S&P: Analysis of Japan's banking sector

01/04/2005 | www.sandp.com

With the economy in Japan entering a recovery Standard & Poor's outlook for the overall Japanese banking industry is now positive

Executive Summary

Over the past ten years, Standard & Poor's Ratings Services' average rating on Japanese banks had fallen to the 'BBB' category from 'AA' in the early 1980s. During this period, the major overseas banks were able to maintain ratings in the 'A' category. In 2004, however, ratings on the operating banks in all seven major Japanese bank groups were raised and are now mostly in the 'A' category, narrowing the gap with their overseas peers.

The slump in ratings was the result of a substantial decrease in asset values in Japan, such as real estate, and a combination of falling economic growth followed by deflation since the late 1990s. These effects were exacerbated by thin spreads on bank lending, which hobbled the banks' capacity to write off surging nonperforming loans (NPLs). Banks' large holdings of shares in their corporate groups, which they were slow to unwind, further depressed the credit quality of Japanese banks, because of the major impact of plummeting stock prices.

However, with the economy in Japan finally entering a recovery, most of these concerns have begun to ease, and Standard & Poor's outlook for the overall Japanese banking industry is now positive. In December 2004 and January 2005, ratings on the Japanese major banks and regional banks were raised and outlooks revised upward. The upward revisions reflect diminished concerns over deterioration of the macroeconomic environment and asset erosion risk. Although the economy is now leveling off, Standard & Poor's considers that the operating environment for Japanese banks has begun to improve, evidenced by the progress in debt reduction by companies and the long-term slide in land prices coming to an end in some areas.

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Nevertheless, Japanese banks still face many financial challenges. A recovery in the business environment does not directly lead to stabilization in credit costs. Concerns over profitability, particularly whether banks can generate sufficient profits to cover surges in credit costs, remain. While some major banks still have a substantial amount of public funds to repay, their capital quality is also still weaker than their international peers.

The first part of this report focuses on the standalone credit quality of the banks and the impact on their credit ratings from the Japanese government's support for the financial sector. In this section, three major factors that will exert strong influences on Japanese banks' credit quality are discussed: trends in interest rates; corporate performance and funding demand; and profit opportunities from fee businesses. The second part examines accounting policies and regulations on Japanese banking.


1. Economic Risk

Standard & Poor's considers Japan's economic risk to be above average by international comparison. Japan is the second-largest economy in the world in terms of GDP, with diverse industries, high export competitiveness in automobiles and electronics, and a strong external liquidity position. Japan's export sector has been an anchor of stability for the economy over the past several years, with its current account balance showing continued surplus. In addition, large financial assets in the household sector standing at ¥1,424 trillion at December 2004, support liquidity at financial institutions.

Japan's GDP growth rate over the past five years struggled to a weak 1.1%, which compares unfavorably with countries with high economic risk scores. Since early 2003, however, Japan's economy has exhibited signs of recovery. Strong external demand, particularly from China, and investments in machinery and equipment—stemming from the positive effects of corporate sector restructuring and pent-up demand—resulted in real GDP growth of 2.7% in 2003, which was among the highest in developed economies. For 2004, real GDP growth is expected to have remained strong at about 2%. The recovery is likely to slow down in 2005, considering external factors such as unfavorable movements in foreign currency exchange rates or weaknesses in key export markets. However, the current slowdown is not expected to deteriorate into a full recession, largely because the corporate sector is in much better shape than several years ago, as Japanese companies have significantly pared down debt and reduced costs.

Despite these cyclical recoveries, structural weaknesses, such as an extremely high fiscal deficit and an aging population, compound Japan's economic risks. Japan's gross general government debt is high, estimated at 173% of GDP in 2003. In addition, Japan has been in primary deficit for the past several years and its debt-to-GDP ratio is still rising. Japan's rapidly aging population is posing another challenge. In only 24 years, the percentage of those aged 65 years or more doubled to 14% from 7%. Japan's total population might start to fall as early as 2007, according to the best-case scenario of official forecasts, which have been consistently more optimistic than historical data. Combined with its prohibitive immigration policy, basically unchanged for the past 60 years, Japan's demographics will pose significant challenges for fiscal consolidation, maintenance of the social security and health insurance systems, and sustainable economic growth. Solutions to these problems are crucial to achieve a sustainable economic recovery.

Deflationary pressure in Japan, measured by its CPI, has been easing, buoyed by higher global commodity prices, increased demand from abroad, particularly from fast growing China, and continuous monetary easing by the Bank of Japan (BOJ). However, significant depreciation of the U.S. dollar against the yen could offset some of these gains in Japan. At the same time, easing deflation will pose a significant challenge to BOJ. How and when it decides to change its monetary policy from the current stance of maintaining ultra low interest rates and creating excess liquidity in the market, to a more orthodox stance without jeopardizing macroeconomic growth while minimizing the increased interest burden for the country, particularly the heavily indebted central government, is a key issue.

Table 1 Japan's Economic Indicators
  2000   2001   2002   2003   2004  
Nominal GDP (bil. €) 511,462 505,847 497,897 497,897 508,560
Nominal GDP (bil. $) 4,746 4,162 3,971 4,523 4,709
GDP per capita (Th. $) 37.42 32.70 31.16 35.44 36.85
Real GDP (% change) 2.39 0.20 (0.30) 1.31 2.43
Real GDP per capita (% change) 2.14 (0.17) (0.42) 1.16 2.28
Real domestic demand (% change) 0.42 0.23 (1.53) 0.12 1.20
Real investment (% change) 1.94 (1.37) (5.75) 0.84 7.13
Gross domestic savings (% of GDP) 28.73 27.86 26.75 27.07 27.86
Gross domestic investment (% of GDP) 26.27 25.76 23.93 23.89 24.30
Real exports (% change) 12.15 (6.03) 7.26 9.07 8.65
Unemployment rate (average claimant count; %) 4.70 5.20 5.40 4.90 4.68
Consumer price index (% change) (0.70) (0.70) (0.91) (0.30) (0.10)
Domestic credit to private sector and NFPEs (% change) (1.56) (2.46) (1.44) (2.97) (1.49)
Domestic credit to private sector and NFPEs (% of GDP) 190.31 187.70 187.96 182.52 175.89
NFPE—Non-financial public enterprise.


