Below 0.6% for a long time, the Japanese banking sector broke through the difficulties of net interest margins

When the net interest margin will "bottom" is becoming a hot topic of increasing concern in the domestic financial market.

Affected by factors such as the decline in LPR, the adjustment of interest rates on existing housing loans, and the trend of fixed-term deposits, the net interest margin of the domestic banking industry has continued to decline in recent years.

Li Yunze, director of the State Administration of Financial Supervision and Administration, revealed in March that domestic lending rates had fallen to historic lows, and banks' net interest margins had fallen to their lowest level in the past two decades.

Taking the six major state-owned banks as an example, only the Postal Savings Bank will have a net interest margin of more than 2% in 2023, reaching 2.01%, but it will be down 19 basis points from 2022. The net interest margins of ICBC, CCB, Agricultural Bank of China, Bank of China and Bank of Communications were 1.61%, 1.70%, 1.60%, 1.59% and 1.28% respectively, down 31, 31, 30, 16 and 20 basis points from 2022, respectively, which were lower than the 1.8% consensus net interest margin threshold released by relevant departments.

The net interest margin between joint-stock banks and small and medium-sized banks is also shrinking. According to the annual reports of a number of listed joint-stock banks and small and medium-sized banks, their net interest margins in 2023 are also lower than the desired net interest margin level of 1.8%, and some banks have fallen below the 1.5% integer mark, and more and more joint-stock banks and small and medium-sized banks believe that the pressure on net interest margins to continue to decline in the future is still high.

A person from the credit department of a joint-stock bank believes that the net interest margin of the domestic banking industry is likely to continue to fall in the future, first, the interest rate on the deposit side is relatively high due to the regularization of people's deposits, but in order to support the development of the real economy, there is still room for the interest rate of LPR and stock housing loans to fall;

As the current banking industry is still highly dependent on the loan business for profits, "since last year, there has been a discussion within the bank on how to maintain good profitability under the continuous downward trend of net interest margins. The person from the credit department of the joint-stock bank said bluntly.

It is worth noting that over the past 10 years, the return on equity (ROE) of the Japanese banking sector has remained at an average of 5% in the face of an extremely low net interest margin environment brought about by the Bank of Japan's negative interest rate policy.

Behind this, the first is that the Japanese banking industry has gradually increased its overseas business layout. As of the end of March 2023, Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group and Mizuho Financial Group (hereinafter referred to as the "three major Japanese banks") accounted for 35.1%, 40.2% and 38.50% of overseas loans, respectively, and the net interest income of overseas credit business accounted for 90.6%, 85.0% and 67.2% respectively. The second is to vigorously expand the intermediary business and trading business, and increase the proportion of non-interest income, especially after the Japanese government lifted the ban on the operation mode of financial control in 1998, Japanese banking institutions through the acquisition of securities institutions and insurance institutions, vigorously develop wealth management business and financial transaction business, so that the proportion of intermediate business income has remained above 30% for a long time, becoming an important source of profit growth for the Japanese banking industry.

The reporter learned that in order to cope with the dilemma of narrowing the net interest margin, in recent years, Japanese banking institutions have also made drastic adjustments in the credit structure, one is to increase the credit supply of small and medium-sized enterprises, so as to obtain higher loan interest rate bargaining power and interest income, and the other is to increase government project loans, in order to avoid the pressure of bad credit caused by the long-term downturn in the Japanese real estate market.

These practices have also been "borrowed" by some domestic banking institutions. "However, in the face of the pressure of continued narrowing net interest margins, it is debatable whether the Chinese banking industry will replicate the business of the Japanese banking industry to go overseas. The above-mentioned person from the credit department of the joint-stock bank said bluntly.

Image source: Xinhua News Agency

Net interest margin is extremely depressed

Since the bursting of the economic bubble in the 1990s, Japan's banking sector has been facing an embarrassing situation of continuous decline in net interest margins.

"Over the past 30 years to the end of 2023, the average loan yield in the Japanese banking sector has been declining year on year. In 2011, the average loan yield of the Japanese banking sector fell below 1.5%, and in 2016 it fell below 1%, and net interest margins have continued to shrink in recent years. A person from a financial institution familiar with Japan's banking industry told reporters. Behind this, the Bank of Japan has continuously lowered its benchmark interest rate, and even adopted a negative interest rate policy in the past 10 years, resulting in the net interest margin of the Japanese banking industry being much lower than that of developed Western countries.

