Japan’s distinctly tiered banking system could change dramatically if local government reform goes ahead, and regional banks are worried by the potential threat that a privatised postal savings bank could pose. Charles Smith reports.

It is well-known that Japan’s banking system almost came apart in 2000-02, when the nation’s top 10 banks ran up bad loans of $8900bn and threatened to trigger a systemic crisis that could have spread to the rest of the world. What is less well known is that the banking scene in Japan is still not an oasis of peace and stability, although the drastic write-off of bad loans enforced by the government between 2002 and 2005 might make it appear so.

The world’s second largest banking industry is headed by three so-called mega banks with solid balance sheets and massive assets of up to ¥185,000bn ($1500bn). Below the mega banks are three legally distinct categories of regional and local lenders with combined assets of ¥414,000bn. The industry also includes a huge monolith, the state-owned but soon-to-be privatised Postal Savings Bank (the Yucho), which boasts more than ¥200,000bn-worth of individual deposits collected through 25,000 branches throughout Japan but does not (yet) make loans.

Analysts who follow the generally uninspiring profit performance of the megas pay relatively little attention to the lower tiers of Japan’s huge banking industry. But it is there that the industry could see its most dramatic changes in the next few years, with a handful of well-run banks in strategic locations headed for stardom while others face absorption or extinction.

The impending changes are likely to upset existing tidy distinctions between different types of institution, allowing mergers that challenge the supremacy of the mega banks. Much will depend, though, on how prime minister Shinzo Abe’s cabinet handles a series of critical policy questions. These include what rules to set for the full privatisation of the Yucho (this October) and how to orchestrate a series of tax measures, known as the Trinity Reforms, which are designed to weaken the financial ties between the central government and municipalities.

The government will have to decide by late summer whether to give a free hand to the Yucho in corporate and individual lending after October 1, when the existing postal savings institution becomes a bank, as required by postal privatisation laws passed in 2005. Officials at the association of regional banks (Chiho Ginko Kyokai – CGK), who have lobbied desperately to maintain restraints on the Yucho after October, think it could use its huge deposit bases to grab a dominant share of the local loan business, which is the mainstay of regional banks.

Trinity Reforms

They are only slightly less concerned about the so-called Trinity Reforms, which will drastically dilute financial links between Japan’s central government and the prefectural and city governments that are the dominant customers of some smaller and weaker local banks. The Trinity programme could turn some local authorities from risk-free into decidedly risky borrowers by removing a de facto guarantee that all local government debts will be underwritten by the finance ministry in Tokyo. That could be a problem for a handful of regional banks that are more than 50% exposed to municipal borrowers in the form of loans and bonds.

Banks that depend primarily on their role as dominant lenders within a single prefecture could be in even worse trouble if Mr Abe’s government goes ahead with a plan to recast Japan’s local government system from one based on 47 small to medium-sized prefectures into a federal system comprised of six to eight regions. The outcome of an election to Japan’s upper house of parliament scheduled for July may determine whether the prime minister feels strong enough to press on with local government reform.

If it goes ahead, the change could trigger a rash of mergers between powerful regionals operating on the fringes of big cities and banks serving remote rural prefectures destined for absorption. Makoto Fukuda, a former senior finance ministry official who is now vice-chairman of the association of regional banks, thinks the Financial Services Agency (FSA), Japan’s chief financial regulator, may have to take control of organising this process, although the FSA claims to be “neutral” on the subject of regional bank consolidation.

The aristocracy of the regional bank sector consists of about a dozen powerful and well-run institutions based in some of the densely populated prefectures surrounding Tokyo and Osaka, or in large provincial cities, such as Fukuoka in the south island of Kyushu or Sendai in north-east Honshu. Regionals do not operate at the centre of Osaka, Tokyo and Nagoya, because those cities are home to the three mega banks (Mitsubishi UFJ Financial Group, Mizuho Financial Group and Sumitomo Mitsui Financial Group). But the fringes of major cities are battlegrounds between megas and regionals, with the latter steadily gaining ground against the former in the market for loans to individuals and small to medium-sized corporate borrowers.

The key to their success, says Takashi Abe, 51-year-old general manager of the planning section at Chiba Bank, based a 35-minute train ride to the east of Tokyo, is that they have cultivated personal ties with borrowers, while the megas, whose main business is still loans to major corporations, adopt a wholesale approach based on “scoring” (awarding marks to a loan applicant in reply to standard questions that are used to determine whether or not a loan application will be granted). Chiba can afford to get personal because of the bank’s extremely dense presence on its home territory – it has 150 branches in Chiba prefecture, the 27th of Japan’s 47 prefectures in terms of size but sixth largest in terms of regional gross domestic product (GDP).