2. INDUSTRY RISK


Asset Quality

According to the Financial Services Agency (FSA), credit costs (cost of disposal of NPLs including loan loss reserves, amount written off, and losses on bonds) incurred by all Japanese banks, including major and regional, during fiscal 2002 and fiscal 2003 (ended March 31, 2004) reached ¥94 trillion. Over the same period, total core profit for the Japanese banks was ¥64 trillion. Although the banks were unable to fully cover the credit costs from their ¥64 trillion core profit, profits from sales of securities (¥17 trillion), and other extraordinary profits, an injection of public funds (¥10 trillion reported in the government's capital account) by the Japanese government helped the banks to limit the erosion of their capital to ¥3 trillion for the two years.

Having survived the surge in credit costs, prospects for the resolution of the banks' NPL problems finally came into sight in fiscal 2004. Japan's major seven bank groups saw their gross and net NPL ratios (NPLs disclosed in accordance with the Financial Revitalization Law) improve significantly to 5.08% and 2.49%, respectively, at the end of the first half of fiscal 2004 (ended Sept. 30, 2004) from 9.29% and 6.30% at March 2002, before the government implemented its financial revitalization program in October 2002. The individual major banks now appear set to fully achieve the financial revitalization program's target of reducing their NPL ratios by half by the end of March 2005.

Standard & Poor's believes that credit costs should stabilize for most banks, at least during fiscal 2004 if not longer. This is attributable to:

  • The improving financial profiles of corporations in Japan;
  • Disposals of NPLs to large borrowers, the major driver behind fluctuations in credit costs, are reaching resolution; and
  • Diversification of loan portfolios is in progress due to the relative increase in the ratio of small loans, including loans to small and midsize enterprises (SMEs) and retail borrowers.

The improving financial profile of corporate Japan is evidenced in particular by the significantly improved debt ratios of formerly 'B'-rated companies, which had peaked in fiscal 2002 (see Chart 2). Therefore, the risk of a resurgence in credit costs compared with previous years appears to be generally much lower.

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New phase of NPL disposals

Cutting NPL ratios by half is only a passing point in the rehabilitation of Japan's banking sector. Coping with NPLs will continue to be an issue as long as banks take credit risks. Therefore, the level of the banks' credit costs after the normalization of the revenue environment following the removal of legacy NPLs, is a key to the banks' future profitability.

To estimate the banks' future credit costs, it is useful to review the historical data in other countries where the operating environment is "normal" to the extent that distorting factors, including deflation and the collapse of the asset bubble, are absent, even though accounting methods for credit cost are different. For all rated major banks in OECD countries, average credit costs to average loans fluctuated between 0.68% and 1.14% over the past five years (see Table 2). The average credit cost ratio for these banks over this period was 0.91%. This level of fluctuation in the credit cost ratio is unremarkable.

Table 2 Credit Costs Of Major Banks In OECD Countries
  1999   2000   2001   2002   2003   5-year Average  
Credit costs/average loans (%) 0.91 0.80 1.14 1.01 0.68 0.91

For major banks in the U.S., where the size of financial institutions is relatively large like in Japan, the five-year average credit cost ratio was 1.07%, which is on par with that of the major banks in OECD countries. However, volatility is not low, with a standard deviation at about 0.36%, and the largest deviation in the last five years was 1.54%, which was partly due to the effects of the slump in technology companies (see Table 3). Given these overseas examples, it is unlikely that credit costs for the major Japanese banks will remain stable between 0.3%-0.4% as estimated in their business plans such as those submitted to the FSA.

Table 3 Credit Costs/Average Loans At U.S. Major Banks
(%)   1999   2000   2001   2002   2003   5-year maximum   5-year average   Standard deviation  
Bank of America 0.49 0.64 1.11 1.07 0.77 1.11 0.82 0.27
Citigroup 1.14 1.46 1.68 2.36 1.70 2.36 1.67 0.45
J.P.MorganChase 0.93 0.66 1.45 1.91 0.97 1.91 1.18 0.50
Wachovia 0.52 1.35 1.38 0.90 0.34 1.38 0.90 0.47
Wells Fargo 0.81 0.82 0.93 0.77 0.62 0.93 0.79 0.11
Average 0.78 0.99 1.31 1.40 0.88 1.54 1.07 0.36

Assuming the fluctuation in credit costs for Japanese banks at the U.S. level of 0.36%, profit and loss for banks with ¥50 trillion of loan assets, the average for the mega banks, would vary by about ¥180 billion. This is equivalent to about 20% of the average core profit of the mega banks in fiscal 2003. In other words, even if the business environment improves to the same extent as in the U.S., Japanese banks could be exposed to a risk of an increase or decrease in credit costs equivalent to about 20% of core profit.


Loan spreads still insufficient despite normalization

If the trends in credit costs in the U.S. over the last five years are applied to Japan, average credit costs would stand at about 1.0% of core profit. Credit costs need to be covered by loan spreads, while adequate capital is built up in preparation for an expected rise. However, Japanese banks' loan spreads (loan management yield minus funding costs including expenses) are currently less than 1%, which is still not enough to cover the banks' credit costs, even if the revenue environment stabilizes to the same extent as the U.S.


Loan concentration remains high

Japanese banks' lending to large borrowers remains a high proportion of their credit portfolios, although the level of concentration is reducing. In general, many Japanese banks still tolerate high concentration risk, with credits to the 20 largest borrowers (excluding the public sector such as the central and local governments) sometimes exceeds 100% of their Tier 1 capital. However, this ratio has declined somewhat in fiscal 2004 as banks have reduced lending through direct write-offs, loan sales, and debt-for-equity swaps, while increasing their capital.

According to Japan's banking law, banks are not allowed to extend credit to a single borrower, in principle, totaling more than 25% of their capital. Even if banks comply with these provisions, there have been many cases in which banks' business results have deteriorated significantly because of management difficulties at just a few large borrowers. In its rating analysis, Standard & Poor's generally analyzes risks more prudently for borrowers to which the lender's exposure exceeds 5% of adjusted total equity. The size of the exposure is not the sole factor that determines the size of risk. However, the larger the exposure is, the larger the impact on the lender if a borrower experiences financial difficulty, and thus large exposures need to be assessed carefully.

In addition, diversification of borrowers would be ineffective if there is strong correlation in business results between individual borrowers. Therefore, it is preferred practice to establish credit limits for each company, corporate group, or industry to diversify risks in real terms, ensuring stable credit costs and consequently stable profitability for the Japanese banks.

