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Japan Banking Outlook 2021: Expect Rising Credit Risks


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Japan Banking Outlook 2021: Expect Rising Credit Risks

S&P Global Ratings expects the COVID-19 shock and its aftermath to dominate the credit outlook for Japan's banking industry in 2021. We think the real test of banks' asset quality will come in 2021 or later. The gradual end of fiscal and monetary support measures will reveal the true impact of COVID-19 on borrowers.

The pandemic dealt a significant shock to Japan's economy and those of other major developed countries in 2020. However, considerable and swift government support measures for the corporate and household sectors kept corporate bankruptcies steady--both in number of entities and aggregated amount of liabilities. The increase in banks' credit costs was also below the level normally estimated for an economic plunge of this magnitude.

However, the support packages are temporary, and the corporate sector's ability to repay debt is weakening amid declining revenues and profits. We believe accumulated risks in bank credit may emerge later, two to three years after support measures end, especially given our projection of a weaker economic recovery in Japan than in other key economies.

COVID-19 Hit To Lead To Slow Recovery In 2021

Japan's economic growth rate dropped significantly in 2020, as it did elsewhere. Chart 1 shows Japan's GDP growth rate over the medium and long term. Before the outbreak of COVID-19, the growth rate was generally positive following introduction of the Bank of Japan's negative interest rate policy in the first quarter of 2016, except for quarters affected by extreme weather, including widespread flooding, or the hike in consumption tax. In 2020, the growth rate became highly volatile as the pandemic took hold. The third quarter of 2020 saw growth, partly due to a rebound from a plunge in the preceding three months and a partial resumption of economic activity. However, we expect results for the fourth quarter of 2020 will show GDP shrank again because of the resurgence of the pandemic in the country, which has reapplied the brakes to economic activity.

Chart 1


Table 1 shows economic growth forecasts for countries to which S&P Global Ratings assigns the same Banking Industry Country Risk Assessment (BICRA) score as Japan, as well as growth forecasts and scores for other major economies. While contractions in Japan's economy and others in 2020 will be generally comparable, we expect Japan's growth to be sluggish in 2021 and thereafter due to weak consumption in the household sector.

Table 1

Japan Forecast To Recover Slower Than Other Economies
GDP growth rates and S&P Global Ratings' Banking Industry Credit Assessment scores
BICRA Real GDP growth (%)
BICRA Group Economic Risk Score/Trend Industry Risk Score/Trend 2019 2020 (f) 2021 (f) 2022 (f) 2023 (f)
Peer Group 3
Japan 3 2/Stable 4/Stable 0.7 (5.5) 2.7 1.3 0.9
U.S. 3 3/Negative 3/Stable 2.2 (3.9) 4.2 3.0 2.1
U.K. 3 4/Negative 3/Stable 1.3 (11.0) 6.0 5.0 2.4
France 3 3/Negative 3/Negative 1.5 (9.0) 6.2 4.4 2.5
Australia 3 3/Negative 3/Stable 1.8 (3.4) 4.0 3.2 2.6
South Korea 3 3/Stable 4/Stable 2.0 (1.0) 3.6 3.2 2.6
Other major countries and regions
Global NA NA NA 2.8 (4.0) 5.0 4.0 3.6
Asia-Pacific NA NA NA 4.6 (2.0) 6.8 4.7 4.6
Eurozone NA NA NA 1.3 (7.2) 4.8 3.9 2.2
China 6 7/Stable 5/Stable 6.1 2.1 7.0 5.0 5.0
Hong Kong 2 3/Stable 1/Stable (1.2) (5.8) 4.8 2.9 2.2
Singapore 2 3/Stable 2/Stable 0.7 (6.1) 6.0 3.0 2.5
Germany 2 1/Negative 3/Negative 0.6 (5.6) 3.7 3.2 1.9
f--Forecast. NA--Not applicable. Source: S&P Global Ratings.

