GOING POSTAL: INTRODUCING THE WORLD'S LARGEST BANK

C O N F I D E N T I A L SECTION 01 OF 03 TOKYO 004658

SIPDIS

SIPDIS

NSC FOR TONG; USTR FOR BEEMAN AND MEYERS; PARIS FOR USOECD;
DOC FOR 4410/ITA/MAC/OJ/NMELCHER;TREASURY FOR IA/DOHNER,
HAARSAGER POGGI, CARNES, AND WINSHIP; STATE PLEASE PASS TO
FEDERAL RESERVE SAN FRANCISCO/A. MAEDA AND FEDERAL RESERVE
BOARD/J. KOHLI;BERLIN PASS TO FISHER; BANGKOK PASS TO THORIN

E.O. 12958: DECL: 03/10/2017
TAGS: EFIN KPRV JA
SUBJECT: GOING POSTAL: INTRODUCING THE WORLD'S LARGEST BANK

REF: A. TOKYO 4555

B. TOKYO 2716

C. TOKYO 1916

D. TOKYO 967

E. TOKYO 894

Classified By: Charge d,Affaires Joseph R. Donovan for reasons 1.4 b/d.

Introduction
--------------

1. (SBU) Yucho, Japan,s postal bank, is the world,s largest
bank, with total assets of 222 trillion yen ($1.9 trillion)
and FY 2007 net income of 300 billion yen ($2.6 billion).
As Yucho,s privatization began on October 1 (ref a),its
sheer size and first steps into new banking businesses
promise a significant impact in Japanese and global
financial markets.

A Bank is Born
--------------


2. (U) On October 1, Japan Post dissolved and its functions
were doled out to successor companies under the Japan
Post Services Holding Company (JPSC). The new successor
companies are to be subject to the same laws and regulations
that govern their respective private industries. A
government corporation will be established as a repository
of the pre-privatization savings accounts held by Japan
Post. The government will continue to guarantee the existing
postal savings obligations and the funds in these
grandfathered accounts will be placed in government bonds.


3. (SBU) Yucho,s traditional business model had been quite
simple: channeling savings back to the government to finance
either directly or indirectly Japanese fiscal policy. The
most popular postal savings product were the teigaku chokin,
a ten-year time deposit account with no early withdrawal
penalty after six months. Yucho has also offered passbook
savings and other time deposits and, since October 2005,
investment trusts. However, Yucho has never had a lending
facility.


4. (SBU) Since inception, Yucho has not paid any deposit
insurance premiums or taxes, has not been subject to
capital requirements, has had a government guarantee on its
deposits, and historically has set its interest rates for
savings deposits higher than banks. For these reasons, the
existence of Japan Post has been criticized by the private
sector, which pointed to Japan Post,s unfair competitive
advantages.


5. (SBU) Yucho,s privatization is expected to increase
competition in the banking sector as the bank seeks to offer
products and services now offered by private banks. A likely
outcome of Yucho,s new status is a privatized postal bank
with little or no government support that has to diversify
its offerings and asset base. The plan is to eliminate
market
distortions and subsidized competition to promote the
efficient allocation of funds within the Japanese economy.
However, risks and questions remain.

But What Kind of Bank?
--------------


6. (C) Observers and other financial market participants
are wondering about Yucho,s business model. Mortgage
finance,
loans to small and medium enterprises, and finance for public
works projects have all been posited as possible business
activities. However, there are questions as well as to how
Yucho can successfully enter these already highly competitive
areas on a meaningful scale and where it will find the needed
expertise. There are also questions as to whether the GOJ
will allow market forces to operate. There are concerns a
financial system already characterized by overcapacity may
end up with excessive competition and risk taking, perhaps
weakening other financial institutions, including the
regional banks and cooperatives, if not Yucho itself.

TOKYO 00004658 002 OF 003




7. (C) One fear is Yucho will continue to be implicitly
or explicitly backed by the government and, by using its size
and the resulting unfair competitive advantages, lead to
problems for the regional banks. Many of the concerns the
USG has repeatedly expressed regarding a level playing field,
raised most often in the context of the Postal Insurance
Company, are designed to ensure that government backing does
not aid what would already be a tough competitor in this
"strong bank" scenario.


8. (SBU) Any new business areas or activities for Yucho must
be recommended by the Postal Services Privatization Committee
(PSPC). However, as the financial services regulator, the
Financial Services Agency (FSA) can deny an application if it
deems Yucho does not have the competence to enter into the new
area. Japan Post issued an outline of its implementation
plan
that included new business areas that Yucho might enter,
including offering foreign currency deposits, mortgages,
business loans, project finance, receivables financing, and
credit cards. The document states Yucho would seek to
begin these businesses promptly after privatization.


