In early 2019, a full year before the global coronavirus pandemic caught the world off guard, regional banks in Japan were said to be already “flailing.” As regional banks compete for a dwindling pool of borrowers in small cities and rural areas deal with severe depopulation, the problems reflect a continuing trend of falling profits. With local economies that these banks serve already dwindling, the risks presented by the pandemic only compound the need for Japan’s regional banks to find creative solutions to survive.
Japan’s 102 regional banks are comprised of 64 first-tier banks which function as support banks for small and medium-sized local businesses. The remaining 38 second-tier banks, despite origins as joint stock companies in the 1950s, were classified as ordinary commercial banks in 1989 and now carry out operations similar to the original first-tier banks. Indeed, both levels of regional banks are seen as vital to strengthening economic and industrial-agricultural competitiveness in their regions in a way that the city banks are not.
But the latest data shows that for the Japanese fiscal year ending March 31, 2019, net income of 64 first-tier regional banks fell 21 percent to a seven-year low of ¥622.3 billion. By September 2019, 66 regional banks were reporting low net profits, with an additional five posting outright losses. In total, regional banks saw their combined net profit fall 13.8 percent on the year to ¥435.5 billion. Local media described regional banks as “plunging into riskier corners of the credit markets, in a battle to survive ultralow interest rates and an industry shakeout.” With the added pressure of a pandemic virus, as of early 2020 Japan’s regional banks face bleak prospects.
Some argue the low-to-zero interest rates maintained by Japan’s central bank for decades, have backfired. This is because on-the-edge regional banks have, over time, taken bigger risks to compensate, often through lending to the local real estate sector and investing in structured finance instruments that include overseas debt, increasingly in the form of collateralized loan obligations (CLOs). In response, the Financial Services Agency (FSA) announced specific measures to ensure regional bank fiscal sustainability in fall 2019 with additional legislation set to exempt regional banks from anti-monopoly laws so as to facilitate mergers. Some view consolidation as the only feasible long-term solution to the dire circumstances facing many regional banks. On the other hand, many regional banks are viewed as central institutions to their communities which garner local pride and, consequentially, fierce resistance to such policy moves.
Some view consolidation as the only feasible long-term solution to the dire circumstances
By April 2020 with the coronavirus wreaking unprecedented economic havoc, analysts’ estimate that 70 regional lenders were vulnerable to rising credit costs and asset losses—up from 64 in March 2019 and 66 in September 2019. One of the biggest threats is the potentially high loss of value on the foreign securities—such as the American Collateralized Loan Obligations (CLOs) which regional banks have been accumulating since 2016. The FSA is also considering allowing regional banks to find new ways to earn profit by offering business consultations and operate as trading companies. This marks a significant change in Tokyo’s approach toward regional banks. Instead of seeking to control risk which is the FSA’s historical role in bank oversight, the new approach encourages banks to remake their business model. Endo Toshihide, commissioner of the FSA, explained that “instead of sitting and waiting for companies to ask for money, why not go to companies yourself offering advice and consultancy on how to find customers and grow your business? If you look at the reality of regional economies, the local businesses themselves are stumped over how to expand. They need support.”
Instead of seeking to control risk, the new approach encourages banks to remake their business model
It comes as no surprise that a new joint operational framework was developed between Michinoku Bank—one of the two regional banks of Aomori Prefecture—and Yamaguchi Bank (Shimonoseki City, Yamaguchi Prefecture), Momiji Bank (Hiroshima City), and the Yamaguchi Financial Group, a subsidiary of Kitakyushu Bank. The new relationship hopes to put aside rivalry and pool resources to establish new domestic and overseas sales routes for local agricultural products. The brains behind the collaboration was a newly formed “regional trading company consulting firm” called RCG which was launched in April by an Aomori native and former regional bank employee who saw the need for a service to help cultivate “low-cost overseas business opportunities.”
As regional banks struggle to deal with the twin forces of dwindling local economies and increasing pressures on performance under the uncertain coronavirus circumstances, taking on more risk seems, well, risky. As an alternative, some have said that a focus on technology and integration of artificial intelligence in banking practices is key while others point to better service aimed at the specific needs of Japan’s aging population as a way to ensure a future.
While an industry “shake-out” might be beneficial, regional banks would do well to work in two directions, both expanding opportunities (and risks) across Japan and across the globe, as well as concentrating on the opportunities available in providing bank services that are needed in their own communities.