Japan Banking Sector | Japanese Banking Industry | Bank Regulatory Environment | Financial Services Agency (FSA)

Japan – Banking Sector

Japanese banking industry

Japan's traditional banking system was segmented into clearly defined components in the late 1980s: commercial banks, long-term credit banks, trust banks, mutual loan and savings banks, and various specialized financial institutions. During the 1980s, a rapidly growing group of nonbank operations—such as consumer loan, credit card, leasing, and real estate organizations—began performing some of the traditional functions of banks, such as the issuing of loans.

In the early postwar financial system, city banks provided short-term loans to major domestic corporations while regional banks took deposits and extended loans to medium-sized and small businesses. Neither engaged much in international business. In the 1950s and 1960s, a specialized bank, the Bank of Tokyo, took care of most of the government's foreign-exchange needs and functioned as the nation's foreign-banking representative. Long-term credit banks were intended to complement rather than to compete with the commercial banks. Authorized to issue debentures rather than take ordinary deposits, they specialized in long-term lending to major keiretsu.

Trust banks were authorized to conduct retail and trust banking and often combined the work of commercial and long-term credit banks. Trust banks not only managed portfolios but also raised funds through the sale of negotiable loan trust certificates. Mutual loan and savings banks, credit associations, credit cooperatives, and labor credit associations collected individual deposits from general depositors. These deposits were then loaned to cooperative members and to the liquidity-starved city banks via the interbank money markets or were sent to central cooperative banks, which in turn loaned the funds to small businesses and corporations. More than 8,000 agricultural, forestry, and fishery cooperatives performed many of the same functions for the cooperatives. Many of their funds were transmitted to their central bank, the Norinchukin Bank, which was the world's largest bank in terms of domestic deposits.

Operating profile :-

Money supply grew steadily while lending rate continued to fall. Due to quantitative easing, the growth of monetary aggregates in Japan continued to climb. As of the end of Q3 2015, the broad money M3 totaled JPY1,227.1 trillion, an increase of 3.1% year-on-year. In the context of loose monetary and credit environment, the lending rate of financial institutions continued its downward trend. The annualized yield of short-term and long-term loans of Japanese banks was 1.1% and 0.8% respectively, down 0.1 percentage points.

The loans and deposits grew moderately with the growth of deposits generally higher than the growth of loans. As of the end of August 2015, the outstanding loans of Japanese banks totaled JPY465.9 trillion, up 3.5% from a year earlier; the outstanding loans of major banks (five banks) totaled JPY188 trillion, up 2.6% from a year earlier; the outstanding loans of regional banks grew by 3.6% from a year earlier to JPY179.8 trillion; the outstanding loans of class 2 regional banks totaled JPY47.5 trillion, an increase of 3.1% year on year. In terms of deposit performance, the deposit balance of Japanese banks totaled JPY674.9 trillion, up 4.3% from a year earlier; the deposit balance of major banks (five banks) totaled JPY302.9 trillion, an increase of 5.6% year on year; the deposit balance of regional banks grew by 3.0% to JPY242.8 trillion; the deposit balance of class 2 regional banks totaled JPY63.4 trillion, up 1.8% year on year.

Profit growth slowed while asset quality improved. In Q3 2015, the three G-SIBs in Japan reported total net profit of JPY2.75 trillion, up 1.3% year on year, but the growth fell by 0.17 percentage points from the previous quarter; the non-performing assets totaled JPY3,422.9 billion, a decrease of JPY139.6 billion from Q2; NPL ratio fell from 0.54% to 0.51%, down 1.6 percentage points from a year earlier; the average CAR of the three G-SIBs reached 16.3%, up 0.8 percentage points.

Regulatory environment :-

The Financial Services Agency (FSA) demanded the three financial groups to enhance their own capital base and reduce the cross shareholding with companies. Although the CAR of three major banks averaged up to 15%, the FSA required them to further increase CAR to guard against unpredictable risks at they expand their overseas business. Meanwhile, due to historic factors and the characteristics of the social and economic growth, the three financial groups have been cross holding shares with companies. In order to mitigate the risks caused by volatile share prices, the FSA explicitly required the three major banks to cut cross shareholding with companies in September. Currently the three major banks have announced their reduction plans under which an estimated JPY2 trillion will be reduced over the next 3-5 years. Though the FSA has no explicit requirement on local banks, so far at least nine local banks have set their reduction targets and 24 local banks have indicated they will clarify the selection criteria on the cross shareholding companies.

Local banks face pressure as the government continues to promote M&A. The booming stock market is currently driving up the performance of banks. However, the structural contradictions such as negative growth of population and stagnant local economy are still severe. According to FSA estimate, 80% of local banks will see performance decline in 2017 and the situation will be more challenging in the next decade. In September, FSA said that it will adopt quantitative indicators to assess the local banks and make them consider the sustainability of their business model. It will also continue to pressure the local banks to engage in M&A activities through benchmarking with peers. In addition, the FSA required the local banks to enhance financing support to local SMEs and is assessing whether banks have provided the right financing service based on corporate needs from the perspectives of companies.

The IPO of Japan Post will have impact on the landscape of the banking industry in the middle and long term. Japan Post has total deposits of JPY177 trillion, higher than JPY152 trillion of MUFG, Japan’s largest commercial bank; Japan Post has over 24000 outlets across the country, while MUFG has 931 outlets. Despite all the advantages, Japan Post, as a state owned financial institution, has been lagging behind commercial banks in terms of both asset structure and business model. 51.8% of its assets are in Japanese government bonds and only 1.3% are in loans. The shareholding reform and IPO of Japan Post is set to have potential impact on the current landscape of the banking industry in Japan.

Outlook :-

Following the YoY growth of -0.7% in Q2, the growth of real GDP in Japan fell to -0.8% in Q3 2015. The equipment investment declined by 1.3% from the previous quarter, the second fall in a row. While retained profit hit new record, the investment sentiment of corporate remained subdued. As the JPY stays at low level, the banking industry will face increasing operating pressure. Given the estimated challenging operating environment of the banking industry in 2016, and in the context of aging population, weak economic recovery and low interest margin, the M&A of local banks will become more prevalent with the strong support of FSA. Japanese banks will continue to rely on such strategies as expanding overseas business and increasing non-interest income.

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