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Japanese banks face higher credit risk from accelerated transition financing


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Japanese banks face higher credit risk from accelerated transition financing

Japanese lenders' plans to step up support for the government's climate goals expose them to greater credit risks, as such funding could put them in uncharted territory.

This dilemma was highlighted when Mizuho Financial Group Inc. announced April 3 that it would boost its planned climate change-related investments and loans over the next decade to ¥50 trillion, four times its previous target of ¥12 trillion. With its new commitment, Mizuho Financial leads Japanese megabanks Mitsubishi UFJ Financial Group Inc. (MUFG) and Sumitomo Mitsui Financial Group Inc. (SMFG) in decarbonization financing.

"Financing net-zero projects could result in bad debt because those would be a daunting task to pursue, and you can't figure out risk [of a failure] from them," said Yoshihiro Fujii, an executive at the Research Institute for Environment Finance.

Japan aims to cut its greenhouse gas emissions 46% below 2013 levels by 2030 and to reach net-zero by 2050. As the country works toward these goals, analysts have noted risks from the uncertainty over developing new technologies to reduce and eliminate pollution. Banks also face risks from conventional emissions-producing projects becoming stranded assets, or from those that suffer premature write-downs, devaluation or risk becoming liabilities.

Loan-loss provisions

To address transition risks, 110 Japanese banks will need to allocate ¥7.2 trillion in loan-loss provisions between now and 2050, according to an analysis by the Japan Center for Economic Research (JCER). That amounts to about ¥250 billion per year, 40% of which will come from the three megabanks, the think tank said in a February report.

Japan's three largest banks do not specify how much of their loan-loss provisions are for decarbonization.

"We acknowledge there is the great possibility of being exposed to the transition risk" when financing coal, oil or gas projects, Mizuho said in an April 3 sustainability report.

Banks usually finance projects like coal plants by partnering with peers to spread the risk, said a manager at one of the megabanks, speaking anonymously. "Betting on such a project would be risky, but we can't get away from it because that is infrastructure for our country," the manager said.

Bigger goal

Mizuho's ¥50 trillion in planned climate financing exceeds targets by Japan's other two megabanks. MUFG aims to provide ¥35 trillion in climate-related financing between fiscal 2019 and fiscal 2030. SMFG plans to invest ¥30 trillion from fiscal 2020 to fiscal 2029, according to company data.

But some environmentalists criticize the banks' climate commitments for not aligning with pathways to net-zero emissions by 2050, such as International Energy Agency scenarios. The banks are signatories to the Net-Zero Banking Alliance.

"In particular, megabanks lag far behind their global peers, which have policies to limit support for new oil and gas development projects," said Eri Watanabe, an Australian lobbyist with Market Forces, in an April 13 joint statement by four environment organizations. "To fulfill their own commitments, they must act immediately to set short- and medium-term targets and investment and financing policies that are aligned with their long-term net-zero goal."

The groups asked the banks to disclose how they will align lending and investment with the Paris Agreement's target of limiting warming to 1.5 degrees C, which requires net-zero by 2050.

Bigger hit

Climate-related credit costs may hurt regional banks more as their margins are thinner and they finance cash-sucking or slower transition sectors such as transportation, steel and vehicles spread into local areas, JCER said, noting that their loan-loss provisions are higher than the megabanks and the bigger trust banks.

Their loan-loss provisions accounted for 14% to 17% of their five-year average operating net profit between fiscal years 2015 and 2021, excluding 2019 and 2020, when the COVID-19 pandemic hit their earnings, according to JCER. That is compared with 5% for major banks including the big three lenders and trust banks, it added.

Higher credit costs will squeeze profits at regional banks more than major banks, "possibly pressing them to consider the consolidation in the industry for survival as they are already mired in declining populations and the decade-long monetary easing," Ikuko Samikawa, principal economist at JCER, said.

Even for major banks, "the 5% credit cost of their operating net profit won't be small," Samikawa told S&P Global Market Intelligence. "It won't be easy to generate that portion of the operating net profit, given the current low interest rates."

Stranded assets

As the world transitions toward low emissions, fossil fuel users and their investors face growing financial risks, including the prospect of stranded assets.

The estimated global net value of stranded assets in coal power generation through 2050, for example, ranges from $1.3 trillion to $2.3 trillion, according to a study by Massachusetts Institute of Technology.

"There is a risk that you can't assess a business falling into a decline," said Takahide Kiuchi, an executive economist at Nomura Research Institute.

As Japanese banks are eager to finance decarbonization projects, the more they finance such projects, the greater credit risk they could face. Decarbonization projects are risky and carry uncertainties, such as transition, or the risk of being unable to develop new technologies toward decarbonization or stranded assets.

As of May 24, US$1 was equivalent to ¥139.11.