TOKYO -- An unusually stark warning from a top Bank of Japan official about the systemic risks posed by weak local financial institutions is being seen as a call for consolidation -- and gives a glimpse of the anxiety and frustration felt at the controls of Japanese monetary policy.
Low profitability and excessive competition among institutions in overbanked, depopulating areas creates a "financial vulnerability that takes a totally different form from the past," BOJ Deputy Gov. Hiroshi Nakaso told an audience in Japan on Nov. 29.
The career central banker also identified a shrinking pool of local corporate customers as another of the "chronic stresses" that will wear down earnings at regional banks.
With capital buffers seen able to withstand a financial shock, local banks may show little outward sign of trouble. But, in Nakaso's view, these stresses over time "could greatly affect the stability of the financial system through intensification of competition." The threat is there, but in a latent form.
The deputy governor's words amount to a call for easing this fruitless struggle through consolidation. But the Japan Fair Trade Commission has frowned on some proposed bank mergers from the standpoint of maintaining competition. Taking questions from the audience after the speech, Nakaso seemed to chide the antitrust watchdog's reluctance. Generally speaking, "a bank failure exacts a far higher social cost than the failure of an ordinary company," he said.
The many faces of crisis
The bitter experience of two decades ago informed Nakaso's warning of what could come. In May 1997, when Nakaso took up his new post as head of the financial and payment system department, different kinds of stresses were building up in the system. Yet he preached a message of optimism to staffers, telling them that with luck things would improve by the end of the year. Then, in November, four banks and brokerages collapsed in quick succession. Japan's financial system avoided total meltdown, but Nakaso saw belatedly that he had been looking in the wrong place for the problem.
When the global financial crisis struck in 2008, he learned that crises take different forms. Now, in what was likely his final speech as deputy governor before his term ends next March, Nakaso felt obliged to call his audience's attention to the future. He spent months crafting it, poring over notes from his time writing speeches for then-BOJ Gov. Yasushi Mieno in the 1990s.
Yet Nakaso may struggle to get his message across. Regional bank executives see the BOJ's negative interest rate policy as a bigger problem than population decline, as if all their earnings woes stem from the unconventional monetary policy pursued under current Gov. Haruhiko Kuroda. To them, ultraloose money is the ultimate source of stress.
Kuroda's experiment in curing deflation with a powerful dose of monetary easing is nearing the five-year mark. Yet consumer price growth registers barely above zero -- far from the BOJ's 2% target. Nakaso acknowledges that telling the benefits of this treatment apart from the side effects has proved a source of constant worry.
The BOJ's understanding of these side effects appears to be changing. After his speech, Nakaso mentioned the reversal interest rate -- the point at which a central bank's efforts to lower the cost of money start having the opposite effect by interfering with banks' function as financial intermediaries -- as "one economic theory to take into consideration" in policymaking. This seems to mark a watershed moment after years of relentlessly pushing interest rates to the lower bound.
Nakaso has earned Kuroda's trust, and some say he would make a good candidate to succeed the governor, whose own term ends next spring. Nakaso has done his part for maintaining the stability of the financial system, but he and the rest of the BOJ leadership must still figure out how to square this with achieving 2% inflation and crafting a strategy for normalizing monetary policy.