripple Daiwa's business around the world, not just in the US.

International banks such as Daiwa need 24-hour access to international foreign exchange and US securities markets - especially the enormous US government bond market where the long bond is a bellwether for global markets.

Banking analyst Jim McDermott, at stockbroker Keef, Bruyette and Woods on Wall Street, said the closure "would be like having your legs cut off at the knees. It will have enormous repercussions for Daiwa around the globe."

The bank, still the 10th largest in Japan by assets, has been ordered to close down or sell off its US operations by February. Its former bond trader Toshihide Iguchi has already pleaded guilty to criminal charges and is awaiting sentencing.

Peter Clarke, deputy general manager of Daiwa Bank in the City of London, said some activities could be transferred to the London arm. But he did not specify any in particular. "It is too early to speculate on what may happen, however, as we have received no formal notification from our Tokyo head office yet," he said. But it is thought likely that the bank will be forced to rein in its other overseas offices.

On Friday, the Bank of England and the Securities and Futures Authority revealed they had launched a joint investigation into the London branch. UK regulators gave Daiwa a clean bill of health, saying they could find no irregularities in London. However, news that the two most senior financial regulators in the country have investigated the bank will do little to allay City concern over the health of the Japanese banking system.

Last month, the US said it would provide a $150bn liquidity facility to Tokyo, in the event of a bank collapse sparking a run on Japanese banks.

Following the revelations at Daiwa, and the continuing bad debt plight of the country's financial system, Japanese banks have found themselves in an increasingly difficult environment. Outside Tokyo, their cost of funds - what they pay other banks in the interbank market on deposits - has soared. On average, the Japanese now pay half a per cent over Libor - the benchmark cost of borrowing for international banks in London - against almost Libor just over a year ago. By contrast, big international companies can borrow at only 0.3 per cent over, in effect forcing the Japanese either to lend at a loss or rein in their overseas lending

Credit-rating agencies remain concerned by the mounting bad debt problem and the failure of the Ministry of Finance to devise a solution.

At present, bad loans among the top 21 Japanese banks stand at around 35 trillion ($350bn), according to calculations by the International Bank Credit Agency (IBCA).

The total for all Japanese banks is put at double that, and it has continued to grow over the past two years.

IBCA Japan watcher David Marshall says the Japanese overseas funding requirements currently run at some $700bn a year.

"Japanese banks can live on thin margins, but if their cost of funds overseas rises too much, they will shrink international lending." He added that the banks' risk-management procedures were below par.