Sumitomo May Rescue Daiwa Bank With Merger : Finance: Combined, the Osaka-based banks would create the world’s largest. Daiwa’s ban from U.S. spells doom.

Japan’s giant Sumitomo Bank appears poised to merge with the scandal-ridden Daiwa Bank next year in an alliance that would create the world’s largest bank.

Reports of a Sumitomo-Daiwa merger in the offing made banner headlines in Japan’s most prestigious newspapers today, and the news was widely accepted. However, Daiwa’s serious legal woes could delay any such action, a Finance Ministry official said.

A merged Sumitomo and Daiwa, both Osaka-based institutions, would have assets of about $641 billion. That would exceed the planned $534-billion merger between the Bank of Tokyo and Mitsubishi Bank--scheduled for April, 1996--as the world’s biggest.

Daiwa’s survival has been cast in doubt by U.S. and Japanese government action drastically reducing the bank’s overseas operations--including banishment from the U.S. market--as punishment for its alleged mishandling of a $1.1-billion bank fraud in its New York branch.

People answering phones at Sumitomo offices in Tokyo and Osaka said that because it was Saturday, nobody was available for comment. Sumitomo officials said Friday that the bank might merge with Daiwa but that no deal had been agreed upon.

“We will provide any support needed, anything we can,” Yoshifumi Nishikawa, a Sumitomo managing director, said at a press conference. “There is a possibility that a merger with Daiwa will be one of the options.”

Daiwa Bank spokesman Masaharu Tamura said today: “There are no talks about a merger.”

But Daiwa might not have much choice. An official at the Finance Ministry, charged with restoring the health and credibility of Japan’s banking system, called such a merger “absolutely necessary.”

A key attraction of a merger for Sumitomo would be Daiwa’s trust banking division and its securities business, which would allow Sumitomo to broaden its range of operations.

Analysts said a merger may be Daiwa’s only chance for survival.

“The punishment by the U.S. means the death penalty for Daiwa,” said one banking analyst at a foreign brokerage in Tokyo who declined to be named.

Thursday’s action by the U.S. government against Daiwa is the harshest penalty ever levied against a foreign bank. U.S. authorities handed down a 24-count criminal indictment against the bank and ordered it to withdraw from the U.S. market by Feb. 2.

The Japanese Finance Ministry also ordered the bank, Japan’s 10th-largest, to scale back all overseas operations and foreign trading activities, and it took away Daiwa’s blanket authority to form banking ties with institutions abroad.

A merger notwithstanding, Sumitomo had already been identified as the likeliest buyer for Daiwa’s U.S. operations, which consist of 17 offices, including two in Los Angeles and one in San Francisco.

Bob Rabbino, general counsel for the Sumitomo Bank Ltd. in New York, confirmed Friday that his bank has agreed to help Daiwa withdraw from the U.S. market. He said it is “within possibility” that Sumitomo would acquire some of Daiwa’s assets in the United States.

But Rabbino said it is too early to speculate on how such a transfer of assets might occur and how it would affect Daiwa’s 400 U.S. employees.

Sumitomo, one of Japan’s largest banks, employs 550 in its New York offices alone, and it operates a vast retail and commercial banking network in this country.

Mike Pascale, a Daiwa Bank spokesman in New York, declined comment Friday on the reports of a Sumitomo merger in Japan or a takeover of Daiwa assets in the United States. But he said the bank hopes to avoid shutting down its U.S. operations and is actively seeking purchasers in hopes of “minimizing the disruptions to employees and customers.”

He said the bank is reassuring anxious customers that it is doing business as usual.

But some U.S. corporate customers, including Talbots Inc., the retailing giant, have already moved their business elsewhere, according to U.S. media reports. And Daiwa’s operations in Japan are also suffering.

The government-run Pension Fund Assn. decided to stop allocating new funds to Daiwa. Japanese media have reported that some individual depositors have withdrawn funds from Daiwa.

Banking executives don’t believe Daiwa’s exit will have a major effect on the U.S. banking landscape, given the bank’s small presence and its focus on the Japanese corporate community. But they do expect U.S. financial regulators to tighten up on foreign financial institutions, given the outrage over the Daiwa incident, in which a lone trader in Daiwa’s New York office was able to hide $1.1 billion in losses over 11 years.

“We foresee there may be stricter rules governing all foreign banks,” said Victor Li, vice president and general manager of the Los Angeles branch of the Bank of East Asia Ltd. Daiwa put on a brave face, saying it hopes to transform itself into a “quality bank” within three years and predicting that it would make a substantial operating profit of about $700 million for the business year ending March 31, 1998.

The bank said its U.S. units together produced only about $30 million in operating profit last year, compared to operating profit of $932 million at the parent bank. Only about 19% of its total $59 billion in overseas assets are in the United States, the bank said.

But analysts said these figures understate the impact of the crippling of Daiwa’s overseas network and the effect of the scandal on its credibility with customers and in employee morale.

*

Iritani reported from Los Angeles and Holley from Tokyo. Times wire services also contributed to this report.