According to the data, the average loan yield of the Japanese banking industry fell to 0.79% in fiscal 2021 due to the negative interest rate policy of the Bank of Japan, and the corresponding net interest margin was only 0.54%. In comparison, the net interest margin of China's banking sector reached 1.94% at that time, which was the envy of its Japanese peers - Mizuho Financial Group, Japan's two largest banks by assets, had a net interest margin of only about 0.5% in the past five years, and Mitsubishi UFJ Financial Group's net interest margin fell from 0.93% to 0.71%.

Affected by the Bank of Japan's continuous interest rate cuts and the continuous decline in net interest margins, Japan's banking industry once experienced a period of credit contraction. During the period of 1996~2010, the loans of the Japanese banking industry continued to grow negatively year by year, and the loan size fell from 565 trillion yen to 425 trillion yen.

"Behind this, in addition to the decline in net interest margins affecting the willingness of Japanese banking institutions to lend, the bursting of Japan's bubble economy and falling into a 30-year economic downturn, coupled with the aging of the population, resulting in a decline in consumer demand and limited business development space for enterprises, also affect the lending ability of the Japanese banking industry. The above-mentioned person from a financial institution who is familiar with Japan's banking industry said bluntly.

In his view, the continued decline in net interest margins has also made it more difficult for the Japanese banking sector to dispose of non-performing assets. Under normal circumstances, banking institutions mainly rely on the considerable net interest margin income and operating profit generated by the credit business to write off non-performing assets, so as to maintain the bank's healthy operating position. However, the continuous decline in net interest margins has caused the Japanese banking industry's deposit and loan spreads, income and profits to continue to shrink, and it is increasingly "inadequate" to dispose of the huge non-performing assets after the bursting of the bubble economy.

This has forced the Japanese government to promote the merger and reorganization of the Japanese banking industry to resolve the problem of non-performing assets, and on the other hand, to help the Japanese banking industry divest huge amounts of non-performing assets by means of government purchases.

During the period of 1993~2006, Japan's banking industry spent more than ten years and disposed of about 100 trillion yen of non-performing assets, which reduced its non-performing loan ratio to a "normal level".

However, it remains a challenge for the Japanese banking sector to maintain high profitability in the negative interest rate environment and extremely low net interest margins over the past decade or so.

"Affected by the negative interest rate policy for more than 10 years, the net interest margin of the Japanese banking industry has been less than 0.6% for a long time, and the economic downturn has led to low credit demand, so the Japanese banking industry can only continue to adjust the credit structure to seek a breakthrough. The financial institution person pointed out.

Specifically, in recent years, the Japanese banking industry has been increasing the expansion of personal loan business, hoping to exchange for a relatively "considerable" net interest margin through the personal loan business with higher interest rates, during the period of 1994~2005, the Japanese banking industry in the reduction of the scale of corporate loans at the same time, the personal loan business maintained an annualized growth of about 2.8%, the latter in the total loan proportion from 15.9% in 1994, gradually increased to 27.5% at the end of 2005, and has remained at the level of about 27% since then.

Second, the Japanese banking industry continues to increase its lending business to local governments, which is mainly based on the consideration of loan security: compared with the higher risk of bad debts faced by real estate loans and corporate loans, although the loan interest rate of local government loan projects is lower, banks do not need to use a large amount of net interest margin income to write off bad debts, but can improve the overall profitability of banks.

"In a negative interest rate environment, it has not been easy for the Japanese banking sector to maintain a net interest margin of 0.6% in recent years. The financial institution said bluntly to reporters.

At the same time, the Japanese banking industry has noticed that the potential risks brought about by the adjustment of credit structure are "accumulating", first, in the context of Japan's aging society, banks are increasingly fierce competition for young customers, compared with the competitive advantages of large Japanese banks in the layout of outlets and customer acquisition, many small and medium-sized banks in Japan can only adopt "customer sinking" to maintain a higher interest rate on personal credit business, but this move has led to greater risks to the credit quality of retail business.

