MNI: UPDATE: BOJ Nakaso Urges Banks To Tackle Profit Problems

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     TOKYO (MNI) - Bank of Japan Deputy Governor Hiroshi Nakaso on Wednesday

urged private banks, especially regional banks, to make serious efforts to

improve their low profitability and tackle their structural problems.

     Nakaso, in a speech to business leaders here, said that the nation's

financial system is stable at the moment but added the BOJ must pay close

attention to the potential system vulnerabilities.

     "Japan's financial system remains stable, but I think that attention should

be paid to potential vulnerabilities. That is what I will talk about today; more

specifically, the problem of financial institutions' low profitability and

intensified competition, with a main focus on regional financial institutions,"

Nakaso said.

     The BOJ's aggregate financial cycle indicator, which is derived from major

financial activity indexes, "has shown no significant imbalances recently,"

Nakaso noted.

     However, Nakaso was quick to add a note of caution.

     "There is no guarantee that the financial system can continue to maintain

stability in the future. The stock market seems to be sending us a critical

signal on this point."

     Nakaso renewed the BOJ's warning to private banks, especially regional

banks, that they must work harder to improve their weak profitability in a

continued environment of super-low interest rates.

     Nakaso's warning follows the BOJ's twice-annual Financial System Report

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

easing has not caused any overheating in the economy or the financial system but

that the profitability of lenders remains low because there are too many of

them.

     He added that consolidation and reorganization among banks are options to

improve their profits in the future but "this is not all." The banks must be

focused on maintaining profitability in the medium- to long-term, he stressed.

     Nakaso said regional banks have sufficient capital now and so it is

unlikely that the stability of the nation's financial system would be in

jeopardy anytime soon.

     Moreover, stress tests of the Japanese banking system have been positive.

"The results of stress testing show that Japan's financial system has resilience

to 'acute' stresses comparable to the Lehman shock," he said.

     "However, even though financial institutions have sufficient capital at

present, the stability of the financial system will not be guaranteed in the

future if 'chronic' stresses weigh persistently on many financial institutions'

profits. If they fail to secure returns that meet their cost of capital for a

prolonged period due to common and chronic stresses, we cannot exclude the

possibility of simultaneous (or a chain of) impairment of capital held by many

of the financial institutions that hold common exposure."

     The decline in financial institutions' profits is common problem in

advanced economies that have had long periods of low interest rates, Nakaso

said. 

     "However, even in this situation, the low profitability of Japanese

financial institutions is striking from an international perspective. Regional

financial institutions in particular have lower gross operating profits per

employee than U.S. and European financial institutions of a similar size."

     He also noted that Japanese regional banks haven't take on excessive market

and credit risks relative to their capatil.

     "However, the point is on how chronic stresses will have an effect in the

future, and a warning from the stock market seems to address this point," he

said.

     Nakaso stressed, "I think that it is most important for individual

financial institutions to make the time horizon of maximizing their profits

longer."

     "Financial institutions' pursuit of profit in a myopic manner would lead to

excessive interest rate competition. This would not only exert downward pressure

on profits of individual financial institutions but also undermine the stability

and efficiency of the financial system, adversely affecting both regional and

nationwide economies in Japan," he said.

     In the question and answer session following his speech, Nakaso said, "The

exit strategy by the U.S. Federal Reserve is one reference for the BOJ exit

strategy in the future."

     "In an exit, there are two issues, such as adjusting (low) interest rates

and (reducing) the balance sheet," he said.

     Nakaso added that the BOJ will face the redemption of government bonds that

it hhas bought and will consider rolling over those bonds.  He also said the BOJ

has tools for draining funds from markets, such as sales of securities.

     "When and which tools the BOJ would use will be up to economic and

financial market conditions at that time," he said. 

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

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

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