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Fitch: Japan banks profitability under pressure

The Bank of Japan’s negative interest-rate policy is also a net negative for the banking system, but the mega banks are likely to be less affected than regional ones.

Japan mega banksAccording to Fitch Ratings Japan banks will continue to face profitability pressures on several fronts. These include a challenging low-growth operating environment, the central bank’s negative rate policy, and increased foreign-currency funding costs, among others.

Net interest margins (NIMs) at the three Japanese “mega banks” – MUFG, SMFG and Mizuho – have declined steadily since 2010, with the average NIM falling to a multi-year low below 0.7% in the fiscal year ending March 2016. The macroeconomic environment remains challenging for the banking sector, with ‘Abenomics’ policies struggling to gain traction and private consumption still dragging on GDP growth. Investment has picked up slightly in recent months, but this has been insufficient to push domestic loan demand significantly higher. This has meant that the banking system has retained significant excess liquidity, which has dragged on earnings. Fitch expects the pace of economic growth to remain at less than 1% through the medium term.

The Bank of Japan’s negative interest-rate policy is also a net negative for the banking system, but the mega banks are likely to be less affected than regional ones. Fitch estimates that this will add to pressure on domestic NIMs, and is likely to mean that banks will seek to maintain their overseas build-out, which could entail higher risk and add to their challenges in funding and capital management.

Foreign lending has been rising steadily over the past several years as banks have sought higher yields and diversification – primarily in the US and Asia. Rising overseas risk appetite could help bolster profitability, but Fitch believes that it will lead to a shift down the credit curve, and asset quality for foreign assets could face greater pressures. The ongoing slowdown in China and its effects on commodities – and emerging-market volatility in Asia – are likely to add to risks in Japanese banks’ overseas portfolios.

Overall credit risks are likely to remain manageable, however. Fitch expects the mega banks’ NPLs and impairment losses to rise modestly, but remain low, while borrower concentration is not out of line with global peers.

Expansion abroad will also mean that the mega banks may need to strengthen foreign-currency funding. Foreign-currency deposits have already begun to rise significantly since 2011, bringing the overseas loans/deposits ratio steadily downward. Further strengthening of the foreign deposit base may be necessary to mitigate risks from wholesale funding, though Fitch holds to its long-held view that the Bank of Japan will backstop banks with FX swap lines in the event of stress. Furthermore, foreign-currency funding costs have risen since the latter half of 2015, due partly to expectations of higher US rates.

Regular bond issuance is likely to continue through the medium term, with the mega-banks on track to meet Basel III total loss-absorbing capacity (TLAC) requirements by 2019. Fitch estimates USD22bn could be issued by 2019, with total issuance of around USD59bn by 2022. This would follow USD15bn in TLAC senior debt issued through to April 2016.

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