9. (SBU) Earlier this spring, an FSA contact indicated that
a range of new business might be considered, with varying
likelihoods of approval. He suggested the bank was likely
to ask for liberalization of risk management tools. He gave
hedging operations to limit interest rate risk on the bank,s
large portfolio of JGBs as one possible area that could meet
with easy approval. More difficult would be loans to small-
and medium-sized enterprises. He indicated entry into this
field could face fierce opposition from Japanese regional
banks,
which would be directly affected by such a move. Technically,
however, such opposition should not be a factor in the
decision.


10. (SBU) An example of an attempted foray by Yucho into a
new business area played out in recent press articles.
Press reports indicated Yucho was preparing to enter the
mortgage market and was soliciting regional bank partners
to join in this venture. In a meeting with the regional
banking supervisory office at FSA, an official there called
the press reports inaccurate, and said FSA was not prepared
to approve mortgages as a new product offering at this point.
However, he continued, Yucho might be allowed to act as an
agent in offering products of the regional banks. In
the end, all but one regional bank, Suruga Bank, declined
Yucho,s offer of a business tie-up in the mortgage area,
with press reports suggesting the result stemmed from
regional banks viewing Yucho as more of a threat than
an opportunity.


11. (SBU) One PSPC member we talked with seemed more
optimistic about possible approvals for expansion into new
businesses. Both FSA and PSPC are concerned about the
level of talent currently at Yucho. Most Yucho employees
have worked for the bank for their entire careers and
therefore have little or no experience with
anything more than the relatively unsophisticated products
Yucho currently offers. The PSPC member suggested Yucho
might look at tie-ups with firms having the required
technical expertise. He specifically mentioned Goldman Sachs
and Morgan Stanley, though this specificity was likely
calculated to appeal to his American audience. However, a
range of views exists, and another PSPC member consistently
has asserted the view that Japan Post should focus on
shrinking its balance sheet, rather than a major expansion
of activities.


12. (SBU) Most American observers have concentrated on the
privatization of the postal insurance company, probably
because the new company will compete directly with U. S.
companies already well established in the Japanese insurance
market. The Yucho privatization has received less attention
because most American banks and other financial institutions,
with the notable exception of Citigroup (which has an
agreement

TOKYO 00004658 003 OF 003


with Yucho allowing Citibank savers to use Yucho ATMs),do
not
have retail banking operations in Japan and are not directly
affected by the privatization. Concerns that have been raised
include a desire by securities firms to be allowed to compete
on asset management service provision to the bank, and a
desire
to have equal access to the postal network.

But What if Yucho Turns Out to be Less Than its Former Self?
-------------- --------------


13. (C) A different fear might be called a "weak bank"
scenario. Under this model, the new Japan Postal Bank does
not have the expertise to enter the various potential lending
markets, but feels pressure to do so anyway in order to show
a
viable business strategy to potential investors before the
eventual IPO. Inexperienced loan officers turn out to be
unable to poach clients from the regional and city banks and
so make ill-advised loans to marginal borrowers. Given the
difficulty in developing new products and showing growth in
the
short time line currently proposed, a number of observers
find
this scenario credible, at least in part, because of the lack
of experience now found in the bank. To counter such a
problem,
it might be that the GOJ, through the holding company,
continues to be involved, limiting outside access to the
postal
network and thus to Yucho,s depositors until Yucho proves
itself a viable entity.


14. (SBU) One PSPC member acknowledged that Yucho cannot be
viewed as a purely private player before 2017 and promised
the PSPC would be proactive as opposed to reactive like the
FTC on anti-monopoly type issues. However, when asked about
his interpretation of the terms level playing field and user
convenience, he stated he was concerned that regional
players are making anti-competitive arguments and that it
was important to protect consumers. Arguably, he added,
far from needing to wait until 2017 and full privatization,
a level playing field requires the postal bank be permitted
to enter into a full range of services in order to compete
with existing banks. In other words, the danger might not be
that the new mammoth postal bank will destroy other banks,
but rather the other way around.

Comment
--------------


15. (C) The size, scope and political history of Japan
Post,s privatization leave no room for anything less than
complete success. Japan,s policymakers seek to structure
the privatized bank as a viable enterprise and increase
competition for the benefit of consumers. Some observers,
however, express concern Japanese policymakers will create
either a strong postal bank that enjoys preferential
treatment with the ability to overpower its competitors,
or a weak bank that will struggle to meet its service
obligations, create market instability, and perhaps ultimately
need a government bail-out. The PSPC, charged with
shepherding the new Japan Post, will have to steer a middle
course to ensure a successful privatization. The committee
is likely to face significant pressure from existing banks
and other financial institutions to limit the range of new
business the postal bank will be allowed to enter. At the
same time, many in government want a successful and early
IPO, the revenues from which will probably go to reduce
Japan,s high public debt load. Striking a balance between
these competing interests will be a difficult enterprise
without precedent.
DONOVAN