Why Japan will excel in the financial services industry

Japanese banks are in trouble today but they will be the reason that Japan will continue to be an economic power and Asia's economic leader. First, I am not sure if Japan has a choice about in which sectors it will lead. While planning and production are going to local markets, Japan still has an advantage in design. Banking and financial services is the one area where Japan's resources dwarf all other nations in the region. The advantages Japan has-savings, assets, foreign currency reserves-are not easily duplicated. This is why Japan will continue to be a leader in Asia.

A lot of production is moving to China and the technological gap between China and Japan is closing. Technology is spreading more rapidly, thanks to software. Be it Japan or China, the country that can win the hearts and minds of the members of ASEAN will become the leader in Asia. Why will financial services be the area where Japan will continue to lead?

The first reason is size. Japan's bank savings is 760 trillion yen-that is in addition to whatever is stuffed under the futon or mattress. Bank savings make up half of Japan's financial assets. Postal savings is at 360 trillion yen. Mizuho Holdings, Japan's largest bank, is larger than China's top three banks combined. Japan is still a very wealthy country. Once the non-performing loans are cleaned up, the postal savings funds will be put back into play. Most people, around the world, put their money in their own nation's banks.

The second reason is knowledge of the regional market. In every financial center, there is a presence of Japanese banks. The tentacles of Japanese banks in the region cannot be matched by banks in Europe or America; and these tentacles should not be underestimated. Japanese banks also have a base knowledge of the region (trade, research, and data) from being active in Asia. It is naive to think that other banks can lend in Asia as well as Japanese banks can, as it takes a strong knowledge of the region to evaluate risk. You don't see other banks having the presence in Asia.

The third reason is that sometimes problems can be an advantage; in other words, Japanese banks' experience with NPL and NPL clean up will give the banks the expertise to lead. Restructuring is the fastest growing segment of the debt market in Asia. Once Japanese banks gain the experience of cleaning up loans in Japan, they will take that experience to clean up problems in the region. Distressed debt can be an asset. It is better if you can make a few cents off the dollar instead of zero. The government must allow the private market to be involved in cleaning up the NPLs because once the private sector is involved they will learn from the experience.

Having experience in the region allows you to better understand where the savings is, how to read and understand a balance sheet, etc. Banks are supposed to price risk. I would trust Mitsubishi Bank to price risk in Asia more than I would a Korean or Chinese bank. Japan's advantage in the region is unparalleled.

Finally, Japan has no other choice. In Japan, you see a lot of inward looking; people are not thinking about being a regional player until the problems are fixed at home. But Japan has little choice. I think the public will see that, as automobiles were in the 1980s, financial services is a key for long term growth and development. Financial services must look at being regional powers, as Japan comes out of this recession. There has been a lot of talk about nano technology. It is more likely that financial services will lead Japan out of the recession. It is not going to be some neat technology or buzzword.

Q: Marcus Noland says that Japan can learn from the Korean experience. Korea was able to take bold steps because of the severity of the problem in 1998. The government was forced to take action. Dr. Noland says the Japanese government is not taking the necessary steps. But you are saying that because of the sheer size of the Japanese financial sector, Japan can continue to dominate. But this is predicated on a successful process of restructuring.

Korea has done a good job at restructuring. But it is not clear how healthy these companies actually are. In Japan, you need the private sector more involved in NPL clean up. The financial sector is the only area in which Japan has the advantage. So the banks must be cleaned up. The loans would be cleaned up more quickly if the private sector were involved.

Q: Japan has 1.4 quadrillion yen in personal assets, but if you look at the assets and liabilities, the money is all accounted for. The number is smoke and mirrors. If we price it to move it, it gets marked down.

Japan's savings is its biggest asset. Even if you write off NPLs, you still have value, even if it is 50 percent. Japanese people have a lot of savings. If they put the money in banks, once the banks clean up their acts, Japanese banks will have the advantage. Look at the per capita income in Japan: Japan is simply richer than Korea. People will continue to get paychecks; people will continue to save. I believe the Japanese people will keep putting their money in banks.

Q: There is a gap between what you are saying and the actual behavior of Japanese banks. Japanese banks are negative on doing business abroad.

You are right; there has been a Japanese pullout in Asia. But the knowledge does not go anywhere. Japanese banks are the only ones that can get the critical capital back into Asia.

Q: Japanese banking business won't be in retail; Citibank is taking care of that. You must be talking about investment banking. But Japanese banks do not have much experience in this area. I don't see your scenario panning out.

I am talking about institutional and corporate lending. If you look six years ahead, this is the one area where Japan will have the advantage. It is not going to be in radios or cars. Japanese banks made lending mistakes at home and abroad. But Japanese banks lead in retail banking. Mitsubishi may be good at the mortgage side. People are looking at Japan as a base of expertise for the region.

Q: You are using a theory of comparative advantage. Yes, Japan is abundant in capital, but it is also abundant in old people. Can't Japan specialize in elderly care?

Services for the elderly and business that deal with the needs of having more women in the workforce will be areas to watch. Transportation for the elderly and daycare are other interesting areas. Companies could have daycare onsite.