Japanese banks, especially regional lenders, may continue to battle low profitability amid falling interest rates that are already among the lowest in the world, according to S&P Global Ratings analysts.
Japan's short-term rates are now at -0.1%, making it the only Asian economy to have a negative interest rate since its introduction in January 2016. Long-term rates are at zero. Regional banks' profits got a temporary lift in 2020 thanks to government stimulus measures. However, the regional banks' profitability will take a long time to recover because their problem of declining earnings capacity remains unresolved and credit costs are likely to rise, the ratings agency said in a report.
"Sectorwide lending rates are yet to hit the bottom," according to Ratings.
Regional banks need to restructure their revenue and cost structure to improve their profitability. They face intense competition in their home markets and highly competitive dynamics in metropolitan areas, Satoru Matsumoto, associate director for financial institutions ratings, said at a webinar July 15.
That means a continuous decline in profitability in terms of lending business. "Especially, the regional banks need to find a way to diversify their revenue sources, such as fee income, to compensate [for the] decline in interest income from the banking business," Matsumoto said.
Regional lenders got a boost from the government's large economic stimulus in 2020, Ratings said. The Bank of Japan is committed to purchasing corporate paper and bonds until the end of September, with a limit of ¥20 trillion. Still, the analysts said that "it will take time" for regional banks to recover their profitability due to fundamental challenges in their earnings capacity as well as higher credit costs than before the COVID-19 pandemic.
Japan's central bank expects real gross domestic product growth for fiscal 2021 to range between 3.3% and 4.0%. In 2020, the country's GDP contracted 4.8%, according to government data.
Meanwhile, elevated credit costs at Japan's five major banking groups — Mitsubishi UFJ Financial Group Inc., Mizuho Financial Group Inc., Sumitomo Mitsui Financial Group Inc., Resona Holdings Inc. and Sumitomo Mitsui Trust Holdings Inc. — may return to pre-pandemic levels, the analysts said. "The COVID-19 shock is of a moderate magnitude to banks, thanks to the government support for the economy," according to Ratings.
Japan's megabanks have been facing weakening credit quality of domestic borrowers, having reported the highest nonperforming loan ratios in more than three years for the first three months of 2021.
The Ratings analysts also expect the five major banks' earnings to grow 5% to 10% annually over the next two years, although this recovery scenario will be significantly influenced by any weakening of borrowers' credit quality as well as irregular market conditions, such as rising foreign-currency funding costs.
As of July 14, US$1 was equivalent to 110.07 Japanese yen.