Key Takeaways
- Japan has introduced new measures to support ailing regional banks on condition they rationalize through consolidation or other means.
- A study of past mergers, considered alongside lenders' root problems, suggests consolidation alone is not the solution.
- We believe active adoption of fintech is necessary for regional banks' survival.
The Bank of Japan recently threw the nation's regional banks a lifeline. But it won't be enough to save them.
Japan's regional banks are failing to adequately meet customer needs because the competitiveness of their offerings trails that of other financial services providers. S&P Global Ratings believes the nation's regional banks must use fintech to boldly streamline their operations to ensure survival.
New Support Unveiled
The Bank of Japan (BOJ) and the central government recently introduced measures to support a regional banking industry suffering from a continued decline in fundamental profitability. The newly introduced measures are:
- Additional interest payments on regional banks' current account balances with the BOJ; and
- Subsidies for costs related to consolidation, such as for investment in information technology (IT), using Deposit Insurance Corp. of Japan's financial resources.
The measures apply only to regional financial institutions, which makes them rather unusual. They result in divergent treatment of different types of financial institutions (i.e., major banks and regional banks).
Policies limited to only certain types of financial institution may be of questionable logic. However, the regional banking industry is structurally depressed and the measures can help minimize future government costs, such as capital injections. The new policies therefore may be an effective temporary measure to nudge regional banks into rationalization.
The new measures will help ease regional banks' high cost structures, which are their weakest points. In addition, revitalization of local economies (those outside the three major metropolitan areas of Tokyo, Osaka, and Nagoya), which account for about 45% of the nation's total GDP, has played a significant role in reinvigorating Japan's entire economy. Therefore, the measures will also serve some purpose as emergency support for the industry and economy if they do not significantly distort Japan's financial industry as a whole.
Consolidation Won't Solve The Root Problem
The essence of regional banks' plight lies in their low profitability. There are three main reasons for this problem:
- Less diversification of revenue sources and high reliance on interest income,
- Lack of economies of scale due to proliferation of small regional banks, and
- Declining local economies, the base markets of regional banks.
While consolidation of regional banks may help address weak economies of scale, it will not be effective in solving problems of a lack of diversified revenue sources and declining local economies. Solutions to these problems will only emerge when banks reach lower break-even points through stringent rationalization and are able to offer customers more attractive products at competitive prices.
Merely increasing asset size through consolidation does not make a bank more operationally efficient and offers little benefit to customers. In general, immediately following a merger, various bank costs increase and profitability declines in the short term. Stringent restructuring of less profitable operations is necessary if consolidation is to deliver benefits.
Let's look at real examples of changes in a typical indicator of operational efficiency, the expense ratio, specifically the overhead ratio (which we calculate as operating expenses divided by gross operating profit). Chart 1 shows changes in the overhead ratios of Kyushu Financial Group Inc. (consolidating Kagoshima Bank Ltd. and Higo Bank Ltd.) and Mebuki Financial Group Inc. (consolidating Ashikaga Bank Ltd. and Joyo Bank Ltd.), before and after their consolidations under holding company structures, in fiscal 2015 (ended March 31, 2016) for Kyushu FG and fiscal 2016 for Mebuki FG. Chart 2 compares changes in the overhead ratios of Hokuhoku Financial Group Inc. and Fukuoka Financial Group Inc. (Fukuoka FG), both of which formed through mergers more than 10 years ago, with those of Chiba Bank Ltd. and Hachijuni Bank Ltd., two large single banks that have not undertaken mergers.
Chart 1 shows overhead ratios have not improved much following consolidations. In addition, Chart 2 suggests the overhead ratios of the merged banks have not improved much in the medium- to long-term compared with those of the large single banks that have not undertaken mergers. On the contrary, depending on the observation period, we see cases where Chiba Bank's and Hachujuni Bank's overhead ratios have improved more than those of the consolidated banks.
Chart 1
Chart 2
Fintech Will Improve Convenience And Efficiency
Japanese regional banks are not currently satisfying customer demand for retail transactions. This is because their services do not offer good cost performance. In today's world of advanced communications and transportation, customers expect regional banks to provide the best services possible in retail banking, not just the best services available in their region. From this perspective, consolidation or restructuring based only on the geographic segregation of Japan's 47 prefectural local governments does not match current customer preferences. Looking beyond regional boundaries is nothing new. Japan could as easily be separated into 28 prefectures: The Ministry of Home Affairs proposed this more than a century ago, in 1903, citing the nation's improved transportation network. Today, it's IT networks that offer consumers the biggest benefits.
We believe active adoption of fintech can help regional banks better cope with the geographic fragmentation of the banking market and surplus funds in the private sector (nonfinancial corporations and households). We take this view because in other countries fintech is developing a strong presence in the investment (fund management) and payment services fields.
In many countries, we see active adoption of fintech increasing the financial depth and frequency of transactions--especially asset management and plain vanilla market transactions--while lowering costs. We also see the increasing presence of new nonbank fintech entrants in cash settlements and payments. Furthermore, in many cases, digitalization of bank documentation saves customers from cumbersome paper processing and reduces banks' operational costs.
In other words, customers in the fintech era may demand more from banks than simple integration among regional institutions can achieve. As Fukuoka FG's head recently told Japan's Nikkei business newspaper, partners in consolidation and restructuring of regional lenders may be companies other than banks, particularly IT firms.
Regional banks have high market shares in their home regions. Therefore, providing their customers with cost-effective financial services through active adoption of fintech is likely to help revitalize local economies. This is because lower costs on transactions that customers make can help spur greater business activity among corporations and households.
It is not just in the banking industry that natural selection will gradually weed out companies unable to meet customer demand. For regional banks, though, a crucial time has come, and we consider it critical that they adopt fintech to improve their value to customers.
Related Research
- Japan Banking Outlook 2021: Expect Rising Credit Risks, Jan. 14, 2021
- Banking Industry Country Risk Assessment: Japan, Aug. 6, 2020
- Tech Disruption In Retail Banking; Better Late Than Never For Japanese Fintech, Feb. 5, 2020
- Japan Banking Outlook 2020: Buckle Down For Major Turbulence, Jan. 21, 2020
- The Future Of Banking: Will Fintech Have An Outsize Impact In Japan? Feb. 20, 2018
This report is an edited version of an article that appeared in Weekly Economist Japan (a Mainichi Newspaper publication) on Dec. 22, 2020.
This report does not constitute a rating action.
| Primary Credit Analyst: | Ryoji Yoshizawa, Tokyo + 81 3 4550 8453; ryoji.yoshizawa@spglobal.com |
| Secondary Contact: | Chizuru Tateno, Tokyo + 81 3 4550 8578; chizuru.tateno@spglobal.com |
No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: research_request@spglobal.com.