Political Commissar Lu is a director of the China Chief Economist Forum and the chief economist of Industrial Bank
Japan, Banks, Interest Rates, Business Models
Since the 90s of the 20th century, with the peak of Japan's housing prices and stock prices, the center of Japanese government bond and loan interest rates has also entered a long-term downward trend, and the Japanese banking industry has experienced a long-term low interest rate environment. How has the Japanese banking sector adjusted its balance sheet during this period, and how has its business model changed?
From the perspective of asset allocation strategy, in the early 1990s, after Japan's housing prices and stock prices peaked, the fermentation and recognition of bad debts in the Japanese banking industry lagged behind, and the asset structure adjustment of the banking industry was not drastic; in the late 90s, with the contraction of credit scale and the loss of equity assets caused by the decline in stock prices, the Japanese banking industry reduced its stock holdings, while increasing its holdings of Japanese government bonds, and slightly increased overseas securities investment; after 2013, in the QQE era, the Japanese banking industry increased the proportion of cash assets, Reducing the proportion of bond investment, China began to significantly increase the allocation of ultra-long-term bonds, and large banks significantly increased overseas loans and overseas securities investment.
From the perspective of changes in the structure of liabilities, since the 90s of the 20th century, deposits in Japan's banking industry have maintained a high growth rate compared with loans; at the same time, from the perspective of deposit structure, as the interest rates of time deposits and demand deposits have gradually approached, the proportion of time deposits has decreased and the proportion of demand deposits has increased. At the same time, Japanese money market funds have been liquidated from shrinkage to liquidation, and currency reserve funds with liquidation functions have become the mainstream of fixed income funds.
From the perspective of the relative duration of assets and liabilities, the loan maturity of the Japanese banking industry has been extended in the low-interest rate environment, the proportion of floating interest rate on corporate loans has decreased, the proportion of floating interest rate on residential loans has increased, and the duration mismatch of small and medium-sized banks has been higher.
From the perspective of changes in income structure, in the low interest rate environment, the absolute scale of net interest income of the Japanese banking industry has declined, accounting for 70%-85%; due to the "financial explosion" after the "financial explosion" in Japan's financial industry to move towards mixed operation, the scale and proportion of net bank fee and commission income have increased significantly, and the net income of large banks accounts for more than 25%; the contribution of investment income (excluding interest income) fluctuates greatly in different years.
From the perspective of business model changes, in order to cope with the decline in interest margin income and increase intermediate business income, the Japanese banking industry has increased its fee standards, broadened its business types, and paid more attention to private banking and wealth management business; in order to cope with the decline in residents' income and the decline in the value of collateral, it has paid more attention to unsecured and high-interest credit loan business; and with the decline in bond investment income, the Japanese banking industry has paid more attention to alternative investments. In addition, in terms of institutional setup, large banks have expanded their international business through overseas mergers and acquisitions, and inter-bank mergers and reorganizations have reduced the number of branches and reduced operating costs.
Since the 90s of the 20th century, with the peak of Japan's housing prices and stock prices, the center of Japanese government bond and loan interest rates has also entered a long-term downward trend, and the Japanese banking industry has experienced a long-term low interest rate environment.
How did the Japanese banking industry adjust its balance sheet during this period, and what changes did the business model of the Japanese banking industry change in response to the decline in interest margin income? This article will focus on the changes in the asset-liability structure of the Japanese banking industry since the 90s of the 20th century, as well as the changes in the income structure and business model of the Japanese banking industry.
