City Banks, Regional Banks & “Other” Banks
By: Norbert Gehrke
Tags: Fintech, Japan, Regulation, Innovation, Banking

Ever since Prime Minister Suga’s statement that “there are too many of them” meaning regional banks, the sector has been the focus of news agencies, speculators, and — this week — an unprecedented proposal by the Bank of Japan (BOJ) to use financial incentives, rather than regulation, in a drive to reduce overhead costs at these institutions, and promote consolidation.

Given that this is a crisis that has been in the making for 20+ years, ultimately caused by the BOJ’s Zero Interest Rate Policy (ZIRP), we will step back and review some of the fundamental information in order to level set, before commenting further on the current state of regional banking and the BOJ’s proposed measures. We expect this to take more than one article, and we also encourage you to take a look at our previous coverage of SBI Holdings’ stated strategy to create a “Fourth Mega Bank”.

20 years of ZIRP

ZIRP was put in place in February 1999 as a means to jolt households and companies to borrow, spend and invest, spurring prices to rise, the economy to perk up and then allow the central bank to wind back the stimulus. It was never meant to run as long as it has, with an initial attempt to “normalize” the policy with a quarter-point rise a mere 18 months later, a rather unfortunate timing due to the internet bubble bursting and the 9/11 attacks impacting the economy.

The pressure was palpable on the morning of February 12, 1999, as Bank of Japan Governor Masaru Hayami led the debate on the matter. Markets were reeling as yields on Japan’s benchmark 10-year bonds more than doubled in the space of three months and the yen surged more than 20 percent from an eight-year low in August the year before. The board took the plunge and the zero rates era began. Source: Japan Times

Can you hear the sound of money disappearing?

From an investment perspective, the overall impact of ZIRP on bank profitability for such an extended period has been disastrous. As Nicholas Smith, Japan Strategist at CLSA in Tokyo, commented in our recent interview: “The banking business has been a license to burn money for decades.”

TOPIX Index vs TOPIX Banks Sector Index as of November 13, 2020 (Source: Google Finance)

The TOPIX Banks Sector includes includes all the Mega Banks as well as many of the regional banks, of which about 80% are listed. Not only did ZIRP destroy the domestic banking business, with the TOPIX up a mere 3% over 20 years, it arguably did not revive the economy either. A lost decade over the bursting of the real estate bubble in the late 1980s has turned into three.

Aomori Bank stock price performance (Source: Google Finance)

Following Prime Minister Suga’s comments, and a report by Nikkei in early September that Aomori Bank and Michinoku Bank may consider a merger, the stock price of both entities surged towards, but not quite reaching, a new 2020 high. Since then, the speculative fever has abated somewhat. Keep in mind that Aomori Bank was trading more than 50% higher about three years ago.

Classification of Banks

In Japan, a banking license is a banking license. Japan does not have a digital banking license regime like it has become popular in Singapore, Hong Kong and Taiwan, because current regulation does not include a requirement to open physical branches. Internet-only banks exist, as do banking entities established by non-financial institutions. The business plan agreed with the regulator determines the scope of activities pursued under a banking license.

The categorization of private financial institutions into city banks, regional banks I and II, etc., is a customary classification for the purposes of administration and statistics, and published by the Financial Services Agency.

Historical Data Source: Japanese Bankers Association (JBA)

City Banks

The City Banks are Mizuho Bank, Sumitomo Mitsui Banking Corporation, MUFG Bank, and Resona Bank. In case you were wondering whether we have recently “lost” one City Bank: Saitama Resona Bank has for a long time been listed separately, and is now subsumed under Resona Bank itself.

The consolidation of City Banks had already started before ZIRP was put into place, triggered already by the bursting of the real estate bubble. In any case, the reduction in the number of City Banks over this 20–30 year time horizon is significant.

Regional Banks

Regional Banks are usually based in the principal city of a prefecture, and they conduct the majority of their operations within that prefecture. Regional Banks have strong ties with local enterprises and local governments.

Like traditional Regional Banks, Regional Banks II serve smaller companies and individuals within their immediate geographical regions. Most of the Regional Banks II have converted from mutual savings banks (joint stock companies) to ordinary commercial banks.

You will have noticed by now that the number of Regional Banks has been unchanged over 30 years, while the number of Regional Banks II has roughly halved. Not only have Regional Banks missed out on any economies of scale, perceived or real, but they have also faced a declining rural population, going hand in hand with a reduction of business volume. We will get back to this topic in our next article.

“Other Banks”

Since the early 2000s, non-financial institutions have entered the banking business, and internet-only banks have emerged. These are all categorized under “Other Banks”.

For example, this category includes Shinsei Bank, GMO Aozora Net Bank, Rakuten Bank, Sony Bank, SBI Sumishin Net Bank, as well as the convenience store banks Lawson Bank and Seven Bank. As the “kitchen sink” category, it also lists The Resolution and Collection Bank and Japan Post Bank among its members.

So, we hope this sets the baseline. In our next article, we will take a look at how many regional banks a specific prefecture can sustain.