Scrutinize the regional bank lending fiasco

Many of Japan’s regional banks face an increasingly difficult business environment. The ultra-low interest rates over an extended period under the Bank of Japan’s massive monetary easing operations have cut the profit margin on their lending, while the client base in their respective markets is shrinking amid the falling population. More than 60 percent of listed regional banks posted either losses or reduced profits in the latest business year to March. A Financial Services Agency estimate shows that in the not too distant future, a majority of regional banks will likely suffer losses in their mainstay lending businesses.

In a turnaround from the earlier emphasis on disposing of nonperforming loans that piled up at financial institutions after the collapse of the bubble boom, the FSA has been calling on the regional banks to take risks and extend more loans that spur growth of local businesses in the markets they serve. Against this industry background, Suruga Bank, a Numazu, Shizuoka Prefecture-based regional lender that maintained a profitable business in recent years with its aggressive focus on real estate-related loans to individual borrowers, has often been hailed by the financial authorities as a model case for survival of regional banks.

That the same bank is now mired in a scandal over alleged improper loans to investors in share houses may spell trouble for the new policy of regional banking industry administration. The problems exposed at Suruga Bank do not lessen the need for other banks to explore new business models as they seek to weather the industry’s tough times, but what lay behind the problem at the bank should be scrutinized as a lesson to be shared by banks and the financial authorities as they try to devise strategies for the industry’s future.

Suruga Bank is a midsize regional lender that has earned robust profits — which rose for six years in a row to the business term ending in March 2017 — by focusing on loans to individual borrowers who were deemed to have difficulty getting past the screening at other institutions.

The bank was lending to most of the hundreds of investors who purchased share houses sold by Tokyo-based real estate operator Smart Days, which rented the properties from the investors and subleased them to female tenants. But as the share house business went wrong — with Smart Days filing for bankruptcy in April after halting the promised rent payments to the investors due to shortage of tenants in the share houses — it surfaced that the documents used for screening the loans to most of the investors had been manipulated or fabricated by a firm linked to Smart Days.

The balance of the borrowers’ bank deposits was padded, for example, so they could borrow beyond their means to repay, while the value of the properties they were buying was inflated so the entire purchase could be covered by the loans. And many of the Suruga Bank employees not only were aware of the manipulation of the documents, but in some cases allegedly took the initiative for the manipulation — so they could increase lending to investors. The total amount of the loans extended to the Smart Days share house investors — many of them company employees — is said to have reached ¥100 billion. It is alleged that most of the loans would not have cleared the bank’s screening had the documents not been manipulated.

An in-house probe by the bank concluded that its employees in charge of providing loans to the clients, under strong pressure to increase profits for the bank, held sway over the loan-screening section — a core function of a bank — thus preventing it from playing a proper role. The bank’s net profit for the year to last March was reduced by half from the previous term as it had to put up loan-loss reserves for the share house-related loans that were deemed irrecoverable. Meanwhile, lawyers for the investors who borrowed excessively from Suruga Bank — many facing the prospect of personal bankruptcy over the large debts — have filed criminal complaints with the police against the bank’s employees for their role in the manipulated loan documents. A probe by a third-party panel commissioned by the bank is reportedly investigating whether there was similar misconduct in the bank’s lending to other clients.

What exactly lay behind the bank’s high-profit business model may have to wait for further investigation by the third-party panel. But it does not appear to be one that other banks should be encouraged to follow as they explore ways to survive the industry’s tightening business conditions. The banks and the FSA should not dismiss the Suruga Bank fiasco as an isolated case but instead try to learn from what happened.