1. Changes in the asset-liability structure of the Japanese banking industry
1.1 A brief review of the Bank of Japan's monetary policy
Since the 90s of the 20th century, the monetary policy of the Bank of Japan can be roughly divided into the following stages: First, in the early 90s of the 20th century, the monetary policy of the Bank of Japan shifted from bursting the bubble to promoting economic recovery, and gradually lowered the policy interest rate, taking July 1991 as the turning point, the Bank of Japan began to lower the benchmark interest rate on loans, and since then the monetary policy has been mainly based on gradually lowering the policy interest rate. Second, at the end of the 90s of the 20th century, the Bank of Japan began to explore zero interest rates and quantitative easing operations (QE), among which, in February 1999, the Bank of Japan reduced the unsecured overnight lending rate by 0.15%, and then further lowered, marking the beginning of the Bank of Japan's implementation of the zero interest rate policy, in the same year, the Bank of Japan began to buy treasury bills, and in 2001, the Bank of Japan's asset purchases expanded to long-term government bonds. Third, since 2013, the Bank of Japan has officially launched "Quantitative and Qualitative Monetary Easing" (QQE), including changing the operation target from the unsecured overnight call rate to the base currency, expanding the purchase amount of long-term government bonds, extending the maturity of government bond purchases, increasing the purchase of ETFs and J-REITs, etc., and began to carry out "yield curve control" operations after 2016. Fourth, on March 19, 2024, the Bank of Japan announced the end of the negative interest rate policy.
1.2 Changes in the asset-liability structure of the Japanese banking sector
In these different periods, the interest rate environment faced by Japanese commercial banks has also changed significantly, and the Japanese banking industry has adjusted its asset-liability allocation and portfolio investment strategy accordingly.
1.2.1 Asset side: three stages of finding desirable assets
From the asset side, after Japan's housing prices and stock prices peaked in 1990, the fermentation and confirmation of bad debts in Japan's banking industry lagged behind, and it was not until the end of the 90s that the concentrated bankruptcy of banks appeared, so in the early 90s, the asset structure adjustment of the banking industry was not drastic; in the late 90s, with the contraction of credit scale and the loss of equity assets caused by the decline in stock prices, banks began to increase the scale and proportion of bond investment; after 2013, in the QQE era, the proportion of bank securities investment declined again, the proportion of cash-like assets increased, and the proportion of credit investment remained at a low level。
In the first stage, in the early 90s of the 20th century, the proportion of asset allocation in Japan's banking industry was relatively stable, and since 1998, the scale of commercial bank loans has begun to shrink. Since 1990, Japan's loan interest rates and government bond interest rates have both begun to decline, but the interest rate differential between deposits and loans has remained above 2 percent, and the asset structure of banks has remained relatively stable; since 1998, the absolute scale of bank loans has begun to shrink, and banks have begun to increase the scale and proportion of securities investment, especially bond investment.
In the second stage, from 1999 to around 2012, Japanese commercial banks shrank in terms of loans and lost equity assets. Since 1998, the scale of loans of Japanese commercial banks has shrunk due to the fermentation of bad debts in the real estate sector, and the decline in the stock market has also been an important reason for the decline in the ability of Japanese commercial banks to expand their credit. Since there is generally cross-sharing between Japanese commercial banks and corporate customers, banks can hold no more than 5% of the company's equity, and the profit or loss of the company's stock price directly affects the bank's capital. Against the backdrop of a sharp drop in stock prices, a chain of "falling stock prices - erosion of bank capital - limited expansion of bank credit" has been formed. Beginning in 2002, some of the shares held by the Bank of Japan were transferred to the newly established Banks' Shareholding Purchase Corp and the Bank of Japan. The proportion of equity holdings in securities investment held by the Japanese banking sector has gradually shrunk from more than 30% to less than 10%. During this period, Japanese commercial banks increased their investment in bonds, especially Japanese government bonds, while slightly increasing their investment in overseas securities.
In the third stage, after the QQE in 2013, banks increased the proportion of cash-like assets and reduced the proportion of bond investment, banks began to significantly increase the allocation of ultra-long bonds, and large banks increased overseas loans and overseas securities investment. After the Bank of Japan opened QQE and yield curve control, Japanese bond interest rates fell further, the yield of 10-year Japanese government bonds has been less than 1%, and even entered negative interest rates after 2016. The share of foreign loans from Japan's large commercial banks has continued to rise to more than 30 percent, and the share of overseas portfolio investment in the Japanese banking sector has exceeded 30 percent of all portfolio investment.