Loan strategy

Chiba Bank has other advantages. Unlike the three mega banks or their predecessors, which called in loans to small and medium-sized enterprises (SMEs) during the so-called lost decade following the bursting of Japan’s notorious asset bubble in 1992, regional banks maintained ties with their SME borrowers. One result of this is that the regionals as a group still have more non-performing loans (NPLs) on their books than major banks – about ¥4500bn in total, according to the FSA, compared with ¥1500bn for the top three megas and a handful of other banks with nationwide operations. The other side of the coin is that small corporate borrowers that deal with mega banks often want to spread their risks by borrowing from a local bank as well, to avoid being left out in the cold in the next recession.

Chiba has many such clients in the eastern wards of metropolitan Tokyo, where it has opened 10 branches in the past few years. Under its current development plan, the bank is due to open another three branches on the fringes of Tokyo. Its corporate strategy is to offer an integrated financial service to customers, including support to smaller companies setting up manufacturing operations outside Japan. It has three overseas branches that stayed open during the difficult years following the bursting of the asset bubble. Mega banks, by contrast, drastically reduced their overseas operations after the bubble.

Chiba’s retail customers, most of whom live in the prefecture but work in Tokyo, lead the rest of Japan in diversifying their savings out of conventional bank deposits into financial products such as mutual funds. The result is that the bank’s earnings are more heavily weighted towards commissions on sales of financial products than those of giants such as Mitsubishi Tokyo UFJ Bank or the two banks making up the Mizuho Financial Group.

Bank of Yokohama, which operates out of Japan’s most famous port city, is following the same game plan. It opened five branches in three southern wards of metropolitan Tokyo between 2004 and 2007, and plans another five openings under its newly launched three-year development plan. “Small manufacturing companies in Ota-ward in Tokyo come to us partly because they are looking for business partners in Kanagawa [the small but wealthy prefecture surrounding Yokohama],” says the bank’s planning manager, Tatsuhiko Matsumura.

Neither Bank of Yokohama (with ¥10,400bn worth of assets – making it the largest regional bank) nor Chiba Bank (with ¥9800bn) come anywhere near the mega banks in asset size, but by Asian standards, the two banks and their home territories are sizeable entities. Bank of Yokohama ranks close to the State Bank of India in market capitalisation while Chiba Bank’s market value places it about ¥1000bn behind Hong Kong’s Bank of East Asia. When it comes to operating territories, Chiba prefecture’s GDP is $1bn ahead of Finland while Kanagawa prefecture is a little smaller than Austria.

The prefecture of Fukuoka (GDP roughly equal to Portugal’s) on the southern island of Kyushu is a classic stronghold of regional banking, with two powerful institutions contending for dominance: Bank of Fukuoka and Nishi-Nippon City Bank. The Bank of Fukuoka is now part of the newly established Fukuoka Financial Group (FFG) due to a recent acquisition, and Nishi-Nippon City Bank is the product of a merger between Nishi-Nippon Bank and Fukuoka City bank.

Fukuoka city is the centre of an industrial and commercial complex spanning three cities with a population of three million and has remained off-limits to mega banks, so both of its dominant regional banks are healthy. Their styles and the personalities of their presidents could hardly be more different, though. Not content with a top ranking in Kyushu’s richest prefecture, Bank of Fukuoka recently acquired Kumamoto Family Bank, second largest in nearby Kumamoto prefecture, and thereby at a stroke became Japan’s second largest regional bank group after Bank of Yokohama.

Ready to expand

“We decided to go the mergers and acquisitions route because there were limits to how far we could grow in Fukuoka and we weren’t ready to expand abroad,” says Takashi Yoshikai, head of general planning at Bank of Fukuoka and the second most influential figure in the institution after its president, Masaaki Tani.

Mr Yoshikai declines to be drawn on whether his bank will convert a minority stake in Kyushu Shinwa Holdings in neighbouring Nagasaki prefecture into full control (a move that would make FFG the largest regional bank group) but says he does not think the bank has finished making acquisitions. “One-hundred and ten regional banks in Japan is too many and we are not the only ones who think so,” he says.

He says he believes that Bank of Fukuoka can afford acquisitions because it acted 18 months ahead of Japan’s major banks in tackling its bad loans crisis in March 2001 – using its own capital, not government funds that were pumped into the mega banks. The move pushed Fukuoka’s capital/assets ratio uncomfortably close to the 8% limit set by the Bank for International Settlements as the minimum for banks conducting international operations, but profits in the past three years have pushed the ratio back to a reasonable 9.5%.

Bank of Fukuoka’s acquisitive stance is criticised by Isao Kubota, a former senior official at the ministry of finance who heads Nishi-Nippon City Bank. He complains that Fukuoka Bank is acting like a mega bank, just chasing profits. A native of the prefecture, Mr Kubota believes that the role of a regional bank should be to foster growth of its home territory, not to build a regional empire.

Strong footholds

Where Mr Kubota and Fukuoka’s Mr Tani agree is that their prefecture has bright prospects because of its low operating costs compared with Tokyo, its proximity to China and the rate at which its two universities are churning out high quality science graduates. They also agree that mega banks have no chance of gaining a significant foothold in the prefecture except to provide services for major national companies, such as Toyota Motor Corporation and Nissan Motor Company, which have set up production bases to serve the Chinese market.

