Japan’s Major Banks Set to Thrive As Bank of Japan normalized policy

Japan's central bank ended eight years of negative interest rates in March, raising its short-term policy rate to a range of 0%-0.1%. Now, at 0.25%, the rate is the highest it’s been since 2008.

Japan's Megabanks Poised for Growth

As the Bank of Japan moves toward policy normalization, the country's three megabanks — Mitsubishi UFJ Financial Group (MUFG), Mizuho Financial Group, and Sumitomo Mitsui Financial Group (SMFG) — are forecasting record net income for the fiscal year that began on April 1. These banks are expecting double-digit growth in earnings, driven by rising interest rates, which are likely to boost domestic net interest margins and offset the effects of lower rates abroad.

According to a June report from S&P Global Ratings, MUFG, Mizuho, and SMFG are well-positioned to capitalize on these favorable conditions. They have already implemented strategies to mitigate risks associated with persistently high U.S. interest rates and rising domestic rates.

In 2023, Japan's megabanks increased their holdings of foreign bonds, particularly U.S. Treasurys, and are expected to continue this trend as U.S. interest rates decline. The gradual rise in Japanese interest rates is making U.S. Treasurys even more attractive to Japanese banks. A narrowing gap between U.S. and Japanese interest rates is also reducing the cost of hedging foreign exchange risks for Japanese investors, according to a May report from S&P Global Market Intelligence.

Challenges remain ahead for Japan’s megabanks

Toyoki Sameshima, a senior analyst at SBI Securities, explained in September that falling U.S. interest rates are likely to reduce unrealized losses in the overseas bond portfolios of Japan’s megabanks. While these banks typically aim for capital gains from trading bonds as prices rise, regional banks seem to prefer the income gains from holding bonds to maturity and benefiting from higher coupon rates, according to Sameshima.

Japan’s megabanks have taken steps to shorten the duration of their holdings in Japanese government bonds. As for foreign bonds, the banks have reduced their risk exposure in recent years. We believe they have managed foreign bond risks prudently, as the timing and pace of the decline in U.S. interest rates remain uncertain.

These strategies appear to be paying off, as MUFG, Mizuho, and SMFG are on track to achieve strong earnings growth this fiscal year. By the end of the first quarter on June 30, each bank had already secured more than one-third of its full-year net income target. Mizuho reported a 17.9% year-over-year increase in net income to ¥289.3 billion, reaching 38% of its full-year target of ¥750 billion. SMFG’s net income surged by 49.6% to ¥371.4 billion, covering 35% of its projected ¥1.06 trillion annual earnings. Although MUFG experienced a slight 0.4% decline in net income to ¥555.8 billion, it still achieved 37% of its projected ¥1.95 trillion annual profit.

Uchida's statement came after the Bank of Japan's "double dose of monetary tightening" on July 31, which caused fluctuations in global markets due to concerns that the popular carry trade in the yen would unravel as the Japanese currency strengthens. Specifically, the central bank raised its benchmark short-term rate to 0.25% and proceeded with its plan to reduce its purchases of Japanese government bonds.

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