Japanese banks ponder the future

Investment banking has not helped JapanÆs banks to juice their profits. On the contrary, the struggle for a profitable model is still on.
Whither JapanÆs banks? The latest spate of third-quarter earnings show that the move into investment banking by Japanese lenders has failed to spice up their sluggish earnings. On the contrary, they are all suffering due to the US subprime crisis, from Nomura to Mizuho. In other words, whether a Japanese version of Merrill Lynch û as Nomura is sometimes referred to û or a massive commercial bank, the local lenders didnÆt make much return on their capital in 2007.

The banking sector is dominated by Mizuho, Mitsubishi UFG and Sumitomo Mitsui Financial Group. These three banks announced combined subprime losses of $5 billion in the third quarter of the fiscal year to March 31, 2008. The countryÆs largest securities company, Nomura, saw its profits collapse by 70% to $225 million for the quarter. On average, Lehman Brothers in Tokyo estimates that the six biggest commercial banks recorded a 10% drop in their year-on-year operating profits.

The Japanese banks, of course, are used to tough news. Ever since the end of the bubble in 1990, Japanese banks have had to contend with bad loans, a volatile stockmarket, a frequently weak economy and lots of competitors. But the desire to break out of this rut is certainly there: the banking sector still attracts many of the traditional elite, those who went to the right schools and universities and who feel that Japan has a destiny to extend its economic clout all over the world.

As a result, Japanese banks have tried to copy the apparently super-profitable investment-bank strategies of the Western banks, but the latest results show this strategy has backfired. ItÆs precisely the banks that were involved in investment banking which suffered the most. Two-thirds of Mizuho BankÆs losses (the largest losses among the big three) are attributable to its trading unit, Mizuho Securities. Worst hit was Nomura, whose performance was hurt by its US residential mortgage business, which has since been closed down.

ItÆs likely that the technical skills for constructing and dealing in fancy, high-margin products are not fully developed yet. Mitsubishi UFJ has set up a promising joint venture with Merrill Lynch, but only in private banking. Japanese banks are capital constrained and unable to afford the acquisition of a major overseas investment bank, although Mizuho did invest $1 billion in Merrill Lynch when the bank was reeling from the sub-prime debacle late last year.

This may have been a rather un-guided investment. ôThe Japanese banks want to step up their activities abroad, and the investment in Merrill Lynch seemed like a good opportunity to access financial technology û but itÆs not clear yet for what in practical terms,ö says one analyst at a European bank, speaking off the record.

The desire to rush into investment banking is understandable, given the struggle the commercial banking arms face to turn a profit. One bright spot in recent years has been investment trust products, but even that is fading. Japanese banks have tried hard to convert their deposits into investment trust products and depositors were initially keen to snap up the products on offer.

But analysts say the market is now saturated and more tricky, due to the Financial Transactions Law, and a tumbling stockmarket. The law is designed to protect retail investors from abuse, but makes the sale of such products far more cumbersome. Mortgages are also under stress, due to the new Building Construction Law which has made some major revisions to the standards applied to new buildings. As a result, Lehman Brothers in Tokyo estimates fee income decreased by 15% in the third quarter year-on-year.

Consumer finance has not taken off with the big banks, because this is an area traditionally dominated by the consumer finance companies. These consumer finance companies have recently been crushed by government regulations capping and refunding excess interest rates û but the mainstream banks have not yet effectively moved into the gap to offer comprehensive consumer finance services. Analysts say this could improve in the future, however.

In other words, the Japanese banks still look roughly as they did before the crisis, with the bulk of their income coming from plain-vanilla, wholesale banking. Worse, if some claims of a recession are correct, these banks could soon be facing an upturn in non-performing loans. Not surprisingly, bank share prices have reacted badly and because of their massive capitalisation they have dragged down the broader market as well.

Still, a moderately profitable banking sector is no bad thing considering that the increasingly investment-led banking model in the West has led to some serious losses. Perhaps the Japanese banks should simply stick to their knitting. They wonÆt be super profitable, true, but they are more likely to be around for the long term.
¬ Haymarket Media Limited. All rights reserved.
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