But a day after the high-profile deal fell through and investors punished the banking sector, shares rebounded on Friday and analysts said the overhaul of the bloated, debt-laden industry remained on course.

Several analysts, though, said they remain underweight in Japanese bank shares as they expect a long haul before the sector shrugs off the overhang of bad loans from the "bubble" economy of the 1980s amid fast-growing online competition. Asahi Bank said on Thursday it was withdrawing from the combination with Sanwa and Tokai banks that had been announced to much fanfare only three months ago.

"The move by Asahi Bank to leave the Tokai-Sanwa alliance underscores the doubts we have had regarding the unprepared and rather defensive nature of the alliances announced over the past year," said bank-watcher James Fiorillo at ING Baring Securities. He and other analysts applauded the break-up, saying Asahi's push to be the "de facto standard" in retail banking never meshed with the more ambitious plans of Sanwa and Tokai to have a hand in investment and overseas banking. But they said the collapse of the deal to create the world's third-biggest bank by assets did not shake expectations for other mega-mergers to proceed.

"The move casts a shadow over the whole mega-merger issue, although it is unlikely any of the other mega-bank merger groups will break up," said analyst Brian Waterhouse at HSBC Securities (Japan).

Lehman Brothers analyst Nozomu Kunishige said the end of the three-bank deal was a special case that would not affect the industry realignment as a whole. In the immediate aftermath of Asahi's withdrawal, the Tokyo banking sector's sub-index IBNKS slid two percent but rebounded one percent on Friday. The recovery was helped when Standard & Poor's affirmed its rating of Asahi and two other credit ratings agencies, Moody's Investors Service and Fitch, affirmed their judgments of the three lenders.

Asahi said it would seek regional partners, but the uncertainty pushed its share price down 2.8 percent on Friday on the heels of Thursday's 6.6 percent tumble. Sanwa, however, which sank 6.1 percent on Thursday, recovered 3.6 percent on Friday. Tokai nudged 0.4 percent higher on Friday after gaining 2.4 percent on Thursday on hopes for a higher profile in the two-way tie-up.

-- (Reuters)