updated 8/30/2004 9:15:43 AM ET 2004-08-30T13:15:43

Japan's Supreme Court on Monday said merger talks could proceed between troubled UFJ Holdings Inc. and Mitsubishi Tokyo Group Inc. which would create the world's largest bank.

Presiding judge Toyozo Ueda upheld a previous court decision challenged by Sumitomo Trust, a unit of Sumitomo Mitsui Financial Group, according to Supreme Court spokesman Takeshi Mamada.

The ruling turned down appeals filed by Sumitomo intended to halt the talks, and will allow UFJ to carry on negotiations with Mitsubishi Tokyo, Mamada said.

With combined assets of about 188 trillion yen ($1.7 trillion), UFJ and Mitsubishi Tokyo would create the world's largest bank in terms of assets, surpassing U.S.-based Citigroup Inc.'s $1.19 trillion.

UFJ scrapped a previous agreement to sell its trust banking operations to Sumitomo Trust in order to pursue plans with Mitsubishi Tokyo to combine their operations by October 2005.

Sumitomo Trust protested, saying its earlier deal with UFJ was legally binding. It fought the case up to Japan's Supreme Court, challenging a Tokyo High Court ruling which lifted an injunction against the UFJ-Mitsubishi Tokyo talks earlier this month.

Sumitomo Mitsui, which owns Sumitomo Trust, also came up with a rival bid last week, offering to buy UFJ for 3.2 trillion yen ($29 billion). That offer matched a proposed cash infusion by Mitsubishi Tokyo of 700 billion yen ($6.3 billion) that would enable UFJ to clean up its balance sheet more quickly.

The high-stakes wrangling has drawn widespread attention in Japan's financial markets.

A UFJ-Sumitomo Mitsui merger would also create the world's biggest bank with 184 trillion yen ($1.67 trillion) in combined assets.

UFJ is the weakest of Japan's "Big Four" banking groups, which also include Mitsubishi Tokyo, Sumitomo Mitsui and Mizuho Financial.

After recording a loss of nearly $3.6 billion in the last fiscal year, UFJ has been eager to merge with another bank to help it write off bad loans more rapidly, as demanded by Japan's banking regulators.

Both Sumitomo Mitsui and Mitsubishi Tokyo are eager to win access to UFJ's extensive branch network, individual customer base and to its top corporate clients such as Toyota Motor Corp.

UFJ has pledged to stick by its plans with Mitsubishi Tokyo _ a deal that analysts and the Tokyo stock market have generally welcomed as a stabilizing force for Japan's overall financial system.

Others, however, have warned that the sheer size of such a merger is likely to be filled with problems, from clashes of corporate cultures to the task of linking computer systems.

Copyright 2004 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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