BOJ's Capital Warning Is Another Reason to Shun Local Banks

(Bloomberg) -- Already out of favor among stock investors, Japan’s regional banks risk losing more of their attraction as the central bank urges them to retain more of their profits to conserve capital buffers.

The Bank of Japan’s warning against a “drain” on capital through dividend payouts and share buybacks is a headache for management of struggling local lenders, who have been trying to lure investors as rock-bottom interest rates erode profitability.

Japanese banks, whose shares are underperforming the broader stock market, will give guidance on their profit and dividend outlook for the fiscal year ending March in the earnings season starting this week. Many regional lenders have stuck to a practice of paying at least the same dividends every year regardless of results.

“It’s a serious message saying banks should be paying attention to capital adequacy rather than capital efficiency,” said Keisuke Moriyama, senior analyst at Macquarie Capital Securities (Japan) Ltd. “It will be difficult to buy regional bank stocks in the hope of higher shareholder returns.”

BOJ's Capital Warning Is Another Reason to Shun Local Banks

While regional banks’ capital ratios remain above regulatory requirements, lenders haven’t been able to secure earnings that match an increase in riskier assets, the BOJ said in its semiannual financial system report last week. The central bank’s record monetary easing has diminished returns on loans and Japanese government bonds, prompting banks to seek higher returns elsewhere.

Read a story on other issues highlighted in the BOJ report

“In recent years, reflecting the growing awareness of the importance of shareholder returns, some financial institutions -- in particular listed regional banks -- have raised their dividend payout ratio” despite declining profitability, the BOJ said.

BOJ's Capital Warning Is Another Reason to Shun Local Banks

“I think banks are trying to support their stock prices by keeping dividends,” said Toyoki Sameshima, a senior analyst at SBI Securities Co. in Tokyo. “Making them stop that would add downward pressure on their stock prices.”

The Topix Banks Index of 82 lenders has risen 3 percent this year, trailing the benchmark Topix’s 8.6 percent advance.

BOJ's Capital Warning Is Another Reason to Shun Local Banks

More pressure on regional banks’ dividends may come from a recent policy adjustment by the Financial Services Agency, according to SMBC Nikko Securities Inc. analysts. The regulator may take action against local banks that are at risk of undercapitalization, with the main outcome likely to involve urging them to cut dividends, the analysts wrote in an April 15 report.

As for the BOJ, its warning is a “manifestation of frustration with bank management, who do not understand authorities’ acute sense of the issue,” said Yoshinobu Yamada, senior analyst at Deutsche Securities Inc. “The stocks will lose appeal.”

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