1.2.2 Liabilities: Deposits are demanded, and money market funds are extinguished
From the perspective of liabilities, deposits in Japan's banking sector maintained a high growth rate compared with loans, and at the same time, from the perspective of deposit structure, as the interest rates of time deposits and demand deposits gradually approached, the proportion of time deposits decreased and the proportion of demand deposits increased.
From the perspective of deposit growth, since the late 90s, although the loan scale of the Japanese banking industry has contracted, the scale of deposits has maintained positive growth, especially the phenomenon of high deposit growth and slow credit growth of regional banks. Beginning in the 80s of the 20th century, the Bank of Japan gradually promoted the marketization of interest rates, and it was not until the early 90s that the marketization of deposit interest rates was completed. During this period, enterprises and residents had a high demand for deposit products with non-controlled interest rates (such as large-amount certificates of deposit, large-amount time deposits, etc.), and the scale of innovative products such as money market funds also expanded rapidly. Bank deposits continued to grow after the bubble burst, with large corporations tending to engage in asset allocation and M&A activities globally, while SMEs increased bank deposits (Murai et al., 2020).
From the perspective of deposit structure, after the 90s of the 20th century, with the rapid decline of time deposit interest rates, the proportion of time deposits in the Japanese banking industry has declined, and the proportion of demand deposits has increased. From 1993 to 1994, Japan's time deposits and demand deposits were marketized. From 1993 to 1996, the interest rate on fixed deposits has fallen from more than 2% to about 0.5%, and after 2016, the interest rate on fixed deposits has been at an ultra-low level of less than 0.1% for a long time. From 1993 to 2003, the proportion of time deposits in Japan fell from about 70% to about 45%, and the proportion of demand deposits rose from about 15% to about 45%.
In the low-interest rate environment, Japanese money market funds have gone from shrinkage to liquidation, and currency reserve funds with liquidation functions have become the mainstream of fixed income funds. In the early 90s of the 20th century, Japanese money market interest rates were higher than fixed deposit rates, and money market funds (MMFs) were also popular in the market, and the scale expanded rapidly. After 2000, the scale of money market funds gradually declined in a zero-interest or even negative interest rate environment, and after 2016, it was difficult for money market funds to maintain their net value, and all of them were liquidated. After 1997, the Money Reserve Fund (MRF) appeared in the Japanese market, and the MRF acted as a clearing fund for the asset management account of the securities company, and the idle funds in the securities account of the customer usually automatically purchased the MRF, and the MRF was subject to stricter supervision in terms of the rating and duration of the portfolio. After the liquidation of the IMF in 2016, only the MRF was retained. Due to the particularity of the MRF in the liquidation process, in order to maintain the net value of the MRF above 1 in a negative interest rate environment, the asset management institution has reduced the management fee, borne the losses of the negative interest rate investment on behalf of investors, and exempted the MRF from the prohibition of subsidies. As of the end of 2023, MRFs accounted for 97% of all fixed income funds, with the remaining 3% being a small number of long-term bond funds.
1.2.3 Duration of assets and liabilities: The maturity of the loan has been extended and the duration gap has increased
From the perspective of the relative duration of assets and liabilities, in the low-interest rate environment, the maturity of loans in the Japanese banking industry has been extended, the proportion of floating interest rate on corporate loans has decreased, and the proportion of floating interest rate on residential loans has increased, and the duration mismatch of small and medium-sized banks is even higher. In terms of the term structure of loans, after 2000, the loan maturity of the Japanese banking industry has been significantly lengthened, and this is the case for both corporate and residential loans; however, in terms of the proportion of floating-rate loans and fixed-rate loans, the proportion of floating-rate loans in corporate loans has decreased, while the proportion of floating-rate loans in household loans has increased. After 2010, the duration gap of Japanese banks' balance sheets increased significantly if core deposits were not taken into account, with a smaller increase in the duration gap of large banks (mainly due to the issuance of long-term fixed-rate loans) and a faster increase in the duration gap of regional banks and credit cooperatives (mainly due to investment in long-term bonds).
