Announcement: Moody's: Japan banking system stable, despite pressure on domestic profitability

Moody's Japan K.K. says that the outlook for Japan's banking system is stable over the next 12-18 months. Specifically, domestic asset risks for Japanese banks will remain low.

"A steady operating environment, supported by above-trend economic growth, will outweigh the persistent pressure on profitability of Japanese banks' domestic businesses," says Tetsuya Yamamoto, a Moody's Vice President and Senior Analyst.

Moody's analysis is contained in its just-released report on Japanese banks titled, "Banking System Outlook - Japan: Low domestic asset risks amid economic pickup support stable outlook," and is authored by Yamamoto.

The stable outlook is based on Moody's assessment of five drivers: operating environment (stable); asset risks and capital (stable/stable); profitability and efficiency (deteriorating); funding and liquidity (stable); and government support (stable).

Moody's says that the operating environment will stay stable for Japanese banks over the next 12-18 months. In particular, above-trend economic growth will support domestic loan growth of around 3% on an annualized basis, which is similar to the 2%-3% annual growth since 2013.

Moody's has raised its real GDP growth forecast for Japan to 1.5% for 2017 and 1.1% for 2018 from 1.1% and 0.8%.

Asset quality will remain stable, with sufficient capital buffers against low domestic asset risks, according to Moody's. Specifically, low borrowing costs and the generally strong financials of corporate borrowers will support domestic asset quality.

While the megabanks are increasing lending to riskier borrowers overseas, they are slowing overall overseas loan growth, which will curb risks from these exposures. And, Japanese banks will continue to have sufficient capital buffers, with planned sales of long-term equity holdings offsetting pressure on capitalization from increasing risk assets.

The banks' profitability will deteriorate, according to Moody's. Net interest margins will continue to narrow — even though market rates have stopped falling — because of the rollover of loans at lower rates and continued intense competition. Nevertheless, the gap between interest rates on existing loans and those on new loans is narrowing, which will slow the pace of further margin deterioration.

Moody's points out that funding and liquidity will remain the banks' credit strength. Domestic liquidity will stay strong because they have stable deposit bases, and dependence on confidence-sensitive market funding is limited. Moody's also says that while the megabanks face tighter foreign-currency liquidity after years of rapid overseas loan growth, a significant slowdown in growth will alleviate the tightening of foreign-currency funding.

Moody's says that the Japanese authorities will likely remain strongly willing and sufficiently able to provide support for the megabanks, and to a lesser degree, other major banks and large regional banks.

However, the Financial Services Agency appears more willing to let small banks — which are bearing the brunt of an aging and shrinking population — fail or be resolved without the use of public funds.

Moody's rates 31 banks in Japan: 28 commercial banks and three government-backed institutions. These banks accounted for about 86% of Japan's total banking system assets at end-March 2017.

The three megabank groups — Mitsubishi UFJ Financial Group, Inc. (A1 stable), Sumitomo Mitsui Financial Group, Inc. (A1 stable) and Mizuho Financial Group, Inc. (A1 stable) — control about half of total system assets. The rated banks' asset weighted-average baseline credit assessment is baa1, and their average deposit rating is A1.

Moody's has maintained a stable outlook on Japan's banking system since November 2012.