By BLOOMBERG

Tokyo • Japanese banks may have too many employees and branches, and the overcapacity is contributing to a drop in earnings power that may hurt the financial system, according to the nation’s central bank.

“The low profitability of Japanese financial institutions is striking from an international perspective,” the Bank of Japan (BoJ) said in its twice-yearly financial system report. The number of employees and branches “may be in excess relative to demand”, it said.

While banks in most advanced economies are struggling to cope with low interest rates, the problem is particularly acute in Japan, where the central bank’s monetary easing has squeezed lending margins to among the lowest in the world. Japanese banks are also having to contend with a shrinking population which has prompted some smaller lenders to merge and larger ones to diversify operations and expand abroad.

In areas with many branches, customers are able to shop around for the best loan rates, weakening the relationships between banks and their clients and potentially making the allocation of capital less efficient, it said.

Japanese banks have a lower return on equity (ROE) than their US and European competitors. The average ROE among lenders on the Topix Banks Index is 5.18%, compared to 8.67% on the US’ KBW Bank Index and 5.6% for the STOXX Europe 600 Banks gauge, according to data compiled by Bloomberg.