TOKYO (Reuters) - Japan is stepping up its supervision of bank lending amid growing concerns a spurt of construction financing for new apartment blocks could be sowing the seeds for bad debts in the future, people involved in the matter say.
Small apartment and condominium block development has been a rare source of lending growth in an economy struggling to revive activity. However, much of this represents speculative investment, not housing demand, as wealthy people chase tax breaks and yield, amid a near zero interest rate environment.
In fact, vacancy rates are climbing even in prime markets like Tokyo as supply starts to outstrip demand.
The Bank of Japan and the Financial Services Agency authorities don't see an immediate crisis, such as the one that befell Japan's banks in the 1990s, but they are quietly starting to lean on the banks.
"We’ve heard that many of these loan deals have been introduced to the banks by real estate agents," Hidenori Mitsui, director-general of the FSA's Inspection Bureau, told regional bank chiefs last month, according to minutes of the meeting seen by Reuters.
"It's possible that regional banks themselves don't have a firm grasp on the their customers' needs or on what happens after they extend these loans."
For banks, loans to build apartments look like good business. They are backed by expected rental income and command a higher interest rate than housing loans to individuals. For borrowers, the properties offer lower inheritance-tax tax rates than other assets, and they can claim deductions on the loans.
Competition for borrowers is driving down lending rates, while banks aren't always scrutinizing the likely profitability of apartment loans as long as the borrower has collateral and can offer a loan guarantee, bankers say.
A regional bank executive said apartment loans will remain popular, as demand for capital spending is weak and the loans are worth millions of dollars each.
The Bank of Japan, in a comment to Reuters, said fast-growing apartment loans are "an issue in terms of financial institutions' credit risk. We are checking their risk management through our examinations and monitoring to promote its enhancement."
An FSA spokesman said, "The agency undertakes inspections and supervision in accordance with its financial administration. However, we are unable to comment on specific cases."
When asked for comment by Reuters, Japan's Regional Banks Association referred to an earlier comment by group chairman Katsunori Nakanishi. He said while an over-concentration of apartment loans or excessive property prices would be a risk, the data did not show any indication that this was the case.
"My view is that we haven't entered dangerous waters," he said at a news conference in November.
BOJ and FSA inspectors are strengthening their surveillance of banks whose apartment loan books have grown, checking whether lenders are properly assessing lending risks and managing loans, officials say.
The authorities have advised regional banks to run strict simulations of how their loans would perform under various interest-rate and vacancy scenarios, bankers say.
The stock of apartment construction loans has grown 4.5 percent from a year earlier to 22.02 trillion yen ($192.5 billion) at the end of September, central bank data shows - twice as fast as overall lending. It has set a record for seven quarters in a row, since inheritance taxes were raised in 2015.
New apartment loans, at 1.89 trillion yen in the fiscal first half year through September, are on track to break last year's record.
But demand for housing is unlikely to match rising supply. Japan's population peaked a decade ago, and Tokyo is projected to follow the downtrend around 2020.
Vacancies in greater Tokyo, around 30 percent until 2015, rose to 34.7 percent in central Tokyo in September and 36.9 percent in neighboring Kanagawa prefecture, says Tas Corp , the highest rates since the property research firm began tracking the data in 2004.
Reporting by Sumio Ito; Additional reporting by Takahiko Wada and Taiga Uranaka; Writing by William Mallard; Editing by Sam Holmes