Japan Scrutinizes Regional Banks' Fund Buying as Risks RiseBy and
FSA talking to bankers about investment trusts held: officials
Regional banks ‘are taking on more risks’: S&P’s Yoshizawa
Japan’s regional banks, desperate to boost returns with interest rates around zero, are coming under scrutiny from regulators as they increase purchases of risky investment trusts.
The Financial Services Agency has been talking to bankers to gauge whether the firms have the knowledge and structure to handle those products, which cover everything from stocks to real estate, according to its officials. Some of the lenders don’t appear to, the regulators say. The FSA has told them to strengthen their risk management, for example by adding staff if needed, said the officials who asked not to be identified due to the agency’s policy.
Japan’s regional banks have struggled in recent years as a shrinking population and narrowed lending margins hurt their loan business, while investment in government bonds loses its appeal with yields below zero. To boost returns, so-called first-tier regional lenders poured a record 1.94 trillion yen ($18 billion) into a category of securities that includes investment trusts and other funds in the year ended in March, according to Regional Banks Association of Japan data, bringing the total outstanding amount to 7.02 trillion yen.
“To put it simply, they are taking on more risk,” said Ryoji Yoshizawa, an analyst at S&P Global Ratings in Tokyo. It would be a problem from a credit perspective if banks lacking sufficient capital or solid profitability keep adding those investment trusts, he said.
Investment trusts in Japan are like mutual funds in the U.S. -- financial institutions such as brokerages raise money from investors and management firms make investments with the funds. Privately placed trusts are sold mostly to financial companies, and there were more than 5,000 of those funds covering equities and bonds in Japan as of August that managed a combined 78.81 trillion yen, according to the Investment Trusts Association.
Japanese lenders’ foreign debt holdings have also been monitored by the FSA after investors suffered losses last year due to the jump in U.S. interest rates on Donald Trump’s election. Five of 11 regional banks surveyed by Bloomberg said the surge in U.S. Treasury yields caused significant damage to their portfolios.
Some of those banks are turning toward private equity, hedge funds and real estate in search of higher returns, according to the survey.
Regional banks accounted for 40 percent of the 1.36 trillion yen being invested in Japan’s private real-estate investment trusts as of June, according to the Association for Real Estate Securitization. They are less liquid than regular REITs traded on the exchange, and their owners generally have to ask the issuers to take their shares back or find buyers through financial firms if they want to exit.
Other regulators have also been eyeing some of the risks.
The Bank of Japan has closely monitored regional banks’ purchases of private REITs since about a year and a half ago on concerns about the impact they could have on the firms should the underlying real estate market turn more volatile, according to a person familiar with the central bank’s thinking. While the BOJ sees no need yet to issue any stern warnings, if the banks keep adding private REITs, it will step up the monitoring, said the person who asked not to be identified because he isn’t authorized to speak publicly.
Regional banks that can’t find a way to cope with muted loan demand and razor-thin lending margins “face extinction,” according to Yoshizawa at S&P.
Combined profit at Japan’s 82 listed regional banks fell 11 percent in the year ended March 31, and is likely to drop another 17 percent this fiscal year, SMBC Nikko Securities Inc. analysts estimated in May. Regional lenders are going through “intense competition” with rival banks as they expand their business into neighboring cities and major metropolitan areas in efforts to enlarge their loan portfolios, according to Shunsaku Sato, senior credit officer at Moody’s Investors Service in Japan.
While low interest rates have also pressured banks in the U.S. and Europe, near-zero deposit rates in Japan have made the situation more severe for the country’s lenders, according to Yoshizawa. That gives them little room to cut deposit rates to cushion the impact of lower loan rates, he said.
The gap between domestic lending and deposit rates has nearly halved to 0.29 percentage point since before the Bank of Japan bolstered monetary stimulus in April 2013, according to the Regional Banks Association of Japan.
The FSA wants regional banks to study investment trusts closely before buying and continue to monitor them after purchase, the officials said. They also ought to draw an exit plan in advance if the products bought are hard to sell, such as real-estate trusts offered through private placement, according to the officials.
That banks are re-balancing their portfolios is “not necessarily a bad thing” for Japan’s economy, as larger inflows into risk assets often lead to stronger growth, said Toshihiro Nagahama, chief economist at Dai-ichi Life Research Institute. “The question, however, is whether they are managing risks appropriately.”