To alleviate the difficulty of quickly eliminating existing concentration risks, it can be effective to use tools such as credit default swaps (CDS). Expansion of the syndicated loan and credit derivative markets would enable banks to transfer their exposure to large borrowers to third parties, and more easily control concentration risks. In terms of systems, incentives to correct concentration risk would increase if the concentration ratio of large borrowers was included in inspections of bank soundness, as in France and Canada, or if the disclosure of the amount of credit to large borrowers was required, as in Italy.

Japanese banks are currently focusing on loans to SMEs and retail borrowers. These trends, together with the greater utilization of the various tools such as CDS, should enable Japanese banks to remedy their credit concentration risks gradually.


Practice of debt forgiveness

Over time, Standard & Poor's expects main banks' supportive stance toward major borrowers will change. At least in the near term, Standard & Poor's believes that the continuing practice to forgive the debt of major customers could result in significant credit costs. This practice has not been strongly opposed by shareholders of banks, bank regulators, the media, or the public, and banks are not wary of forgiving credit to failing borrowers. In addition, as in the cases of Mitsubishi Motors and Sojitz, repeated instances of debt forgiveness to individual borrowers are not uncommon. Increased loans to SMEs and retail borrowers may help alleviate risks of Japanese banks' excessive support to large borrowers. In comparison with larger borrowers, credit problems stemming from loans to SMEs are more likely to be resolved before they become very serious, since banks are far less motivated to extend unreasonable additional loans or postpone action.


Profitability Still Low, But Rising

The pace of recovery of the fundamental profitability of Japanese banks is slow, even though asset risks are decreasing steadily. The ratio of operating profit to regulatory capital before deducting credit costs (ROA) over the past five years is an average 0.75% for Japanese banks—still much lower than the 2.59% for most major banks in the U.S. At the same time, ROA volatility at Japanese banks is not significantly lower than that of the U.S. banks (see Chart 3).

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The low profitability of Japanese banks is attributable to slim loan-to-deposit margins, the smaller contribution from fee income, and the large proportion of low-profit assets in their total assets. Nevertheless, profitability is likely to improve to some extent in the future.


Loan-to-deposit margins

Credit costs for Japanese banks may fluctuate even after the operating environment is normalized. Loan-to-deposit margins for Japanese banks are much lower than that for U.S. and European banks. The gap in interest rates—interest rates on loans minus interest rates on deposits—is between 1.35%-1.97% at major Japanese banks, compared with over 3% at many U.S. banks (see Table 4). The narrow margin reflects the Japanese banks' lower lending to relatively profitable retail borrowers and SMEs, intense competition in lending amid increasing deposits and low demand for funds, and underdeveloped risk management systems to set appropriate interest rates based on risks.

Table 4 Loan-To-Deposit Margins Of Major U.S. and Japanese Banks
U.S. major banks
Japanese major banks (standalone basis)
Bank of America   CitiGroup   JP MorganChase   BTM   SMBC   Mizuho Corporate Bank   UFJ   Resona  
2004   2003   2002  
As of Sept. 2004
4.74 6.76 3.88 1.35 1.77 1.37 1.64 1.97

In fiscal 2002, Japan's major banks focused on expanding their loan spreads as one of their key management goals. However, the focus seems to have shifted back to banks' outstanding loan balances recently, which is highly likely to lead to reduced loan spreads over the next few years. This is because total deposits exceed total lending by more than ¥140 trillion, and thus Japanese bank managements are now struggling to locate lending opportunities to use these surplus funds (see Chart 4).

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Lending to SMEs

A strong correlation exists between loan-to-deposit margins and the proportion of lending to SMEs in each bank's total loans (see Chart 5). Although most major banks are still restrained in their lending to SMEs, some, such as Sumitomo Mitsui Banking Corp. (SMBC), are becoming more aggressive in lending to this sector. However, loans to SMEs usually carry higher credit risks. Therefore any rise in loan-to-deposit margins should be examined for a possible increase in risk.

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Retail lending

The speed at which the four mega bank groups are expanding their retail business has lagged far behind their original plans, announced when the groups were formed around 2000. The degree of achievement by each group is not easily identified, however, since most of the groups announce their final results only on a stand-alone basis, while releasing earnings forecasts on a consolidated basis. Mitsubishi Tokyo Financial Group (MTFG) discloses its forecasts and results on a consolidated basis, despite some differences in definitions. In fiscal 2003, MTFG's net operating income from retail business (consolidated net operating profit before inter-company elimination adjustments) was about 50% lower than its operating earnings (net operating profit plus operating income of the group) of MTFG at its foundation.

However, the four major bank groups are aggressively expanding lending to retail customers, as well as to SMEs, following an easing in NPL burdens. For example, Mizuho Financial Group strengthened its retail-lending business through a business alliance with a major finance company, Orient Corp., while SMFG and MTFG have allied with consumer finance companies as equity method subsidiaries. Earnings from retail businesses are expected to increase by ¥20 billion-¥30 billion in total (current profit of subsidiary companies multiplied by estimated equity before goodwill) owing to their affiliations with consumer finance companies. In addition, some bank groups have formed alliances with finance companies that have stakes in credit card companies or operate their own credit card business (see Chart 6).

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Nevertheless, reducing expense ratios in retail businesses will be a key for the banks to strengthen profitability through alliances with affiliated companies. According to the banks' data, expense ratios in the retail operations of UFJ Bank and SMBC were high, at over 70% as of September 2004, compared with Citigroup in the U.S. and HSBC in the U.K., which stood at about 50% (see Table 5). One of the major reasons for this gap is the difference in size of the banks' operations. The retail operations of major banks in the U.S. and European countries, which can include SME business, have strong operating efficiencies and their earnings levels are generally higher than that of Japanese banks. In addition, in some cases in the U.S. and Europe, a financial subsidiary with strong operating efficiency boosts the group's profitability. For example, The Associates, a finance company acquired by Citigroup, maintained its expense ratio at a low 33% in 2000 just before the acquisition.

Table 5 Profitability Of Retail Operations
(Bil. ¥)  
September 2004
2003
  MTFG*   SMBC   Mizuho Bank   UFJ Bank   CitiGroup¶   HSBC  
Gross income N.A. 1,672 N.A. 1,413 N.A. N.A.
Expense N.A. 1,185 N.A. 1,063 N.A. N.A.
Net operating income 61.1 49 46.3 35 2,281 1,175
Retail expense ratio (%) N.A. 70.9 N.A. 75.2 45.7 52.3
¶Global consumer sector. Earnings = gross income - expense. HSBC: Personal Finance Service Sector. Earnings = operating income before depreciation. Data for Japanese banks on standalone basis, excluding MTFG. Japanese banks' figures for 1H fiscal 2004. 1US$ = ¥105

Fee income improving slowly

While the ratio of fee income to gross revenue at Japanese banks remains far below that of their overseas peers (see Chart 7), it is improving slowly. Although the increase is partly attributable to the fact that gross revenue decreased in the first half of fiscal 2004 due to lower profits on bond holdings, particularly JGBs, this contributed only 1% to this ratio. Japanese banks' fee incomes are lower than that of their international peers by about 30%-50%, although the gap is gradually narrowing.

