The banking sector in Japan has been stuck in a rut for several years, with little currently happening to galvanise it into action. The Banker’s Top 1000 World Bank Rankings 2023 showed the country’s banks have continued to see a decline in their Tier 1 capital in the year to March 2023, with all but one of the 82 in the ranking suffering a drop.
Mitsubishi UFJ Financial Group (MUFG), Japan’s largest bank, is in 14th place in the Top 1000 ranking with $111.3bn in Tier 1 capital, an 11.93% decline on the previous year. Until last year, the bank had ranked within the top 10 overall and at its peak in the 2018 ranking, it reported $153bn in Tier 1 capital.
Despite these declining numbers, however, Japan’s banking sector remains one of the biggest in the world, with the sector as a whole holding a total of $19.6tn in financial assets in 2021, according to Statista.
Liquidity buffers
With this in mind, the outlook for the banking sector is both complex and hard to predict. Kaori Nishizawa, Japan banks analyst at Fitch, says: “Japanese banks are not back to pre-Covid 19 levels, with credit costs higher and core profits and interest margins lower. Interest hikes mean costs have been passed on to the business, and spreads are compressed. Lending has increased, but margins are low. This is the weakness of the Japanese banks.”
The damage caused by Covid was severe, but [SMBC] has recovered and this year is exceeding expectations.
Jun Ohta, director, president and CEO of Sumitomo Mitsui Financial Group (SMBC), is optimistic about his bank’s prospects, however. “SMBC has seen good performance. The damage caused by Covid was severe, but the bank has recovered and this year is exceeding expectations,” he says.
Indeed, SMBC’s outlook appears buoyant, with the bank reporting profits of ¥248bn ($1.7bn) for the first quarter of 2023. While the total is a 1.8% decline on the same period in 2022, it represents 30% of the bank’s annual profit forecast. In the Top 1000 ranking, the bank remained in 21st position overall and second in Japan, with $86.5bn in Tier 1 capital. Though this was a 5.33% decline on the 2022 ranking, SMBC’s pre-tax profits increased by 8.36% to $8.2bn.
But while Japan’s banking sector is stable, overall results are lacklustre — as is the economy. Tetsuya Yamamoto, vice-president and senior credit officer, financial institutions group at Moody’s Japan, says: “The environment is improving and we expect Japan’s gross domestic product (GDP) growth will reach around 1.5% in 2023, and slightly down to 1% in 2024. Unemployment figures remain low, at around 2.5% in 2023 and 2.4% in 2024.”
As such, the banks are supported by solid economic foundations that bolster their coffers. “There is stability in liquidity, with large bank deposit bases consisting of up to 40% to 50% retail deposits,” Ms Nishizawa adds. “After the global financial crisis, the banks built up a large foreign exchange (FX) balance sheet, and most are compliant with total loss absorbing capacity, at additional Tier 1 (AT1) and AT2 levels.”
According to Mr Yamamoto: “The high level of liquidity in the banks is built on the basis of strong retail deposits. Around 70% of Japanese deposits come from retail clients, and there is no reason for this to change.”
Economic pressures
In common with many markets, Japan has also been hit by rising inflation. The rate slowed in August 2023, with the Corporate Goods Price Index climbing 3.2% on the previous year. The figure is also down from the 10.6% year-on-year increase recorded in December 2022. The figures are higher than the Bank of Japan (BoJ) 2% target, having been exacerbated by commodity prices and a weak yen.
Takehiko Nakao, chairman of the institute, Mizuho Research and Technologies, says: “The yen is weaker in dollar terms partly due to ultra-expansionary monetary policy, with lower wages and lower GDP impacting Japan’s business strength.
“Japan has seen a low rate of inflation and significant imported inflation. Unless there is a shift, this will be passed on to retail prices and the consumer. The Consumer Price Index will rise,” he adds.
Ms Nishizawa at Fitch is less pessimistic. “There are risks posed by rising inflation,” she says. “While it is increasing, the sentiment is calm. We don’t expect to see a dramatic increase in rates.”
Rising rates have helped the banks to achieve stronger financial results. Mr Ohta says: “Interest rate hikes have increased profits in the short term by around 10 basis points (bps), which is around ¥20bn. But the yen has depreciated against the US dollar, which has had a significant impact. We have also seen our competitor Japanese banks impacted in a similar way.”
Regional differences
However, this is consistent across the whole country. According to S&P Global Ratings senior director Ryoji Yoshizawa, while rate rises have been positive and increased net revenues, this is limited to the larger banks. “This could pose a risk to the regional institutions. If there was a 100bps rate hike, it would impact heavily on these banks via increasing unrealised losses on holding bonds,” he explains.
There are 98 regional banks across Japan and, according to the Japan Asset Management Platform Group, 49 of them saw net profits fall in the second quarter of 2023. Rising interest rates in the US also hit earnings, causing some banks to sell bonds at a loss. Also blamed for the losses is a rise in bad loans, as repayments are now due for many small companies that received interest-free and unsecured loans during the Covid-19 pandemic.
Former prime minister Yoshihide Suga, who was in office between 2020 and 2021, previously stated openly that the country has too many regional banks.
Mr Yoshizawa says: “The regional banking industry with its local banks could face a different level of risk. Smaller banks take on greater risk factors than the larger banks. The regulator has seen a trend of declining profitability in these banks, and is looking to work with the shareholders and stakeholders on how to conduct mergers and acquisitions (M&A) and consolidate some of these smaller institutions.”
There are some limitations to consolidation because the regional banks operate solely within their city or prefecture limits. “Regional banks comprise 40% of overall market share, but represent a fragmented banking space. Due to their regional nature, they are not going to compete with banks in other regions,” Mr Yoshizawa adds.
