Japan's regional banks look at M&A advisory, investments to diversify

Japan's regional banks are eyeing increased startup investments and M&A matchmaking for smaller firms, responding to a government policy encouraging diversification beyond traditional lending.

The Financial Services Agency plans to relax restrictions on regional banks' acquisitions of nonbank companies through investment subsidiaries. The current 10-year age limit for acquired companies will likely be lifted in June via a banking act amendment, an official from the regulator told S&P Global Market Intelligence, requesting anonymity.

The new limit will be industry-specific, acknowledging that startups in some sectors require longer than 10 years to mature and generate investment returns, the official said.

Diversifying income sources

Facing limited growth in traditional lending, regional banks are ramping up investments in startups and fee-based businesses such as M&A.

Ultralow interest rates and an aging population stifle loan growth for Japanese banks, even with an anticipated end to the Bank of Japan's negative rate policy. Smaller lenders stand to benefit less than their larger counterparts in shifting costs to borrowers.

The aggregate fee income for a sample of 57 regional banks increased to ¥631.03 billion in fiscal 2023 from ¥554.36 billion in 2016, while net interest income fell slightly to ¥2.815 trillion from ¥2.866 trillion over the same period, data from S&P Global Market Intelligence showed.

Tax boost

"Increasing their investment into local startups won't be bad for them as they could find new seeds of growth," said Shinichi Tamura, a senior analyst at Okasan Securities. Tax breaks for M&A deals "would help them to serve more as a matchmaker."

A tax reform proposal announced by the government in December 2023 includes increasing the tax-deductible share of acquisitions to 100% from 70% currently for M&As involving smaller companies facing succession challenges. This aims to incentivize local lenders and boost their advisory services in such deals.

About 2.45 million executives at smaller companies will be 70 or older by 2025, with more than half lacking identified successors, according to data from the Small and Medium Enterprise Agency.

M&A activity driven by succession needs has surged, as announcement-based deals nearly tripled to 697 in 2023 from 239 in 2014, according to M&A advisory firm Recof.

– Click here to download a spreadsheet with data featured in this story. – Click here to read our recent story on M&A trends in Asia-Pacific finance sector.

Succession planning

"The succession issue will continue to drive up M&A deals," said Fumihiko Suzuki, executive director for research at Daiwa Institute of Research. But bankers need to enhance their dealmaking expertise, particularly in conducting due diligence. "Making an investment and offering loans are quite different," Suzuki noted.

Japanese regional banks have established over 60 investment-focused units as of June 2023, representing about 10% of their total subsidiaries, according to a November 2023 report by Daiwa Institute of Research. These units cover areas such as consultancy, securities, credit cards, leasing and trading services.

From July to December 2023, six domestic banks in Awa, Akita, Iwate, Kyoto, Fukui and Kagoshima launched investment arms. These arms provide capital not only to startups, but to companies undergoing restructuring or seeking successors for management transitions.

Kyoto Financial GroupInc. exemplifies this trend, having launched Kyoto Capital Partners in November 2023. The regional lender aims to grow its investment fund to ¥100 billion by 2030, from ¥7.5 billion currently, a company spokesperson said.

Half of these funds will support startups, while the remainder will assist companies grappling with succession challenges. The proposed policy aligns with the reality that "some tech companies we already put in funds" are more than a decade old, the spokesperson added.

An expansion of investment subsidiaries will be a trend for local lenders, according to Suzuki of Daiwa Institute of Research. "That would help banks offer one-stop services."