Major bank groups in the U.S. and Europe generate stable income from a variety of sources, including investment banking, asset management and investment, credit cards, deposit account charges, insurance policy sales, and securities brokerage. In the case of UBS AG, which has strength in global asset management, the bank earns relatively high fee incomes that account for more than 50% of its gross revenue.

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Japanese banks have also made some progress in increasing fee income through sales of investment trusts and insurance to retail customers, and syndicated loans and derivative products to corporate customers. Although concerns remain over new entrants to the trust business and a downward trend in stock brokerage commissions, deregulation of securities brokerage and over-the-counter sales of insurance products should contribute to increase in earnings to some extent. Insurance products, in particular, are expected to make effective profit contributions as deregulation is implemented in phases, given the relatively higher fees and low surrender ratios of this business. In securities brokerage services, opened to banks in December 2004, SMBC has already started aggressive marketing particularly in foreign bonds. With the full introduction of the payoff imminent, depositors growing interest in financial products other than deposits should also provide further opportunities to increase fee income.

While the profit contribution from these fee businesses is small compared with that of lending, increasing fee income would help stabilize and diversify earnings from a credit assessment perspective.


High proportion of low-profit assets

High proportions of low-profit assets, such as cross-held shares and loans to affiliate companies, characterize the asset profiles of the major Japanese banks. For example, Japanese banks still have large equity portfolios compared with banks in the U.S. and Europe, despite reductions through stock sales. At the end of September 2004, the equity holdings of the major banks in Japan were still high at 82% of their Tier 1 capital, which was far higher than the 10%-20% at U.S. and European banks, excluding German banks. In addition, investments in JGBs and lending to the Deposit Insurance Corp. of Japan and other government-related entities to cover gaps between deposits and loans pushes interest rates downward.


Asset-Liability Management And Interest Rate Risk

As of September 2004, major banks' consolidated total deposits, excluding CDs, far exceeded total lending by about ¥45 trillion. In addition, deposit concentration at major banks with relatively higher credit quality is likely to follow the removal of full government protection for bank savings deposits in April 2005.

The drop in the value of the major banks' bond holdings due to a rise in long-term interest rates is estimated at about 14%-20% of their Tier 1 capital (see Table 6).

Although these estimates do not incorporate the possible profit increase from a rise in short-term interest rates, it is possible that short-term interest rates could remain flat temporarily while long-term interest rates rise. As a result, Standard & Poor's considers that interest rate management will be a key determinant of the banks' future credit quality. In assessing the credit quality of Japanese banks, Standard & Poor's will intensify its focus on the banks' interest risk management, profitability, and risk hedging of bonds holdings.

Table 6 Japanese Banks' Bond Portfolios And Tier 1 Capital
(Bil. ¥, %)   Major Banks   Regional Banks   Tier II Regional Banks  
Domestic bond portfolio 75,327 39,301 9,920
Estimated duration (years) 3 4 4
Loss on interest rate increase by 1% 2,260 1,572 397
Core operating profit (annual) 4,236 1,436 437
Loss/core operating profit (%) 53 109 91
Tier 1 capital 16,454 8,043 2,285
Loss/Tier 1 capital (%) 14 20 17
As of September 2004 for major banks. Regional Banks: Data from Regional Banks Association of Japan, unconsolidated basis as of September 2004. Average balance for bond portfolios. Tier II Regional Banks: Data from Second Association of Regional Banks, unconsolidated basis as of September 2004.


Improving Capitalization, But Quality Still Low

The capital quality of Japan's major banks is improving, but remains low compared with that of the major overseas banks. This is mainly due to the higher proportion of weaker forms of capital, such as preferred stock, following public fund injections in the late 1990s, and the constraints on earnings from aggressive disposals of NPLs. However, capital quality is gradually improving, as the banks reduce the amount of deferred tax assets and losses carried forward. The capital quality of regional banks is better than that of the major banks, given the lower proportion of preferred stock and deferred tax assets in their Tier 1 capital.

The average Tier 1 capital ratio of the major Japanese banks is notably weaker than that of the major overseas banks (see Chart 7), although there is considerable disparity in adjusted core capital, which is a key indicator in Standard & Poor's credit analysis. The main factor behind low Tier 1 ratios is Japanese banks' high reliance on preferred stock in their capital.

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Public funds that were injected as a part of the government's recapitalization measures are being repaid steadily. The total amount to service the fund injections, including repayment of subordinated debt by Mizuho Financial Group and Chuo Mitsui Trust & Banking during fiscal 2004, will have reached ¥3.2 trillion at the end of March 2005. Nevertheless, the public funds are mainly comprised of weak capital, such as subordinated debt and loans. As a result, when and how the public funds injected in the form of preferred stock will be repaid will be a key issue for the banks' capitalization. Although the impact of each repayment method will be different these include: repayment by buying back the stock; selling preferred stock to a third party; and selling the stock as common stock in the market. In general, the buyback method, which was executed by banks such as Mizuho Financial Group, results in a drop in its capital and therefore has a comparatively negative impact on its credit quality. The sale to a third party, executed by Bank of Tokyo-Mitsubishi and Sumitomo Trust & Banking Corp., has a neutral impact, given the level and structure of its capital account remains unchanged. The other method of selling preferred stock as common stock in the market, executed by Bank of Yokohama, has a positive impact on its credit quality, given the stock conversion will lead to an improvement in its capital quality, while the current level is maintained. Nevertheless, even if a bank adopts the first or second methods, the impact on Standard & Poor's ratings on the bank would be limited given this scenario has already been incorporated in the ratings analysis since the public funds were first injected. On the other hand, the ratings on the banks could be raised or outlooks revised to positive if the banks select the third method or convert preferred stock into common stock after selling to a third party.


Challenges To Improving Credit Quality

The key challenge for Japanese banks in improving their credit qualities is their ability to successfully enhance profitability. Since the banks' nonperforming asset problems have bottomed-out, the next hurdle is to ensure continuing profitability to sufficiently cover their credit costs. The low quality of capital of banks remains a big problem, but profitability is the more crucial factor, since increased profits can improve capital quality through greater sums of retained earnings and the redemption of preferred stock.

