Uninteresting Japanese banks have become some of the world’s best investments in 2023, and a change in monetary policy could see them continue to accumulate resources.
Last year, shares of the country’s three big banks rose an average of 73%, driven mainly by expectations that the Bank of Japan (BoJ) will finally abandon its ultra-low interest rate policy. Since December, the BoJ has made some important adjustments to its yield curve control policy – effectively allowing long-term bond yields to rise – and an end to the negative rate policy implemented in 2016 may be on the horizon. This is if inflation sustainably reaches the BOJ’s 2% target, according to BoJ President Kazuo Ueda.
Higher interest rates would benefit banks in several ways.
Firstly, they could bring banks higher returns on their deposits held at the Bank of Japan, which for the most part do not generate interest or currently have a negative real rate. These are considerable sums. For example, in March, banking giant Sumitomo Mitsui Financial had the equivalent of 21% of its assets in the BoJ – 57.5 trillion yen, equivalent to US$390 billion.
Banks could also invest these deposits in government bonds and reinvest bonds held at higher yields. Japanese 10-year government bond yields have already risen to 0.75% from 0.23% a year ago.
Higher rates may also allow banks’ loan spreads to widen, especially on longer-term loans and those with floating rates. Deposit rates will likely stay stickier than lending rates and won’t rise as much – at least at first.
The “big three” banks in particular have large, stable deposit bases, which means plenty of room for margin expansion. Goldman Sachs estimates that the three megabanks’ net profit could increase by between 4% and 8% if long-term yields increase by 0.3 percentage points. The earnings expansion could be greater if short-term rates also rose and banks shifted their assets into higher-yielding bonds.
Japan’s big three banks trade at an average of 0.85 times tangible book value – well above the average of 0.5 over the past five years and more in line with where they stood before the interest rate era. negative interest rates, according to S&P Global Market Intelligence. It’s still a far cry from JPMorgan’s tangible 1.9x valuation, and there are good reasons why Japanese banks continue to trade at a discount to their global peers. Japan’s growth prospects overall do not resemble the pace expected for the U.S., bloated balance sheets remain an issue, and Japan’s corporate governance reforms are underway.
But the change in Japan’s interest rate regime, along with Tokyo’s push to get companies to improve their returns on equity, could benefit Japanese banks for some time. Returns on bank stocks have been low in Japan for a long time – but with a little help from the Bank of Japan, that is starting to change significantly.
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