As of the end of September 2023, the net profit of small and medium-sized banks in Japan was 563.3 billion yen, down 5% year-on-year, due to the scale of non-performing loans reaching 5.6 trillion yen, up 2% year-on-year, including the risk of bad debts in some personal credit businesses starting to explode due to the sinking customer base.

Second, in order to compete for high-quality local government credit programs, the Japanese banking industry often encounters interest rate and price wars, further squeezing net interest margin income, resulting in many institutions increasing their credit scale on the one hand, and interest income falling "against the trend" on the other, "weakening" the profitability of banks.

How to break through

More and more Japanese banks are embarking on a new journey of business transformation.

A Japanese banker told reporters that in the face of the negative interest rate environment in the past 10 years, his biggest feeling is that the scale of overseas business of the Japanese banking industry has continued to increase year by year.

As of the end of March 2023, Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group, and Mizuho Financial Group accounted for 35.1%, 40.2%, and 38.50% of overseas loans, respectively. Correspondingly, in FY2022, the three major Japanese banks accounted for a staggering 90.6%, 85.0% and 67.2% of their overseas net interest income, respectively. To some extent, the high deposit and loan spread income generated by overseas business has enabled large Japanese banks to successfully escape the problem of extremely low net interest margins in Japan.

The Japanese banker said that the Japanese banking industry's "credit business going overseas" is not intentional, but more like an unexpected "harvest" to catch the east wind of Japanese enterprises collectively going overseas - due to the downturn in Japan's local economy in the past 30 years, more and more Japanese companies have moved their business overseas to obtain new business growth space, during which the Japanese banking industry has seized the huge credit financing demand brought about by the "collective going overseas" of enterprises to earn quite rich loan interest income. Especially in Southeast Asia and other places, due to the considerable interest rate spread of local deposit and loan business, the net interest margin return of Japanese companies can be much higher than that of Japan when lending to Japanese companies according to the local loan interest rate.

In particular, large Japanese banks have become the biggest beneficiaries of Japanese companies' collective overseas expansion. In recent years, due to the impact of Japanese companies' collective overseas expansion, the proportion of overseas loans by large Japanese banks has increased from less than 15% in 2010 to more than 30% in 2023. Among them, Mitsubishi UFJ Bank's overseas loans accounted for 45.2% in fiscal 2022.

The reporter learned that the Japanese banking industry can achieve considerable net interest margin returns by expanding overseas business, which is also closely related to their active development of local bank mergers and acquisitions. For example, in 2013, Mitsubishi UFJ Bank acquired a 70% stake in Thailand's fifth-largest bank, Ayutthaya, and two years later promoted the merger of the latter with its Bangkok branch, and in 2017, it acquired a 20% stake in the Philippines' seventh-largest bank, Safe Bank, and increased its stake to 94.1% two years later.

Today, these acquisitions are effectively improving the net interest margin and performance of the Japanese banking sector, which has further improved the net interest margin and profitability of the Japanese banking industry overseas by many Asia-Pacific countries following the sharp interest rate hike since the Federal Reserve raised interest rates sharply last year.

"Taking the initiative to increase the allocation of overseas bonds is another major move for the Japanese banking industry to get rid of the extremely low domestic net interest margin and the weak profitability of the credit business. The Japanese banker said bluntly. Before the Bank of Japan launched a negative interest rate policy in 2011, the Japanese banking industry mainly invested in local fixed income assets such as Japanese government bonds, but after the negative interest rate policy, it took the initiative to significantly increase the proportion of overseas bonds.

Today, the share of large Japanese banks in foreign securities allocation has increased significantly from about 10% in 2001 to 27.47% at the end of 2023. The higher interest rate returns on overseas bonds have effectively boosted the profitability of the Japanese banking sector.

The reporter learned that in addition to going overseas, another strategy for the Japanese banking industry to deal with the extremely low net interest margin environment is to vigorously develop trading business and intermediate business.

Over the past 10 years, Japan's banking industry has taken the initiative to diversify its business through the acquisition of other types of financial institutions such as securities companies and insurance institutions to increase the proportion of intermediate income, and gradually reduce its dependence on credit interest-bearing business. For example, large Japanese banks have stabilized the proportion of median income at more than 30% by developing integrated financial businesses such as syndicated loans, asset securitization, and mergers and acquisitions.