Japanese banks and their credit qualities are very sensitive to changes in interest rates, corporate performance, and fee income. These factors and their likely credit impacts are described below.


Interest rate trends

Rising long-term interest rates will lead to losses on Japan Government Bond (JGB) portfolios, while those losses will be covered by higher short-term rates, which in general enhance the interest income of banks. Unfortunately, information that may be helpful in simulating such profit and loss outcomes under various interest rate scenarios is very rarely disclosed. Given that a rise in interest rates leads to a rise in lending rates to some extent and a rise in deposit rates to a lesser extent, such a trend should boost profitability materially. Therefore, even if the long-term interest rate rises and the price of JGBs falls, the mega banks are unlikely to suffer a net loss as long as the long-term interest rate does not exceed 3% (these assumptions follow from the basis point values as of Sept. 30, 2004, and do not take into consideration hedging or position changes).

The ratings on Japanese banks incorporate a possible rise in long-term interest rates, but not a rapid rise. If rates increase, banks are expected to adjust their positions under their loss-cut rules to minimize the impact on their coverage ability. However, if the long-term interest rate rises more rapidly than expected, banks may not be able to adjust their positions fast enough, eroding their financial standing and putting downward pressure on ratings.

Regional banks, in particular, are more sensitive to rising rates, as they have large JGB holdings relative to the size of their lending portfolios, and government bonds tend to have longer maturities. Therefore, if regional banks fail to act quickly to mitigate risks when long-term interest rates start to rise, their credit qualities will be under even greater pressure than those of major banks. It should also be noted that the regional banks in general have poorer risk management systems than the major banks, partly because of the smaller size of their asset portfolio.


Corporate performance and funding demand

Deterioration of domestic corporate performance directly leads to increased credit costs for banks. If credit costs increase to more than 2% of the banks' outstanding lending balance, achieving a net profit would be difficult (see Table 7). Considering their concentrated credit exposure, Japanese banks may need to incur credit costs at the same level or even higher than those borne by major banks overseas, even after the profit environment returns to normal.

The recovery of loan demand in the corporate sector and the subsequent increase in lending should in principle have a positive impact on banks' profitability. The key challenge is whether the banks can increase lending while keeping their own cost of credit low. Even if lending increases, it could be a negative factor for a bank's credit quality if it is followed by an increase in credit costs. A major determinant for possible upgrades is therefore the banks' abilities to increase lending steadily while securing appropriate spreads for the risks they undertake.

Table 7 Estimated Pretax Profit Sensitivity Of Japanese Mega Banks To Credit Costs
(Bil. ¥)  
Increase/decrease in loans
Credit costs/loans -20%   -10%   0%   10%   20%   30%  
0.50% 1,847 2,062 2,277 2,491 2,706 2,921
1.00% 1,013 1,123 1,234 1,344 1,455 1,565
1.50% 178 185 191 197 203 210
2.00% (656) (754) (852) (950) (1,048) (1,146)
2.50% (1,490) (1,693) (1,895) (2,097) (2,299) (2,502)
   Estimated pretax profit is calculated by: (actual annual core profit * actual spread - credit cost ratio * loans) x 0.6. To simplify the calculation, increases in expenses or profits other than core profits were excluded.

Fee income

An increase in fee income does not generally involve any additional credit risk. Also, fee income is not directly affected by corporate performance, acting as a stabilizing factor against profit volatility. Given such factors, an increase in fee income has a large positive impact on the credit quality of banks. Continuing deregulation and enhanced marketing efforts should contribute toward fee income growth from investment trusts and insurance products, while income relating to JGBs is expected to decrease. Standard & Poor's rating analysis assumes that fee income will account for an increasingly large portion of gross profit for Japanese banks.

Nevertheless, competition in fee-income businesses is intensifying. Discounts now found in stock brokerage and trust fees are expected to spread to other types of products, such as investment trust sales fees. As competition heats up, banks will need to provide more sophisticated goods and services to customers to maintain fee margins. A key challenge for the mega banks will be to provide multiple, attractive fee services that can generate more profit from their vast customer accounts. Deregulation on insurance products and consolidation in and among bank groups will also be key factors affecting credit qualities.


Credit Trends For Regional Banks

Currently, Standard & Poor's rates 22 Japanese regional banks, including Tier I and Tier II regional banks. Some of these ratings have been assigned without an initial request from the bank.

The pace of NPL disposals at regional banks has been slower than that at the major banks. However, in general, the banks rated by Standard & Poor's have made some progress in improving their fundamental profitability, disposing of NPLs, and increasing capitalization. Based on this progress, Standard & Poor's upgraded 11 Japanese regional banks and revised upward the outlooks on its ratings on eight other regional banks in January 2005.

However, it is important to recognize that the trends in the credit quality of rated regional banks do not always match those of the entire regional bank industry since the rated banks are comparatively larger and generally have stronger credit quality than non-rated regional banks. An important factor affecting the banks' credit profiles is the condition of each regional economy. Although concerns over a relapse in the Japanese economy overall have receded, the health of regional economies varies widely. While some regions have experienced faster recovery of capital investment, driven mainly by the manufacturing sector, many regions still face the negative impact of reduced public projects and the long-term slide in land prices; although land prices in metropolitan areas have started to bottom out, the recovery in regional land prices is slow. Under these circumstances, Standard & Poor's expects improvements in credit quality will take longer for regional banks that have low profitability or that are located in regions experiencing slow economic recovery.


Credit Trends For Financial Cooperatives

Standard & Poor's has assigned ratings to Norinchukin Bank and Shinkin Central Bank. Like regional banks, the operating performances of Japan's cooperative systems (JAs and shinrens) under Norinchukin, and credit cooperative banks (shinkin banks) under Shinkin Central Bank are vulnerable to the respective regional economies in which they operate. Accordingly, some of these entities have weak financial profiles. In addition, the operating performances of Norinchukin and Shinkin Central Bank are also vulnerable to interest rate fluctuations given their high securities-to-deposit ratios.


3. Government Support

Standard & Poor's incorporates potential government support as well as assessments of financial profiles in determining its ratings on Japanese banks.


Article 102 Of The Deposit Insurance Law

If the Japanese government determines that the country's financial system faces a crisis, it can take preventive action, including capital injections to financial institutions, financial support to failed or insolvent institutions in an amount exceeding the cost of payoff, and putting failed institutions under public control through acquisition of outstanding stock using Deposit Insurance Corp. Funds in the financial crisis account currently total ¥15 trillion.

