COMMENT & ANALYSIS: Resona's downfall: an auditor's death and a $17bn bail-out: Rescue culture will not solve problems By Michiyo Nakamoto and David Pilling, Financial TimesPublished: Jun 13, 2003
It was a typically muggy spring afternoon when Satoshi Hirata, a young auditor with one of Japan's top accountancy firms, arrived back at his flat in Toshima ward, central Tokyo. Dressed in a grey business suit, he took the lift to the 12th floor, walked to the emergency stairway and, according to police reports, jumped from the building. There was no will and no suicide note.
Not even Mr Hirata's parents know for sure what drove him to his desperate act. But his apparent suicide appears to have been intimately connected with the equally dramatic fall of Resona, Japan's fifth biggest bank, whose $17bn bail-out has sent tremors through the entire banking system.
In the months leading up to April 24, the day he died, Mr Hirata had been part of a team conducting a preliminary audit of Resona for Asahi, the KPMG-affiliated accountant and one of two firms looking into the bank's accounts. His work had helped to uncover a gaping hole where Resona's capital ought to have been.
Two days before Mr Hirata's death, Asahi had all but decided it could not continue with the audit. That left Shin Nihon - the other, Ernst & Young affiliated, auditor - with the sole responsibility of deciding Resona's fate. Three weeks later, after discussions with Shin Nihon, Resona reluctantly accepted that it could not continue operations without a massive infusion of public funds.
Precisely what triggered this spectacular train of events is still the topic of heated debate, not to mention a parliamentary inquiry. This week senior executives from Asahi, Shin Nihon and Resona - though not from the Financial Services Agency, the regulator - were summoned to Japan's Diet, or parliament, to answer questions about the bank's demise. Specifically, they were asked about allegations that some FSA executives tried to influence the auditing process to save Resona from the pain and embarrassment of a bail-out - an accusation that the FSA and the auditors all vehemently deny.
The full answers to these questions are yet to emerge - key figures in the bank's downfall blamed each other this week in the Diet hearing - but are crucial for Japan's entire banking system. That is because the decision to bail out Resona before it became insolvent could become a blueprint for future pre-emptive capital injections into struggling banks (see right). It could also transform the role of Japanese auditors, previously bit-players in regulating the financial industry.
In all of this, the role of Heizo Takenaka, the academic who heads the FSA, is shrouded in mystery. Some politicians argue that Mr Takenaka has skilfully manoeuvred from behind the scenes, forcing Resona into a corner and obliging it to beg for public funds. If that is true, he may have done so without the consent of senior officials within his own agency, many of whom oppose his radical plans to shake up the banking system.
Another possible explanation of Asahi and Shin Nihon's action is that the auditors themselves, emboldened by Mr Takenaka and terrified by the fate of Arthur Andersen over its flawed auditing of Enron, reluctantly took Resona's fate into their own hands.
If that is so, the Resona affair could in effect amount to the privatisation of Japanese banking regulation, turning auditors into a powerful agent of policymaking.
The events that led to Resona's downfall can be traced back to September 30 last year. That was when Mr Takenaka - a mop-haired university professor whom Junichiro Koizumi, prime minister, had already controversially installed as economy minister - was also named head of the FSA. His remit was to do what so many had tried and failed to achieve over the previous decade: clean up a banking system infested with bad debts.
Mr Takenaka's arrival, bitterly opposed by some FSA officials as well as by many senior politicians within Mr Koizumi's own Liberal Democratic party, was explosive. Within days the politically unconnected but now extremely powerful minister began to talk about sweeping changes to the way banks were regulated.
Among his initial proposals were stricter assessment of banks' bad loans, already estimated at Y43,000bn ($360bn), about 8 per cent of gross domestic product. Crucially, he raised the issue of deferred tax assets, the credits on future tax payments that Japanese banks have been using with abandon to pad their capital base.
Mr Takenaka's proposal severely to restrict the use of such tax credits amounted to a declaration that he intended to nationalise the banks, or at least force them to accept public funds. In one press interview, he claimed that the era of government coddling was over and that no bank or company was considered "too big to fail".
Banks were so incensed by his perceived threat that they threatened to sue him. Politicians and public figures such as Eisuke Sakakibara, who once ran Japan's yen policy, likened Mr Takenaka to a mad professor carrying out an untested laboratory experiment on the fragile Japanese economy.
The political uproar forced Mr Takenaka to water down his policies. Or so it seemed. When his plan was at last announced on October 30, instead of concrete policies on the stricter assessment of loans and the use of deferred tax assets he merely promised further study of such issues. Richard Jerram, economist at ING and a veteran observer of Japan's start-stop economic policies, said the document should be assigned to the rubbish bin with all the other failed bank clean-up plans.
Yet even then, close advisers to Mr Takenaka told sceptics that there was more to the package than met the eye. The idea that he has been beaten back is nonsense, said one friend of the minister. "Takenaka-san has got virtually everything he wanted. Just give it time."
