A regional bank’s unscrupulous lending bites back

The lending irregularities that have been exposed at Suruga Bank, a regional bank based in Numazu, Shizuoka Prefecture, are all the more problematic given that the bank was once hailed by the Financial Services Agency as a role model. The FSA touted its highly profitable operation at a time when the regional banking industry as a whole is suffering from a declining pool of clients in the struggling regional economies and the protracted low interest rate environment is reducing their lending profits. What’s also disturbing are industry rumors that the practice of financial institutions colluding with real estate companies to use lax screening to lend to prospective investors who otherwise would not qualify for the loans may not be unique to Suruga Bank.

A report released last week by a third-party panel of lawyers commissioned to probe the alleged misconduct at Suruga Bank stated that in the bank’s pursuit of sales over compliance, a large number of its workers, led by a former managing director, were involved in the falsification of loan-related documents and other irregularities so they could increase lending to investors in a share-house business led by a real estate operator. It accused the bank of “an extreme lack of sense of legal compliance” as a financial institution and highlighted its “failure of corporate governance.”

In the business scheme in question, a share-house operator solicited investors — many of them ordinary company employees — to build women-only share houses by claiming guaranteed rental income, with Suruga Bank providing the loans to the investors to pay for the construction of the properties. In providing such loans, lenders will normally take a hard look at the business prospects of the share-house scheme as well as the borrowers’ means to repay the loans. Instead, the loan-related documents were manipulated so that the loans would be provided to borrowers who otherwise would have been disqualified during screening.

In many of the cases the amount of borrowers’ bank deposits were padded to make them look better able to repay the loans, while in other cases the value of the properties being built were inflated to circumvent the bank’s standard that it can lend only up to 90 percent of the price of the property being purchased. Under strong pressure from the managing director who reportedly took the initiative in such problem practices, nearly 100 percent of the share house-related loans were cleared by the bank’s loan-screening section.

When the share-house business went bust due to a shortage of tenants and the operator stopped payment of the rents to the property owners in January, many of the owners were saddled with debt up to the tune of ¥100 million without the anticipated rent income. Many of the loans became irrecoverable and Suruga Bank put up more than ¥70 billion in loan-loss reserves by the April-June quarter — a figure that may climb further. The amount of its nonperforming loans surged to ¥135 billion at the end of June — 4.6 times larger than it was a year earlier.

Japan’s regional banks face an ever-tightening business climate. Steep population declines in many parts of the country have eroded their customer base by reducing loan demands by local companies, while the ultralow interest rates under the Bank of Japan’s monetary easing policy have cut their profitability by reducing their lending margins. In the last business year to March, more than 60 percent of the 80 regional banks listed on stock markets either reported declining profits or suffered losses — many incurring them in their mainstay lending operations.

Despite this market environment, Suruga Bank has for years continued to set new record profits with its aggressive real estate lending. As financial authorities urged the struggling regional banks to explore new business models, former FSA chief Nobuchika Mori once hailed Suruga Bank as a model institution for its strong performance. Now the FSA is reportedly considering severe administrative penalties for Suruga Bank, possibly including an order to suspend part of its operations, for the misconduct in its real estate-related business that used to shore up its robust profits.

Many other regional banks are struggling to find prospective borrowers as their markets shrink. There are reportedly rumors in the industry that Suruga Bank was not alone in working with real estate companies to lend to investors who would normally be rejected in loan screenings so that they could buy expensive properties. It surfaced last month that a real estate company listed on the Tokyo Stock Exchange altered documents submitted to a regional bank for the screening of a loan to its client — although the bank rejected the loan application after learning of the falsification. The issue requires continued surveillance.