The BoJ has been encouraging bank consolidations, such as offering additional interest on deposits with the central bank if they meet benchmarks, and some areas have seen mergers taking place. Aichi Bank and Chukyo Bank merged to form Aichi Financial Group, known as AFG, while Aomori Bank and Michinoku Bank united to become Procrea Holdings. Both new institutions appeared in the Top 1000 ranking in 2023, in 520th and 677th places, respectively.
Searching for growth
In an overly saturated banking market, international banks and Japanese megabanks alike are looking for new channels of growth, and SMBC’s Mr Ohta highlights some bright spots.
“The domestic wholesale business and global business is very active,” he says. “The domestic wholesale side is looking towards liquidity, how to restructure the business portfolio, supply chains, or deal with clients to improve productivity. Last year saw an increase in working capital, which decreased the short-term capital balance of lending. The changing FX rate was an opportunity to combine rate swaps.”
For the global banks, there is opportunity in using their international banking knowledge and presence. For instance, Takasuke Sekine, head of global banking Japan, HSBC, says: “In addition to our activities supporting Japanese organisations to access global markets, we’re also helping inbound businesses entering Japan. Post-pandemic, domestic consumption has been rebounding and Japan is seen as a key market for many industries, such as luxury goods retailers.”
While Japan’s ageing demographics causes concerns for some, others perceive it as a positive, adds Mr Sekine. “Numerous companies are seeing potential growth opportunities and are looking to enter the market.”
External markets are also proving to be a tempting option for domestic Japanese banks. Mr Ohta says: “The engine for growth is outside of Japan. The global strategy is to expand our existing business overseas. Last year, we expanded the partnership with [investment bank] Jefferies, expanding the reach of the US and European business and return on equity.”
SMBC announced further collaboration with Jefferies in April 2023 on more corporate and investment banking opportunities. Under the agreement, the bank is responsible for credit products and debt capital markets, while Jefferies will cover M&A and equity capital markets.
Moving into Asian markets is part of the bank’s long-term plans, Mr Ohta adds. “There is a growth strategy towards specific countries in Asia, in particular India, Indonesia, the Philippines and Vietnam. We expect this to take 10 to 15 years.”
Going digital
Through opening up to foreign markets, Japan is also having to adapt its processes to meet international expectations. This includes a move towards greater digitisation in banking services. For example, SMBC launched its Olive all-in-one card in March 2023, which combines the customer account, credit, debit and point payments. “Digital touches all areas of our growth strategy, and we will increase investments to develop new features and bring more value to investors,” Mr Ohta says.
“Clients are increasingly digitally savvy and expect a consistent approach in their global treasury set-up,” says Mr Sekine at HSBC. “They want to see the same products and services offered across all markets that they operate in. There’s a demand for more effective treasury solutions that are cost efficient and as easy to use as possible. They must also align to clients’ environmental, social and governance (ESG) and digitalisation goals.”
The trickiest part is encouraging domestic consumers to move away from cash to digital payments, though the Covid-19 pandemic increased this, as consumers became reluctant to handle physical cash.
The government is also looking to encourage adoption through incentives such as subsidies for small businesses to help enable payments through credit or debit cards, e-money and QR codes. Ultimately, there is a goal for digital payments to hit 40% of total private sector consumption by 2025. (By comparison, UK Finance reported that in 2021 just 15% of all transactions in the UK were made using cash.)
Tomoya Suzuki, vice-president, senior analyst, financial institutions group at Moody’s Japan, says the country’s demographic crisis may inadvertently spur adoption of digital payments. “The use of cash remains prevalent in Japan, but the adoption of electronic transactions will accelerate because you don’t need as many employees to handle cash,” he says. “It will help ease labour shortage constraints that are a feature of Japan’s ageing and shrinking population.”
We aim to strengthen and promote M&A advisory services in the sustainability field on a global basis.
He believes multiple issues continue to curtail the adoption of digital payments, pointing to consumer distrust and concerns of access to personal information, and issues within the system itself. “The challenge in Japan is the lack of interoperability between platforms. There is not an easy transition between banks, payments apps, and QR codes for payments,” he adds.
S&P’s Mr Yoshizawa says banks should recognise the potential additional benefits of digitisation. “Greater use of digital transactions would introduce a new layer of opportunity for fees, such as on automatic transfers and FX,” he adds.
Green banking
Currently, a relatively untapped source of growth is sustainable finance. Nomura is one bank that has made ambitious steps forward with the acquisition of Greentech Capital Advisors in 2020, combining existing teams to form the greentech, industrials and infrastructure (GII) unit.
Masahiro Goto, global head of investment banking at Nomura, says: “The GII sector is a potential growth area. We aim to strengthen and promote M&A advisory services in the sustainability field on a global basis, including supporting decarbonisation through the restructuring of our clients’ business portfolios.
“Nomura will connect companies working to create sustainable technologies with investors and clients across different geographies to help them incorporate innovation into a wide range of sectors ranging from low carbon molecules, renewable energy, transportation, advanced materials, water and waste infrastructure, to agritech and sustainable foods.”
The bank is also focused on increasing ESG bond underwriting, and was both the structuring and the executing bank for NTT Group’s green bond — the largest green bond issued in Japan. The bond consists of three-year, five-year, and 10-year tranches valued at ¥100bn each.
“Nomura has set a goal of supporting clients and stakeholders in their decarbonisation ambitions in the debt capital markets space. It has announced the target of deploying $125bn in sustainable financing by March 2026. In the first 24 months, to the end of March 2023, Nomura is on track and has been able to cover approximately $47bn,” Mr Goto adds.
