Daniel Tabbush hascovered banks in Asia for 20 years, most recently as head of Asian bankresearch at CLSA. The following does not constitute investment advice, and theviews and opinions expressed are those of the author and do not necessarilyrepresent the views of S&P Global Market Intelligence.
Negative interest rates, coupled with rising credit costs,could hit Japanese bank earnings hard.
With Bank of Japan's adoption of a negative interest rate policy, banks inthe country are basically being charged to park their excess deposits. Giventhat Japanese lenders are incredibly liquid, this can be significant. Limitedeconomic growth in Japan has meant little demand for credit. At the same time,banks have continued to take in deposits, thereby creating a rising surplus ofexcess funds.
The combined cash and cash equivalents at the country'sthree mega banks — Mitsubishi UFJFinancial Group Inc., Mizuho Financial Group Inc. and —and Resona HoldingsInc. ballooned to ¥138.455 trillion as Dec. 31, 2015, from ¥84.043trillion as of March 31, 2014, according to SNL Financial data.
But while Japanese banks have grown their cash balancessignificantly, their loan balances have not moved in tandem.This is important because loan yields will obviously have a higher yield thannegative rate the Bank of Japan applies to some excess deposits from banks.
The four large Japanese banks' combined gross loans totaled¥292.457 trillion at Dec. 31, 2015, compared to ¥266.170 trillion at March 31,2014. Not only are cash and cash equivalents sizable compared to loans, buttheir change has been far greater. The oversized increase of excess liquiditycompared to loans could not come at a worse time. If Japan's banks were to seea contraction of cash and cash equivalents, making balances low compared toloans, the impact of negative interest rates would not be so dire.
In addition, there is little margin buffer to absorbnegative interest rates. Net interestmargins at Japanese banks are some of the lowest in the world, and certainly inAsia-Pacific. This is partly due to how they operate, which is not as muchabout maximizing profit as about supporting companies in their groups.
Risk-based pricing of loans has never been tantamount tobanking in Japan, at least not in the way it is in most other countries. Thisis one reason banks have very low net interest margins. For the four largestJapanese banks, net interest margins averaged just 0.78% for the quarter endedDec. 31, 2015.
While net interest margins will likely further narrowerunder the negative interest rate regime, there will also be a knock-on impacton loans. With Japan's move to a negative interest rate policy, wheregovernment bond yields are even negative, there will be some feed-through tovariable loan rates.
But this is not the end of it; there are credit costs tothink about. Nonperforming loans havebeen benign for some time, but it appears that this may be changing. Bankingremains cyclical and it is rare for credit costs to remain at nil forever. Inthe case of Japan, a rise in credit costs could be detrimental given theensuing pressure on net interest margins, and in turn, the most core incomeitem: net interest income.
In the fiscal year ended March 31, 2014, credit costs at allfour major banks were negative, with the lenders booking gains, rather thanlosses, from the item, according to SNL Financial data. In the subsequentfiscal year ended March 31, 2015, Resona was the only bank among the four thathad credit costs in reversal. By the quarter ended Dec. 31, 2015, SMFG andMizuho Financial saw far higher credit costs to loans. Resona still had creditcosts in reversal, but the magnitude was less than in the fiscal year endedMarch 31, 2015. Only MUFG saw an improvement for the quarter, although itscredit costs as a proportion of loans were still the second highest among thefour banks.
The risk is that with a weak economy domestically, as wellas slumps in China and the EU, it becomes more normal for Japanese banks toactually incur losses from credit costs. This means credit costs at the fourbanks could rise to 0.20% of loans from 0.06% at the end 2015.
The impact on earnings can be acute. Because of theirincredibly low net interest margins, the four large Japanese banks' return onaverage assets was 0.41% on average for the quarter ended Dec. 31, 2015. Withpressure from the Bank of Japan's charge on excess funds, combined withpressure from more normalized credit costs, there is a considerable risk tobanks' earnings.
SNL Financial is anoffering of S&P Global Market Intelligence.
As of May 4, US$1 wasequivalent to ¥106.95.