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Economy

Loose lending keeps Japan's 'zombies' shambling along

Ultralow rates and tough competition force banks to take more risks

The Bank of Japan's monetary easing policy has distorted the country's lending market.   © Reuters

TOKYO -- Fueled by an economic recovery and ultralow interest rates, Japanese banks are ramping up lending to small and midsize businesses -- even "zombies" that are barely surviving with little hope of repaying their debt.

Total domestic loans by Japanese companies came to 504.4 trillion yen ($4.59 trillion) as of the end of 2018, the highest figure since 1997, according to data released Friday by the Bank of Japan.

The trend is one of the negative side effects of the deluge of cash unleashed by the central bank's large-scale monetary easing, allowing unprofitable companies to stay afloat and delaying necessary renewal in the corporate sector.

In areas with several local lenders, fierce competition has brought interest rates down so low that the banks are actually losing money once they account for costs. The interest margin at Japanese banks came to just 0.25% for the year ended March 2018, down 0.28 percentage point in five years, based on data from Tokyo Shoko Research.

This means that banks stand to earn about 1.4 trillion yen less despite total lending topping 500 trillion yen for the first time in two decades.

"We're almost at our limit," said a lending officer at a regional bank in western Japan.

An increase in risk assets, like loans, paired with shrinking profits have squeezed regional banks. Their capital-to-asset ratio now stands at about 10% -- still significantly above the 4% minimum required by law, but down from around 12% in 2012. Some at the BOJ worry that too much risk-taking could eat further into their capital.

Just as worrying is the rise in subprime lending. "In order to get interest payments, we have no choice but to extend loans to companies that may be unable to pay them back," admitted a regional bank executive.

One institution in the greater Tokyo area refinanced debt held by a small business that fell three months behind in payments to a credit union. Such debts would be considered nonperforming under normal circumstances, but once they are refinanced, they are treated just like any other loan.

Big banks accounted for 64% of total lending in Japan at the end of 1997. That figure had sunk to 46% by the end of 2018 as they turned overseas for new sources of income. In order to survive in the stagnant home market, regional banks have taken the flood of cash from the BOJ's aggressive monetary easing and funneled it into smaller businesses and real estate.

The problems associated with looser lending extend beyond Japan. Last September, the Switzerland-based Bank for International Settlements wrote in a report on the "rise of zombie firms" that for 14 developed economies including Japan, the percentage of companies unable to cover debt-servicing costs with current profits for three straight years hit 12% in 2016, up from about 2% in the late 1980s.

The increase in zombies, the BIS wrote, stemmed partly from looser monetary policy. With low rates crimping a main source of income, banks tend to lend more aggressively to higher-risk businesses in hopes of eking out a profit, reducing pressure on zombies to address their problems.

BIS estimates that each 1 percentage point rise in the share of zombies in an economy drives down capital expenditures at healthy firms by 17% and employment growth by 8%, as well as productivity growth by 0.3 point.

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