In addition, many Japanese banks are paying more and more attention to expanding their trading business on behalf of customers, such as foreign exchange, stocks, and derivatives, as well as wealth management business such as pension and insurance. Since 2017, the insurance business of Japanese commercial banks has maintained rapid development, and its insurance sales reached 5.5 trillion yen in 2022, a year-on-year increase of 70% compared to 2021, bringing considerable insurance product distribution business revenue.

At the same time, many small and medium-sized Japanese banks are actively expanding their interbank asset management business, entrusting their funds to large banks to manage in order to obtain corresponding business returns.

According to the data, after the negative interest rate policy, the proportion of interbank asset management and cash business in the Japanese banking industry has increased significantly from about 5% in 2013 to 25.7% in 2023, which not only shows the asset shortage in the credit market caused by the economic downturn in Japan, but also highlights that small and medium-sized banks in Japan have been expanding their interbank asset management business to obtain new business income.

In terms of income structure, the proportion of non-interest income in the Japanese banking sector has continued to increase in recent years. For example, the share of non-interest income in net income of the three major Japanese banks has increased significantly from about 20% in 2000 to 60% in recent years.

"This has indeed enabled the Japanese banking sector to effectively alleviate the profitability dilemma caused by very low net interest margins. The Japanese-funded banker pointed out to reporters. Now, as the Bank of Japan (BOJ) begins to tighten monetary policy, the Japanese banking sector may see a recovery in net interest margins.

Some institutions estimate that even if Japan's deposit and loan interest rates are slightly raised, it will significantly increase the deposit and loan spread income of the Japanese banking industry. After the Bank of Japan (BOJ) raised interest rates for the first time in 17 years in March, the three major Japanese banking groups will see their annual lending rates rise by 35%, adding at least 12% to their operating profits, assuming that the Japanese banking sector raises its short-term floating interest rate and long-term fixed interest rate by 0.2% and long-term fixed interest rates by 0.4% and 0.4%, respectively.

Some financial institutions have also pointed out that some of the practices of the Japanese banking industry in dealing with extremely low net interest margins also carry risks. For example, the Japanese banking sector has increased its overseas business aggressively in recent years, which is making its business robustness more vulnerable to the impact of escalating international geopolitical risks.

"Since the beginning of this year, global geopolitical risks have continued to escalate, and some financial asset bubbles in European and American countries are likely to burst due to black swan events. A representative of a Japanese-funded financial institution in China pointed out to reporters. Among them, Japan's Blue Sky Bank has sounded the "alarm bell" for the expansion of overseas business of the Japanese banking industry.

Over the past few years, Japan's Blue Sky Bank has been pursuing an overseas expansion strategy, lending to a number of U.S. commercial real estate projects to increase its deposit and loan spread income, at one point making U.S. office loans account for 6.6% (about 1.89 billion U.S. dollars) of its portfolio. However, the value of U.S. commercial real estate has continued to decline over the past two years, and Japan's Blue Sky Bank has had to classify $719 million of U.S. office lending business as a "non-performing loan asset."

In February, the bank's stock value plummeted by more than 33 percent, wiping out about 44 percent of its value, as it had to plan to set aside 32.4 billion yen ($221 million) to write off non-performing loans, resulting in a loss of 28 billion yen last year (the market expected a profit of 24 billion yen), its first annual loss in the past 15 years.

The Stone of Other Mountains "Gains and Losses"

In the face of the various responses of the Japanese banking industry to the extremely low net interest margin, many domestic bankers believe that Chinese banking institutions should not "copy everything".

A person from the credit department of the above-mentioned joint-stock bank told reporters that the Japanese banking industry has been able to achieve a relatively good net interest margin level in the negative interest rate environment for more than 10 years, mainly due to their active overseas business. But this may not be the right move for China's banking sector.

