Daiwa to Sell U.S. Business to Sumitomo

Japan’s Daiwa Bank Ltd., ordered to leave the United States by Feb. 2, has taken a major step in that direction by agreeing to sell its U.S. business to Sumitomo Bank Ltd.

Sumitomo has asked U.S. regulators for permission to buy Daiwa’s business, a spokesman for the Federal Reserve Bank of San Francisco said Wednesday. A purchase, discussed since November by the firms, is seen as a possible precursor to a bigger alliance and perhaps even a merger between the two giant commercial banks.

If approved, Sumitomo’s purchase would resolve a Federal Reserve order that Daiwa shut its U.S. business as punishment for covering up $1.1 billion in trading losses in its New York office over the last 12 years.

The Daiwa scandal, one of the largest cases of trading fraud ever, has darkened the cloud hanging over the Japanese banking system. Japanese banks are struggling with an estimated $400 billion in bad loans accumulated in the 1980s and early ‘90s through speculative lending practices.

Sumitomo Bank had previously said it would assist Osaka-based Daiwa in winding up its U.S. operations. The filing with the Fed, which must approve such transactions, signals that the two parties have reached an agreement.

Sumitomo, the world’s third-largest commercial bank, with $531.8 billion in assets, has said it is talking with Daiwa officials about a merger. That combination would create the world’s largest bank. Buying Daiwa’s U.S. operations could be an important step toward such a combination.

Robert Fienberg, a spokesman for the Federal Reserve Bank of San Francisco, said that Sumitomo submitted a draft application last Friday. Sumitomo’s U.S. operations are based in San Francisco. He would not provide further details.

“Negotiations are still underway. All I can say at this stage is that we have no comment,” Makiko Tanaka, a spokeswoman for Sumitomo Bank in Japan, said.

Masao Maeda of Daiwa Bank said talks are continuing and that no concrete terms have been reached. He added, however, that the two banks are expected to announce an outline regarding Sumitomo’s takeover of Daiwa’s U.S. operations by the end of the month.

Daiwa owns 17 bank branches in the United States and also Daiwa Bank Trust Co., which provides banking services to institutions and individuals. The bank is primarily a lender to multinational corporations, and it engages in trading and other capital markets activities for customers and its own accounts.

U.S. authorities in early November gave Daiwa 90 days to shut down those operations. They account for 15% of the international loans and securities the bank holds.

As part of its compliance with the orders to close U.S. operations, Daiwa has said it will reduce its work force to 7,000 from about 9,600.

A 24-count federal indictment against Daiwa accuses bank management of directing and participating in a cover-up of the $1.1-billion trading loss. Daiwa has denied the charges and vows to exonerate itself, portraying the scandal as the scheme of a rogue employee, New York bond trader Toshihide Iguchi.

Iguchi pleaded guilty last month to fraud and embezzlement. He is being held awaiting sentencing and is cooperating with prosecutors.