In July 2003, the government injected ¥1.96 trillion into Resona Bank, whose capital was found to have slipped below 4% two months earlier. In November the same year, Ashikaga Bank was placed under regulatory control. Neither of the institutions had defaulted on debt, and all payments, including those on subordinated instruments, had been made in a timely manner.


Expanding The Scope For Support

The Law Concerning Special Measures for the Enhancement of the Functions of the Financial System was established in June 2004 to enable the government to inject capital into banks for which support would be difficult to provide under Article 102 of the Deposit Insurance Law. Expanding the scope for potential public support has had a positive effect on the credit quality of relatively small financial institutions and other financial institutions that are otherwise supposed to inject capital to these small financial institutions such as Shinkin Central Bank. However, as Kanto Tsukuba Bank Ltd. and Ibaraki Bank Ltd. are the only banks that have officially indicated they may apply for capital injections under this law, the system has yet to be widely utilized. Kiyo Bank and Wakayama Bank are reported to be considering joining the scheme, although no public announcements have been made.


BOJ Liquidity Support

Bank of Japan (BOJ) can provide financial support in the form of loans in order to maintain credit order (Article 38 of the Bank of Japan Law).

Methods of potential support from BOJ include:

  • Providing bridging loans for a required period to ensure business continuity following public capital injections and prevent insolvency or a financial crisis.
  • Subordinated loans, such as those extended to Midori Bank (currently Minato Bank).
  • Contributions such as those made to the New Financial Stabilization Fund, which was established to dissolve housing loan companies.

However, BOJ support is not always utilized, since there are restrictions, such as the central bank's own financial health.


Government Support Risk Factors

Risk factors regarding government support include the following:

  • Credit ratings reflect a mid- to long-term perspective, and government support for banks could change in the long term, either in response to public opinion, or if the government fails to obtain BOJ support.
  • A shift in regulatory stance toward market discipline amid globalization and deregulation trends.
  • The counterparty rating incorporates the obligor's overall debt servicing ability, including subordinated debt. In some cases, subordinated creditors have incurred losses, and government support has not necessarily protected sub-debt creditors.

The most recent default of a Japanese commercial bank based on Standard & Poor's criteria was Nippon Credit Bank in 1997 (see Table 8). However, the ability to provide capital injections to prevent insolvency has since been enhanced via Article 102 of the Deposit Insurance Law and the Law on Enhancement of the Functions of the Financial System, and such an insolvency case is unlikely to occur again in the near future. Furthermore, the Resona Bank capital injection and the special crisis management for Ashikaga Bank have also shown that these measures provide protection for all debt including subordinated debt.

Table 8 Financial Support by DIC For Troubled Banks
Year of financial support   Failed Institution   Supported by   Treatment of credits   Default  
1992 Toho Sogo Bank Iyo Bank All credits were protected. No
1995 Hyogo Bank Midori Bank Subordinated creditors waived 40% of credits, and 60% of credits were converted to stake in Midori Bank. Yes. Conversion to lower quality sharholding constitutes a default.
1995 Taiheiyo Bank Wakashio Bank All credits were protected. No
1997 Hanwa Bank Kii Yokin Kanri Bank All credits were protected. No
1998 Fukutoku Bank, Naniwa Bank Namihaya Bank (new) All credits were protected. No
1998 Kyoto Kyoei Bank Kofuku Bank All credits were protected. No
1998 Hokkaido Takushoku Bank Hokuyo Bank, Chuo Trust & Banking Redemption of all credits, followed conversion of a part of subordinated credits to stake in Hokuyo Bank and Chuo Trust & Banking No. Conversion was enforced after credits were redeemed, which may be regarded as financial loss for creditors.
1998 Tokuyo City Bank Sendai Bank and others All credits were protected. No
1999 Midori Bank Hanshin Bank All credits were protected. Equity in Midori Bank, including equity converted from credits to the former Hyogo Bank, was decreased. No
1999 Long-Term Credit Bank of Japan New LTCB Partners All credits were protected. No
2000 Kokumin Bank Yachiyo Bank All credits were protected. No
2000 Nippon Credit Bank Softbank and others When the restructuring plan was drafted in 1997, some junior subordinated debt was converted to common stock, and subordinated loans to preferred stock. Yes
2000 Namihaya Bank Osaka Bank, Kinki Osaka Bank All credits were protected. No
2000 Kofuku Bank Kansai Sawayaka Bank All credits were protected. No
2001 Niigata Chuo Bank Taiko Bank and others All credits were protected. No
2001 Tokyo Sowa Bank Tokyo Star Bank and others All credits were protected. No
2002 Chubu Bank Bridge Bank of Japan All credits were protected, including deposits placed protection was removed, until the business was transferred to the bridge bank. No
2002 Ishikawa Bank Bridge Bank of Japan All credits were protected, including deposits made after protection was removed, until the business was transferred to the bridge bank. No
Undecided Ashikaga Bank Undecided A support policy was formulated. Public funds will be injected when business is transferred to a bridge institution.  
Sources: DIC, media reports.

However, as the government's position on providing support for banks may change over time, Standard & Poor's incorporates, albeit with less emphasis, individual default risks in its counterparty ratings on the banks. If the government safety net is strengthened further, and it is clear that any change in government policy will not reduce the effectiveness of the safety net, Standard & Poor's may raise its ratings on a bank even if its financial strength or profitability has not significantly improved.

Government initiatives, including the removal of the full deposit guarantee, tend to encourage bank reform efforts. As such, a key issue in improving bank ratings will be how the banks respond to the challenges in the operating environment to improve their financial profiles and profitability.


4. Accounting Policies And Regulations


Accounting Policies

Two developments are leading to a gradual improvement in the transparency of financial reports by Japanese banks: the staged implementation of mark-to-market accounting, which was completed in fiscal 2001, and the introduction of quarterly financial disclosure in fiscal 2002.


Valuation of securities

Beginning in fiscal 2001, Japanese banks fully adopted new standards for financial product accounting. This move affected capital adequacy figures and certain other financial data. As Standard & Poor's analysis of banks has already factored in the changes, the application of the new standards was not the direct cause of recent credit rating revisions.

In March 1998, Japanese banks were authorized to begin valuing other marketable securities available for sale, which mainly represent cross-shareholdings, at original cost rather than the lower-of-cost-or-market method. By fiscal 1998, all major banks except BTM had switched to the original-cost method. For bonds, banks have always had the option of selecting the original cost or lower-of-cost-or-market method. With a few exceptions, almost all Japanese banks have elected to use original cost. Prior to the adoption of the mark-to-market rule, Japanese banks primarily used the original cost method to determine the carrying value of market-traded securities.

