Downward trend: the yield of the Japanese government's 10-year bond has turned negative for the first time
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When Freee, an accounting software provider for small businesses, started out four years ago, few Japanese investors were excited by the machine learning technology behind its services. So the start-up turned to DCM, a Silicon Valley venture capital firm, to raise funds.

But in 2016 the financing environment for Freee has drastically changed, thanks to a big helping hand from the Japanese government.

For the first time since 1998, Japan is preparing to ease banking regulations to allow financial institutions to take larger stakes in “fintech” — financial technology — start-ups.

Currently, the nation’s banking groups are mostly restricted from having units operating in areas that are not directly linked to financial services.

Government and bank officials say the push for deregulation is driven by a sense of crisis that Japan was falling behind the US and UK in capturing the growth of online financial services, such as online payments, lending and digital currencies.

“Unless we change drastically in terms of both speed and technology, we feel a strong sense of threat that the market will be overtaken by the rise of technology players,” says Sumitomo Mitsui Financial Group, Japan’s second-largest bank by market value.

The sense of urgency is further driven by the need for Japan’s banks to diversify investments and boost returns by reducing exposure to government bonds. Those pressures have intensified with the Bank of Japan’s decision in January to adopt negative interest rates, which have sent the yields on 10-year Japanese government bonds into negative territory for the first time.

With more Japanese companies rushing to join the fintech boom, Freee now has a richer range of funding sources to choose from.

In December, it raised Y1bn ($8.9m) from a fintech fund formed by Japanese financial services company SBI Holdings, bringing its total fundraising amount in 2015 to Y4.5bn.

“The hurdle for the fintech industry was high due to regulations and the need to work closely with existing financial institutions,” says Sumito Togo, Freee’s chief operating officer. “In that sense, government support has been a big factor in creating an environment for fostering fintech start-ups.”

SBI’s fund aims to raise Y30bn from investors including telecoms group SoftBank, regional banks and others, which would make it the largest domestic fund focused on fintech start-ups. Japanese ecommerce group Rakuten also launched a $100m global fintech fund in November.

Both fintech players and investors admit the removal of regulatory hurdles is just one of many steps Japan needs to take to close its gap with overseas competitors in the field.

Another hurdle is the tiny market. Japan’s fintech firms raised about Y14bn ($124m) in funds last year, according to data provided by Money Forward, a Tokyo-based fintech business that provides online personal accounting services. Meanwhile fintech investments tripled from $4.1bn in 2013 to $12.2bn in 2014, according to Accenture.

Takeshi Goto, managing executive officer at SBI Investment, estimates that there are up to 130 fintech start-ups in Japan. “There is back-up from the government, but we need to see the emergence of more start-ups to spur the industry,” Mr Goto says.

The paucity of fintech firms stems from longstanding challenges in nurturing young entrepreneurs. Many people still prefer to work for big companies. In an effort to boost activity, Freee offers software to ease the burden of heavy paperwork associated with starting a business.

Mobile payments emerged in Japan more than a decade ago, and analysts say confidence in existing services and infrastructure led financial institutions to underestimate the disruption technology companies such as Google and Apple would cause.

“In addition to government regulations, it is undeniable that the response of Japanese banks to fintech has been slow,” says Sadakazu Osaki, head of research at Nomura Research Institute’s centre for strategic management and innovation.

Many more businesses are now claiming to be fintech start-ups and Japanese banks will need to assess their goals and how they will keep up with the pace of change in the industry.

Companies such as Freee are, in turn, under pressure to deliver the growth to justify the rising investments. Global competition is already intense for the company, with rivals such as Xero and Intuit already offering similar cloud-based financial software.

And Shunsuke Hayashi, business producer at start-up consulting firm Dream Incubator, warns: “Some fintech start-up firms have successfully raised capital, but the next phase is generating concrete results. Unless those results follow, some players may face fundraising challenges.”

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