First, at present, Chinese enterprises are going overseas at a gradual pace, unlike Japanese enterprises that are eager to go overseas due to the macroeconomic downturn in their own countries, so that the current overseas business development space of the Chinese banking industry may face a certain bottleneck; second, compared with the Japanese banking industry, which has relatively rich and mature experience in various types of risk management and control in overseas markets, many Chinese banks still have room for improvement in the risk management capabilities of overseas business; third, although the domestic net interest margin is facing the pressure of continuing to narrow, it is still better than the Japanese banking industry as a whole, and the Chinese banking industry can still obtain relatively considerable income through domestic credit business, and the urgency of business going overseas is relatively low。

In his view, in response to the narrowing of net interest margins, the structural adjustment of the credit business of the Japanese banking industry is more worthy of reference for the Chinese banking industry. First, in the face of the bursting of Japan's bubble economy and the long-term downturn in the real estate market, the Japanese banking industry has decisively reduced the credit supply in the real estate sector and invested more credit funds in the field of personal credit; second, in response to the "low-desire society" formed by the aging population, the Japanese banking industry has been increasing the credit supply to small and micro enterprises, and by supporting the development of small businesses and small enterprises in various places, it can not only effectively maintain the scale of credit delivery, but also improve the bargaining power of credit interest rates.

A number of domestic bankers believe that the experience and practice of the Japanese banking industry in vigorously expanding intermediary business and trading business may be another breakthrough for the domestic banking industry to alleviate the pressure of continuous narrowing of net interest margins.

"In recent years, the income of the intermediary business and trading business of the Japanese banking industry is quite extensive, including the income from the distribution of insurance fund products, and the income from various trading business brought by carrying out various foreign exchange, overseas stocks, bonds and derivatives transactions on behalf of customers, which is indeed worthy of reference and learning from the domestic banking industry. A person from the credit department of a city commercial bank pointed out to reporters.

However, the above-mentioned city commercial bank believes that the reason for the rapid development of the intermediate income and trading business of the Japanese banking industry is largely due to the fact that the Japanese government allows the Japanese banking industry to acquire securities institutions and insurance companies, and creates a broad source of income from the intermediate business and trading business through the mixed business model. In order for the Chinese banking industry to "replicate" the practice of the Japanese banking industry, on the one hand, it needs relevant domestic policy support, and on the other hand, it needs to continue to optimize and improve the risk management capabilities of the mixed business model.

The reporter learned that more domestic banking institutions believe that in order to resolve the pressure of continuous narrowing of net interest margins, it is still necessary to "target" according to China's actual national conditions.

"The reason why the net interest margin of the banking sector is generally under pressure mainly comes from two aspects, one is to further support economic growth, the need to continue to lower the lending rate to further reduce the financing cost of the real economy, and the other is the people's deposit regularization behavior, so that the cost of obtaining deposits is still relatively high. A person from a large state-owned bank told reporters. In this environment, domestic banks still need to continue to actively respond to the challenge of narrowing net interest margin by optimizing the asset-liability structure and coordinating the development of volume and price.

Liu Jin, President of Bank of China, said that in the future, Bank of China will continue to optimize the asset structure, fully protect the financing needs of entities, increase support in key areas, continue to promote the reduction of debt costs, increase customer acquisition efforts in scenarios, and promote the rising proportion of low-cost settlement funds through business opportunities such as payroll, quick payment and treasury, and then improve the downward pressure on net interest margin through proactive management measures.

Liu Jianjun, president of the Postal Savings Bank, said that on the liability side, the Postal Savings Bank will still take measures such as creating differentiated growth poles and optimizing the asset-liability structure to consolidate the interest payment advantages of the Postal Savings Bank, and further strengthen the comprehensive assessment of wealth management and AUM, so that customers can retain more demand deposits, and try to increase the proportion of demand deposits.

"Although the trend of narrowing the net interest margin of commercial banks may continue in the future, the Postal Savings Bank will, as always, build differentiated growth poles in accordance with the established strategy, allocate more credit resources to the five differentiated growth poles, and maintain moderate growth in loans. He noted.

The reporter learned that many banks plan to increase credit support for small and micro enterprises, green and other fields this year, because the bargaining space for credit interest rates in these areas is relatively flexible, which can make the decline in banks' net interest margin "smaller".

According to media reports, recently, a number of small and medium-sized banks in Henan, Guangdong, Yunnan, Guizhou and other places have lowered their deposit interest rates. This means that under the situation of intensifying the trend of fixed-term deposits and continuing to be under pressure on net interest margins, small and medium-sized banks are improving their net interest margins by adjusting the financing costs on the liability side.

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