Japan's regional banks: Neglected troubles
By Scott B MacDonald

Discussions about Japan's bank problems usually focus on the country's large city banks, which hold the bulk of bank business in the Pacific nation. Despite this focus, Japan's regional banks represent another dimension of the national banking crisis. Many of the regional banks are plagued by poor asset quality, large loan losses and weak capital. Since the late 1990s, a number have failed. Moreover, most prefectures have economies that are either struggling to stay afloat or are depressed. If Japan is ever to have a sustainable economic recovery, the banking system in all its parts, not just the city banks, must be reformed.

According to research from UBS Warburg, Japan's regional banks account for 20 percent of all loans in Japan, while smaller cooperatives and trust banks have a further 30 percent of outstanding loans. Each prefecture has a bank, with its focus on that particular geographical unit. To generalize, the importance of the regional banks is that they control large shares of the local deposit and lending markets and usually are the major financial clearing institution in their respective area. This central financial intermediary role has actually become more significant in recent years as many of the city banks have closed regional branches or otherwise retreated.

In contrast to their city bank counterparts, the regional banks have not been as hard hit by plunging equity prices that have recently roiled the Nikkei. This is because the quantity of cross-sharing holdings held by regional banks is considerably smaller than their city bank counterparts. In addition, the regional bank exposure to the list of 30 major zombie companies - defined as companies technically bankrupt but kept alive by their banks with the support of the government - is substantially lower. Considering that regional banks make most of their loans to small and medium sized businesses, a bankruptcy is usually a much smaller and manageable affair.

Indeed, not all regional banks are in dire shape. Earlier this year Shizuoka Bank, won the praise of the rating agency Fitch, which noted its "overall performance and strength indicators are superior to any of the major Japanese banks". Other Japanese regional banks also maintain strongly investment grade ratings, as with Chiba Bank and Joyo Bank.

However, there can be no denying that the regional banks are having their set of difficulties. The problems confronting the regional banking sector include difficult economic conditions, related corporate bankruptcies, the departure of manufacturing firms to lower cost locations such as China, a slowness to embrace tighter credit standards, and over-banking. Reflecting the difficult economic conditions in Japan's regional economies, a Nihon Keizai Shimbum survey conducted in August 2002, indicated that 41 percent of the regional banks polled could not predict when their problems concerning non-performing loans would end. In the same survey, only 19 percent believed that their bad-debt problems were over, leaving 34 percent thinking that such problems would likely be resolved within two years. Although there was economic growth over the past two quarters, unemployment has remained high and land prices are still falling in the regions (reducing the value of the banks' collateral). More importantly, the expectation is that the Japanese economy could well slip back into another round of recession. If the same bank survey were held today, it is likely that sentiment would largely be the same, perhaps even more negative considering the ongoing bit of deflation.

Some regional economies are clearly in dire straits. In Hokkaido in the north, economic growth is virtually nonexistent, unemployment is close to 6 percent (one of the highest in the country), and consumer spending is thought to be negative for this year. The local economy is dependent on public works, though the efforts of Prime Minister Junichiro Koizumi's government to curtail public spending leaves a question as to when the economy will emerge from the recession. Hokkaido is hardly alone. As regional economies seek to find an equilibrium in a more globalized economy, there are obvious implications, many of them negative, for Japan's regional banks.

What's next for Japan's regional banks? Three major trends are evident. First and foremost, there is a growing separation between the banks that are restructuring and those that are not. Banks such as Chiba, Bank of Yokohama and Shizuoka are seeking to clean up their operations, enhance cost-efficiencies, and improve their lending practices. These banks are likely to survive and grow once the economy recovers. Others are still adrift and run the risk of becoming even bigger drags on the regional as well as the national economies. And some could threaten to fail.

The second trend is a push toward mergers. Although there has not been a lot of activity in this area, the Koizumi government favors this path. A number of financial incentives to promote regional mergers are being prepared, including the financing of the integration of computer systems. Despite regional resistance to surrendering independence of local banks, pressure is mounting for consolidation across prefecture boundaries to occur at a more rapid pace.

The third trend is that the regional banks are not lending. Indeed, most loan books at the regional banks are getting smaller. The reason for this is simple - many companies are themselves undergoing restructurings and seeking to reduce debt. The companies that want more loans, however, are usually already heavily indebted and many are not likely to survive. Consequently, there is not a strong interest in growing loan portfolios in the current economic environment. Instead, many regional banks have opted to put their deposit-generated funds to work via low-yielding, but ever abundant government bonds.

Banks are supposed to function as financial intermediaries between those with credit and those in need of credit. Japanese regional banks are not fulfilling their role. They operate in local economies which are struggling and threatening to get worse. As Japan focuses on bank reform, it clearly needs to include reforming the regional banks. This means taking difficult decisions to close some banks and merge others. Without that, any national bank reform with the main focus on the city banks will only be half-baked.

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Nov 19, 2002

Japan's banking crisis: Post-mortem (Nov 5, '02)


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