The central bank’s negative interest rate regime has hit Japan’s banking sector hard. But three local mega-institutions have shown resilience, both at home – partly through fintech investments – and abroad – by aggressive international expansion. Stefania Palma reports.


Negative interest rates; withering net interest margins; an ageing and shrinking population; low consumer and corporate confidence: these are just some of the obstacles that Japan's mega-banks – Mizuho Financial Group, Mitsubishi UFJ Financial Group (MUFG) and Sumitomo Mitsui Financial Group (SMFG) – are coming up against in their home market.

As the negative interest rate policy set by the central bank, the Bank of Japan (BoJ), squeezes revenue sources at home, local banks are expanding aggressively abroad.  

But while revenue potential dwindles – especially from banks’ lending business – an acceleration in Japanese fintech development could be a saving grace for local banks, especially after the Financial Services Agency (FSA) reformed the banking act in 2016 allowing banks to own majority stakes or take full ownership of fintech companies.

Squeezing margins

Ever since the BoJ implemented a negative interest rate policy in January 2016 to fight Japan’s deflationary pressures, local lenders have struggled to make money from their lending businesses. Banks’ net interest income declined by 5.2% for the six months to September 2016, while domestic loan yields dropped to 1.12% at the end of September 2016, from 1.22% a year earlier, according to a report by rating agency Moody’s.

“The negative interest rate policy has influenced us negatively in terms of lending. In financial year 2016, we lost Y40bn [$360m] in revenue margin just because of negative interest rates,” says Yasuhiro Sato, president and group CEO of Mizuho Financial Group. “We shouldn’t rely on lending too much,” he adds.

Nobuyuki Hirano, president of MUFG, also believes the BoJ’s rates regime has hit Japan’s financial sector. “The negative interest rate policy caused the yield curve to flatten too much and posed serious harm to the profitability of the financial industry,” he says.

Market participants also started to question the sustainability of the central bank’s quantitative easing policy. “Sooner or later, the BoJ will buy out all available [Japanese government bonds, or JGBs],” adds Mr Hirano.

However, he believes the quantitative and qualitative monetary easing with yield control that the BoJ implemented in September 2016 to push the 10-year government bond yield to 0% has successfully controlled the yield curve and the volume of JGB purchasing, while bringing stability to the market and the policy framework.

Nonetheless, the BoJ’s loose monetary regime has so far failed to boost consumer and corporate confidence in Japan. Local corporates are still hoarding cash, capital expenditure is weak and consumer confidence remains low.

“I have to admit that at the moment, even with negative interest rates, there is no conspicuous reinvigoration of the Japanese economy,” says Koichi Miyata, chairman of SMFG.

Japan banks interest rates

New business

With lending margins through the floor, Japanese banks have had to boost non-interest income. According to Graeme Knowd, managing director, banking, at Moody’s, the three mega-banks have so far been successful.

“The mega-banks have dealt with [the BoJ’s negative interest rates] well. The portion of their domestic books that is market-rate sensitive is very small. Large corporate loans still get hit, but they have got better at getting fees out of their large clients,” he says.

Indeed, non-interest revenue, mainly from the advisory and securities business, now accounts for 54% of Mizuho’s total revenues. The ratio will reach 60% by 2018. “Our competitiveness is based on how quickly we can build non-interest income versus our lending margins,” adds Mr Sato.

While negative interest rates have hit Japanese banks’ profitability, this has also generated new sources of revenue, such as lending restructuring. In order to enjoy Japan’s low rates, borrowers are modifying their lending, from floating to fixed, or they are opting for hybrid solutions, according to Mr Sato.

Japan’s ageing population, combined with low interest rates, is creating further business opportunities for Mizuho. “Pension savers now need to take care of additional pension obligations, so we offered them opportunities to change from defined benefits to defined contribution solutions,” says Mr Sato.

Thanks to these new sources of income, Mizuho has so far recuperated 70% of the Y40bn drop in revenues caused by low interest rates.

