KYOTO (Reuters) – The coronavirus pandemic is worsening the pain of regional lenders in Japan, exacerbating fears that a potential wave of business closures will test the ability of policymakers to avert a damaging banking sector crisis.

FILE PHOTO: Visitors, wearing protective masks following an outbreak of coronavirus disease (COVID-19), walk through wooden torii gates at the Fushimi Inari Taisha Shinto shrine in Kyoto, Japan March 13, 2020 . REUTERS / Edgard Garrido / File Photo

Many central government and bank officials see the risk of a crisis emerging in the coming months, when more distressed firms could go bankrupt and hit regional banks already weakened by a shrinking national economy and years of rates. ultra-low interest.

Yet officials still have few plans aside from getting distressed lenders to recapitalize or consolidate – and little clue on how to do it in an orderly fashion, say five government and banking sources with first-hand knowledge of the matter. .

“Banks are lending aggressively now because the government asks them to, but that could change once it becomes clearer that some businesses cannot survive,” one of the people said.

“The key test will come in the fall, when liquidity problems turn into solvency problems.”

While Tokyo still encourages regional banks to pump money to borrowers in need, efforts to mitigate the subsequent build-up of bad loans will take a back seat, another source said.

“At the end of the day, there is no other option but to induce weaker banks to consolidate, restructure or seek public capital,” said the second person.

The sources – policymakers with first-hand knowledge of the banking industry and discussions of how to deal with its problems – declined to be named due to the sensitivity of the issue.

SHORT TIME

A wall of money printed by the central bank has helped contain bankruptcies and job losses, even as the recession in Japan deepens.

But the protracted battle with COVID-19 is straining even the strongest regional banks in places like Osaka and Kyoto.

Regional economies are more vulnerable to shocks than large cities due to their overdependence on sectors such as tourism, and fewer jobs as more and more businesses emerge from aging. reduced local markets.

After Japan closed its borders to contain the pandemic, the Osaka White Bear Family hotel chain lost 27.8 billion yen ($ 262 million) in liabilities – the biggest bankruptcy linked to the virus to date in Japan.

This left the regional lender Kansai Mirai Financial Group 7321.T with 800 million yen of bad loans. The group expects credit costs to triple to 12.5 billion yen this year.

Osaka saw 147 companies disappear in June, overtaking Tokyo as the hardest-hit hub in Japan, according to think-tank Tokyo Shoko Research.

“The damage from the pandemic (to the region’s economy) is likely to last around two years,” Kansai Mirai chairman Tetsuya Kan told Reuters.

Already under the wings of national lender Resona Group, Kansai Mirai can survive by cutting costs, consolidating branches and gaining more advisory fees, Kan said.

Bank of Kyoto faces a similar situation. It has set aside 5 billion yen to guard against bad loans until March, 10 times the average of the past five years, as weak global demand and falling foreign visitors hit borrowers.

Regional banks were already shaken by lines of credit that fell to a meager 0.2%.

While their average capital-to-asset ratio, at 9.52%, is more than double the required minimum of 4%, more than 70% of regional banks experienced declining profits or recorded losses during the year. ending in March.

Even before the COVID-19 eruption, their combined bad debts were worth 3.7 trillion yen, nearly four times the combined profits of basic operations.

“At present, the Japanese financial system is stable,” with regional banks having sufficient capital reserves, the country’s banking regulatory agency, the Financial Services Agency (FSA), said.

“But we will be monitoring the situation closely as (COVID-19) could potentially affect various factors such as their credit costs and holdings of securities,” the agency told Reuters in response to a request for comment.

For an interactive graph on Japanese lender earnings, click:

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WORST TO COME

Analysts warn that the worst is yet to come.

Responding to requests from regulators to increase lending to companies affected by the virus, regional banks increased their lending by 4.7% in June from a year earlier to a record high of 262 trillion yen.

While much of the emergency loans are government guaranteed, other loans could deteriorate if the protracted pandemic hits businesses on life support, analysts said.

Fear among policymakers is a negative loop where rising bankruptcies weaken the ability of regional banks to lend, forcing more businesses to collapse.

The government is building safety nets. He extended the deadline for lenders to request a bailout by four years and extended to 15 trillion yen, from 12 trillion yen to inject capital into troubled banks.

But there is no guarantee that lenders will gladly seek help.

Years of efforts by policymakers to shore up Japan’s overcrowded regional banking sector have failed as many leaders are reluctant to step down or open up room for government intervention.

Kyoto Bank Chairman Nobuhiro Doi told Reuters the prospect of a merger was “not something we think about”, saying such a move “will not have much effect. positive on earnings “.

Doi also ruled out the possibility of seeking government help. “The government says it will make it easier for banks to ask for help by not asking leaders to take responsibility. But I wonder if it will really work that way, ”he said.

There is also no consensus on the degree of involvement of the Bank of Japan in bank bailouts, which could complicate Tokyo’s efforts to avert a generalized financial crisis.

BOJ officials argue the onus is on the government to bail out companies and banks, pushing back demands from some lawmakers asking the central bank to play a bigger role.

Time is running out for banks to find ways to boost profits and cushion the blow from rising bad debts, as more businesses reeling from COVID-19.

“There is no one-size-fits-all approach as it all depends on how long the pandemic lasts and how the fallout affects each regional economy,” a third source said. “It’s probably a slow death for many regional lenders.”

Reporting by Leika Kihara and Takahiko Wada; additional reporting by Daniel Leussink; Editing by Lincoln Feast.