Plans for a merger among three of Japan's largest banking companies are moving forward, but observers said such a deal would do little to solve deep-seated problems in the country's banking system.

Dai-Ichi Kangyo Bank, Fuji Bank, and Industrial Bank of Japan -- the country's No. 2, 6, and 7 banks -- confirmed Thursday that they are in talks. Japanese banking sources in New York said the companies are expected to unveil details of a planned merger today.

The combined company would have $1.2 trillion in assets, making it the world's largest bank. Its market capitalization would total $65 billion, placing it ninth.

But analysts and bankers said the plan would do little to improve profits in the country's banking system or to reduce the more than $1 trillion in bad loans held by Japanese banks. Creating a bigger banking company, they added, would only intensify the need for more government support should the company stumble.

"Reducing the number of banks alone is not going to restore health to the Japanese banking system," said Reiko McCarthy, a banking analyst at Moody's Investors Service in New York. "Creating a bigger bank just creates a bank that's too big to fail."

Japan has been under intense international pressure to get its banking system in order. The country's banks have for decades occupied a crucial position in financing growth in Asia and have also been significant players in U.S .financial markets.

Although big Japanese banking companies have been slowly merging for two decades, pressure on banks to cut costs has increased enormously in the wake of a prolonged recession, the overhang of bad debt, and increasing failures of banks and securities firms.

The difficulties prompted the Japanese government to take over several large banks, including Long Term Credit Bank of Japan and Nippon Credit Bank. Smaller regional banks, such as Hokkaido Takushoku Bank Ltd., were liquidated along with major brokerage firms such as Sanyo Securities Ltd. and Yamaichi Securities. Meanwhile, Nikko Securities last year sold a 25% stake to Citigroup Inc. as part of an effort to bolster its capital.

The prospective merger partners have felt their share of the pain. In the 12 months that ended March 31, Fuji wrote off $5 billion in bad loans, Dai-Ichi Kangyo, $8.5 billion, and Industrial Bank of Japan, $7.5 billion.

U.S. bankers familiar with Japan expressed surprise that the companies, which have radically different cultures, would seek to merge. IBJ, they said, is very similar in culture to J.P. Morgan & Co., while Fuji mainly caters to wholesale corporate clients. Dai-Ichi Kangyo is the product of a merger of two big regional banks that never really succeeded.

"The pay scales are different, the people are different, and the rules governing the way they operate are different," said one U.S. banker who declined to be named. "It would be a very curious combination.''

According to Japanese banking sources in New York, the three companies would set up a single holding company with five subsidiaries: retail banking, international and corporate banking, trust banking, investment banking, and securities brokerage.

Sources added that the three-way Japanese merger has already largely passed muster with the Japanese finance ministry, which is determined to reduce the number of large money-center banks and regional banks in the country from 18 to seven over the next few years.

Both bankers and analysts said that more mergers are expected and that a merger between the three banks could very well be a test case for further consolidation. But they added that Japanese banks are unlikely to improve their profitability until attitudes toward banking in Japan change radically.

"Japanese banks don't have a great track record when it comes to merging and cost-cutting," said Tanya Azarchs, a bank analyst at the credit rating agency Standard & Poor's.

She and others noted that banking in Japan has long been regarded as a public service where profits haven't really mattered much. This has been encouraged by a Japanese government interest in maintaining social and financial stability, these sources said.

"They've got a kind of credit union philosophy where they're all in business to help each other," said the U.S. banker. "I'm not sure that attitude has really changed."

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