What Is the Aim of Restructuring Regional Banks?

Regional Companies Face a Mountain of Issues

Prime Minister Suga Yoshihide has called for a paring down of the numbers of regional banks active in Japan, but he has yet to set forth a clear goal that this industry restructuring would achieve. There is actually no need to wait for this statement from the prime minister, though. If we accept the the restructuring of regional banks as necessary, the end goal is easy enough to imagine. One objective frequently cited in discussing this issue, for example, is the stability of the financial system. But there is a more fundamental objective: the revitalization of regional economies by enhancing the sustainability of the small and medium-sized enterprises active there. That is why it is pointless to restructure Japan’s smaller banks when the activity does not benefit the country’s local economies, with the exception of mergers to rescue banks experiencing management difficulties.

Many businesses have seen their sales vanish during the spread of COVID-19. The heads of Japan’s smaller companies now average nearly 70 years in age, an all-time high. Setting aside the COVID-19 pandemic, regional SMEs are faced with such issues as a shrinking and aging population, a sluggish birthrate, and the digital transformation of the economy. They are confronting a mountain of difficult management issues.

The Need to Share Corporate Risk

Commissioner Himino Ryōzō of the Financial Services Agency has stated that the risk of companies adjusting to changes in the industrial structure in the postpandemic economy should be shared by financial institutions. This is the understanding he has reached in reflecting on 20 years of financial administration since the FSA’s founding, a period when banks did not always share in this risk.

In order to surmount the financial crisis that commenced in the 1990s, there was a period when it was necessary to dispose of bad loans and to prioritize the stability of the financial system. This was also a trial for companies. They experienced the tightening of credit standards and the calling in of loans by banks, and they were forced to implement self-defense measures like accumulating retained earnings and increasing equity capital, despite the criticisms of the capital market.

While the financial crisis abated around the start of 2000, the FSA made no change to its strict inspection regime cracking down on bad loans. As a result, banks came to depend excessively on security and guarantees, and they became incapable of ascertaining the viability of companies or of assuming risk.

This was the context for the arrival of the COVID-19 pandemic. What followed was a new normal for society and the economy that limited peoples’ contacts, gatherings, and movements. Companies are also having to adapt to these changes. Maintaining the stability of the financial system alone is no longer sufficient for the financial functions required by the economy.

Regional financial institutions including regional banks, shinkin (regional cooperative) banks, and credit cooperatives have an essential mission. There is work that they alone and not major banks must fulfill.

One example is the business succession of customer companies. The main customers of major banks are large companies. For these firms, there is always a successor to the CEO should a scandal come to light. This is not necessarily the case for SMEs, which may not survive the loss of a leader even though they may possess superior technology, a skilled workforce, and a profitable track record.

Should a regional SME be acquired by a company outside the region, factories, technologies, engineers, and jobs may be transferred elsewhere under the name of efficiency and consolidation. The business succession of SMEs is thus directly linked to the survival of regional economies. Supporting them is thus an essential duty of regional financial institutions as a means of protecting their business foundations.

To achieve this objective, it would be better to consider the restructuring of regional banks in those cases where banks lack operational strength, personnel, and managerial capacity.

Scale No Longer an Advantage

There are risks in expecting too much from restructuring. Not all past cases of regional bank restructurings have been successful. They were promoted nonetheless since banks’ business model—accepting deposits and making loans—was considered an ideal match for expansion of the institutions’ scale. There is a reason that I write this in the past tense, though.

The main business model of banks is accepting deposits and making loans, while their source of earnings is bank lending rates and yields on government bonds and other securities being higher than deposit interest rates. This is known as the lending spread. The remaining work of a bank is to manage its assets so they do not turn bad.

Hence, the earnings of banks depend on the lending spread. Scale then becomes the issue for banks. Should they boost their scale through restructuring and rationalize operations as appropriate, their earnings capacity would increase. This approach was considered to be the proper business model for banks.

However, the Mizuho Financial Group, which has restructured on repeated occasions, is experiencing difficulties, and is now offering employees a maximum of four-day weekends accompanied by pay cuts of 40%. While Mizuho is calling this work-style reform, a senior officer of the FSA states that it is hard to see Mizuho’s move as being motivated by anything other than a desire to reduce labor costs.

Even for major banks, accepting deposits and making loans is no longer a viable business. In Japan and in other major countries, the policy interest rate has declined through aggressive monetary easing, leading to a collapse in the lending spread. Even if regional banks merge, they will not surmount this difficulty unless they reduce the number of employees by more than half.

The Moment for Restructuring Has Past

The current concern of major regional bank groups is the poor performance of some second-tier regional institutions that have executed mergers. Indeed, some of these banks are now examining the possibility of breaking up once again. That is how poorly the restructuring of regional banks has gone. Times have changed.

The restructuring of regional banks pursued by the FSA has also lost its direction. In the 2010s, the FSA promoted wide-area restructurings. All that was accomplished, however, were truces in conflicts between players in different prefectures. Little progress was made in mergers that combined multiple banks spanning prefectural borders into single entities, and the FSA’s efforts ended in failure. In the second half of the 2010s, the FSA changed its policy to intraregional mergers, as seen in the merger of Daishi Bank and Hokuetsu Bank in Niigata Prefecture and the merger of Eighteenth Bank and Shinwa Bank in Nagasaki Prefecture. It is still unknown, however, whether these mergers will serve to benefit regional economies.

