Curve It Like Kuroda Spells Little Profit Relief for Japan Banks

(Bloomberg) -- The Bank of Japan’s decision to engineer the perfect yield curve isn’t convincing analysts an end is in sight to falling bank earnings.

By refraining from dragging short-term interest rates further negative and pledging to keep 10-year bond yields around zero, the central bank will give lenders room to protect their razor-thin loan margins. The policy will also help them to secure interest income from their longer-dated bond holdings.

Yet the consensus of analysts is that loan spreads aren’t likely to improve as interest rates stay low, credit growth slows and competition stiffens. Banks also tend to hold bonds with much shorter maturities than 10 years. In a sign margins may remain compressed, the benchmark three-month Tokyo interbank offered rate slid to a record low 0.059 percent on Friday and longer-dated yields plunged, while bank shares lost some of the gains made after the BOJ’s Sept. 21 decision.

“The more that time passes, the more we will likely see bank profits fall,” said Hidetoshi Ohashi, the chief credit strategist in Tokyo at Mizuho Securities Co.

The BOJ started charging banks 0.1 percent on some of their reserves in February so they would use their spare cash more productively and help to revive the economy and inflation. Instead, loan growth slowed, bank shares plunged and long-term interest rates sank along with consumer prices. Lenders avoided charging customers for deposits, so the difference between their funding costs and lending rates narrowed to record lows.

For a QuickTake Q&A on why the BOJ is targeting the yield curve, click here.

The 87-stock Topix Banks Index fell 1.4 percent Friday. Mitsubishi UFJ Financial Group Inc., the nation’s largest lender, and fellow megabanks Sumitomo Mitsui Financial Group Inc. and Mizuho Financial Group Inc. have slid at least 21 percent this year.

BOJ Governor Haruhiko Kuroda acknowledged earlier this month that negative rates were squeezing banks’ profits. In last week’s policy review, the monetary authority said that lenders may become more reluctant to extend loans if sub-zero rates were to excessively reduce their earnings. A flat yield curve would shrink the spread between deposit and lending rates, it said.

“The impact of a negative interest rate on financial institutions’ profits is particularly large in Japan’s case,” the central bank said. Deposits far exceed loans and credit spreads are “already extremely small, reflecting long-standing competition among financial institutions,” it said.

Lenders lauded the BOJ’s shift toward controlling the yield curve.

“We welcome the foregoing of deepening negative rates this time as the result of the BOJ listening sincerely to discussions with markets and financial institutions,” Katsunori Nakanishi, chairman of the Regional Banks Association of Japan, said in an e-mailed statement. Takashi Oyamada, the chief executive officer of MUFG’s main lending unit, said in an interview on Sept. 15 that a steeper yield curve would be a “positive development.”

That won’t be enough to bolster banks’ profits, according to Toyoki Sameshima, a senior analyst at BNP Paribas SA in Tokyo.

“There is still room for lending rates to go lower, so we think domestic loan-deposit interest spreads are likely to deteriorate,” Sameshima wrote in a report on Sept. 21. Because the average duration of banks’ bond holdings is between two and three years, lenders won’t benefit much from the BOJ propping up yields on 10-year government bonds, he said.

Combined net income at MUFG, Sumitomo Mitsui and Mizuho fell 28 percent in the three months ended June. Net interest income at the Tokyo-based companies slid 15 percent.

‘Major Challenge’

There’s also no guarantee that the central bank will succeed in controlling yields. Japan’s 30- and 40-year securities jumped Friday, suggesting traders aren’t convinced that Kuroda has the tools to achieve the goal.

Japan Post Holdings Co. Chief Executive Officer Masatsugu Nagato said Friday that it will be a “major challenge” for the BOJ to tackle the curve, though the central bank is capable of doing so. Lenders are unlikely to benefit much unless yields on three- to five-year debt go up, said Nagato, whose group is among the biggest holders of Japanese government bonds.

The BOJ’s policy shift increases the incentive for banks to continue pursuing business abroad, according to Nana Otsuki, an executive director and chief analyst at Monex Group Inc. in Tokyo. She said the potential for negative rates to be cut deeper is now higher, which will force banks to look overseas for profit if short-term rates are pushed lower.

The central bank has room to add stimulus, including cutting the deposit rate further below zero, Kuroda said after last week’s announcement.

“Just because a new policy came out last Wednesday doesn’t mean things are going to get significantly better,” said Futoshi Sasaki, an analyst at Bank of America Corp. in Tokyo. “Loan spreads are still going to tighten, albeit not as much as they might have before.”

--With assistance from Finbarr Flynn To contact the reporters on this story: Gareth Allan in Tokyo at gallan11@bloomberg.net, Takako Taniguchi in Tokyo at ttaniguchi4@bloomberg.net. To contact the editors responsible for this story: Marcus Wright at mwright115@bloomberg.net, Sandy Hendry at shendry@bloomberg.net, Russell Ward, Tomoko Yamazaki

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