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Beginning Friday, in a sure sign of the renewed strength at Japanese banks, the government will reimpose the legal cap on deposit-insurance coverage. Nine years ago, in 1996, that ceiling — 10 million yen in principal plus interest — was removed amid widespread concern about banks’ ballooning bad debt.

More than 20 percent of Japanese households are believed to have bank deposits totaling more than 10 million yen. From now on, though, individual bank deposits of that size will no longer be fully protected in the event of a bank failure — except when “regional credit order is seriously threatened.”

Smaller depositors are not entirely risk-free. For example, residents in a condominium, even if their deposits fall short of the ceiling amount, could be affected nonetheless if a bank taking care of their union’s large reserve goes bankrupt. Similarly, a company’s employees may suffer if it has a large retirement account in a failed bank.

Generally, though, the lifting of the blanket deposit guarantee has caused little confusion, indicating that depositors are taking it in stride. By contrast, the reinstatement of the cap on time deposits in spring 2002 triggered massive withdrawals of those funds. A similar reaction has not occurred this time around, according to a Bank of Japan survey.

Banks also appear to be better prepared now than they were three years ago. Most of them have created a new type of deposit that yields no interest yet provides full protection of the principal amount, provided that the money — including taxpayer money held by local-government offices — has been deposited only for settlement purposes. Most public funds are said to be secure in this manner.

The improving banking system still has soft patches. One such area is regional banking. During the half-year business term that ended in September 2004, large banks reduced their bad loans to less than 5 percent of their total lending, but the figure for regional banks, including smaller “second-tier” banks, remained around 6 percent.

Admittedly, small banks are finding it more difficult than large ones to shed problem loans because they are more closely tied to small businesses and regional economies. With the banking sector entering a more competitive period, however, they face a greater need to upgrade their performance. Depositors will most likely withdraw their funds from lenders that show signs of weakness.

Regional banks, to be sure, are trying to raise their capital-asset ratios, which are much lower than those of national banks. They are also offering more depositor-oriented services, such as higher interest rates, lower rents for safety deposit boxes and preferential user fees for automated teller machines. These services, however, are expected to translate into higher costs.

Weaker banks may have compelling reasons to lure depositors, but doing so by makeshift or artificial methods will miss the big picture. Their basic aim should be to improve the bottom line. That requires returning to the basics of corporate management: accumulating a sound base of assets and expanding profitable operations.

Over-banking — the presence of too many banks — is another weakness in regional banking. This problem no longer exists in the national banking sector, which now consists of four groups, largely as a result of mergers and consolidations among the 20-odd major banks that once existed.

Nationwide, at the local level, there are still 64 first-tier regional banks, 48 second-tier regional banks, 301 credit unions and 175 credit associations. While the number of credit unions and associations have dropped by one-third to nearly one-half, respectively, regional banks have been slow, or reluctant, to merge or consolidate. The number of regional banks has remained unchanged for the past 20 years.

In such an overcrowded situation, it is difficult for regional banks to meet the growing demands of a wider regional economy that is expanding well beyond prefectural borders. Regional banking is said to be the chief domain of the “postal savings bank,” comprising 25,000 post offices nationwide, that will come into existence if the nation’s postal services are privatized. Unless they join hands, regional lenders will likely face life-or-death competition from the giant newcomer.

A number of recent merger moves indicate that regional banks are increasingly aware of the need to cover wider regions. Last year, Hokkaido Bank and Hokuriku Bank (Toyama Prefecture) set up Hokuhoku Financial Group, while Yamaguchi Bank and Momiji Holdings (Hiroshima Prefecture) agreed to merge in or around fiscal 2006. The limited deposit guarantee is a wake-up call for problem banks to get their act together through bold reforms, including mergers.

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