The Economist, 5 January 2006
THE world's biggest bank, with $1.6 trillion of assets, opened for business on January 4th, and you are forgiven a few trips of the tongue before you can say “Bank of Tokyo-Mitsubishi UFJ” as readily as “Citigroup”, the number two. The new entity is the core bank of Mitsubishi UFJ, formed last autumn and one of three huge groups that now dominate retail banking in Japan. All are the products of mega-mergers. Mizuho, the second-biggest group, was formed in 2000 by crunching together Industrial Bank of Japan, Dai-Ichi Kangyo Bank and Fuji Bank; Sumitomo Mitsui grew in 2001 out of the merger of Sumitomo Bank and Sakura Bank. All these entities at the time were in the greatest distress, and deep concerns about the state of the financial system occasioned government intervention on a vast scale.
What a difference time, lashings of public money and strong-arming by regulators have made. At the peak, in 1986, Japan's top banks made up over a quarter of the Topix stockmarket index by capitalisation. At the nadir, in April 2003, when the sky still looked like falling, they accounted for just 2.7%. Since then, however, bank share prices have risen up to 16-fold (see chart); banks have been the engine driving Japan's stockmarket to five-year highs. Meanwhile, bad loans have been written off and losses turned to profit. Last autumn the banks announced record first-half profits. Mitsubishi UFJ alone expects full-year profits of ¥520 billion ($4.4 billion) in the year to the end of March.
Now banks are even thinking of expanding overseas for the first time since their sharp retreat in the Asian financial crisis of 1997-98. This week Bank of Tokyo-Mitsubishi UFJ was said to be thinking about investing $300m in the state-run Bank of China—which would be the first Chinese stake of any big Japanese bank. Many analysts and investors express a growing confidence that the megabanks have not only turned the corner, but have a sunny path before them. Are they right?
Certainly, the banks are far healthier than they have been in a long time. At the end of March 2002, the big banks' ratio of bad to total loans stood at 8.4%. The government subsequently gave them until March 2005 to cut the number by half. The banks beat that, bringing the ratio down to 2.9%, and by last September to 2.4%. At the same time, banks have rebuilt their capital. Today, capital-adequacy ratios stand at 11%, comfortably above the 8% required for international banks.
Of course, none of this would have been remotely possible without government help, which is now being repaid. Mizuho expects to repay its remaining ¥600 billion in public funds this year, and Mitsubishi UFJ and Sumitomo Mitsui expect to take a year or so longer to repay their remaining aid, ¥820 billion and ¥1.1 trillion respectively. Both profits and the ability to repay bail-out money have been greatly boosted by a recovering economy, which has allowed the banks to write back big amounts of bad-loan provisions.
There are lingering health concerns. One is over information-technology systems—the reason why this latest merger was put off by three months, so as not to have a repeat of glitches that plagued Mizuho. Another is the scale of non-recourse lending by banks to property funds. But by and large, says Toshihide Endo, director of the major-banks division at the supervisory bureau of the Financial Services Agency, banks have now “put their past problems behind them at last, and have managed to get to the point where they can build strategies for the future.”
And the strategies? Awkward question. Given that so much of the banks' recent profits comes from provisioning write-backs, profitability remains abysmally low by international standards. In the core business of lending to corporations, the market is still topsy-turvy: the weakest credits pay a lower rate of interest than stronger ones, partly because the maturity of such loans is shorter, but largely because to demand more would send many weak companies to the wall. Profitability from lending will presumably improve when the central bank finally abandons its policy of zero interest rates, perhaps next year. At that point, lending rates would rise faster than would deposit rates, and banks would pocket the spread.
But almost everybody expects companies to raise money more from debt markets in future, by-passing the banks. That is why the big three are looking increasingly at lending to small and medium-sized enterprises (SMEs) and to catering better to retail clients, a class wretchedly treated hitherto. Sumitomo Mitsui, in particular, is focusing on SMEs with less than ¥1 billion in annual sales. The bank no longer demands collateral, but runs sectoral portfolios of loans. It promises to respond to requests within three days, with loans of up to ¥50m. This type of lending has grown fast, much of it simply poached from smaller local banks. As for the longer-term potential of SMEs, Koyo Ozeki, credit analyst in Tokyo at PIMCO Japan, an international bond-fund manager, points out that such lending will not necessarily be an automatic answer for the banks, because of the pressure of competition on interest margins.
