Japan's Banks Are Yet to Grow a Taper Tail

Japan's big financial groups are sitting pretty as speculation grows of BOJ tapering.
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Soon, Japanese banks may no longer be the cheapest in the world.

The yield-curve control undertaken by the nation's central bank has done lasting damage. Data compiled by Bloomberg on financial institutions with a market capitalization of $10 billion or more show those from Japan are the biggest value traps, trading at just 0.69 times book, despite having an average 5.7 percent return on equity.

Granted, Germany's Deutsche Bank AG and Commerzbank AG are cheaper, but they generate hardly any returns to shareholders. Even Chinese lenders, saddled with bad debt, trade at book value.

Going Cheap

Japan's banks have the lowest valuations despite a decent return on equity and robust capital buffers

Source: Bloomberg

Note: Data include global banks with a market cap of $10 billion or more.

And don't forget, Japan's banks are sitting on a mountain of gold. The three largest -- Mitsubishi UFJ Financial Group Inc., Mizuho Financial Group Inc. and Sumitomo Mitsui Financial Group Inc. -- could, combined, have realized more than 7 trillion yen ($63 billion) in capital gains had they sold their stock holdings at the end of September. That's close to 30 percent of the trio's market value, and that windfall would be higher now, following the 13 percent gain in the Topix since then.

Negative interest rates have forced the lenders to seek new ways of making money. Since Bank of Japan Governor Haruhiko Kuroda took office five years ago, borrowing costs have been in steady decline, with average interest rates on contracted loans coming in at 0.95 percent in November, the latest data available. Meanwhile, banks' average expense ratio, defined as operating expenses over assets, is about 0.6 percent.

Borrowing Blues

Interest rates on loans have been falling since the BOJ's Kuroda took office in 2013

Source: Bloomberg, Bank of Japan

Note: Loan rates show averages of rates on new or extended loans and discounts during the month. Excludes overdraft accounts.

One obvious solution would be to cut overheads. But as my colleague Nisha Gopalan wrote, Japan's megabanks aren't firing workers fast enough, in part because job cuts are still a sensitive area in Japan. They don't have much room to maneuver there.

Any hint, therefore, that the central bank may be reversing its policies is enough to jolt stocks into action. On Tuesday, the BOJ unexpectedly cut purchases of Japanese government bonds, prompting a spike in yields and talk of "stealth tapering."

Social Climber

Ten-year government bond yields in Japan spiked earlier this week, as traders bet the central bank will start tapering this year

Source: Bloomberg

Even if the BOJ doesn't officially tweak its policies this year, as Morgan Stanley predicts, it may slow net purchases of government notes. JPMorgan Chase & Co. and Deutsche Bank are in the other camp, contending that the central bank will reduce bond purchases to 40 trillion yen in 2018.

Party Time

Bank shares have rallied since BOJ Governor Kuroda's November speech, which sparked speculation the central bank may start tapering in 2018

Source: Bloomberg

Either way, banks would get some breathing space, and markets have been cheering for them.

Whatever the policy pronouncements, the current inflation target is ludicrous, as I've argued. Deflationary trends are hitting global economies from the U.S. to China, so why does Kuroda think Japan can reach 2 percent inflation, when the current level is 0.9 percent and the economy is in full employment?

To be sure, we're not quite at the policy breaking point yet. It's widely understood that the official stance of "around zero percent" means the central bank is willing to tolerate movements between negative and positive 0.1 percent, a trading band that hasn't been breached since July. But if U.S. Treasuries break higher, Kuroda will be on the hot seat again. 

In a November speech, Kuroda himself talked about the negative impact of his policies. He pointed to the possibility of "reversal rates," an environment in which banks won't lend because there's no profit in it. Indeed, if I was a Japanese banker, I'd shun a net interest margin measured in basis points and use my fat wad of cash to buy into some sweet Indonesian or Indian assets.

Since Kuroda took office five years ago, bank stocks have underperformed the broader market by more than 50 percentage points. It's time for them to come alive again.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Shuli Ren in Hong Kong at sren38@bloomberg.net

    To contact the editor responsible for this story:
    Paul Sillitoe at psillitoe@bloomberg.net

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