Japan's regional banks gain lifeline with regulator's strategy switch

The Financial Services Agency has let go of its bank inspection manual.

Japan’s financial industry faces its biggest overhaul in decades as its regulator looks to ease its infamously stringent regulations to aid its struggling regional banks, and help solve the crisis of low profits and negative interest rates that has plagued the country for years.

The deregulation includes the abolishment of the inspection manual and the relaxation of banks’ business scope regulations. The latter allows banks to own more than 5% of the voting stock of operating companies, according to a set of new policies outlined by the Financial Services Agency (FSA).

“The operating environment surrounding regional banks remains harsh due to structural issues such as reduced lending margins and declining populations, as well as intensifying competition in the days of digitalization,” Japan’s FSA told Asian Banking & Finance in an exclusive official correspondence.

“Amidst these circumstances, the conventional banking business model of competing simply through higher volume is approaching its limits, and we believe that regional banks need to build sustainable business models that would ensure their soundness into the future and enable them to perform financial intermediation on an ongoing basis,” the regulator added.

Under the policy package published by FSA in October 2019, banks may now take larger capital stakes in companies carrying out regional revitalisation projects. Similarly, holding more than 5% up to 100% of voting stock of regional trading companies can also be approved from the same month. Some banks have already gotten approval, according to the FSA.

“We expect regional banks to take advantage of such deregulation if they think it would contribute to supporting their corporate customers and developing sustainable business models,” the regulator said in the correspondence.

Another aspect of FSA’s plans is to create an environment that will allow regional banks to build sustainable business models, which in turn is expected to help facilitate their reformation.

Such a sustainable environment is projected to help the local economy as well as regional businesses and communities.“In this respect, regional financial institutions are expected to identify clients’ business needs and issues and provide appropriate consulting and other professional services accommodating those needs, as well as providing appropriate financing, which may in turn secure banks’ own stable revenue base,” FSA noted.

In a conference hosted by the Tokyo Metropolitan Government last November, FinCity.Tokyo director Hiroshi Nakaso noted that regional banks can help the national government redistribute surplus funds to local regions that are in shortage.

Breaking free
Perhaps most important of the changes is the abolition of the bank inspection manual, which had long been criticised for limiting banks’ operations. The inspection manual required local lenders to provide for bad loans based on a lender’s past performance.

The manual was first launched in 1999, when Japan was in the brink of a financial crisis due to the high number of bad loans, a result of companies defaulting as land prices abruptly fell.

“In those days, inspections and supervision based on the inspection manual made a huge contribution to resolving the non-performing loan problem, but it has been subject to criticism that it overly emphasises past performance as well as collateral and guarantees, and that it could therefore serve to limit various initiatives concerning lending by financial institutions and impede accurate estimation of future losses,” FSA stated.

With FSA shifting away from inspections and supervisions centred on rules and checklists, and instead wanting inspections grounded on principles, approaches, and methodologies, the regulator decided to scrap the manual in December 2019.

Instead, the regulator announced a set of approaches and methodologies in lending.

“Amongst them, we provided financial institutions with viewpoints for more accurately estimating provisions based on their lending policies and risk profiles of loan portfolios. In particular, regarding non-impaired loans, we have set out a roadmap for relying not only on past performance, but also for accurately reflecting recognized credit risks, including current and future information, in provisions,” the regulator added.

Japan’s regulator expressed confidence that the move will not pose any risks in the banking sector’s health. FSA can still demand a financial institution to correct its governance and internal management systems should they be found to disguise credit situations, underestimate provisions, or exhibit questionable soundness and appropriateness. Non-performing loans still need to be disclosed.

“Therefore we do not believe that the abolition of the inspection manual will lead to an increase in non-performing loans or pose a risk to the banking sector as a whole,” concluded FS