KONTAN.CO.ID - TOKYO. Japan's financial regulator said it would beef up surveillance of local banks that show signs of stress as years of ultra-low rates and a shrinking population erode their profitability.

The Financial Services Agency (FSA) will take preventive steps such as on-site inspection and administrative punishment when banks post continuous deficit or their capital adequacy ratio drops below 4%, the regulator's annual report shows.

"The environment around regional banks has become increasingly severe," the report said on Wednesday.

"Regional banks need to establish a sustainable business model and secure financial health."

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The FSA also said it would consider lowering the deposit insurance rate for financially robust banks in a move to drive consolidation among regional lenders.

All domestic financial institutions are currently required to reserve a deposit insurance fee of 0.033% to hedge against bankruptcy. With the change, the FSA would require different rates depending on a bank's financial health, measured by factors such as the size of its core capital.

Years of near-zero interest rates have made traditional banking barely profitable in Japan, where regional lenders also have to contend with dwindling populations.

Also, recent data showing Japan's exports fell for an eighth month in July and manufacturers' confidence turned negative for the first time in over six years will keep the Bank of Japan under pressure to ease further.

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Market watchers have long called for consolidation as a primary means of growth, and even survival, for banks.

Most recently, Japan's two biggest local lenders, Bank of Yokohama Ltd and Chiba Bank Ltd, agreed to set up a partnership to fight against such headwinds.

Editor: Herlina Kartika Dewi