In September 2000, all Japanese banks were ordered to begin valuing their "trading account securities" at market cost. Following this, banks disclose unrealized gains and losses on "other marketable securities available for sale" in their financial statements, first in their footnotes from September 2000, then in their capital (after adjusting tax effect) from September 2001. When the market value of stock declines considerably (more than 50% according to the FSA manual) with no prospect for recovery, resulting valuation losses now also need to be shown on the income statement.

Japanese banks' cross shareholdings, which are classified as other marketable securities available for sale, are very large relative to their equity. As a result, the switch to mark-to-market accounting is likely to cause substantial fluctuations in balance sheet equity as stock prices rise and fall. The deduction of unrealized losses on other marketable securities available for sale can also have a major impact on Tier 1 capital. Furthermore, a drop in stock prices can reduce distributable profits, since unrealized losses are also deducted from this figure. This situation will continue as long as the banks continue to hold large amounts of securities, including cross-shareholdings.

To tackle the size of shareholdings, the government enacted legislation in November 2001 prohibiting banks from holding stock in excess of their capital. Banks, including long-term credit banks Norinchukin Bank and Shinkin Central Bank and their subsidiaries, became required to use their equity as the upper limit for holdings of stock and similar instruments. Following the protracted slump in stock prices, the legislation was revised in July 2003 and the enforcement was postponed to September 2006.

In February 2002, the government established the Banks' Shareholding Purchase Corp. (BSPC) to enable banks to sell their stock in an orderly manner. The entity is scheduled to operate until Sept. 30, 2006. Until revisions to the legislation in July 2003, banks needed to make a deposit equivalent to 8% of the price of shares sold to the BSPC. Stock purchases by the BSPC totaled ¥1,385.3 billion at the end of January 2005. In addition, between November 2002 and the end of September 2004, the BOJ purchased banks' stocks that met its rating or liquidity criteria. The BOJ's stock purchases have been relatively large, totaling ¥2,018 billion by September 2004 out of a purchase ceiling of ¥3 trillion, mainly because the BOJ scheme has not required banks to provide a deposit when they dispose of shares.


Tax effect accounting

Japanese companies introduced tax effect accounting in fiscal 1999, one year after the major banks. Banks are thus able to record deferred tax assets (in effect, prepaid taxes) on taxes paid on write-offs of problem loans that were not treated as tax-deductible. These deferred tax assets can then be used at a time when the write-offs can be recognized as losses for tax purposes. In addition to benefiting from the temporary differences in tax obligations resulting from the posting of deferred tax assets, banks can, in the event that their taxable income is negative, carry the loss forward for up to five years to offset taxable income. Consequently, unrealized losses on securities must also be viewed with these tax-related implications in mind. At September 2004, net base deferred tax assets (gross deferred tax assets minus valuation reserves and deferred tax liability) totaled ¥5.1 trillion at the seven major bank groups. This amount has decreased in recent years due to progress in disposals of NPLs, and a drop in unrealized losses on securities due to higher stock prices. As the overall possibility of realizing tax credits derived from deferred tax assets is increasing based on improving revenue outlooks for Japanese banks, asset quality problems have recently been alleviated. However, the ratio of net base deferred tax assets (gross deferred tax assets minus deferred tax liabilities on the balance sheet) to Tier 1 capital of 31% remains higher than that of major overseas banks at less than 15%.


Loan loss provisions

Since fiscal 1998, Japanese banks have been categorizing loans based on a self-assessment system, so that reserves can be set aside in a manner that reflects the true quality of assets. Prior to this system, tax-deductible reserve additions were possible only after a bank had conducted lengthy negotiations with tax authorities. The resulting difficulty in setting aside tax-deductible reserves was undoubtedly one reason why banks delayed action on the problem loan issue. Since the introduction of self-assessments, some banks have started direct write-offs, without first setting aside reserves, of the unrecoverable portions of loans to bankrupt and quasi-bankrupt borrowers.


Quarterly financial reports

In the first quarter of fiscal 2002 (ended June 30, 2002) the major banks and several regional banks began releasing quarterly financial reports. As further disclosure, such as the composition of profits and losses, was initiated in fiscal 2004, the seasoning of this data over a full year will facilitate year-on-year comparison of quarterly data from fiscal 2005.


Accounting for impairment of fixed assets.

Accounting for the impairment of fixed assets is an accounting standard requiring a corporation to report the difference between the book value and the fair value of a fixed asset as a loss if the fair value drops significantly. This standard will be compulsorily applied to all listed companies from fiscal years beginning on or after April 1, 2005 with early adoption permitted for fiscal years ending on or after March 31, 2004. Some banks including Resona Holdings, Shizuoka Bank, Fukuoka Bank and Hiroshima Bank have already adopted this accounting standard. The accounting for impairment of fixed assets standard is less likely to have a direct and significant impact on the financial profile of banks that usually do not own large fixed assets including factories. Among the rated banks that have already adopted impairment accounting, relatively large impairment losses reported include ¥27.8 billion recorded by Resona Holdings for fiscal 2003 (ended March 2004) and ¥2.4 billion posted by the Bank of Fukuoka for the first half of fiscal 2003 (ended September 2004). However, as banks that adopted these standards earlier have relatively sound financial profiles, a more significant impact is expected for some banks when the standards are applied to all Japanese banks. As the banks have some discretion in applying the standard, it should also be noted that losses are not always calculated by the same method. Key points in calculation methods include whether a grouping for calculation of the future recoverable amount is based on sufficiently small units, such as the branch unit, and whether the independence from banks is ensured in appraisal of real estate properties. If a bank owns large unutilized assets with no prospects for being utilized as business assets, the reported loss amount is likely to increase. In general, banks with weaker financial profiles tend to postpone the recognition of losses incurred in the past. The impact of the compulsory application of the accounting standard for impairment of fixed assets is expected to be more significant on these banks.