More recently, SBI Holdings has created a stir in regional bank circles by announcing a fourth megabank plan and by making successive investments in members of the Second Association of Regional Banks. SBI is believed to be acquiring the undervalued stock of association members with price-to-book-value ratios of less than 1.0. This investment has proven productive so far, and moreover, the investor is having investee regional banks sell products and services of the SBI Group and the IT startups that it has also invested in. In this manner, SBI is providing regional banks with opportunities to book earnings.

Meanwhile, leading regional banks have become concerned about burgeoning nonperforming loans due to the COVID-19 pandemic, and are not rushing to acquire Second Association members. Senior officials of the FSA, meanwhile, are merely tracking the moves of SBI, maintaining that it could be an opportunity for regional banks to develop sustainable business models. There is no indication that SBI’s actions will trigger any major restructuring among regional banks.

The Yamaguchi Financial Group and several other regional bank groups are strengthening their efforts in nonfinancial areas. It is no longer possible to solve the issues companies and governments face through strictly regulated banking functions. The FSA is belatedly revising its regulation of the business scope of banks with the aim of getting companies the support they need.

Rather than restructuring the regional banking industry, the times call for devoting energy to getting companies through the COVID-19 pandemic. This is because regional banks, having prioritized the avoidance of risk, may have forgotten how to truly support their clients.

Supporting the Future of the Regions

With the enactment of the SME Financing Facilitation Act in the aftermath of the 2008 financial crisis, loan repayments were reprieved for many SMEs. Currently, the government has responded to the COVID-19 pandemic by issuing a large amount of 100% guaranteed loans with repayment deferred for a maximum of five years. A regional bank officer has stated that the pandemic is having a far greater impact than the 2008 crisis.

When loan repayments were reprieved in the past, companies did not see their debt increase. The only change was the extension of the repayment period. With COVID-19 loans, however, SMEs have assumed a substantial amount of debt, and some of them are certain to become effectively insolvent.

When the deferment period ends, COVID-19 debt will be added to existing loan repayments, and the debt burden will rise. Companies will not recover if they only receive emergency loans to bolster their cash positions. What is required is a different form of support that engages with company management.

Companies in the manufacturing sector can lower their costs through improved efficiency, such as by shortening inventory time lags in the production process by adjusting supply and order fulfillment timing. Concurrently, they will need to reduce costs by consolidating and shifting distribution, warehousing, and office functions. With the COVID-19 pandemic requiring social distancing, society is changing to one where contactless interactions are encouraged. This is driving moves to flexibly apply technological solutions to shift market focus and improve earnings. It will also be important to calculate the profitability of each product and to focus on those items that contribute most to the bottom line.

Some companies will also take the current opportunity to transfer the business to a successor. Cases where feuding in the president’s family threatens this process will need attention. Personnel and labor management will also be important management issues, and negotiations will be likely over the revision of rent levels and supplier choices. Financial institutions will need to consider measures to support companies including reducing their debt burden by delaying the order of repayment, by packaging debt for sale to loan servicers, and by swapping debt for equity.

Some companies will require even more support. Should a company have no competitor in the region, such as a water supply company, a merger with a regional company promising synergistic effects will be desirable. In such cases, coordination with related financial institutions, shareholders, and other stakeholders will be indispensable. What is urgently needed is comprehensive support in an effort involving all involved for the future of the regional economy.

From Bank Restructuring to a Rethinking of Banking Functions

The COVID-19 pandemic is not the only issue. There is a need to understand the true meaning of the rise of financial technology. Fintech enables the digital provision of such functions as remittances, settlement, household accounting, and asset management. Its true aim is to unbundle many banking functions from current operators.

The Seven Bank, for example, has sought to split off the ATM function from banks. Such unbundling has spread with the support of users. As this trend progresses, past frameworks for discussing the restructuring of banks may end up anachronisms representing a direction that is inconvenient for users.

There are people in the FSA who believe that the unification of functions should be examined in the longer term. Such functions as cash transport vehicles, ATMs, remittances, settlements, deposits, and computer systems are not areas for competition. What users likely want is a nationally uniform, safe and secure, and low-priced infrastructure. Competition areas that would remain are the support institutions offer to companies in creating added value and their asset management that aligns with peoples’ life plans.

The changes we now see are transcending the domain of banks. A century ago, people called automobiles horseless carriages. It was not understood at the time that the motorization revolution would bring dramatic changes to the distances people travel as well as to business models, distribution, and even emergency medicine. People living in a certain age have difficulty understanding the true meaning of the epochal changes resulting from their current activities.

Rather than being swayed by the present restructuring of banks, it would be better to return to the issues that are important to users and to reconsider what needs restructuring and what needs preserving from their perspective.

(Originally written in Japanese. Banner photo: From left, Shinwa Bank President Yoshizawa Shunsuke, Fukuoka Financial Group President Shibato Takashige, and Eighteenth Bank President Mori Takujirō join hands following the approval by the Fair Trade Commission of the merger of Eighteenth Bank and the Fukuoka Financial Group. © Jiji.)