2. Changes in the income structure and business model of the Japanese banking industry
2.1 Changes in income structure
From the perspective of the changes in the income structure of the Japanese banking industry[1], the absolute scale of net interest income of the Japanese banking industry has decreased in the low interest rate environment, and the scale and proportion of net bank fee and commission income have increased significantly due to the mixed operation of the Japanese financial industry after the "financial explosion", and the contribution of investment income has fluctuated greatly in different years.
Since 1997, the absolute scale of net interest income in the Japanese banking industry has declined, accounting for roughly 70%-85% of operating income. From 1996 to 2019, the size of net interest income of the Japanese banking sector fell by about 40%, and the scale of net interest income has rebounded since 2020, although the asset scale of the banking sector has continued to expand. In terms of the proportion of revenue, net interest income accounts for 70%-85% of operating income.
In a low-interest rate environment, the deposit and loan spreads of the Japanese banking industry have been compressing, with the minimum deposit and loan spreads being less than 1%. From the absolute level of lending rates, from 1993 to 2000, the average lending rate fell from more than 4% to around 2%, from 2000 to 2010, the average lending rate remained roughly in the range of 1.5% to 2%, and after the opening of QQE, the average lending rate fell further, with the lowest falling to around 0.77%. At the same time, although deposit rates have also fallen rapidly, deposit and loan spreads have continued to decline slowly. From 1993 to 2000, the spread between loans and deposits in the Japanese banking sector narrowed from about 2.50% to about 1.90%, and from 2000 to 2010, the spread between deposits and loans continued to narrow to 1.40%. After the launch of QQE, the Japanese banking industry gradually entered a period of ultra-low net interest margin of less than 1%, and in 2022, the deposit and loan spread will be compressed to around 0.70%.
Second, the net fee and commission income, the Japanese banking industry has gradually increased the scale and proportion of net fee and commission income from separate operations to mixed operations, especially the fee income of large banks. Against the backdrop of Japan's "financial explosion," the ban on financial holding companies was lifted after 1998, and after 2004, the control of banks' securities intermediary business was lifted, and Japan's financial industry gradually shifted from separate businesses to mixed businesses, and the scale and proportion of banks' net income from fees and commissions increased significantly. Around 2000, large banks merged and reorganized to form a comprehensive financial group and expand their wealth management and trading business, and in recent years, the proportion of net fee and commission income of large banks has increased to more than 25%.
Third, investment income fluctuates relatively large from year to year, and the absolute scale and proportion are relatively low. In the low interest rate environment, various interest rate spreads in the Japanese financial market have generally narrowed, such as credit spreads (lending rates - deposit rates), conversion spreads (bond rates - money market rates), and passive interest rate spreads (money market interest rates - deposit rates), and the banking industry has experienced a "failure" of conversion functions (Murai et al., 2020). In this environment, it is more difficult for banks to obtain investment income from proprietary trading. Since 1996, the investment income of the Japanese banking industry (including the income from trading accounts and other bond investments, derivatives, and foreign exchange transactions) has accounted for about 13% of the operating income, and the comprehensive profit and loss of the Japanese banking industry has turned negative in some years when bond interest rates have risen (such as 1999 and 2003), and the investment income (excluding interest income) of the proprietary business has turned negative in fiscal 2008 and fiscal 2022.
2.2 Changes in banking business models
First, in order to cope with the decline in interest margin income, banks have increased intermediary business income by raising charging standards and broadening business types. On the one hand, since the 90s of the 20th century, the Japanese banking industry has tried to raise the fees charged by traditional bank payment and settlement services (such as ATM and transfer fees), but this attempt has also faced competition from new banking business models, such as "7 Bank" opened in the 7-Eleven convenience store chain. On the other hand, the banking industry pays more attention to private banking and wealth management business for high-net-worth customers, including the sale of investment trusts, pension insurance, etc. For example, 17% of the intermediary business income of MUFG Bank comes from the asset management business, and some small and medium-sized banks choose to jointly establish asset management companies to participate in related businesses.
