Negative interest rates batter small Japanese banks hard

Bad loan ratio stood at 1.8% in September 2017 versus 0.7% for massive banking players.

Regional Japanese banks are caving in on increasing pressure from negative interest rates as their primary source of profit continues to steadily dwindle, according to BMI Research.

Net interest income accounts for 90% of gross operating profits of regional banks and the unfavourable environment engineered by the central bank has pushed small banks into consolidation and various partnerships to stay afloat.

Also read: Should Japanese banks consider mergers to combat profit woes?

The NPL ratio for the regional banks came in at 1.8% in September 2017, versus 0.7% for major banks, BMI pointed out.

Moreover, the buffers of regional banks are similarly bearing the brunt of the downtrend as capital adequacy ratio fell to 9.9% in September 2017 compared to 11% in March 2014.  “This suggests that the buffers of regional banks are diminishing and the ability to withstand a large negative economic shock over the coming quarters is weakening,” BMI added.

Here’s more from BMI Research:

Despite our expectations for a better cyclical economic performance, we believe that the Japanese banking sector will continue to face intense domestic competition over the coming quarters, resulting in downside pressures on profitability.

We therefore expect regional banks to likely lose out, resulting in a consolidation in the sector. For example, the Fair Trade Commission, Japan’s antitrust regulator has approved a merger between Daishi Bank Ltd and Hokuetsu Bank Ltd in December 2017 in light of the challenging operating environment. The regulator has approved 15 proposed mergers between regional banks in the past decade, and the pace has potential to pick up over the coming years.

Data from the Financial Services Agency appear to show that the y-o-y decline in the trailing 12-months gross operating profits (from core business) for major banks has already bottomed out, coming in at -1.5% in September 2017 (from a low of -6.4% y-o-y in September 2015) while that for regional banks continues to trend lower to -8.0% y-o-y in the same period.

The ongoing deterioration in Japan’s demographic profile and the narrow geographical scope of regional banks are also likely to limit their profitability over the long-term as their loan portfolios are constrained.