TOKYO, Jan 29 (Reuters) - The Bank of Japan's shock move to impose negative interest rates is another blow to regional banks already hit by low returns on lending and weak corporate borrowing, and may add to pressure for them to consolidate or accept the advances of bigger rivals.
Regional banks have long struggled to put their huge cash reserves to profitable use. Now, they face charges to keep deposits with the BOJ, and government bonds are less attractive than ever.
"We're in trouble, it's very tough," said an official at a regional bank near Tokyo. "Each of us will have to start from scratch to think of a strategy for the next fiscal year."
Beyond parking cash at the BOJ, options for Japan's smaller banks are limited.
"Banks have been hit hard," said Yasuo Sakuma, portfolio manager at Bayview Asset Management, referring to the BOJ's decision. "It's particularly serious for regional banks with low loan-deposit ratios, which may well act on pressure for restructuring."
Corporate demand for borrowing has been weakened by slow economic growth at home and abroad, meaning firms are reluctant to invest in either plant machinery or raise wages.
That is despite sustained pressure on them from Prime Minister Shinzo Abe and BOJ Governor Haruhiko Kuroda to spend more on equipment and wages.
Last month, Kuroda stressed that companies needed to spend further on new innovation and increased salaries to assist the BOJ in reaching its two percent inflation target.
The head of the Keidanren, Japan's biggest business lobby, responded with only conditional support, underscoring the difficulty policymakers face in persuading risk-averse Japanese companies to spend.
For regional banks, alternatives to lending to companies, such as passing on negative interest rates to customers, are not an option.
"For the small- and medium-sized banks whose reserves are parked at the BOJ, negative rates will be a big problem," said Takashi Hiroki, chief strategist at Monex. "They'll find it very hard to pass on the costs to individual customers."
Reflecting those concerns, Tokyo Stock Exchange's banking index hit its lowest level since October, 2014, after the BOJ's announcement, falling 2 percent despite a 2.9 percent gain in the wider Topix index.
Shares in regional banks fell, with Fukuoka Financial Group dropping 3.6 percent and Bank of Yokohama Ltd shedding 2.2 percent. Investors also sold shares in major banks, with Mitsubishi UFJ Financial Group losing 2.8 percent.
Japan's roughly 100 regional banks account for around half of the country's outstanding bank loans, which were last month worth 432 trillion yen ($3.6 trillion), according to the BOJ.
Unlike Japan's top three "megabanks," which have offset weak domestic demand for loans with an aggressive buildup of overseas lending, most regional banks only compete domestically, mainly extending low-risk loans to small and mid-sized businesses.
Loan interest rates have been falling amid fierce competition among lenders.
Japan's Financial Services Authority has been encouraging regional banks to consolidate since 2014, as a response to falling demand caused by Japan's greying population.
However, only three regional banks have consolidated in the past three years.
The BOJ's Kuroda said on Friday at a news conference following the decision that while negative interest rates may have a short-term impact on financial institutions, he did not expect a major impact.
$1 = 120.7800 yen Additional reporting by Taiga Uranaka, Tomo Uetake and Emi Emoto; Editing by Mike Collett-White