KYOTO: The coronavirus pandemic is deepening the pain for Japan's regional lenders, heightening concerns that a potential wave of business closures will test policymakers' ability to avert a damaging banking-sector crisis.
Many central government and bank officials see the risk of a crisis emerging in the next few months, when more struggling firms could go under and hit regional banks already weakened by a shrinking domestic economy and years of ultra-low interest rates.
Yet officials still have few plans besides prodding the ailing lenders to recapitalise or consolidate - and little clue on how to do this in an orderly fashion, say five government and banking sources with direct knowledge of the matter.
"Banks are aggressively lending now because the government is asking them to, but that could change once it becomes clearer some companies cannot survive," one of the people said.
"The key test will come in autumn, when liquidity problems turn into solvency problems."
With Tokyo still encouraging regional banks to pump money to needy borrowers, efforts to mitigate a subsequent build-up of bad loans will take a back seat, another source said.
"In the end, there's no other option besides prodding the weaker banks to consolidate, restructure themselves or seek government capital," the second person said.
The sources - policymakers with direct knowledge of the banking industry and the discussions on dealing with its troubles - declined to be named due to the sensitivity of the matter.
TIME RUNNING SHORT
A wall of money printed by the central bank has kept a lid on bankruptcies and job losses, even as Japan's recession deepens.
But the prolonged battle with COVID-19 is straining even the strongest regional banks in places like Osaka and Kyoto.
Regional economies are more vulnerable to shocks than big cities because of their over-reliance on sectors such as tourism, and fewer jobs as more firms move out of ageing, dwindling local markets.
After Japan closed its borders to contain the pandemic, Osaka-based hotel chain White Bear Family went under with 27.8 billion yen (US$262 million) in liabilities - the biggest virus-related bankruptcy so far in Japan.
That left regional lender Kansai Mirai Financial Group with 800 million yen in unrecoverable loans. The group expects credit costs to nearly triple to 12.5 billion yen this year.
Osaka saw 147 companies go under in June, exceeding Tokyo as the hardest hit centre in Japan, according to think tank Tokyo Shoko Research.
"The damage from the pandemic (on the region's economy) will probably last for about two years," Kansai Mirai President Tetsuya Kan told Reuters.
Already under the wings of nationwide lender Resona Group, Kansai Mirai can survive by cutting costs, consolidating branches and earning more advisory fees, Kan said.
Bank of Kyoto faces a similar plight. It set aside 5 billion yen to guard against bad loans in the year to March, 10 times the average in the past five years, as soft global demand and plunging overseas visitor numbers hit borrowers.
Regional banks were already reeling from lending margins that have sunk to a meagre 0.2per cent.
While their average capital-to-asset ratio, at 9.52per cent, is more than double the minimum required 4per cent, over 70per cent of regional banks suffered falling profits or chalked up losses in the year ending March.
Even before COVID-19 erupted, their combined bad loans were worth 3.7 trillion yen, nearly four times combined profits from core operations.
"At present, Japan's financial system is stable" with regional banks having sufficiant capital buffers, the country's banking regulator Financial Services Agency (FSA) said.
"But we will closely monitor the situation as (COVID-19) could potentially affect various factors such as their credit costs and securities holdings," the agency told Reuters in response to a request for comment.
WORST TO COME
Analysts warn the worst is yet to come.
Responding to requests by regulators to boost lending to virus-hit firms, regional banks increased loans by 4.7per cent in June from a year earlier to a record 262 trillion yen.
While a bulk of the emergency lending is guaranteed by the government, other loans could sour if the prolonged pandemic hits firms on life support, analysts say.
The fear among policymakers is a negative loop where rising bankruptcies weaken regional banks' ability to lend, forcing more firms under.
The government is preparing safety nets. It extended by four years a deadline for lenders to apply for a bail-out and expanded to 15 trillion yen from 12 trillion yen a pool of funds to inject capital into ailing banks.
But there is no guarantee lenders will willingly seek help.
Years of efforts by policymakers to consolidate Japan's crowded regional banking industry failed as many executives are wary of stepping down or opening room for government intervention.
Bank of Kyoto president Nobuhiro Doi told Reuters the prospect of merging was "not something we're thinking about", saying such a move "won't have much of a positive effect on profits."
Doi also ruled out the possibility of seeking government help. "The government says it will make it easier for banks to seek help by not asking executives to take responsibility. But I wonder whether it will really work out that way," he said.
There is also no consensus on how deeply the Bank of Japan should be involved in bank rescue plans, which could complicate Tokyo's efforts to avoid a full-blown financial crisis.
BOJ officials argue the onus is on the government to bail out companies and banks, pushing back against requests from some lawmakers for the central bank to play a bigger role.
Time is running short for banks to come up with ways to boost profits and cushion the blow from rising bad loans, as more companies reel from COVID-19.
"There's no one-size-fits all approach because so much depends on how long the pandemic persists and how the fallout affects each regional economy," said a third source. "It's probably a slow death for many regional lenders."