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Bank of Japan's policy tweak to offer limited comfort to lenders

TheBank of Japan'slatest decision not to deepen negative interest rates has given a short respiteto the country's lenders, which had feared another rate cut amid already razorthin interest margins, though their business environment remains as difficultas it had been.

TheBOJ on Sept. 21 saidit will maintain the minus 0.1% rate applied on some reserves held bycommercial banks, while seeking to keep the yield on 10-year government bondsat around zero percent by controlling the purchase amount of such bonds. Theyield on those notes has been below zero since the central bank adoptednegative rates in February.

Thedecision was received positively at first, boosting the share prices of Japan'sthree megabanks — Mitsubishi UFJFinancial Group Inc., Mizuho Financial Group Inc. and The three closed Sept. 21 up 7.3%, 6.9% and 7.3% from the previous day,respectively. But that cheer dissipated quickly, and the banks' share priceshave since retreated, giving up most of those gains.

"Certainlyit was good for banks that the BOJ didn't cut its policy rate further. Butthat's the absence of an additional negative rather than a positive thatalleviates the existing pressures on the industry," said David Threadgold,an analyst at Keefe Bruyette & Woods.

Onepotential bright spot of the policy decision for lenders is that the centralbank admitted there were side effects to its negative interest rate policy,Koichi Fujishiro, a senior economist at Dai-ichi Life Research Institute, toldS&P Global Market Intelligence.

"Wesaw that buying a large volume of government bonds and imposing a negativeinterest rate at the same time significantly affected the yield curve,"BOJ Governor Haruhiko Kuroda said during a press conference after theannouncement. Kuroda also noted that the flattening of the yield curve may havehad a negative impact on the economy.

Afurther cut to the policy rate is unlikely after these comments by Kuroda andthe language in the BOJ release, Fujishiro said.

Buteven without a deepening of negative rates, the business environment forJapan's banks remains tough. Negative rates have not created new loan demand,as interest rates have already been very low for a prolonged period, saidTakeshi Kunibe, president of Sumitomo Mitsui Banking Corp. and chairman of theJapanese Bankers Association. Kunibe on Sept. 15 attributed the 4.9% yearlyrise in the combined value of outstanding loans by Japanese banks in August tobanks' efforts to cover thinning margins, not the BOJ's policies.

SumitomoMitsui Financial Group's domestic interest margin fell to 1.12% in the Junequarter from 1.21% a year ago, while the margin at Mitsubishi UFJ fell to 0.92%in the June quarter from 1.02% a year ago.

Another threat facing Japanese banks is the potentialappreciation of the yen, which could arise from a reduction in the volume ofJapanese government bonds purchased by the BOJ.

Beforeits most recent policy statement, the central bank had been purchasing ¥80trillion of government bonds per year since October 2014. The BOJ's steadypurchase of domestic government bonds has helped keep Japan's long-terminterest rates low by buoying bond prices.

Tosteepen the yield curve, the central bank has now abandoned its numericaltarget for the expansion of the monetary base, freeing itself up to buygovernment bonds more flexibly depending on where yields are. A fall ingovernment bond purchase volume to raise yield and long-term interest ratescould lead to an appreciation of the yen, eroding banks' overseas profit.

Assuch, the BOJ's yield curve control may eventually lead to a deepening ofnegative rates, as that is the only real weapon it can still wield to combat asharply stronger yen, with quantitative easing not working very well in thatregard, said Katsuyuki Hasegawa, chief market economist at Mizuho ResearchInstitute.

Despitewhat appears to be an about face on negative interest rates, Kuroda did pointout during the press conference that the central bank is prepared to makefurther rate cuts. That may be a warning against a sharp appreciation of theyen, Fujishiro said.

Thusthere has been little change in what banks can do to stay afloat, Hasegawasaid. It remains essential for Japanese lenders to diversify from interestincome and in terms of asset classes and the countries where they operate.

As of Sept. 28, US$1 wasequivalent to ¥100.73.