Japan’s banks to benefit from postal privatization

(September 14, 2005) For the most part, the business community applauds government plans to privatize operations, often seeing the move as a chance to invest in a long-standing monopoly. In the case of Japan’s post office, the prospect of a massive competitor coming into private hands is seen as a boon for the financial services sector.

While it may sound odd to North Americans, where the postal service is usually seen as a rather inefficient way of delivering birthday cards, the Japanese seem to prefer the post office over banks for savings deposits. This is not peculiar to Japan, as it is also the case in some European markets.

On Sunday, Japan’s ruling Liberal Democratic Party (LDP) won a majority in an election called specifically over the issue of privatization.

“The government comes out of the election much stronger,” says Pauline Lee, portfolio manager for Investors Japanese Equity fund. “Prime Minister Koizumi is going to continue reforms — accelerate reforms and broaden into other aspects that are required in Japan.”

She calls a more reform minded government “great news” for Japan’s economy and the stock market, saying the LDP victory has reinforced foreign investors’ confidence in Japan.

The plan to privatize starts with placing the post office in a holding company in 2007, dividing operations into four divisions: mail delivery, the postal branch network, savings and insurance. By 2017, the government would privatize the two financial divisions.

“I think it’s a very positive development for the Japanese economy,” adds Alan Pasnik, portfolio manager of the Mackenzie Maxxum Global Explorer Fund. “It reflects the fact that they’re prepared to embrace some degree of change and that’s good.”

He credits the early discussions on privatization with boosting the key Nikkei stock market index, which is up more than 12% on a year to date basis.

“Over the past four or five months, the effect has been to raise the Japanese stock exchange in anticipation,” says Pasnik. “We have to see what occurs over the next few years, but I think it’s probably favourable for the Japanese financial institutions, so that’s an area that one may want to look at.”

Lee agrees that privatization should be benefit existing financial services providers, which have been competing with the post office for years. Privatization will place the banks on an equal footing with the post office, which for years has enjoyed several advantages.

As a branch of government, the post office was free of corporate taxation and exempted from such standard requirements as deposit insurance premiums and maintaining capital reserves for its insurance unit.

Offering term deposits and life insurance, Japan’s post office has about $3 trillion US in assets under management. With privatization, operating costs will increase, promptly at least some account holders to look elsewhere for their banking needs. Even if the post office loses just 5% of its business, that would send $150 billion US into other accounts at the banks.

In 1998, the government bailed out the banking industry, which was reeling from bad loans in the real estate market. Since then, at the direction of the government, the Japanese banks have cut their non-performing loans ratio in half.

Since the real estate bubble, property values fell by as much as 70%, Lee says, but in March 2005 commercial property in some parts of Tokyo started to show signs of recovery for the first time in 15 years.

“In the past the banks suffered from lending too much to corporate borrowers. Now they can expand into consumer lending and mortgages. They have a new area of business opportunity.”

Japanese banks are struggling to catch up with their global peers, with only about 20% of their revenues being fee-based, compared to 35% to 50% in the U.S.

“If they really follow the U.S. model, that means they’ll have a more stable, growing source of income,” says Lee.

Aside from the potential benefits to the banking sector, privatization will mark a mass restructuring in the way the government conducts its own business. For years, the government has treated the post office assets as the public cookie jar, using capital to fund public works spending. The remainder of the cash was invested in Japanese government bonds, controlling 25% of such outstanding debt.

“It’s a waste of resources, it’s more than necessary and it’s inefficient,” says Lee. “There will be a reduction in public works spending and a downsizing in government offices. This money will go into the more efficient private sector.”

There are downsides to the privatization scheme, though. With 270,000 public service employees, there are bound to be staff cuts. With luck, the expected economic benefits will dampen the affects of any layoffs.

“Whenever you free up a capital market, which is the implication, I think it’s good for investors and society in general,” says Pasnik. “Long term, I think it’s a very positive development for Japan.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(09/14/05)

Steven Lamb