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BOJ’s negative interest rate to promote banking consolidation and diversification

Article - August 23, 2017

The Bank of Japan’s unprecedented cut of interest rate down to negative territory aims at ending Japan’s chronic deflationary pressure. At the same time, it squeezes profit margins for banks, which are now looking at diversifying their services


In January of 2016, the Bank of Japan announced that it would impose a negative interest rate of 0.1%. This meant that commercial banks would be charged for balances that exceeded reserve requirements. In other words, the central bank would begin charging them for looking after their cash.

It was a surprise move taken from a page out of the European Central Bank’s playbook, along with that of several other countries. Japan was the first country in the world to seriously consider the option of lowering the cost of borrowing to zero, as far back as the early 2000s, but Denmark, Sweden and Switzerland were the first to implement the policy, followed by the European Central Bank (ECB) after the Eurozone economic crisis.

The rationale behind the Bank of Japan’s decision was that commercial banks would be encouraged to use their reserves to lend to business, thereby stimulating investment and growth. The move was designed to drive out of the banking system some of the estimated $2.8 trillion held there by financial institutions, thus giving a boost to spending and inflation. The Japanese central bank also stated that it would venture further into negative territory if it were needed to achieve an inflation target of 2%.

“The introduction of negative interest rates had a very strong impact on investment banking, for the industry as a whole and for companies with assets under management. This is something that has created a direct jolt in our sector as a whole” Mitsuyoshi Okano, President, Suruga Bank

It remains to be seen if the Bank of Japan’s move will pay off, but results elsewhere have been encouraging. In 2014, the ECB became the first major institution to adopt sub-zero interest rates, keeping the cost of borrowing for banks at 0% and charging 0.4% interest for parking money with them. Since then, lending volumes and credit growth within the Eurozone have picked up.

Prime Minister Abe’s government is determined to boost consumer spending and to combat falling prices. Although Japanese savers are not directly affected by the rate decrease, in the case that banks decide to pass on the costs they incur, they may also be paying to keep money in their accounts, which is, effectively, an incentive to spend.

It was a daring measure, but Prime Minister Abe has said radical moves are necessary to jolt life back into the Japanese economy after many years of stagnation that has ingrained a deflationary mind-set among the country’s citizens.

“Extended deflation has caused the Japanese people to be inward looking and unless we’re successful in changing this shrinking mind-set, we will not be able to get rid of deflation. This is an undertaking of historic proportions. In order to change from inward-looking to outward-looking, we have to break through barriers that are like bedrock,” the Prime Minister said at the time.

Japan has suffered chronic deflation since the bursting of its real estate bubble in the late 1980s. In the years since, the government has implemented years of near-zero, and now below zero, interest rates. It has also spent trillions of dollars attempting to lift the economy, in the process accumulating the largest public debt in the developed world.

The effects on the Japanese financial sector have been mixed. Some economists warn that low rates may damage the banking system, which is already undergoing a deep transition with challenges posed by the domestic market and opportunities arising from global expansion. If regional banks are not solid enough to overcome this period of volatility, many may go out of business in the next few years, while others will need to accept mergers and consolidation. After a multi-decade absence of a merger and acquisition culture in Japan, this may, in the end, have a highly positive effect on the sector.

“Japan will undergo a major consolidation of regional banks in the coming decade, as a shrinking customer base and negative interest rates squeeze profitability, according to a new report by consulting company Bain & Co., which predicts that regional banks are likely be halved by 2025,” says Takashi Tsuchiya, President of Ogaki Kyoritsu Bank (OKB), who says he has thought deeply about OKB’s survival in the context of the consolidation process.

“Merging with another bank is challenging, as it is difficult to bring together different business cultures. Therefore, we are embarking on a diversification strategy to tap into new high growth opportunities.”

Mitsuyoshi Okano, President of Suruga Bank, says though the effect of the rate change on his bank has been positive, for others it has meant a decrease in revenues.  “The introduction of negative interest rates had a very strong impact on investment banking, for the industry as a whole and for companies with assets under management. Negative interest rates make it very difficult to generate positive revenues. This is something that has created a direct jolt in our sector as a whole,” he says.

He adds: “I do believe there are too many financial institutions in Japan. Looking at all mega banks, regional banks, trust banks, trust associations, obviously there is a saturation that is not necessarily in the Japanese market. The consolidation in this area will likely continue whether it is under the current model, with the same holding company, or through actual absorption by larger banks.”

The regional bank headquartered in Numazu City, Suruga Bank specializes in the retail market, providing unique products based on individual customer needs. The bank, for example, offers 26 types of mortgage loan products, making it much easier to meet customers’ needs. This type of focus has meant the bank was less susceptible to the interest rate change.

“Suruga Bank is highly focused on personal loans, as opposed to corporate loans. This has been our business model over the last 20 years and we have not invested our capital surpluses into securities, assets, or bonds. Therefore, the introduction of negative rates really has not had such a big impact on our business model. In fact, over the last four quarters, we have seen the highest revenues in our history,” explains Mr. Okano.

Other banks that are ahead of the curve are those that have already undergone a consolidation process, such as North Pacific Bank. President Junji Ishii says the process has been completed in Hokkaido, when one city bank, Takushoku, and three regional banks, Hokoyo, Hokkaido and Sapporo, merged into one in 1989.  Based in Sapporo, North Pacific Bank today operates 172 branches and 3 overseas representative offices that offer various products and services for personal and corporate banking.

“Because of the consolidation, North Pacific became the largest bank in Hokkaido and acquired a very strong business foothold which we’ve been working on in order to capitalize and improve profitability,” Mr. Ishii concludes.