Hope is therefore fixed on retail banking, the former poor relation, to generate not just interest income but welcome fees. Drab branches are slowly being tarted up, renamed consulting centres. Some are even open at weekends. There has been some success selling new products: Sumitomo Mitsui, for example, has made a go of selling cast-iron dollar bonds, such as those issued by the World Bank, as well as bond and equity mutual funds. All three banking groups are big on mortgages, and are attracted by consumer finance.
Yet building solid retail businesses will prove hard. For a start, with Japan's population likely to fall (see article), demography is not on the side of the banks. Mortgage lending, certainly, has grown, but this reflects a one-off shift as people borrowing from public institutions remortgage with private ones. Meanwhile, deep cuts in branch networks over the past few years, welcomed at the time for bringing down costs, are now working against the sowing and harvesting of new revenues. David Atkinson, banking analyst at Goldman Sachs, calculates that, flat out, staff at Mizuho, which has the least appealing retail business of the big three, could spend at most 20 minutes a year with each of the bank's individual clients. That is an infeasibly short time to sell complex yet profitable financial products.
The big banks, in other words, while out of trouble, are now likely to be plagued by poor profitability and productivity. They will therefore face increasing pressure from investors to cut costs further, for instance, by streamlining or outsourcing cumbersome IT systems and by cutting staff. That could take years. Meanwhile, they will be tempted to seek profits abroad where they cannot be had at home. That may not be wise without a strong domestic base to build on; still, Citibank's snatching of Guangdong Development Bank (see article) must be galling for Japanese banks which have sat on the sidelines of the China game. One American banker puts it more bluntly. Will Japanese banks commit overseas some of the mistakes made in the past? “You bet.”
THE world's biggest bank, with $1.6 trillion of assets, opened for business on January 4th, and you are forgiven a few trips of the tongue before you can say “Bank of Tokyo-Mitsubishi UFJ” as readily as “Citigroup”, the number two. The new entity is the core bank of Mitsubishi UFJ, formed last autumn and one of three huge groups that now dominate retail banking in Japan. All are the products of mega-mergers. Mizuho, the second-biggest group, was formed in 2000 by crunching together Industrial Bank of Japan, Dai-Ichi Kangyo Bank and Fuji Bank; Sumitomo Mitsui grew in 2001 out of the merger of Sumitomo Bank and Sakura Bank. All these entities at the time were in the greatest distress, and deep concerns about the state of the financial system occasioned government intervention on a vast scale.
What a difference time, lashings of public money and strong-arming by regulators have made. At the peak, in 1986, Japan's top banks made up over a quarter of the Topix stockmarket index by capitalisation. At the nadir, in April 2003, when the sky still looked like falling, they accounted for just 2.7%. Since then, however, bank share prices have risen up to 16-fold (see chart); banks have been the engine driving Japan's stockmarket to five-year highs. Meanwhile, bad loans have been written off and losses turned to profit. Last autumn the banks announced record first-half profits. Mitsubishi UFJ alone expects full-year profits of ¥520 billion ($4.4 billion) in the year to the end of March.
Now banks are even thinking of expanding overseas for the first time since their sharp retreat in the Asian financial crisis of 1997-98. This week Bank of Tokyo-Mitsubishi UFJ was said to be thinking about investing $300m in the state-run Bank of China—which would be the first Chinese stake of any big Japanese bank. Many analysts and investors express a growing confidence that the megabanks have not only turned the corner, but have a sunny path before them. Are they right?
Certainly, the banks are far healthier than they have been in a long time. At the end of March 2002, the big banks' ratio of bad to total loans stood at 8.4%. The government subsequently gave them until March 2005 to cut the number by half. The banks beat that, bringing the ratio down to 2.9%, and by last September to 2.4%. At the same time, banks have rebuilt their capital. Today, capital-adequacy ratios stand at 11%, comfortably above the 8% required for international banks.
