Easing rules on public funding delivers capital relief for Japanese banks

But it does not solve the long-term problem of weakening profitability.

The Japanese regulator’s move to ease rules on public funding and support regional banks through government capital injections will help Japan’s embattled regional banks and shrinking banks mitigate capital pressure, reports Moody’s Investors Service.

On 27 May, Minister of State for Financial Services Taro Aso stated that the Financial Services Agency (FSA) plans to support the financial intermediary function of regional banks through government capital injections to deal with coronavirus-related disruptions. The FSA also plans to ease laws on funding. These revisions include a relaxation of the conditions attached to capital injections, including bank managements’ responsibility to improve profitability and efficiency.

This measure will allow regional banks and shrinking banks, especially ones with relatively weaker capital, to strengthen their capital bases without losing flexibility of bank management, according to Moody’s.

“This will enable them to expand loans to local small and medium enterprises (SMEs) and support the local economy,” the report added, noting that the government’s action will help local SMEs and support local economies by strengthening financial intermediary functions through pre-emptive capital support.

However, the support under the act will not resolve the challenge of weakening profitability, the report noted.

Many regional banks are already struggling to improve profitability because of structural challenges, such as prolonged domestic ultralow interest rates, forcing them to take additional risks to sustain profitability.

However, growth in riskier loans and weak profitability erodes capital buffers. “The average capital adequacy ratio of Japanese regional banks under domestic capital standards has been declining and is now below 10%. More than 70% of listed regional banks had declines in net income or recorded net losses in the fiscal year ended March 2020 (fiscal 2019) from a year ago,” Moody’s noted.

The coronavirus put a further strain on banks’ profitability and capital, it added.

One option for regional financial institutions facing the most pressure on profitability, to improve their credit profiles, is to merge with other banks to improve cost efficiencies and benefit from larger economies of scale, said Moody’s in the note.