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Mergers, nonbank investors key to survival for battered regional banks in Japan

More regional lenders in Japan may need to merge with peers or seek new capital from nonbank investors, as their already weak profitability is further hit by rising default risk and loan-loss provisions due to COVID-19, analysts say.

The combined unconsolidated net income of listed regional banks in Japan could drop by another 10% to ¥532.9 billion in the current fiscal year ending March 2021, according to the Regional Banks Association of Japan. Earnings of these banks, which primarily serve rural communities that have for years been hit by aging population and low economic growth, had shrunk by almost 40% in the four fiscal years ended March 2020, while their loan-loss provisions increased more than fivefold, according to the association.

Michael Makdad, senior analyst at Morningstar, estimates loan-loss provisions of regional banks to be about 0.15% of total loans in the current fiscal year. "However, I think next fiscal year will be more difficult as problems arrive with a lag," he said. If the provisions rise closer to 0.40%, it may be enough to push the regional banks as a whole "into the red," he said, adding, "I think ultimately we will see more bank mergers than we saw."

With ultra-low interest rates already weighing on net interest margins, further economic disruptions caused by the pandemic will make it even harder for regional banks to restore their financial health just by themselves, analysts say.

Japanese bankruptcies hit 806 in June, the highest since the start of the year, with total debts of ¥126.4 billion, compared with 734 bankruptcies with ¥80.3 billion owed in the same month a year ago, according to Teikoku Databank.

The Japanese government cut red tape that, in theory, would encourage consolidation in the banking industry. The lawmakers approved a new policy in May for regional banks to exempt them from antitrust law for potential mergers, and the country’s financial regulator said such tie-ups would help alleviate intensified competition in shrinking local markets.

"They have to survive the tough market where credit costs [have] increased and profits are squeezed," Toyoki Sameshima, a senior analyst at SBI Securities Co., said.

Cross-segment partnerships

Sameshima expects cross-segment alliances or mergers to accelerate.

SBI Holdings Inc., a Japanese online brokerage house group that owns SBI Securities, is in talks to acquire stakes in six regional banks by September, bringing its total portfolio up to 10 lenders, according to a company spokesman.

SBI Holdings acquired 19.25% in Fukushima Bank Ltd. in January and took over about 3% each in Chikuho Bank Ltd. and Shimizu Bank Ltd. on unspecified dates after grabbing a 34% stake in Shimane Bank Ltd. in November 2019.

Those tie-ups allow banks to draw online know-how from SBI and to cut costs by sharing operating systems, the spokesman said. The deals will also allow SBI to expand into local areas through the partnerships while enabling it to get returns on its investments after restoring the banks' financial health.

Recent deals also include Fukuoka Financial Group Inc. acquiring Eighteenth Bank Ltd. in 2019 after taking over Kumamoto Bank Ltd. and Shinwa Bank Ltd. in 2007 to expand a customer base and streamline operations.

By October, FFG plans to consolidate Eighteenth and Shinwa banks in the same prefecture into one entity to mitigate the effects of intensifying competition.

Japan's Financial Services Agency in 2018 had identified 10 prefectures in Japan where competition is possible for two banks, 13 regions where one bank alone can survive and 23 unprofitable areas even for one bank. The FSA said that a merger can be taken as "an option to exercise to maintain health of banks in a tough business environment caused by shrinking population."

Two years on, the situation for banks may have only gotten tougher.

As of Aug. 5, US$1 was equivalent to ¥105.44.