Profits from lending and fees at Japan’s smaller banks are falling faster than expected amid ultra-low interest rates, with more than half of the institutions losing money on these core operations, the financial regulator warned in a draft report.

The Bank of Japan’s radical monetary policy, which has seen interest rates fall to near or below zero, has squeezed lenders across the country, especially the more than 100 regional banks whose local economies are slumping due to depopulation.

Many of these smaller banks are staying in the black only thanks to securities trading, which could in turn open them to new risks, according to the draft of an annual Financial Services Agency report, which was seen by Reuters yesterday.

The FSA has fretted for some time about the long-term health of regional banks, which hold about half the country’s $4 trillion in outstanding bank loans.

We do not see any problems in their financial health

The agency warned smaller banks in July that they must find new ways to make money if they are to survive, saying many of them face risks when interest rates eventually rise and that some are already in a precarious state.

“We do not see any problems in their financial health but many regional banks are struggling to boost profitability from their core business,” said a report for the year through June, which is being released next week.

In last year’s report, the FSA projected that the share of banks losing money on their core businesses would rise to about 60 per cent in 2025 from about 40 per cent, but the new draft shows the figure is already more than 50 per cent.

“Some of the banks seem to be expecting the environment will improve in the near future led by a possible rise in interest rates,” the draft says. “But it is uncertain whether the banks can enjoy lending margins again as the environment could continue to be unfavourable for the banks.”