Regulation, Inspection, and Reporting


Regulatory agencies

Japanese banking regulatory agencies are aiming to establish frameworks similar to those used in the U.S. Specifically, this involves enhancing transparency through the disclosure of more information and greater use of external auditing. Banks are also encouraged to maintain a sound financial position by adhering to market principles. The goal is to foster an environment in which banks assume responsibility for their own actions within the scope of a clear set of guidelines and regulations. Until the 1998 establishment of the Financial Supervisory Agency, the predecessor of the Financial Services Agency, Japanese banks ranked well below global standards for financial disclosure. Certain information was submitted only to regulatory authorities. The authorities provided "administrative guidance" and other directions, not all of which were prescribed in the rules. Under this system, the government often influenced decisions made by banks' senior management. It is not surprising, therefore, that the scale of the banks' credit problems took some time to surface, as well as for corrective measures to be implemented.

To break away from this ineffective system, authority to regulate banks was largely transferred from the Ministry of Finance (MOF) to the independent FSA in 1998. During the transitional period between 1998 and 2000, some of the planning and policy-making responsibilities remained with the MOF. The Financial Reconstruction Commission was responsible for the oversight of insolvent banks. In 2001, all of these functions were unified under the FSA.

As the sole regulatory body, the FSA is responsible for all financial institutions in Japan, including banks, credit unions, credit cooperatives, securities companies, and insurance companies. Between 1998 and 2000, the FSA adopted measures aimed at eliminating delays in dealing with problem loans and preventing "moral hazard" at financially weak institutions.

As a result, the overseers of Japan's financial system have made some progress toward establishing tighter rules over the past few years. However, compared with most industrialized countries, Japan still relies heavily on the principle of forbearance. In 2002, for example, the government stated its intention of delaying the implementation of limits on insurance for deposits of all types.

In addition to the financial revitalization program and subsequent development of guidelines, the government has implemented some measures to advance financial system reform. These including acceleration of NPL disposals so that the bad debts of the major banks will be halved by the end of fiscal 2004, and implementing concrete conditions for the conversion of state-owned preferred shares.


Ownership

Restrictions on major shareholders are specified in the amended Japan Banking Law, which was enacted on Nov. 2, 2001. One change was a requirement that shareholders holding more than 5% of a bank's equity report regularly to the government. Furthermore, shareholders deemed to have a significant influence on bank management (as a rule, holding at least 20% equity of a bank or a bank holding company) are designated "important shareholders" and, as such, must obtain prior approval to establish equity positions of this scale. These shareholders can be required to submit reports and undergo investigations in cases where such action is believed to be critical to preserving sound and appropriate management practices at a bank. When the condition of a bank worsens, and a recovery is judged to be possible if certain actions are taken, important shareholders holding more than half of the bank's equity may be asked to take action to ensure the soundness of the bank.


Licensing

The FSA grants licenses to ordinary banks under the Banking Law and to long-term credit banks under the Long-Term Credit Bank Law. The Banking Law contains requirements concerning restrictions on business activities, the preservation of a certain level of financial strength, regulatory supervision, inspections, and processes for liquidations when necessary.


Inspections

The BOJ inspects banks that maintain current deposits at the central bank. The FSA also conducts inspections of all licensed banks. In conjunction with the FSA, the respective prefectures and the Ministry of Agriculture, Forestry and Fisheries conduct inspections of agricultural cooperative banks.

Since the second half of fiscal 2000, the FSA has conducted "special inspections" of large borrowers at major banks in addition to its ordinary inspections. The purpose was to ensure that banks classify borrowers in a manner that reflects changes in operating results and market conditions in a timely manner, and that reserves and write-offs are made accordingly. As a result, the difference in classifications of the same borrower between different banks has diminished, since the inspections are usually executed around the same time. However, the inspections do not necessarily provide a picture of overall lending trends at major banks, given that they cover only 161 borrowers with total loans at ¥13.1 trillion (at the first half of fiscal 2002), which is small compared with total lending.


Capital requirements

Japanese banks that do not operate internationally can choose to comply with either Bank for International Settlements (BIS) capital adequacy guidelines or domestic guidelines. The domestic standard requires banks to maintain capital (Tier 1 plus Tier 2 capital minus deductions) of at least 4% of risk assets. Regarding the new BIS standard scheduled to be implemented in fiscal 2006, while domestic guidelines have not been finalized yet, international standard is likely to require banks to maintain capital of at least 8%, same as before.

The primary difference between the calculation of BIS and domestic capital ratios is that the domestic standard does not include interest-rate, stock, and other forms of market risk in calculating risk assets, and does not add Tier 3 capital to equity. At banks using BIS guidelines, 45% of unrealized gains on other marketable securities for sale are included in Tier 2 capital. Under domestic standards, however, unrealized gains are not included in Tier 2 capital (numerator of the capital ratio), but are also not included in risk assets (denominator of the capital ratio).


Exposure limits

At ordinary banks, credit extended to any single borrower cannot exceed 25% of the sum of capital and loan loss reserves.


Dividends.

Under the Japanese commercial code, earnings eligible for distribution as dividends at all companies, including banks, are defined as follows:

Distributable profit as dividends = Net worth (including net unrealized gains/losses on equities) - Paid-in capital - Statutory reserves - Net unrealized gains on equities (if applicable).

Here, unrealized gains or losses on equities refers to gains or losses on "other marketable securities available for sale" net of tax effects. Consequently, unrealized gains on these securities do not contribute to earnings that can be distributed as dividends, while unrealized losses reduce these earnings.

Normally, banks are required by the Banking Law to increase their legal reserves to equal paid-in capital. While the commercial code stipulates a level of one-quarter of paid-in capital, the Banking Law applies a higher standard from the standpoint of maintaining the soundness of the banking industry. Meanwhile, according to the commercial code, which applies to bank holding companies, statutory reserves need only be one-quarter of paid-in capital, well below the 100% requirement. Some banks established the holding companies to ensure a source of dividends by transferring a portion of their legal reserves, which could boost distributable profit.


Appendix: Japanese Banking System Data

Number of banks: As of May 1 2005, there were 2,165 financial institutions in Japan.

Table 9 Number Of Banks In Japan
Banks 155
   City banks
7
   Long term credit banks
1
   Trust banks
27
   Regional banks
64
   Tier II regional banks
49
   Other banks
7
Cooperatives 2010
   Shinkin banks (credit unions)
306
   Shinkumi banks (credit cooperatives)
181
   Rokin (labor credit unions)
13
   Central institutions
3
   Agricultural cooperatives
1507
Total 2165
Data as of May 2004, excluding agricultural cooperatives data, which is as of March 2004.

All of these financial institutions are insured by DIC, except for agricultural cooperatives. Agricultural cooperatives are insured by the separate, but very similar, Savings Insurance Corp.

System deposits: Total deposits of Japanese residents as of December 2004 stood at ¥967 trillion.

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