For a change, I wrote about poorly performing Japanese stocks. Many thanks to Tetsuya Inoue-san at the Nomura Research Institute, Osamu Takashima-san and Naomi Fink-san at BTMU. The story was published by Asia Times today. If you have time, please go over

Capital rules weigh on Japan stocks

Good weekend! Cheers, Kosuke

Capital rules weigh on Japan stocks
By Kosuke Takahashi

TOKYO - Japan's economy has moved out of recession, but the country's stock market continues to suffer from the impending imposition of tougher international capital rules to be compiled by the end of this year in Basel, Switzerland.

The nation's financial sector, led by Japan's three megabanks - Mitsubishi UFJ Financial Group, Mizuho Financial Group and Sumitomo Mitsui Financial Group - is dragging down the recovery of Japanese share prices, on concerns that the lenders may seek additional capital increases by issuing common stock in preparation for the tighter capital-adequacy rules that will apply to globally active banks. A weak point of Japanese banks is that without ample ordinary shares they lack capital.

A recent spate of capital-raising in the already weak market in Tokyo, combined with a rising Japanese yen and a heightened sense of uncertainty about the fiscal policies of new Prime Minister Yukio Hatoyama's administration, are also hampering stocks.

On Wednesday, Mitsubishi UFJ Financial Group said it plans to bolster its capital base by issuing one trillion yen (US$11.2 billion) in new shares - a record public sale of additional common shares. This gave rise to speculation that other banks would follow suit.

Japanese stocks have been the worst performer among major economies this year. The key Nikkei stock index has risen only 7.2%. More notably, the broader Topix index of all the Tokyo Stock Exchange First Section issues has fallen 2.4% - the only major broad-based stock index in the world that has lost ground this year. The Topix Index on Thursday fell for a seventh day, its longest losing streak since July, and slid to the lowest level since April 28, although it recouped some of its losses on Friday. The benchmark Nikkei average fell to its lowest level since July 17.

By contrast, the Dow Jones Industrial Average has gained 17%, while China's Shanghai Composite Index has climbed more than 80%, followed by Brazil's nearly 80% rally and India's more than 70% advance.

"It is true Japanese financial stocks are falling due to dilution concerns involving new shares," said Tetsuya Inoue, chief researcher for financial markets at the Nomura Research Institute in Tokyo and a former Bank of Japan official. "The new rules will also force Japanese banks to reconsider their traditional practice of holding shares in other companies over the long term."

Even so, he did not belive that new capital rules being finalized in Basel are specifically targeting Japanese banks. The change "has been discussed for many years and was finally agreed in principle in the Group of 20 (G-20) Pittsburgh summit in September."

The earlier BIS (Basel Capital Accord) agreement on strengthening the risk-capital adequacy requirement in the late 1980s and early 1990s "might have targeted the 'overpresence' of then burgeoning Japanese financial institutions, which foreigners often criticized," Inoue said. "But not so this time."

The Basel Committee
With the global financial crisis receding, international policymakers are working on adjusting rules on capital standards so as to avoid a repeat of the mistakes that can come from highly leveraged capitalism, exemplified by the failure in September last year of US investment bank Lehman Brothers. The planned changes will push banks to have a sufficient cushion of high-quality capital.

In September, leaders from 20 leading countries agreed at a summit in Pittsburgh, Pennsylvania, to impose tougher capital requirements on banks operating internationally. Before this summit, central bank governors and banking regulators of 27 major countries and regions participating in the Basel Committee on Banking Supervision also arrived at the same agreement, designed to standardize minimum capital requirements for banking institutions.

The agreement requires banks to raise the ratio of so-called core capital such as common stock and retained earnings. Although the specifics of the requirements will be worked out by the year-end, the new bank capital rules are widely expected to require banks to hold core Tier 1 capital - mainly common stock and retained reserves - equal to at least 4% of total risky assets. Reuters on Thursday reported the Basel-based committee is likely to require at least 6%.

The tricky thing is that Japanese banks, which are seen as less affected by the subprime loan crisis than their US and European counterparts, generally have lower ratios of common stock in their capital than major US and European lenders.

The core Tier 1 capital at Mitsubishi UFJ Financial was 6.8% as of the end of September, at Mizuho Financial 5.4%, and at Sumitomo Mitsui Financial 5.9%, according to their latest press releases.

On the other hand, US-based Citigroup held 9.1% of core Tier 1 capital, and Bank of America 6.9%, thanks to huge injections of public funds into those banks, according to the Mainichi Shimbun newspaper on September 3.

Late last year, Mitsubishi UFJ issued around 790 billion yen in common shares and preferred stocks. Mizuho raised up to 526.3 billion yen in July by issuing new shares, while Sumitomo Mitsui issued 862.9 billion yen in new shares in the previous month. All seem to have aimed at bolstering their core Tier 1 capital.

With the contours of Mitsubishi UFJ's capital-raising plan for the second consecutive year now announced, attention turns to its two main competitors, in particular Mizuho, which lags in terms of core Tier 1 capital. Market players in Tokyo expect Mizuho and Sumitomo Mitsui to issue new shares early next year, possibly between January and February. This could further buffet the already sluggish stock market in Tokyo.

Political vacuum
Nomura's Inoue said it is unfortunate that the "political vacuum" created by the transition process following the Democratic Party of Japan (DPJ)'s sweeping victory over the long-ruling Liberal Democratic Party (LDP) in a House of Representatives election on August 30 coincided with the intensive discussions regarding banking standards going in the US and the Europe.

Japan's then finance minister, Kaoru Yosano of the LDP, did not attend a meeting of G-20 finance ministers and central bank governors in London in early September, which was aimed at determining the priorities of the G-20 summit in Pittsburgh on September 24 to 25. His absence, attributed to health reasons, raised concern about Japan's low-key presence at the ministerial meeting.

The authorities in the US "have in effect been introducing a tougher de-facto standard for capital adequacy since bank stress tests in May, although it is unclear whether that was intended or not. For the Japanese side, frustration has arisen," Inoue said.

Kosuke Takahashi is a Tokyo-based journalist. Besides Asia Times Online, he also writes for Jane's Defence Weekly as Tokyo correspondent.

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