Diversity drive

In this environment, diversifying fee-based business is crucial, according to SMFG’s Mr Miyata. The group started this process in 2015, with the acquisition of Citibank Japan’s retail business by private banking subsidiary SMBC Trust Bank.

Consolidating SMFG’s subsidiaries is part of this process. SMFG has increased its stake in the group’s asset management company, making it a consolidated subsidiary, and by January 2018, SMBC Nikko Securities will have finalised its acquisition of brokerage firm SMBC Friend Securities.

In Japan, there is enormous untapped potential for securities firms. Local individuals are holding almost Y1,700,000bn in cash, 70% of which sits with more elderly citizens. “This cash needs to create more value and it can do so if it is invested in capital markets. This is the securities companies’ role and the FSA is trying to push us to enhance the transfer away from deposits,” says Mr Sato.

SMFG’s Mr Miyata also sees strong potential in the securities business. “With negative interest rates, major institutional and retail investors cannot expect high returns while investing in bonds. So we can introduce them to different investment products,” he says.

But according to Mr Knowd at Moody's, the shift from deposits to savings and investment still has not materialised due to the depressing effect of the BoJ’s rates policy on depositors’ perception of the economy. “They’re thinking the economy must be doing really poorly if we need negative interest rates,” he says.

International push

In addition to growing fee-based business, perhaps the most aggressive form of income diversification that Japan's mega-banks have taken is their international expansion, with limited lending opportunities at home pushing banks beyond Japanese borders. BoJ data shows that year on year, total bank loans grew 2.8% by year-end 2016, down from 3.3% at year-end 2015.

What is more, as of March 2016, interest income on loans accounted for only 37% of total ordinary income for Mizuho, BTMU, SMBC, Resona Bank and Saitama Resona Bank, of which 40% came from overseas, according to a Moody’s report.

To counter this trend, MUFG opened a sub-branch in Sri Lanka in January 2016 and is also deepening its presence in China, with a new branch in Fuzhou, as well as opening another in Kaohsiung, Taiwan. This is aimed at serving corporates involved in China’s One Belt One Road, says Mr Hirano. MUFG has also opened a sub-branch in Suzhou in Changshu province, and a new branch in Jiangsu, while in the Middle East, it will open a branch in Riyadh, Saudi Arabia, in 2018.

Like MUFG, Mizuho is also focusing on China and the Middle East. Mr Sato sees big potential for Japanese companies in the Middle East, as the latest oil price crash is pushing the region to create new industries. Mizuho has already opened a securities subsidiary in Saudi Arabia, and may consider expanding into lending and asset management services.

In China, Mizuho wants to grow beyond its existing 17 branches. “Although China has fundamental issues such as an ageing population, environmental concerns and over-capacity, it is leaving the middle-income trap behind and has a growing middle class as it moves towards a consumption-led economic model. China is a huge market for every service company out there,” says Mr Sato.

For SMFG, expansion in Asia mainly involves Indonesia, where it already has a 40% stake in local lender Bank Tabungan Pensiunan Nasional (BTPN) and 35.1% stakes each in auto and motorbike leasing companies Oto Multiartha and Summit Oto Finance.

SMFG is collaborating with the leasing businesses and BTPN to offer full banking services in the country. “Indonesia has a large, very young population and is rich in natural resources. It will definitely grow strongly,” he says.

Beyond Asia, Mr Miyata sees growth potential in SMFG’s aircraft leasing business headquartered in Dublin, Ireland, as well as its railway cargo operations based in Chicago. “As the US economy recovers, movement of goods will also grow and expand our railway business further,” he says.

Overseas risks

But excessive overseas expansion could become a risk for Japan’s banking sector, according to Mr Knowd. “A bank CEO put it very eloquently: today’s Japanese banks are like the French banks pre-Lehman. They have solid positions in their home market and they’re expanding abroad, with very large [overseas] funding needs,” he says.

Excessively rapid growth overseas could lead to asset quality problems. “The worst-hit countries [in the 2008 financial crisis] were those whose external balance sheet was much bigger than the local balance sheet. We haven’t got there yet with Japanese banks, but we have to see if they have the sense to stop before they do,” says Mr Knowd.