The second is to expand international business and increase the income of asset portfolios, with large banks accounting for more than 30% of their loans and securities in overseas markets. As we pointed out in our previous analysis, large Japanese banks have increased their asset allocation in overseas markets to improve their overall asset returns. After the 2008 financial crisis, Japan's large banking groups further accelerated the pace of overseas expansion and acquired some overseas financial institutions, especially after the Bank of Japan launched QQE, the Japanese banking industry further increased the proportion of overseas loans and overseas portfolio investment, and the proportion of overseas loans and overseas securities investment of large banks reached more than 30%.
Third, in order to cope with the decline in residents' incomes and the decline in the value of collateral, the Japanese banking industry has paid more attention to the business of unsecured credit loans, and has acquired institutions that are specialized in credit reporting. As household wages and incomes have fallen, high-interest credit loans to individuals without collateral have become more attractive to banks, and some banks have acquired institutions that have expertise in obtaining personal credit information to enhance their business capabilities (Murai et al., 2020). Since 2012, the balance of credit card loans in the Japanese banking sector has ended its downward trend and has rebounded significantly, from 3.2 trillion yen to more than 4.5 trillion yen. In terms of corporate loans, the Japanese banking sector began to offer non-recourse real estate loans based on project cash flow and unsecured fixed loans based on credit scoring models (BOJ, 2005).
Fourth, with the decline in bond investment returns, the Japanese banking industry is paying more attention to alternative investments. According to the Bank of Japan (2005), in order to cope with the decline in investment returns, large banks and regional banks have increased the number of investments called "other investments" in the statistics of the Bank of Japan, and their size and proportion have gradually increased, and they have now reached about 10% of the securities investment in the Japanese banking industry.
Fifth, inter-bank mergers and reorganizations have reduced the number of branches and reduced operating costs. Since the 90s of the 20th century, Japan's banking industry has experienced the bankruptcy of some banks and the merger and reorganization of banks, with the number of city banks reduced from 13 to 5,[2] and the number of secondary regional banks (most of which were reorganized from savings banks) reduced from 68 to 39. Since 2001, the number of branches of commercial banks has decreased from about 15,000 to about 13,000, especially the number of branches of banks in the second region has declined significantly, and the number of branches of urban banks has declined for a time, but has rebounded again in recent years. Since 1996, personnel costs in the Japanese banking sector have fallen by about 30 percent and non-personnel costs by about 9 percent as the number of branches has declined. However, in a low spread environment, the cost-to-income ratio of the Japanese banking sector is still above 60% due to the same reduction in the size of revenues (declining denominator).
Bibliography:
1. Fang Ming Shirakawa, translated by Pei Guifen et al., Turbulent Times, CITIC Press, 2021.
2. Bank of Japan, Current Situation and Assessment of the Financial System: Focusing on the Banking Sector, August 2005.
3. Wang Luolin, Yu Yongding, Li Wei, Major Changes in Japan's Macroeconomic Policy, International Economic Review, July-August 1998.
4. Takao Komine, translated by Chen Xi, Thirty Years of Turmoil in Japan: Heisei Economy 1989-2019, Zhejiang People's Publishing House, 2022.
5.Baxter R.，Japan’s Cross-Shareholding Legacy: the Financial Impact on Banks, Asia Focus, 2009.
6. Ishihara,H.，Why unrealized losses at Japanese banks are only 5-10% of the US[EB/OL]，2023/6/5[2024/4/11]，https://market-news-insights-jpx.com/insights/article005056/
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Annotation:
[1] In order to facilitate comparison with the statements of the banking industry in mainland China, this article adjusts the income statement accounts disclosed by the Japan Banking Association, net interest income is interest income minus interest expense, net fee and commission income is fee and commission income minus fee and commission expenses, investment income includes trading account income and other ordinary income, trading account income includes securities and derivatives investment income of trading account, and other ordinary income includes bond maturity and sale income, Income from foreign exchange transactions and income from derivatives, etc., the same below.
[2]5家城市银行包括三菱日联银行(MUFG Bank)、瑞穗银行(Mizuho Bank)、三井住友银行(SMBC)、里索纳银行(Resona Bank)和崎玉里索纳银行(Saitama Resona Bank)。