Here, we analyze recent financial conditions in the corporate sector (excluding the financial and insurance sectors) that will significantly affect banks' future asset quality. Chart 2 shows the year-on-year rate of change in total revenues and current profits from the third quarter (July-September) of 2019 to the same period in 2020. Both figures decrease significantly. Chart 3 shows the net debt ratio (= (total debt – cash and deposits) / total assets) and liquidity ratio (= (Avg. of cash and deposits + of marketable securities) / (sales x 4) for the corporate sector in Japan. In contrast to decreasing corporate earnings, the latest net debt ratio is barely 0.2 percentage point higher than a year earlier. Also, the liquidity ratio has improved more than 4 percentage points recently. This suggests that, in general, Japan's corporate sector is increasing cash on hand (including deposits) to prepare for emergencies while also increasing liabilities (mainly bank borrowings). This trend is also shown in bank lending, which increased about 6% year on year in the most recent financial results for fiscal 2020's first half (ended Sept. 30, 2020).

Chart 2


Chart 3


Government Support Curbed Banks' Credit Costs

Chart 4 shows medium- and long-term trends in corporate bankruptcies before and after the outbreak of COVID-19. Thanks to the government's support package for the corporate sector, the number of corporate bankruptcies has not increased since 2020.

Chart 4


On the other hand, at this stage we estimate the credit cost ratio (= credit costs / loans) for Japan's banking sector in fiscal 2020 (ending March 2021) will be 0.45%. We base this on analysis of the relationship in historical data about the credit cost ratio and the nominal GDP growth ratio. Charts 5 and 6 show the relationship between credit costs and the nominal GDP growth ratio, and its regression analysis. We took into account not only the results of quantitative regression analysis for a statistically significant period (fiscal 2006 to fiscal 2019) but also, from a qualitative perspective, the credit costs ratio during a few significantly stressed periods, such as after the Great East Japan Earthquake in 2011 and the financial crisis of 2007-2008. Even so, our estimated credit costs ratio of 0.45% is higher than and different from the actual results of Japan's three major banking groups (Mitsubishi UFJ Financial Group Inc., Mizuho Financial Group Inc., Sumitomo Mitsui Financial Group Inc.) and regional banks (64 entities) in the first half of fiscal 2020, as Chart 7 indicates. At this stage, we believe this difference stems from the government's support measures for the corporate sector, which led to the difference of the estimated credit costs that can normally be seen in stressed times and actual costs. Also, we understand the difference in actual results between the three major banking groups and regional banks is due to a difference in the forward-looking approach to set aside loan loss provisions (including overseas subsidiary banks).

Chart 5


Chart 6


Chart 7


Table 2 shows a list of financial support measures to mitigate the shock of COVID-19. Japan's government has provided a wide range of measures for both large corporations and small and midsize enterprises (SMEs)--the total facility amount of ¥124 trillion being equivalent to about 22% of Japan's nominal GDP. Prefectural government support loans, executed by private financial institutions with government or prefectural subsidies, account for about the half of the financial support the government has provided. In the period from April to September 2020, the balance of 100%-guaranteed obligations (average: sum of the balance at the end of each month divided by the number of months) that the National Association of Credit Guarantee Companies provided was ¥13.4 trillion. This amount includes a "safety net" guarantee.

Table 2


Charts 8 and 9 show S&P Global Ratings' estimates for the credit cost ratio and growth of loans (between fiscals 2019 and 2021). We expect the credit cost ratio to decline in fiscal 2021 because we have incorporated our main macroeconomic scenario, which is that economic conditions will start to recover in many countries from mid-2021. In addition, considering the corporate sector already has sufficient liquidity, we expect the growth rate of banks' outstanding loans to decline in fiscal 2021.