Japanese banks’ high dollar demand to sustain their international expansion is also pushing up US dollar funding costs. “The volume in yen swaps is not sufficient to meet banks’ funding requirements, so they will mostly rely on US dollar funding,” says Mr Knowd.

Fintech rising

Although Japan’s mega-banks are resorting to international expansion to escape a dormant domestic market, a recent acceleration in local fintech development could offer lenders some respite at home. The country’s anticipated fintech boom is arguably late compared to other parts of Asia, with some pointing to slow adoption of new technology and historically tight financial regulation as some of the main causes.

But the FSA’s reform allowing local banks to take majority stakes in or full ownership of fintech companies has been widely perceived as a watershed moment for Japanese fintech. The three-mega banks are now scrambling to invest in tech companies.

In October 2016, Mizuho and SoftBank established a 50/50 joint venture to launch J.Score, a mobile application offering unsecured consumer loans based on artificial intelligence credit scoring. The J.Score app will launch in the first half of 2017.

Market participants say J.Score’s potential is enormous. The app can generate credit scores based on customers’ transactions with both Mizuho and SoftBank. A local telecommunications and internet giant with a larger customer base than Mizuho’s, SoftBank and its data are a precious addition to J.Score.

SoftBank also has know-how in running credit checks since it already takes credit risk with its phone customers, according to Mr Knowd. In the future, the app could offer a digital wallet to disburse J.Score loans without using an ATM, as well as insurance and asset management products.

J.Score’s innovation also lies in the app not needing branches – only 30 Mizuho staff man this project, which is unusual in a market where mega-banks still rely heavily on physical outlets to carry out consumer finance. “There are so many bank branches in every station, where land is very expensive. Mizuho now has a total of 800 branches in Japan. I want to cut that by at least 10% to 20% in the next three to four years,” says Mr Sato.

In the future, Mizuho is looking to invest in agritech in what would be the group's first investment in the sector. Further details remain undisclosed.

According to Mr Knowd, being the closest mega-bank to SoftBank in the tech space is a “huge advantage” for Mizuho. “SoftBank has access to every start-up in the world. It doesn’t even need to build technology from scratch because it can bring in what has already worked elsewhere in the world,” he says.

SMFG building alliances

SMFG is also building alliances with fintechs via equity investments. In addition to gaining access to new technology, these collaborations could help SMFG allocate human resources in a more efficient way and cut costs, according to Mr Miyata. In 2015, the bank established a joint venture with Japanese settlement and payment company GMO Payment Gateway.

Mr Miyata says a potential limitation for banks investing in fintech is their ability to fully understand new technology. “To address this limit, we are setting up funds with companies that are specialised in evaluating this kind of technology, such as Toyota Motor Corporation and [IT firm] NEC,” says Mr Miyata. SMFG has also set up offices in Singapore and Silicon Valley to network with fintech companies daily.

MUFG has set up offices in the same locations for the same purpose. According to one market participant, MUFG has also invested in tech firm Xenodata Lab, which rapidly generates equity research based on companies’ financial reports.

MUFG reportedly wants to incorporate Xenodata Lab in its online retail brokerage, which would be very promising in a market such as Japan, where only 14% of listed stocks have equity research coverage. MUFG did not confirm or deny this investment. Xenodata Lab is part of MUFG’s start-up incubator Fintech Accelerator – the first to be launched by a Japanese bank.

So far, relationships between Japanese banks and fintechs seem mutually beneficial. Fintechs provide banks with ready-made technology they cannot develop themselves, while banks offer fintechs the know-how to navigate Japan’s historically tight financial regulations. “Fintechs are not really a threat to Japanese banks at the moment,” says Mr Knowd.

Japan’s mega-banks have reacted to the BoJ’s negative interest rates policy well. At home, they are riding the growing fintech wave that could help them cut costs and improve efficiency. Abroad, they are expanding rapidly to find new sources of income.

But for Japanese banks’ profitability to be sustainable, there needs to be a resurgence in the domestic economy. And only structural reforms, not just quantitative easing and negative rates, can break Japan’s stagnation cycle.


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