The Financial Services Agency is said to be shifting the focus of its inspection of regional banks from checking the conditions of their assets — such as their moves to cut nonperforming loans — to examining how the banks are engaged in supporting local companies in their business turnaround efforts. It is a positive development that should encourage the banks to serve their foremost mission as financial institutions — to help fund promising business projects and revive struggling regional economies.

Since the inception of its predecessor in 1998 — in the middle of the post-bubble boom crisis that swept Japan’s financial industry — the biggest concern of the FSA has been to restore health of financial institutions by reducing the massive load of nonperforming loans to their clients.

That has been manifested in the manual that FSA inspectors long cherished in their routine checkup of regional banks. In accordance with the manual that set a detailed check list of items to be examined under uniform standards, such as the ratio of nonperforming loans to each bank’s overall lending, the inspectors reportedly focused on appraising the latest business performance of the bank’s client firms and how much collateral the bank has secured against its lending to the firms. Any concern over a client’s near-term prospects triggered calls on the bank to ask for repayment of the principal, and the banks are said to have responded by seizing the properties put up as collateral.

Under such an inspection policy, fresh loans to new business projects of the clients tended to be discouraged due to the risk that they could go sour and add to the piles of the bad loans. The bad loan-averse policy led banks to even resort to the widely criticized practice of withdrawing the credit that had been extended to some of the clients.

That policy is believed to have changed since the current commissioner, Nobuchika Mori, took up the position in July last year. The long-cherished inspection manual has effectively been shelved, and the FSA is now reportedly preparing a set of new benchmarks that will instead assess each bank’s engagement with the efforts of its local client companies to revive their business, such as their role in improving the firms’ management. Reportedly behind the move is the realization that the regional banks, even if they manage to restore their own health by getting rid of the nonperforming loans, will not be doing their job as financial institutions serving as a pillar of the economy unless the businesses in the region they serve are reinvigorated.

The FSA is now said to be urging banks to change their ways and tie their lending decisions to the prospects of their clients’ business projects, instead of their near-term performance. And in line with the new policy, the focus of its inspection of the banks is now shifting from their bad loan volumes to their contribution to the regional economies, such as their track record and plans of financial support for the local businesses, based on the thinking that the banks should take a risk in lending to companies that have promising business plans.

Such a turnaround in the FSA policy also poses a tough question for the banks themselves — whether many of the bank staff, having spent much of the time since the 1990s on disposing of the nonperforming loans, are qualified to the task of properly assessing the prospect of their clients’ business plans. There are reportedly caution on the part of the banks that the new benchmarks being prepared by the FSA — including the numbers of their client firms whose performance turned for the better with their involvement and the volume of their uncollateralized lending to local small and medium-size businesses — could be used as tool for tough guidance on their management.

It’s time that these banks realize that their job lies in exploring promising projects by their clients, instead of spending more energy on weeding out potential sources of bad loans. Some of the regional banks are moving ahead of the FSA’s policy shift to lend on fresh projects, but such moves are still believed to be limited nationwide. They should understand that this is the reason why banks exist in the first place — and that’s how they can contribute to revitalization of regional economies that continue to suffer from the unabated population and business exodus to Tokyo.

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