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Why Trump's policies will sink or save Japan's megabanks in 2017

With little improvement likely in Japan's domestic business environment in 2017, Japanese banks will be looking west -- and specifically to the policies of Donald Trump's new administration in the U.S. -- for either salvation or further sorrow.

The Bank of Japan's surprise adoption of a negative interest rate policy in February made 2016 a landmark year for Japan's financial industry. Although the three big banking groups -- Mitsubishi UFJ Financial Group Inc., Sumitomo Mitsui Financial Group Inc. and Mizuho Financial Group Inc. -- had managed to survive the preceding two decades of ultralow interest rates in Japan, the BOJ's move to negative rates further squeezed their already thin margins.

In the fiscal first half ended Sept. 30, the combined net profit of the megabanks fell 12% year over year to ¥1.208 trillion. For the full year to March 2017, Mitsubishi UFJ expects to take a ¥100 billion hit from negative rates, while Sumitomo Mitsui and Mizuho estimate an impact of ¥30 billion and ¥40 billion, respectively.

Japan's megabanks have diversified their businesses away from the country for more than a decade, and now each of them produces roughly a third of their income abroad. North America is one of two major foreign geographies for the banks, alongside Asia. Their combined outstanding loans in North America for the half year ended March 31 -- at a total of US$176.5 billion -- surpassed their combined loans in Asia for the first time in years.

The U.S. will be the most important focus for the megabanks in 2017, and probably their biggest growth area, according to Katsuyuki Hasegawa, chief market economist at Mizuho Research Institute. The focus by U.S. President-elect Donald Trump on tax cuts and infrastructure spending should be positive for the economy, although protectionist policies could undermine the global economy, and with it the hopes of the Japanese banks, Hasegawa said.

After Trump takes office, protectionist policies such as an import tariff hike may also emerge, which then would prompt retaliatory hikes by other nations, eventually leading to a drop in global trade, said Hajime Inoue, senior economist at the Japan Research Institute. "If it happens, the U.S. wouldn't be able to avoid being affected, in a heavily linked world," Inoue said.

The conciliatory tone in Trump's victory speech relieved many people worldwide, and tax cuts and infrastructure building, part of his campaign promises, are a big focus of the market now. But he also quickly declared his intention to exit the Trans-Pacific Partnership, a multination trade pact the U.S. has been negotiating with countries including Japan, and signaled he would oppose firms planning to move production out of the U.S.

While investors have flocked to U.S. equities, bond prices have fallen and the U.S. has increased interest rates, strengthening the dollar against most currencies, including the yen.

A weaker yen increases overseas earnings in yen terms, while a depreciation in the value of U.S. government bonds poses a potential problem to the Japanese megabanks, which own large quantities of U.S. government notes.

All three banks have kept full-year earnings guidance unchanged.

"The recent market rally does not seem to be based upon tangible facts, because at this stage, it's unclear what the Trump administration will really do; for example, how big tax cuts or infrastructure investments are going to be," Nobuyuki Hirano, president and group CEO of Mitsubishi UFJ, said during a Dec. 9 press conference in Tokyo.

"Whether it is realistic or appropriate to try to bring jobs back to the [United] States or protectionist trade policies is subject to further scrutiny," he warned.

Mitsubishi UFJ, the biggest of the three, has had a strong presence in the U.S. since the 1980s, mainly in California. The company is the eighth-biggest lender in the U.S. wholesale and regional lending market and has more than 6,000 people on staff. Roughly half of its foreign operating income, or about one-sixth of its entire operating income, comes from the U.S.

Meanwhile, Mizuho strengthened its presence in the U.S. with its 2015 purchase of Royal Bank of Scotland Group Plc's U.S. wholesale assets, including loans to about 200 non-Japanese corporate borrowers. "[Trump's] policy is still unclear. But if he really does what he said during his campaign, the economy and people's lives would see a huge impact," Mizuho President and Group CEO Yasuhiro Sato told reporters at an earnings press conference in November.

"Mr. Trump is unpredictable. We have to be prepared for all scenarios," said Takeshi Kunibe, president and CEO of Sumitomo Mitsui Banking Corp., a banking unit of Sumitomo Mitsui Financial Group, during a Dec. 15 press conference.

As of Dec. 27, US$1 was equivalent to ¥117.60.