The Financial Services Agency has begun stress tests on regional banks to determine how much their earnings would suffer if long-term interest rates remain near record lows under the Bank of Japan's loose money policy, according to two sources with direct knowledge of the process.
The FSA is concerned that with 10-year Japanese government bond yields near a record low around 0.3 percent, regional lenders could see a decline in earnings as the gap between what they pay for deposits and what they collect on loans and bond holdings shrinks, the sources, who asked not to be named, said.
The action by financial authorities highlights one of the unintended risks of Prime Minister Shinzo Abe's program to end decades of deflation with the support of the BOJ, which by injecting monetary stimulus into the economy is helping to keep interest rates exceptionally low for a prolonged period.
Japan has more than 100 regional banks, accounting for around 40 percent of the country's $4.6 trillion in outstanding loans. But overall loan demand has shrunk 10 percent over the last 20 years.
Regional lenders have typically extended loans to smaller businesses, but demand has been falling as the population ages. To win business, many small banks have lowered the interest rates they charge, which has dented profitability.
For more than a year, the FSA has been urging regional banks to consolidate or seek customers abroad.
It was not clear how long the FSA tests will take or how the agency will follow up with lenders that appear to be at particular risk from a period of persistently low, long-term interest rates.
Japan's second-largest regional lender, Bank of Yokohama Ltd., said last month it was considering a merger with Tokyo-based Higashi-Nippon Bank Ltd. in a potential deal that analysts said could spur consolidation.