Chart 8


Chart 9


Government Support Is Temporary, And Reduced Debt Servicing Capacity May Be An Emerging Risk

Most financial support measures related to the COVID-19 shock are temporary. For example, support loans from the government and prefectures are virtually interest free--the interest being government-subsidized--and such loans accounted for about 80% of the total facility amount. However, the period in which interest will be subsidized is mostly limited to three years after loans are implemented. If a borrower's ability to repay is not restored within three years, they will be subject to a heavy burden of interest on newly accumulated loans (in most cases, the terms include no (partial) principal payment for the first five years, and the final maturity is 10-15 years or 20 years).

As these measures are temporary, it is inappropriate to treat them as extendable and incorporate their long-term effect into our analysis of banks' creditworthiness. If the government were to roll over the financial support measures at the three-year mark, it would have a short-term positive impact on financial conditions and the creditworthiness of private financial institutions and the corporate sector. However, in that case it would become more of a measure to support a structurally ailing corporate sector, rather than temporary assistance, and it may distort the competitive environment of various industries, likely negatively affecting industry and the country's economy in the medium to long term. In addition, there are costs associated with implementing various financial support measures. As a result, the government may try to scale back the support, from the perspective of pursuing its own fiscal soundness.

We believe Japanese banks will need to develop the ability to identify industries and companies that are viable over the medium to long term. In 2020, the pandemic focused much attention on the impact on banks' creditworthiness. However, two significant issues affected Japan even before the outbreak:

  • Slow digital transformation, including at large corporations, and
  • Banks' inability to charge enough interest on SME loans to cover possible credit costs and capital costs, partly because the productivity of SMEs is low and their financial capacity to pay such high margins is generally limited (this is also partly due to significant competition in the banking industry).

In short, the weak performance of borrowing companies is not a temporary phenomenon, and it is necessary for banks to be aware of the changing dynamics of international competition, where companies' strengths are shifting to effective investment in intangible assets from tangible assets. In other words, there is a persistent issue: Even large companies in Japan sometimes lag in responding to structural changes brought on by digital transformation.

Fintech's Growing Importance

Banks themselves face surging competitive pressure to survive in the era of fintech. Japan's financial markets will likely change drastically as fintech develops, given the following unique conditions of the country:

  • A geographically fragmented banking system between major banks and regional banks, and
  • Surplus funds in the private sector (household and corporate), which saves more than it spends.

In many countries, we see active adoption of fintech increasing the financial depth and frequency of transactions--especially asset management and plain vanilla market transactions--while lowering costs. Nonbank entrants involved in cash settlements and payments are also an increasing presence. Furthermore, in many cases, digitalization of bank documentation saves customers from cumbersome paper processing and reduces banks' operational costs (see "Fintech Can Revive Japan’s Regional Banks," published Jan. 14, 2021).

In addition, banks will need to invest money and resources to make effective use of fintech. Therefore, apart from boutique-type banks with a focused product offering or new nonbank entrants, large banks are likely to be more competitive in the fintech era. This is because they have two advantages over smaller counterparts: budget and customer base. On the other hand, the legacy of being large organizations with rigid corporate cultures will challenge large banks' abilities to develop fintech.

Likewise, companies that do not meet customer demand will come under pressure. It will be essential for banks to use fintech to streamline operations and make life easier for customers.

Other Risk Factors

  • The degree to which each bank's risk appetite increases as they work to compensate for falling profits amid flattening yield curves globally;
  • The extent of the increase in Japanese banks' foreign currency-denominated assets, which would raise foreign currency risk in terms of funding and liquidity; and
  • The harm to the Japanese banking system that might arise from contagion if there is a significant decline in regional banks' core earnings.

As vaccine rollouts in several countries continue, S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic and its economic effects. Widespread immunization, which certain countries might achieve by midyear, will help pave the way for a return to more normal levels of social and economic activity. We use this assumption about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: As the situation evolves, we will update our assumptions and estimates accordingly.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Ryoji Yoshizawa, Tokyo + 81 3 4550 8453;
Secondary Contact:Chizuru Tateno, Tokyo + 81 3 4550 8578;

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