Priorities for the Japanese Economy in 2016 (January 2016)
Will We See Changes in the Corporate Governance of Regional Banks?
Faculty Fellow, RIETI
Unwinding of cross-shareholdings likely to accelerate
The introduction of Japan's Corporate Governance Code (hereinafter referred to as the "Code") in June 2015 was no doubt among the most important news of the year for corporate finance in Japan. The provision calling for the appointment of "at least two independent directors" has attracted much attention. However, the intended purpose of the Code is to enhance the effectiveness of corporate governance for "sustainable corporate growth and increased corporate value over the mid- to long-term" as stated in its subtitle.
The Code provides for cross-shareholdings as follows:
When companies hold shares of other listed companies as cross-shareholdings, they should disclose their policy with respect to doing so. In addition, the board should examine the mid- to long-term economic rationale and future outlook of major cross-shareholdings on an annual basis, taking into consideration both associated risks and returns. The annual examination should result in the board's detailed explanation of the objective and rationale behind cross-shareholdings. Companies should establish and disclose standards with respect to the voting rights as to their cross-shareholdings.
According to media reports, some major companies and banks have already begun to accelerate their efforts to unwind their cross-shareholdings, the significance of which cannot be explained. For instance, Japan's three mega bank groups respectively announced plans to sell approximately 30% of their cross-held shares within the next several years.
Regional banks to be affected by the unwinding of cross-shareholdings
In calling for reducing cross-shareholdings, the Financial Services Agency (FSA)'s 2015-2016 Strategic Directions and Priorities made explicit reference only to the three mega bank groups. However, the Code also has a significant impact on regional banks (including both first-tier and second-tier). First, as most regional banks have their shares listed, they need to take concrete actions to respond to the Code as shareholders. Second, their shares are held in large amounts by many companies and other banks for the sake of maintaining long-term relationships, and, as such shares are sold in the market with the unwinding of cross-shareholdings, they will need to cope with their new shareholders.
Regarding the first point, nine of the 82 regional banks that had disclosed corporate governance reports as of November 13, 2015 stated that they will either "reduce" or "refrain, as a matter of principle, from" cross-shareholdings, according to the Nihon Keizai Shimbun (November 16, 2015). As such, a significant change is observed in regional banks' policies regarding shareholdings. At the same time, however, "while there is a growing move particularly among leading regional banks to reexamine the practice of cross-shareholdings, 60% of regional banks--mostly small- and medium-sized ones--have not specified their policies on cross-shareholdings" (idem). Thus, many regional banks are still keeping a wait-and-see stance. However, given the strong lockstep mentality of the banking industry, more regional banks will likely follow the forerunners in 2016 albeit slowly at the beginning.
One major challenge for regional financing in Japan is how to secure the supply of venture finance locally. This is a problem that should be addressed by various funds. However, the reality in rural regions--i.e., those other than metropolitan areas--is that banks remain the main, if not the sole, source of funds. I believe that the supply of funds similar to equity capital is important for the revitalization of local economies. In this regard, I am hopeful that the establishment of the Corporate Governance Code will increase room for regional banks to redirect their risk-taking capacity, which has been used hitherto for holding shares in listed stocks, to supply venture finance to local businesses. How they will utilize their funds and risk-taking capacity released by eliminating cross-shareholdings is the focal point of regional banks' operations in 2016 onward.
Who will be the owners of regional banks?
Meanwhile, regional banks will also likely undergo significant changes in their ownership structure. In terms of influence over the behavior of regional banks, these changes may have a greater impact than those accompanying the unwinding of cross-shareholdings.
Traditionally, it has been quite common for mega banks to hold shares in regional banks. When mega banks reduce their shareholdings for non-investment purposes, shares held in regional banks will naturally be among those subject to sell-offs (Note 1). Cross-shareholdings between regional banks will be unwound as well. Furthermore, major companies are also beginning to reduce their shareholdings in banks (Note 2). It is inevitable that a large number of cross-held shares will leave the hands of stable shareholders.
What will happen as a result of this? In April 2016, the Taisho Bank, Ltd., an Osaka-based regional bank and an equity-method accounted affiliate of the Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU), will merge with TOMONY Holdings, Inc., a banking group operating mainly in the Shikoku region. Reportedly, BTMU's policy to reduce shareholdings for non-investment purposes has been a factor behind this merger. As exemplified by this, the unwinding of cross-shareholdings will certainly stimulate the restructuring of ownership in regional banks. Since the restructuring of regional banks has a profound impact on financing for local companies, the destination of cross-held shares will be a matter of great concern.
However, in reality, it is quite rare that the new owner of such shares is prearranged by such means as organizational realignment. What is important--though not a game changer--for regional bank managers is to take this opportunity to seek to increase local shareholders, those who live in the regions they serve and share their management philosophy.
For instance, in a statement on its efforts to appeal to its existing and potential shareholders, Miyazaki Taiyo Bank, Ltd., a second-tier regional bank based in Miyazaki, says as follows: "With an aim to encourage more local customers to become our shareholders, we have been working to better communicate with our shareholders alongside disseminating information on our contributions to the local communities. We will further enhance information disclosure (or investor relations), for instance, by holding briefings to explain our business and earnings performance to our shareholders and customers to deepen their understanding of our bank" (Note 3). Although some people might question the idea of managers selecting shareholders, I believe that it is quite natural for them, as regional bank managers, to seek to increase the number of shareholders who understand and agree with their management philosophy. Forcing small- and medium-sized corporate customers to purchase shares is absolutely out of the question. However, I do hope that regional banks will turn their misfortune called the "unwinding of cross-shareholdings" into an opportunity to develop a shareholder policy that would enable them to become a truly locally oriented bank.
- ^ For example, see "Mega Banku, Susumu Chigin-Banare, Shihon Kisei Futan [Mega Banks Pulling Away from Regional Banks under the Growing Burden of Capital Requirements]," Sankei Shimbun, November 14, 2015.
- ^ For instance, Kikkoman Corporation reportedly sold approximately half of its shares held in Chiba Bank, Ltd. (Nihon Keizai Shimbun, July 17, 2015).
- ^ See Miyazaki Taiyo Bank's "Management Enhancement Plan" (approved in August 2015), a document disclosed by the bank as a recipient of public funds.
January 7, 2016
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