Three major Japanese banks announced today that they plan an alliance that would form the world's largest bank, and that is expected to spur consolidation in Japan's troubled banking industry.

The presidents of the Industrial Bank of Japan, Dai-Ichi Kangyo Bank and Fuji Bank said they will form a holding company next year with assets worth about $1.26 trillion.

Japan has too many banks--more than 800--and most are saddled with bad loans and low profits, which are acting as a drag on recovery of the world's second-largest economy, according to analysts and officials.

The country's top bank reform official has said he would like to see the shakeout end with four banking groups.

"We want to be front-runners in bringing about a revival of Japan's financial sector," said Masao Nishimura, head of the Industrial Bank of Japan.

The announcement of the merger is significant because it illustrates a dramatic change of mind-set--a realization that many banks here will have to combine to survive, analysts said.

After receiving public funds to boost their capital bases and help write off bad loans, the major banks "expected to be independent concerns and muddle through," said Brian Waterhouse, senior analyst at HSBC Securities Japan. "Something changed in the past couple of months and the three realized they faced common enemies, domestically and overseas. They finally realized that by pooling resources, they can survive and prosper."

Nishimura also cited foreign competition and worldwide changes in the banking industry as factors behind the merger. "If you look at what's happening overseas, at the dynamic changes in banking, compared to that Japanese banks are tied up dealing with the bad loan problem and we're left out of the action."

The merger would create a financial institution with a full range of banking services--deposits and mortgages for individuals, as well as commercial operations and investment banking. Industrial Bank of Japan--the only bank left in Japan specializing in long-term loans to businesses--has strong investment banking operations but has been limited by regulations that prevent it from accepting deposits from individuals. Fuji and Dai-Ichi Kangyo have extensive retail operations serving a huge base of individual customers.

But whether the new institution becomes the Godzilla of Japanese banks will depend on how effectively the three can combine units, cut costs and deal with their nonperforming loans--those that are not earning interest--which are valued at close to $50 billion.

Ratings agencies, analysts and editorials all warned that scale alone does not guarantee success. "The days are over when bigger is better," said the national newspaper Asahi. "The success of this alliance lies in what fruit they can bear."

The banks said they would shed 6,000 employees and 150 branches over five years.

"A 15 percent cut in staff and 19 percent cut in branches is probably as good as you're going to get in Japan," said analyst Garry Evans of HSBC Securities Japan. "It's not up to what you'd expect in the U.S., but it's on par with the early big mergers in Europe."

"It's a very important step, but the real effect of [the merger] will take place very slowly and over a long time span," said Koyo Ozeki, an analyst at Merrill Lynch & Co. "The only immediate effect will be boosting stock prices."

The new bank, whose name will be decided after a survey of employees, will have two co-chairmen--Nishimura and Yoshiro Yamamoto of Fuji Bank--with Katsuyuki Sugita of Dai-Ichi Kangyo as its president.

The executives plan to form a holding company next year and merge their wholesale, retail, securities and investment banking units by early 2002. They plan major investments in information technology and said they are aiming for an annual profit of more than $8.9 billion.

Akiko Kashiwagi in Tokyo contributed to this report.