Of course, none of this would have been remotely possible without government help, which is now being repaid. Mizuho expects to repay its remaining ¥600 billion in public funds this year, and Mitsubishi UFJ and Sumitomo Mitsui expect to take a year or so longer to repay their remaining aid, ¥820 billion and ¥1.1 trillion respectively. Both profits and the ability to repay bail-out money have been greatly boosted by a recovering economy, which has allowed the banks to write back big amounts of bad-loan provisions.
There are lingering health concerns. One is over information-technology systems—the reason why this latest merger was put off by three months, so as not to have a repeat of glitches that plagued Mizuho. Another is the scale of non-recourse lending by banks to property funds. But by and large, says Toshihide Endo, director of the major-banks division at the supervisory bureau of the Financial Services Agency, banks have now “put their past problems behind them at last, and have managed to get to the point where they can build strategies for the future.”
And the strategies? Awkward question. Given that so much of the banks' recent profits comes from provisioning write-backs, profitability remains abysmally low by international standards. In the core business of lending to corporations, the market is still topsy-turvy: the weakest credits pay a lower rate of interest than stronger ones, partly because the maturity of such loans is shorter, but largely because to demand more would send many weak companies to the wall. Profitability from lending will presumably improve when the central bank finally abandons its policy of zero interest rates, perhaps next year. At that point, lending rates would rise faster than would deposit rates, and banks would pocket the spread.
But almost everybody expects companies to raise money more from debt markets in future, by-passing the banks. That is why the big three are looking increasingly at lending to small and medium-sized enterprises (SMEs) and to catering better to retail clients, a class wretchedly treated hitherto. Sumitomo Mitsui, in particular, is focusing on SMEs with less than ¥1 billion in annual sales. The bank no longer demands collateral, but runs sectoral portfolios of loans. It promises to respond to requests within three days, with loans of up to ¥50m. This type of lending has grown fast, much of it simply poached from smaller local banks. As for the longer-term potential of SMEs, Koyo Ozeki, credit analyst in Tokyo at PIMCO Japan, an international bond-fund manager, points out that such lending will not necessarily be an automatic answer for the banks, because of the pressure of competition on interest margins.
Hope is therefore fixed on retail banking, the former poor relation, to generate not just interest income but welcome fees. Drab branches are slowly being tarted up, renamed consulting centres. Some are even open at weekends. There has been some success selling new products: Sumitomo Mitsui, for example, has made a go of selling cast-iron dollar bonds, such as those issued by the World Bank, as well as bond and equity mutual funds. All three banking groups are big on mortgages, and are attracted by consumer finance.
Yet building solid retail businesses will prove hard. For a start, with Japan's population likely to fall (see article), demography is not on the side of the banks. Mortgage lending, certainly, has grown, but this reflects a one-off shift as people borrowing from public institutions remortgage with private ones. Meanwhile, deep cuts in branch networks over the past few years, welcomed at the time for bringing down costs, are now working against the sowing and harvesting of new revenues. David Atkinson, banking analyst at Goldman Sachs, calculates that, flat out, staff at Mizuho, which has the least appealing retail business of the big three, could spend at most 20 minutes a year with each of the bank's individual clients. That is an infeasibly short time to sell complex yet profitable financial products.
The big banks, in other words, while out of trouble, are now likely to be plagued by poor profitability and productivity. They will therefore face increasing pressure from investors to cut costs further, for instance, by streamlining or outsourcing cumbersome IT systems and by cutting staff. That could take years. Meanwhile, they will be tempted to seek profits abroad where they cannot be had at home. That may not be wise without a strong domestic base to build on; still, Citibank's snatching of Guangdong Development Bank (see article) must be galling for Japanese banks which have sat on the sidelines of the China game. One American banker puts it more bluntly. Will Japanese banks commit overseas some of the mistakes made in the past? “You bet.”
