Banking Strategies after the End of Japan's Bad Loan Crisis
June 10 (Friday) 2005
Japan's major banks have finally solved their “bad loan” crisis and regained a healthy standing. Their current non-performing loan levels of below 4% do not pose a major risk factor for the economy in general anymore.
A major reason for the recent success of Japanese banks in cleaning up their balance sheets has been the stabilizing economy, which resulted in less corporate bankruptcies and debts. In April alone, bankruptcy cases declined 13.8% from the month before (to only 948 cases), while the non-performing debts from these bankruptcies decreased by 30.7%. This marks the 28th consecutive month of decline in bankruptcies.
Furthermore, while writing off their non-performing loans, major banks have greatly developed their risk-assessment systems, so that they would now be able now to provide competitive credits to corporate customers again. Aozora bank, for example, has already started to provide new loans at higher risks to corporations - which is now pushing up its non-performing loan ratio beyond 3% again. This return of Aozora towards lending at risk, with appropriate reserve coverage, is an essential part of any successful bank's business model, and the other banks will hopefully soon be able to follow.
Unfortunately, however, not all of this improvement in economic conditions is due to stronger growth and corporate restructuring. A large share of Japan's falling bankruptcy rates is a result of vast governmental credit-assistance programs for SMEs, which add to Japan's public debt and supply-side deflationary pressures. And although the BOJ's zero-interest policy was able to keep deflationary pressures within (arguably) reasonable bounds, the economic environment remains unfavorable for the banking sector. As long as deflation prevails corporations are unlikely to develop a stronger appetite for new and higher-margin credits from their banks. The chances for banks to develop their business models on the basis of increasing corporate credit remain therefore limited.
As a consequence, banks have been racing towards fee-based business and retail banking, which are still comparatively underdeveloped and promising in Japan. Compared to the 40% share of non-interest-based bank revenues in the U.S., for example, Japan's 15-20% shares of fee-based revenues at major banks still seem to be quite low. But such a shift towards retail banking in a congested market can only become a success for those banks who run ahead of their competitors by developing new services and keep consolidating their operations, as recent retail-based upstarts in Japan and the consolidation of Europe's over-banked markets have demonstrated. Especially the newly merged major banking groups will have to focus on further rounds of cost cutting and consolidation before they can hope to become competitively profitable on the basis of their retail banking operations. Mizuho Financial Group, for example, which has been the most successful bank in writing off non-performing loans, still has a cost/profit ratio of 51%, which is considerably higher than its American peers' or Sumitomo Mitsui's 38% ratio.
For their long-term strategies, Japan's major banks are therefore developing more diversified, classic banking models, grouped around Global Corporate, Retail, Asset Management and Investment Banking. But all these models require major steps towards internationalization, which is still lacking in Japan compared to the already achieved globalization of operations at major U.S. and European banks.
After pulling out of many international markets as a consequence of the bursting of Japan's asset “bubble” and an additional hit from the Asian crisis in 1997, Japanese banks now have to return to these markets as fast as possible because their two main customer groups are heading in this direction. Today, Japan's investing corporations and households increasingly demand international expertise and products. At corporations, the business focus is shifting towards production in Asia, and the banks have to follow with their international services. Within the household sector, demand is directed towards diversification and internationalization of asset holdings, and the banks need to provide appropriate advice and portfolio products.
Currently, Japan's major banks are developing their international operations through partnerships with U.S. banks. An example is the partnership between Mizuho Financial Group and Wachovia and Wells Fargo, which spans from distribution in the U.S. to portfolio offerings in Japan. For Japanese banks, this is an important first step, which soon needs to be replaced by competitive products that keep a higher share of the value-added within the groups.
But despite being latecomers in international financial markets and the strong competition from their Western peers, Japanese financial institutions still have good chances to develop their competitive edge in Japan and Asia. With the return to economic stability, Japan's domestic economy is likely to develop a healthy appetite for advanced financial services and a good basis for international expansion. With the regained competitiveness of Japanese producers and their advancement in Asia, the corporations are likely to support the expansion of Japan's banks in Asia. And with the gained experience of Japan's banks in fragile and politically sensitive markets for corporate restructuring and non-performing loans, Japanese banking skills could prove to be profitable in the financially less-developed East and Southeast Asian markets. Finally, the development of technology-driven banking and trading platforms is internationally already advanced but still in full swing. The fusion of crisis-proof banking skills with Japan's traditional knack for technology could therefore become a key to the return to international financial markets.