In retrospect, it appears the minister's allies may have been referring to vague promises in the plan to assess banks' capital more strictly and, perhaps decisively, a warning that auditors should carry out their work with "grave responsibility".
That message was reinforced in February when Akio Okuyama, head of the Japanese Institute of Certified Public Accountants, told members they must assess banks' books more strictly. In remarks barely noticed at the time, but now considered crucial, he specifically brought up the issue of deferred tax assets that was to prove Resona's downfall.
While these political storms were blowing, Resona was quietly putting the finishing touches to the long-drawn-out merger that created it. In March, signs belonging to Daiwa and Asahi, the two main merging banks, were being replaced by a bright green logo bearing an unfamiliar name: Resona. Soon it would be on everybody's lips.
The merger was one of a series being orchestrated by the government to reduce the nation's top 13 banks to just five - a reflection of Japan's shrinking economy and the need for its financial sector to hunker down.
The main partner in Resona was Daiwa, which had retreated to its base in the industrial city of Osaka, central Japan, after a 1995 scandal in which one of its New York traders lost $1.1bn in a series of fraudulent deals. Daiwa, which later swallowed several smaller banks in Japan's Kansai region, of which Osaka is the hub, was now taking over Asahi, another struggling bank based in the Tokyo area.
Like all their peers, Daiwa and Asahi were weighed down with bad debts, which made up about 10 per cent of their loan books even after years of aggressive write-downs. Many of those dated back to reckless lending during the bubble years, when banks were falling over themselves to provide companies with money based on what turned out to be grossly overvalued collateral. New bad loans were also being conjured up by persistent deflation, which has dogged Japan's economy since 1995 and makes it progressively harder for borrowers to repay loans from shrinking revenues.
Asahi was supposed to be the weaker of the two banks. But Daiwa looked in pretty bad shape too. It had lent heavily to several grandiose and now loss-making government-led schemes, such as the World Trade Centre, built on an artificial island. It was also massively exposed to small and medium companies in Kansai, once the engine room of Japan's economy but now the region most threatened by competition from cheap foreign producers, especially China.
These problems were more or less familiar to all Resona's peers. But, in one fatal respect, Resona was more vulnerable still. At other banks, deferred tax assets made up about half of capital, a level high enough to raise serious concerns at ratings agencies such as Fitch. But at Resona this figure rose to an alarming 77 per cent of capital.
The problem for Resona was that auditors, galvanised by changes in Japan and in post-Enron America, had suddenly become a lot tougher.
Like all their peers, Daiwa and Asahi were weighed down with bad debts, which made up about 10 per cent of their loan books even after years of aggressive write-downs. Many of those dated back to reckless lending during the bubble years, when banks were falling over themselves to provide companies with money based on what turned out to be grossly overvalued collateral. New bad loans were also being conjured up by persistent deflation, which has dogged Japan's economy since 1995 and makes it progressively harder for borrowers to repay loans from shrinking revenues.
Asahi was supposed to be the weaker of the two banks. But Daiwa looked in pretty bad shape too. It had lent heavily to several grandiose and now loss-making government-led schemes, such as the World Trade Centre, built on an artificial island. It was also massively exposed to small and medium companies in Kansai, once the engine room of Japan's economy but now the region most threatened by competition from cheap foreign producers, especially China.
These problems were more or less familiar to all Resona's peers. But, in one fatal respect, Resona was more vulnerable still. At other banks, deferred tax assets made up about half of capital, a level high enough to raise serious concerns at ratings agencies such as Fitch. But at Resona this figure rose to an alarming 77 per cent of capital.
The problem for Resona was that auditors, galvanised by changes in Japan and in post-Enron America, had suddenly become a lot tougher.
Mr Hirata, who had once been seconded to the FSA as a bank inspector, must also have been struck by Resona's heavy dependence on tax credits. The bank's calculations were based on optimistic assumptions about its future profits, from which these tax credits could be deducted. But such assumptions were difficult to square with the fact that Resona had been bleeding red ink for three years in succession.
So grave were the doubts at Asahi that, at a meeting held on April 22, just two days before Mr Hirata's death, the audit committee concluded that Resona could not claim any deferred tax assets at all. That rendered the bank in effect insolvent. Rather than send Resona to its doom, Asahi decided to pull out of the audit, leaving Shin Nihon in sole charge of the bank's fate.
Only senior regulators and Resona bankers knew about Asahi's dramatic withdrawal. If the public had been informed, it would have sent a wave of panic across Japan's banking system. Yet even at this late stage, Yasuhisa Katsuta, Resona's politically influential president, thought his bank could persuade auditors to sign off the accounts.
As Japan prepared for its annual Golden Week holidays - a time when city-dwellers return to their home towns and business grinds to a halt - Resona had no idea what was about to hit it.
