Under the programme unveiled this month, the BOJ plans to pay 0.1% interest to deposits held by regional lenders that cut costs, boost profits or consolidate.

HOW DOES IT WORK?

Regional banks that consolidate and submit plans on how the move would help their local economies will be paid 0.1% interest on reserves they park with the BOJ for up to three years.

Lenders that meet targets for improving their financial health, such as by cutting operating costs or boosting profits, are also applicable for the remuneration.

The scheme is a three-year programme running through March 2023. By setting a deadline, the BOJ hopes to speed up mergers and consolidation of Japan's 102 regional banks.

WHY NOW?

Concerned of the plight of regional banks, bureaucrats at the BOJ and banking regulator Financial Services Agency (FSA) have worked together for over a year on a coordinated plan to fix the ailing industry.

A law exempting regional bank consolidation from antitrust rules - drafted by the FSA - took effect in November. That laid the groundwork for the BOJ to announce its plan incentivising lenders to merge.

Policymakers also got a nudge from a recent pledge by new Prime Minister Yoshihide Suga to focus on consolidating regional banks and revitalising local economies.

HOW IS IT RADICAL AND WHAT ARE THE CONCERNS?

The BOJ has been a pioneer in monetary innovation. But it has never offered payouts to a particular industry for fear of meddling in the government's realm and violating the central bank tradition of being "a lender, not a spender."

The new scheme crossed that line by offering to pay regional banks to merge. Critics say the scheme is unfair since it would reward lenders that dragged their feet up till now, while offering nothing to banks that had already merged.

Pushing lenders to cut costs at a time when borrowers are still suffering the hit from COVID-19 could also lead to job cuts and branch closures, which may hurt regional economies.

HOW WOULD IT AFFECT MONETARY POLICY?

The BOJ says the move isn't tied to monetary policy and is aimed at keeping Japan's banking system stable. It also says the scheme won't affect its yield curve control policy, which guides short-term rates at -0.1% and long-term rates around zero.

But paying 0.1% interest to a bigger pool of reserves could push up money market rates and complicate the BOJ's efforts to achieve its -0.1% short-term rate target.

Underscoring uncertainty on how the scheme could affect market, the BOJ said it may tweak features of the aid programme if unexpected fund flows disrupt its market operations.

WILL IT WORK?

There is uncertainty on how effective the scheme will be in prodding weak lenders to consolidate. Some regional banks have already complained the operating target for applying could be too high, as they face headwinds from the coronavirus pandemic.

The BOJ says it will spend up to 50 billion yen per year in payouts under the scheme, just 7% of regional banks' combined annual net profits.

(Reporting by Leika Kihara; Editing by Sam Holmes)