Japan's regional banks feel impact of BoJ stimulus

Monetary stimulus is forcing Japan's regional banks to take risk on foreign debt and equity-like securities, the sector's most senior figure told the Financial Times, as Bank of Japan easing shakes up the country's financial industry.

Japan's roughly 100 regional banks must improve their asset and liability management as the BoJ drives them out of Japanese government bonds, said Kazuyoshi Terakado, head of the regional banks association and president of Joyo Bank, the sector's fifth largest lender.

His comments highlight the sweeping changes - and potential risks to financial stability - that ultra-low BoJ interest rates are causing at Japan's regional lenders, which have significant deposits but few lending opportunities because of their ageing local customer base.

"From the risk point of view, with a lot of JGBs we had a lot of yen interest rate risk; with this rebalancing, we will have more foreign interest rate risk or price volatility risk," said Mr Terakado.

With 10-year JGB yields at 0.34 per cent, regional banks are investing in overseas sovereign debt or buying real estate funds in search of a yield pick up.

Mr Terakado said that, thus far, gains on security portfolios from the rising stock market had offset lower profitability in core bank lending. But the flat Japanese yield curve means it is hard to make money from the traditional banking business of borrowing short-term and lending long.

"The fall in interest income means the stability of profits from our true function - financial intermediation and maturity transformation - has degraded. While that is being covered from securities profits I think it is true that the stability of future profits has weakened [because of the BOJ change]," he said.

For the past 20 years, regional banks have invested their excess deposits in JGBs, earning a margin between the near-zero rates they pay depositors and the 1-2 per cent they could get on the bonds. That model is now breaking down.

The best way out would be profitable lending, and Mr Terakado spoke about the need to spread the benefits of prime minister Shinzo Abe's stimulus to regions such as Ibaraki prefecture, north of Tokyo, where Joyo Bank is based.

Mr Terakado points out that his funding cost is only four basis points, so the main thing Joyo can charge for is taking credit risk, as a provider of growth capital. His bank has turned into a kind of business match-maker for local companies as it seeks new places to lend.

But there is a huge headwind from population ageing. "It's very difficult. The population of Japan as a whole is expected to fall 20 per cent in the coming decades. That's not an forecast, it's a reality," said Mr Terakado.

The most important question, he said, is how to avoid a downward spiral in regional economies as falling a population leads to weak consumption, lower investment, and overstretched local services.

An alternative to higher lending is consolidation and there has been a rush of mergers in the past six months. Last November, the Bank of Yokohama and the Higashi-Nippon Bank, both based in the Greater Tokyo area, merged to form the sector's largest lender.

Last week it emerged that Osaka-based Taisho Bank was planning to join an earlier merger of two regional banks on the island of Shikoku.

Mr Terakado refused to say if there were too many regional banks, or advise them what to do, but he did acknowledge the pressure.

"In the low interest rate environment, there are only about 20 banks [out of 64 in the first tier] that can cover their operating costs from lending income," he said. "For the remainder the question is how can they strengthen their profitability, and of course one idea is to raise volume."

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