On May 5, the last day of the holiday, Shin Nihon decided that it too could not accept Resona's deferred tax assets in their entirety. As a result, the bank's capital adequacy requirement would fall well below the legal minimum of 4 per cent, it concluded. On the following day, Shin Nihon met Resona's executives and dropped the bombshell.
"Mr Katsuta called this a betrayal," says Shunji Koike, a prominent Osaka businessman who this month was named an external auditor of Resona. "Before Golden Week, it had all been accepted . . . but after Golden Week, we were notified by Shin Nihon that they had to be more strict."
Even at this stage, there appear to have been attempts to save Resona. According to leaked memos that have since been distributed in parliament, senior FSA officials encouraged Resona to go back to Shin Nihon and persuade the auditor to change its mind.
That, according to Kouhei Ohtsuka, an opposition member of the upper house of parliament, was a breach of the Securities and Exchange Law and could lead to action from the prosecutor's office. "This is Japan's Enron," he says. "But in Japan, the regulator tries to stop auditors from doing what they need to do."
There was a considerable gap between Shin Nihon's decision on May 5 and the government's shock announcement on May 17 that it would have to bail Resona out. "During this time, there was a heated debate between the bank and the auditors," says Mr Koike. "But in the end, the auditors would not listen to Mr Katsuta."
Mr Koike is not alone in thinking that the death of Mr Hirata, who had friends within the FSA, could have played an important part in determining the eventual outcome. "Partly because of the suicide, Asahi pulled out of the audit and Shin Nihon had no choice but to comply [with the stricter assessment]," he said. One political analyst who has closely followed the Resona affair described Mr Hirata's suspected suicide as a dramatic gesture designed to persuade his seniors that Japan could no longer afford to keep covering over the cracks.
As a result of the bail-out, the government now controls 70 per cent of Resona. Some 140 of the bank's senior executives, including Mr Katsuta, have been forced to resign.
It is still far from clear whether the potential scandal surrounding the Resona bail-out will escalate or quietly fizzle out. If accusations spread, Mr Takenaka might seek to strengthen his position by purging the FSA of those who oppose his methods. On the other hand, as head of the agency, Mr Takenaka - already a target of senior LDP politicians - could find himself having to take responsibility.
What is more, there are serious doubts that the $17bn bail-out with public funds can really transform Resona into a successful bank. The former Daiwa and Asahi banks received a total of Y1,100bn in public funds in 1998 and 1999, yet the revival plans they drew up at that time have failed in spectacular fashion.
In all of the uncertainty, one thing is patently clear. Japan's big four banks, whose problems are not materially different from those of Resona, will be watching hawk-eyed as events unfold. If Mr Takenaka hangs on and the Resona bail-out proceeds smoothly, it may only be a matter of time before auditors are unleashed on one of them.
There is already talk about the possibility of Resona, The Sequel. Resona's problems were marginally worse than those at Japan's other big banks - but only just. It is not too far-fetched to imagine the same thing happening to one of the big four banks in the future, only on a larger scale.
One of the criticisms of Resona's rescue is that the government did not articulate a policy for bank bail-outs; instead it passed responsibility on to the auditors.
Yet from the fog, a blueprint is emerging.
The Financial Services Agency is preparing a rule that would allow it to inject public funds into banks without declaring a systemic crisis.
This could also allow it to bail out banks without sacking managers, which might soften opposition from bank executives.
This will not please those who object to the handling of the Resona bail-out.
First, there is the issue of moral hazard. Kazuhide Uekusa, professor at Waseda University, complains that shareholders of Resona should have been punished through a capital write-down. By allowing shareholders to get off with almost no penalty, he says, Japanese investors are free to prop up any bank they choose, safe in the knowledge that the government will bail them out.
Second, it is unclear what kind of bank is being created by the bail-out. It could become a hardbitten model of banking efficiency. More probably a well capitalised Resona would be used as a means of dispensing subsidies to hard-hit small and medium-sized enterprises in the depressed Kansai region. In a few years the bank could be in terrible shape all over again.
Bankers are furious at the Resona bail-out for another reason. They complain that Japan's tax system is punitive for struggling banks. Rule changes to deferred tax assets should be compensated for by more generous tax treatment, they say. That would allow them to keep doors open, at least for now, without fresh funds.
Paul Sheard, economist at Lehman Brothers, says that from a macroeconomic perspective it is all the same. Whether by tax rebates, a Resona-style bail-out or full nationalisation, the central truth remains that banks need more capital, he says.
Resona proves Japan has the wherewithal to pay, he argues. Not only is there another Y13,000bn ($110bn) where the Resona funds were drawn from, but because of deflation, says Mr Sheard, Japan has a "free lunch option" of printing as much money as it needs to recapitalise the banks. On its own that is not enough. Macroeconomic and monetary policies are needed too.
But Mr Sheard, for one, cannot wait for Resona, Part II.