Japan's regional banks face fresh risks as higher rates may trigger bankruptcies

Japan's regional banks face higher credit risks as increasing rates in the once ultra-low interest environment raise the chances of weaker companies going bankrupt.

The Bank of Japan (BOJ) is expected to raise benchmark rates further after it abandoned its negative rates policy in March. While Japanese lenders expect to improve their net interest margins due to higher market rates, they also face the possibility of some customers failing to absorb higher borrowing costs and going bankrupt, analysts told S&P Global Market Intelligence.

Regional banks, which often cater to companies that cannot get loans from bigger lenders, face the greatest risk.

"When the rates are raised further, that would trigger a series of bankruptcies of underperforming companies," said Toyoki Sameshima, a senior analyst at SBI Securities Co. "Credit risk could increase for smaller regional banks first, then for larger regional banks and megabanks."

Historic shift

In a historic shift, the Japanese central bank said March 19 that it would guide its short-term policy rate in a range of zero to 0.1% from the negative 0.1% set in 2016. The first rate hike by the BOJ since 2007 is likely only the start of a monetary policy shift.

"As the BOJ is in a tightening mode, companies that had relied on the minus rate would get thrown out of the game," Tsuyoshi Ueno, a senior economist at NLI Research Institute, told Market Intelligence in a telephone interview. "Banks will need to assess credit risk” for loans to such stragglers, Ueno said.

Several economists, including Ueno, expect the central bank to lift its benchmark rate to 0.5% by 2025, and as high as 1.0% to 1.5% in the coming years. The Japanese yen fell to more than ¥154 against the US dollar, the lowest in 34 years, adding pressure on the central bank to tighten monetary policy further.

The central bank itself did not rule out a possibility of further tightening the policy. "Depending on incoming data and information, we may change the shorter policy rate," Kazuo Ueda, BOJ governor, said in a speech at the Peterson Institute for International Economics, a think tank, in Washington on April 19. "If underlying inflation continues to go up, we will be very likely raising interest rates."

Japan's inflation climbed 2.6% on the year in March, below the 2.8% year-over-year increase in February, according to government data released April 19. The core consumer price index, excluding fresh foods, has been above the BOJ target of 2.0% for a year at least.

Weaker profile

Aggregate nonperforming loans at 46 regional banks stood at ¥2.884 trillion as of Sept. 30, 2023, versus ￥2.570 trillion at the end of the fiscal year ended March 31, 2020, according to Market Intelligence data. Bad loans at the regional banks rose sharply in the fiscal year that ended in March 2021 to ¥2.833 trillion, and have been inching higher to ¥2.868 trillion in the following year and ¥2.878 trillion in the fiscal year that ended in March 2023.

The aggregate nonperforming loans ratio, however, declined to 1.82% as of Sept. 30, 2023, from a recent peak of 1.95% in the fiscal year ended March 31, 2021, Market Intelligence data shows. Aggregate loan loss provisions by the same sample of regional lenders has been on a decline in the last three years.

Bankruptcies in Japan climbed 33.3% from the previous year to 8,497 in 2023, the highest since 2015, with total debt of more than ¥2 trillion going bad for the second consecutive year, according to Teikoku Data Bank, a research firm.

The Shimizu Bank Ltd. was among more than 50 lenders hit by the 2023 bankruptcy of Horimasa Kogyo, a local machine tool seller, with total debt of ¥28.26 billion. The regional bank, which had a loan exposure of ¥862 million to the bankrupt company, said in a statement that it would set aside ¥582 million as provisions in the fiscal first quarter to June 2023. That pushed the bank's loan loss provision to ¥679 million during the quarter, reversing write-off profit of ¥15 million a year ago.

"The question is, how much the [policy] rate will be raised," said a Shimizu Bank spokesperson. "The more the rate is increased, the more we could earn money but the more credit risk we could see."

A potential increase in bad loans has prompted the Financial Services Agency to assess how disciplined and prepared the lenders are. "Getting credit risk under control is among the basics for banks," said an agency official, who declined to be named. "We will conduct on-site inspections of their offices and see if they evaluate customers' financial status properly," the official said.

Several Japanese companies have yet to recover from the COVID-19 pandemic downturn. "For smaller companies that were already damaged by the pandemic, higher rates would be another blow," said Hideo Ohshima, a senior economist at the Japan Research Institute. "As those companies have long been accustomed to low interest rates, regional banks need to prepare for an unexpected rise in credit risk."