MNI INSIGHT: BOJ: Stronger FSA Control Of Regional Banks Vital

By Hiroshi Inoue

     TOKYO (MNI) - With concerns growing over the health of some Japanese

lenders, Bank of Japan officials believe the Financial Services Agency, the lead

regulator, needs to make significant changes to its rule book in order to exert

greater pressure on regional banks to strengthen risk management, MNI

understands.

     The BOJ feels the capital bases at regional banks are in reasonable shape

at present, but worries are growing as some have upped investments in risk

assets without a sufficient corresponding buffer boost, exposing their reserves

to increased erosion risk as they seek to overcome low investment returns.

     Possible tools the BOJ thinks the FSA could use include increasing regional

banks' capital adequacy ratios from 4%, while forcing then into stricter risk

evaluation, and prompt regional banks to increase non-performing loan reserves.

     In the continuing low rate environment, the BOJ is growing increasingly

vigilant that overreach among competing financial institutions could damage

profitability, risking a pullback in lending activity and maybe a destabilizing

of the financial system. Some BOJ analysis already suggests major banks have

reduced loans to some small- and medium-size companies on risk management

grounds.

     Along with riskier investment portfolios, regional lenders are to some

extent picking up the slack offered as the majors hold back, extending loans to

the smaller companies deemed as 'risks' by the megabanks, further threatening

their financial position.

     The BOJ is aware that precarious lending at such low rates could also

impact on its policy transmission in the event of an extended downturn, as

pushing policy rates deeper into negative territory would further pressure bank

profitability and their lending ability.

     --MORAL HAZARD

     There are concerns that the regionals in part are looking to support local

companies, which, the BOJ feels, throws up moral hazard issues, as lawmakers

elected in provincial cities will seek to coddle even the most indebted banks in

their regions -- feathering their political position by protecting both the

constituency and corporates who bankroll them.

     The BOJ continues to monitor the situation and urge banks into necessary

action, but it has no power to force commercial banks to restrict businesses, as

it isn't the competent authority.

     Unless the FSA strengthens its regulation framework, regional banks will

not take risks seriously and will not preemptively deal with potential threats,

BOJ officials feel, who are concerned that it will be too late for banks to

address risks if a slowing economy exposes them.

--MNI Tokyo Bureau; tel: +81 90-2175-0040; email: hiroshi.inoue@marketnews.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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