“The megas called in 30% of their SME loans in Kyushu during the recession and that hasn’t been forgotten,” says Mr Kubota. Nishi-Nippon currently has 180 branches in its home prefecture compared with 21 for the three mega banks, down from 26 in the immediate post-bubble era.

Institutions such as Bank of Fukuoka and Chiba Bank have a wealth of regional contacts and accumulated expertise in lending that could make them virtually impregnable on their home ground, even to the soon-to-be privatised Yucho bank. That is not just because they are solidly entrenched but because the Yucho, with its 25,000 branches covering the whole of Japan, has no private sector lending experience. The bank was reorganised after World War Two to help finance Japan’s fiscal loan and investment programme (FLIP) or ‘second budget’, a system for channelling funds to major public works programmes that required very long-term finance.

Until the government began to reform the system, all post office deposits were transferred to the FLIP or invested in Japan government bonds. Loans to the FLIP were guaranteed by the government with funds from its regular budget available to compensate shortfalls in earnings of less successful projects. When the system changed to direct finance of public corporations and the FLIP through bond issues, the Yucho was left without a risk-free outlet for its funds and was groomed for privatisation in a series of laws enacted in the autumn of 2005.

Managers at some of the more powerful regional banks believe it could take more than a decade for the post office savings bank to train a competent core of managers who can run all aspects of a commercial banking business. Even once it has acquired professional experience, a number of regionals operating in highly competitive, fast-growing constituencies believe they will be able to take on any challenge the Yucho is likely to mount against them.

Hiroshi Shimao, head of corporate planning at Musashino Bank, a medium-sized regional bank based in Saitama Prefecture, north of Tokyo, asserts that the Yucho is not a serious problem. “We already face competition from more than 15 local banks that have invaded our territory from other prefectures and we have proved we can win,” says Mr Shimao. Musashino boasts the fastest rate of loan growth among Japan’s 110 regional banks.

Mr Shimao’s views are largely echoed by Yusuke Tamura, group leader of the corporate administration division at Saitama Resona Bank, the prefecture’s biggest lender, with special strength in housing loans.

Others are not so confident, however. For example, Kazuto Nishikawa, senior managing director of the National Association of Shinkin Banks, believes that the postal lending could be a big problem for his members. Members of the association, who form the second legally defined tier of regional financial institutions below regional banks proper, depend on grassroots experience to assess credit risks at very small corporate borrowers (defined as companies with up to ¥900m of capital or a maximum of 300 employees). Mr Nishikawa believes that the Yucho will use “stereotyped” lending techniques based on a scoring process that assesses a borrower’s financial position but ignores human factors such as experience and competence.

A particular concern voiced by some regional bank sources is that the three mega banks, which have failed to penetrate Japan’s regions, might try to ally themselves with the post office to make small corporate loans outside big cities. “The post office has the branches and the megas have loan expertise, so there is a shared interest,” says Mr Kubota. That is one way in which the megas could try to reconquer the territory they lost to the regionals in the years after the 1990s bursting of the asset bubble.

Fears of an outflanking alliance between megas and the post office are enhanced by the fact that the newly appointed president of Japan Post, Yoshifumi Nishikawa, headed Japan’s Sumitomo Mitsui Financial Group until the summer of 2005, when he retired after the group had incurred heavy losses in writing off bad loans. As president of the All Japan Bank Association (Zenkoku Ginko Kyokai) before his retirement, Mr Nishikawa attacked the post office for offering a special 10-year deposit instrument combining liquidity with a fixed interest rate that banks were not allowed to offer. “It’s incredible that the man who did that should be serving as president of the privatised Yucho,” says a regional bank executive.

Polarisation problem

A senior manager at Chiba Bank pinpoints what is probably the real issue facing regional banks: rapid polarisation. He notes that the weakest regional banks still have NPL ratios of more than 8%, two years after Japan ‘solved’ its banking crisis at the national level by forcing mega banks to more than halve NPLs to less than 3%.

It could take years to reduce the NPL gap between megas and regionals, and, while that is happening, differences in financial strength between the weakest and strongest regional banks will certainly widen. What makes the problem more scary is that the goal posts are being moved. The regional bank system in Japan was set up as part of a government philosophy that allocated different roles to different categories of financial institution, clearly separated by law. That system is being deliberately dismantled by the central government. In the next few years, another pillar of the system, the central government’s paternalistic control over the regions, could also be discarded.

The result may be a free-for-all in which, for the first time in Japan’s recent history, a few strong institutions flourish while a majority of others are pushed to the wall. The changes could strengthen Japan but could also threaten its much-vaunted principle of maximising social and economic equality.

Isao Kubota: Fukuoka prefecture future is bright

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter