MNI INSIGHT: BOJ To Urge Regional Banks To Raise Profitability

--Increasing Concern About Their Profitability Due To Lower Interest Rates

By Hiroshi Inoue

     TOKYO (MNI) - The Bank of Japan will renew its warning to regional banks

that they must improve their profitability, as super-low interest rates due to

the BOJ's large-scale monetary easing program will continue squeezing their

profit margins at least for a few more years, MNI understands.

     In its warning to be made in the coming weeks, either in a working paper or

speech by a BOJ board member, the BOJ will also note that declines in the

working population and number of small firms are reducing banking business

opportunities.

     The warning is a follow-up to the BOJ's twice-annual Financial System

Report released last month, in which the BOJ said that more than four years of

its aggressive easing has not caused any overheating in the economy or financial

system but that the profitability of lenders remains low because there are too

many of them.

     It is not certain what specific ideas the BOJ may put forward to regional

banks. One idea is to push consolidation of the industry, as suggested by BOJ

Governor Haruhiko Kuroda earlier this year. He also called on banks to find new

sources of loan demand and cut costs by closing some branches.

     The move also comes amid the stalemate between the Financial Services

Agency -- the government industry watchdog that is promoting mergers among

regional banks to ensure their survival -- and the Japan Fair Trade Commission,

which is concerned that fewer, more dominant regional banks would reduce

competition.

     Public broadcaster NHK reported this week that the FSA will study whether

the share of lending in each of the 47 prefectures should be used as a guide

when judging if a merger plan would create too dominant a lender, and whether

competition would continue if banks from other parts of Japan were to enter the

regional market if reduced competition were to lead to higher lending rates.

     In the southwestern region of Kyushu, Fukuoka Financial Group and

Eighteenth Bank have postponed their merger for the second time this year in the

face of antitrust concerns from the FTC.

     The merger plan by Daishi Bank and Hokuetsu Bank, the top two lenders in

the northeastern prefecture of Niigata, has also been put on hold due to

monopoly concerns.

     In its October report, the BOJ warned, "The low profitability of Japanese

financial institutions is striking from an international perspective. The number

of financial institutions' employees/branches may be excessive relative to

demand."

     "This structural factor, in turn, has led to a decline in financial

institutions' profitability through the intensified competition among financial

institutions in Japan."

     The drop in loan demand due to the decline in both the number of consumers

and the number of companies is a common shock occurring throughout Japan, the

BOJ noted.

     "In this situation, the intensification of competition among regional

financial institutions would affect systemic risk by increasing the effects of

common exposure, that is, by decreasing net interest income," it said.

     There are 64 regional banks in Japan. In addition, there are 41 second-tier

regional lenders that are not big enough to cause a serious systemic risk in the

event of a bankruptcy, the BOJ believes.

     BOJ officials think that the negative impact of super-low interest rates on

the soundness of financial institutions is rising, requiring increasingly close

attention.

     They are also concerned that should the central bank conduct additional

easing in response to a large shock to the economy, the banking sector's capital

constraints would become even tighter through a further decline in net interest

margins.

     That would impair financial institutions' intermediation function, reducing

the intended stimulative effects of the monetary easing.

     In the coming weeks, the BOJ will also warn that regional banks tend to be

too optimistic about their profit outlook because they believe that operations

will return to normal after the BOJ starts raising interest rates.

     BOJ officials think that even if their easy policy is normalized over time,

regional banks' profits will not rise sharply and their business conditions will

not improve significantly, as the population and the number of firms will

continue to fall.

     Banks' overly optimistic outlook is preventing them from taking necessary

measures to improve their business structures and thus profits, BOJ officials

believe.

     Amid intensified competition, financial institutions are making efforts to

increase loans to companies at low lending rates, including long-term loans at

low fixed lending rates.

     In the process, some regional banks are extending low-interest loans to

less creditworthy companies, BOJ officials say.

     In its Financial System Report released in April, the BOJ warned that some

regional banks were taking unnecessary risks in local real estate, including

construction of apartments for housing rental businesses even though local

demand for such housing is weak.

     The aggressive lending is tied to the apartment construction bubble being

fed by the quest for higher investment returns and lower inheritance taxes by

senior citizens, farmers and others of moderate income to secure their

retirement. Using inherited land for housing lowers payments of the inheritance

tax, which peaks at 55%, the highest among major developed nations.

     The BOJ's April report revealed that 58% of regional banks and credit

unions didn't check the going rate for rents in a neighborhood before making a

real estate loan there, 68% didn't conduct research on vacancy rates and 76%

failed to assess the supply and demand balance in the real estate market based

on demographic changes.

     In February, Governor Kuroda warned that prolonged low interest rates under

the bank's aggressive monetary easing would reduce lender profit margins

further, repeating his view that mergers among banks was an option to raise

profitability.

     The governor urged banks to review their business models and devise new

profit opportunities, such as finding new fund demand among small firms and

households, taking risks in the securities markets, strengthening fee-collecting

business lines and cutting costs including extensive restructuring of their

branch networks.

     "Individual financial institutions must choose approaches that are best

suited to their individual needs," he said. "In some cases, mergers or

consolidation between financial institutions could be an option."

     Kuroda stressed that the stability of the financial system is essential for

monetary policy to be fully effective.

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

--MNI Tokyo Bureau; tel: +81 90-4670-5309; email: max.sato@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

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