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US Fed's rate cut poses challenges for Japanese megabanks

The US Federal Reserve's recent interest rate cut is likely to create headwinds for Japanese megabanks, as it could squeeze overseas loan spreads and slow the Bank of Japan's monetary policy normalization.

The Fed on Sept. 18 announced it would lower the federal funds rate by 50 basis points to a range of 4.75% to 5%. This is the first rate cut the US central bank in more than four years, and the Fed is expected to cut rates further by the end of the year.

The Fed's recent rate cut "would have a sizable impact on [the megabanks'] lending margins [outside Japan]," Toyoki Sameshima, a senior analyst at SBI Securities Co., told S&P Global Market Intelligence. "But that's just the first of some [rate] cuts."

Japanese megabanks — Mitsubishi UFJ Financial Group Inc., Sumitomo Mitsui Financial Group Inc. and Mizuho Financial Group Inc. — have all expanded into overseas markets in recent years, primarily in the US and Asia, to shore up their investment banking and financing businesses as Japan's eight-year negative rate policy peeled away their interest in domestic lending. While the banks do not specifically provide a regional breakdown of their profits, their lending data shows that about 40% of their overall outstanding loans were extended in overseas markets during the fiscal quarter ended June 30.

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At Mitsubishi UFJ Financial, loans booked in overseas branches grew to ¥49.1 trillion as of June 30 from about ¥44.1 trillion in the same quarter a year ago. Its overseas lending spread in the quarter ended June 30 was 1.42%, up from 1.25% during the same period in 2023.

Mizuho's loans outside Japan rose to ¥38.1 trillion from ¥36 trillion. Mizuho's overseas loan spread for the quarter was 1.13%, compared to 1.06% for the fiscal year ended March 31.

At SMFG, meanwhile, overseas loans increased to ¥38.9 trillion as of June 30 from ¥35.2 trillion a year ago.

"The Fed's rate cut will obviously be negative for [the megabanks] as they have much exposure to the US," said Hideo Oshima, a senior economist at the Japan Research Institute.

In addition, further US Fed rate cuts may pose as a headwind for the Bank of Japan's (BOJ's) push to raise interest rates since it will narrow the gap between the US' and Japan's interest rates, strengthen the yen against the US dollar and ease inflationary pressure in Japan. Such a move could slow possible BOJ rate hikes and create challenges for the megabanks' plans to raise lending rates at home.

Japan's central bank decided in late July to raise its policy rate to 0.25% from a range of 0% to 0.1% following its exit from its negative rate policy in March. It left the rate unchanged at the end of its two-day policy meeting this September.

"We do not believe that the outlook [for the US economy] has become more certain and that we should immediately raise rates," BOJ Governor Kazuo Ueda said at a press conference on Sept. 20, two days after the Fed rate cut. "The risk of an upward swing in inflation due to the yen's depreciation has somewhat decreased. ... We believe there is enough time to check before making policy decisions."

Tailwind

Japanese megabanks could benefit from lower US interest rates when they allocate cash to overseas bonds.

Lower rates that move inversely to bond prices would trim down unrealized losses in their overseas bond holdings, SBI Securities' Sameshima said. The megabanks tend to seek a capital gain from higher bond prices through their trading, while regional lenders seem to prefer an income gain from a higher coupon rate by holding bonds to the maturity, the analyst said.

Japanese banks bought a net ¥2.542 trillion of foreign bonds in August, turning around two straight months of a net sale, according to data from Japan's Ministry of Finance.

Lower US rates "would be a tailwind for [the megabanks'] bond investment," said Takahide Kiuchi, executive economist at Nomura Research Institute.

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