End to negative interest rates in Japan to boost lenders' margins

Japanese lenders can expect improved net interest margins (NIMs) after the nation's central bank ended its eight-year experiment with negative benchmark interest rates — with more hikes expected to follow.

The Bank of Japan (BOJ) will guide its short-term policy rate in a range of 0% to 0.1%, from the prior negative 0.1% introduced in 2016, it said March 19. Along with a first rate hike since 2007, the BOJ also scrapped its yield curve control policy of guiding yields on benchmark 10-year government bonds in a range of up to 1.0%. The central bank had allowed yields to rise to 1.0%, from 0% in the past, in a series of de facto tightening moves using the yield curve control policy since December 2022.

The BOJ’s policy shift will be "a big turning point for entering a world of positive rates and will be a game changer," Mizuho Financial Group Inc. CEO Masahiro Kihara said in a March 19 statement. The bank plans to raise rates in ordinary and fixed deposits, Kihara said after the policy announcement.

The policy change "will help improve their [banks'] profits" by increasing their NIM, said Toyoki Sameshima, a senior analyst at SBI Securities. However, an "unavoidable" consequence will be higher unrealized losses for banks on their investment in government bonds, Sameshima said, pointing to an expected increase in yields. Bond yields move inversely to their prices.

Japan was widely expected to normalize monetary policy and bring it in line with other major global economies. Inflation is likely to stay around 2% or higher — the BOJ's key condition for a policy shift.

Separately, several large companies and their labor unions agreed on considerable wage hikes this year. The Japanese Trade Union Confederation, or Rengo, the nation's largest labor organization, said March 15 that this year's annual wage negotiations resulted in increases averaging 5.28%, the highest in 33 years.

"Banks will set interest rates on loans ... but we don’t expect loan rates to surge," BOJ Governor Kazuo Ueda said at a March 19 press conference. "Long-term interest rates depend on the markets."

Profitability boost

Major Japanese banks had been preparing for higher interest rates. Mitsubishi UFJ Financial Group Inc. and Mizuho estimated that an increase of 10 basis points in short-term rates would boost annual net interest income by ¥35 billion each, according to statements by the lenders at different times in 2023. Sumitomo Mitsui Financial Group Inc. expects to earn an additional ¥30 billion from a similar increase in interest rates, according to a statement in November 2023.

The bigger banks will likely gain more as they have greater flexibility to pass higher rates to their customers.

The BOJ's exit from its negative interest rate policy will boost the profitability of country's banks, Nozomi Moriya, Japan equity strategist at UBS Investment Bank, said during a March 18 media briefing. "We also think that the inflation and the nominal economic growth in Japan will lead to the expansion of domestic loans for Japanese banks," Moriya said.

Loans at major and regional lenders grew more than 3% year over year each month between July 2023 through February, according to BOJ data. Major lenders, including the three megabanks, recorded strong demand, with 3.8% year-over-year growth in January and February. Regional banks increased loans by 3.2% and 3.1% during the same two months, BOJ data shows.

Further hikes likely

Economists expect the BOJ to continue to further raise its benchmark rate.

Takahide Kiuchi, executive economist at Nomura Research Institute, forecasts that the rate will go up to around 0.5% by next year. "That could be an immediate terminal rate," Kiuchi said, adding that the US Federal Reserve's potential rate cuts and an economic slowdown in and outside Japan could prevent the central bank from being more hawkish with monetary policy.

Masamichi Adachi, chief Japan economist at UBS Investment Bank predicts the BOJ will be more hawkish. "For the next couple of years and nominal GDP grows at 3% ... so I believe the BOJ policy rate should be more than 1% sometime in 2025 to 2026," Adachi said.

A negative of higher rates could be an increase in unrealized losses for banks from their investment in government bonds. MUFG, for example, shouldered a latent loss of ¥77.1 billion in government bond holdings as of December 2023, while SMFG and Mizuho posted a similar loss of ¥50.6 billion and ¥22.2 billion in their assets, respectively, at the same time as yields rose following tweaks to the BOJ's yield curve control policy.