The coronavirus pandemic threatens to force Japan’s large regional banking sector to regret aggressive overseas investments and buy-to-let lending during its four-year battle with negative interest rates.

Analysts say many of about 70 listed regional lenders are more vulnerable to rises in credit costs than the country’s megabanks because they are already under severe strain from the demographic and economic decline of large portions of the country.

As the regional lenders enter the 30-day stretch ahead of full-year results in mid-May — the period in which they must submit any big revisions to the Tokyo Stock Exchange — Moody’s has warned that they are vulnerable to even small setbacks in asset quality because their cushions against loss are so thin.

“Stiff competition is driving down loan yields even though banks are taking more risks, leaving banks vulnerable to any increase in credit costs,” wrote Tomoya Suzuki, Moody’s analyst. Average capital adequacy ratios across the sector had fallen to less than 10 per cent, he said.

The regional banks held more than $3tn in assets at the end of last year, more than the entire Italian banking system.

One of the biggest threats to earnings is potentially high valuation losses on foreign securities. Regional lenders have energetically accumulated these assets since 2016, as the Bank of Japan’s negative interest-rate policy drove a worldwide hunt for yield.

That could also have created a hidden spread of risk across the sector, according to Brian Waterhouse, a banks analyst at Windamee Research. Smaller lenders lacking the courage or expertise to invest overseas bought stakes in regional peers that did, in the hope of benefiting from the dividend, he said.

The recent capitulation in global markets because of the coronavirus pandemic is set to hit Japanese regional banks hard, he added, with many of them having turned to alternative investments overseas, particularly real estate and investment trusts in the US.

“Quite a number are teetering on the edge of losses. I would expect a flurry of downward revisions by Japanese regional banks,” said Mr Waterhouse.

The sector also took a strong lead in a real estate lending boom, which took Japan’s system-wide real estate loan balance to a record ¥81tn ($750bn) last year — higher than during the 1980s bubble.

Since 2013, Japan’s regional banks have used various methods to improve their appearance of health, according to analysts. Regulators allowed them leeway to reverse their loan-loss provisions to reflect the stronger economy, and they have sold assets from their hefty securities portfolios. By 2018, 23 per cent of regional banks’ ordinary profits came from equity gains.

Concerns over the regional banking sector have risen ahead of the BoJ’s semi-annual report on the state of the country’s financial system, which is expected later this month.

The last report, published in October, warned that the increasingly aggressive overseas investments by larger Japanese banks had made the country’s financial system “more susceptible to the effects of overseas financial cycles”.

Mia Nagasaka at Morgan Stanley MUFG said that in an environment of falling interest rates and rising credit costs, regional banks’ net income could drop by 20 per cent in the financial year that began on April 1.

“The greatest downside risk within Japan’s financial industries under our coverage is for the regional banks,” she said.

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