Japanese regional banks are facing an increasingly difficult earnings environment. According to earnings reports for the fiscal year ended March 2017, Japan's 64 first-tier regional banks reported a combined total of 1.066 trillion yen in core net business income, which represents the profit earned from their main line of business, down by 12.6% from the previous fiscal year. Only four of them managed to post a year-on-year increase in ordinary income with the remaining 60 suffering a year-on-year decrease. As such, the deterioration of earnings is not a problem limited to specific banks.
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A decrease in interest income, the largest source of revenue for regional banks, is a major cause for their deteriorating earnings. Interest income is the product of the principal amount of loans and the interest rate thereon. In fact, the total amount of loans issued by regional banks has been on an upward trend over the past 10 years, posting a 3.9% year-on-year increase in the fiscal year ended March 2017. However, a significant fall in lending interest rates has more than offset the increase in the amount lent.
Many banks blame the Bank of Japan's negative interest rate policy for the drop in their lending interest rates. However, while the negative interest rate policy has undoubtedly had a significant impact, it is not the sole reason for the lower lending rates. Many banks pushed themselves hard to increase their lending despite a decrease in demand. This has exerted considerable downward pressure on lending rates.
In the past, when the Japanese economy was suffering from liquidity problems, providing financing was the role expected of regional banks as their customers were in need of funds at any rate. However, now that the Japanese economy is awash with surplus liquidity, simply providing financing is far from enough. What Japanese companies are looking for is information that will help increase the value of their main lines of business. Regional banks need to shift their focus from merely lending money to offering solutions to resolve the challenges facing their customers. If they fail to do so, they deserve to lose their raison de'tre.
Regional banks cannot capitalize on their strengths by just providing information. They also need to provide appropriate support so that client companies can utilize the information for their business. In other words, they should find their role in providing growth-enhancing financial services, which I believe will give them the best chance of survival.
This is because regional banks should be able to provide appropriate advice according to the specific situation of each customer or in preparation for anticipated future challenges, if they have a full understanding of their customers' business potential. They have capacity to offer not only loans but also various support services.
What I would like to emphasize here is that Japanese regional banks have human resources willing to provide such services. As part of a RIETI research project, we conducted a survey of branch managers of local financial institutions (i.e., first- and second-tier regional banks, shinkin banks, and credit cooperatives) nationwide in January 2017, and received nearly 3,000 responses (see the RIETI website for details).
Asked whether and to what extent they agree with the idea that "it is part of the mission of banks to support companies with management problems," 46.9% of the respondents "agree strongly" with the idea. Combined with 50.7% who "agree to some extent," almost all of the branch managers have a sense of mission to support companies. It is fair to say that local financial institutions have the sufficient human capital foundation for providing growth-enhancing financial services.
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There are three challenges that the top managers of regional banks must address in order to create an organizational structure for implementing this new business model.
First, they need to develop appropriate human resources enabling the new business model. In the aforementioned survey, "inability to provide appropriate instructions to young employees due to a shortfall in mid-career staff" was found to be the biggest obstacle hampering the improvement of consultation skills (see Figure).
Following the wake of the financial crisis, many financial institutions reduced the number of new hires in and around 2000, resulting in a shortfall in mid-career staff today. There also exists a qualitative problem. That is, since collecting on loans was their top priority in the post-crisis years, many of those hired around that time lack sufficient experience in providing growth-enhancing financial services. This is substantiated by the factors cited as the second and third biggest obstacles above.
However, I want to convey the following message to regional bank managers lamenting the lack of appropriate human resources: "Employees of regional banks have high potential, and the problem lies with the managers who are unable to draw out their potential." The lack of appropriate human resources is not a problem on the part of employees but is essentially attributable to the management's failure to develop and utilize such human resources.
Employees would not feel motivated to engage in the burdensome task of providing management support services, if they are to be evaluated for their short-term performance, for instance, solely based on the amount of new loans made. A demerit-based performance review would not create momentum for employees to take on new challenges. It is high time for Japanese regional banks to overhaul their performance review and promotion systems, even though doing so may cause friction or stir up difficulties within the organization.
Second, the top managers of regional banks need to accelerate efforts to strengthen collaboration with other players. Challenges facing customers are so diverse that it is often difficult for regional banks to find solutions on their own, relying solely on their human resources. In order to provide high-quality support, regional banks should focus their efforts on connecting customers with appropriate experts, such as those specialized in business reconstruction and intellectual property. In doing so, regional banks should remember that their strength lies in thoroughly understanding the needs and circumstances of the customers receiving support from experts.
Collaborating with external experts also has a beneficial effect in terms of compensating for decreased day-to-day contact between regional banks and their customers. In particular, I am placing high expectations on regional banks' collaboration with tax advisors and financial accountants for client companies. Unfortunately, few small and medium-sized enterprises keep accurate accounting records. The availability of accounting records that accurately reflect the true state of a company is an absolute prerequisite to evaluating its business potential, and collaboration with tax advisors and financial accountants will help improve the quality of the evaluation.
Tax advisors and financial accountants are among the first to detect any changes in companies through the process of preparing the monthly trial balance. If regional banks collaborate with these experts more closely and provide support at an early stage, they will have a better chance of success in helping their customers.
Unfortunately, in the aforementioned survey, 32.0% of respondents described the relationship between their sales representatives and the customers' tax advisors as being at a level where they "just know each other's name," and 7.7% said that their sales representatives "do not even know the names" of the tax advisors for their important customers. As such, the reality is that many financial institutions do not have satisfactory relationships even with their major customers' tax advisors.
Third, regional banks must reorganize their business. If the current size of their business poses a bottleneck in solving their customers' problems, reorganization by means of mergers and acquisitions (M&As) may be a good option. With more economic activities expanding beyond prefectural borders, it is only natural for regional banks to reexamine their primarily intra-prefectural operations. However, such reorganization involves other parties. It should also be remembered that relying solely on economies of scale would bring them nowhere because regional banks—even after merging with some others—are no match for enormous megabanks.
One little recognized benefit of realignment among regional banks is its potential to improve the quality of the top management of regional banks. Truly capable top managers are limited in number. And if so, it is not a bad thing that more management resources concentrate in organizations led by capable top managers as a result of M&As. The success or failure of business combinations depends on the selection of members of the post-M&A top management team.
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Although regional banks are finding themselves in an increasingly severe business environment, it is imperative that they play an active role in order to enable the revitalization of local economies. This involves the development and fostering of human resources capable of providing growth-enhancing financial services. Fortunately, regional banks have a strong human capital foundation with many of their employees finding it both challenging and worthwhile to provide support to customers.
The top managers of many regional banks seem to be working to build capacity for providing growth-enhancing financial services. However, shifting to a new business model involves reforming the organizational structure. Thus, it will take some time before such reform begins to deliver any tangible results. Whether Japanese regional banks can weather through the difficult time and carry through their reform initiatives hinges on the commitment and determination of the top managers.
* Translated by RIETI.
August 29, 2017 Nihon Keizai Shimbun
