Moody’s Japan Upgrades Outlook on Japan’s Banking System to Stable

Credit rating agency (CRA) Moody’s Japanese unit, Moody’s Japan, has revised its outlook for Japan’s banking system from negative to stable.

Moody’s Japan said the revision was prompted by the stability evident in the banks’ operating environment, asset quality and capital, as well as funding and liquidity. The change is the first since the negative outlook was assigned in 2008.

Moody’s announcement was contained in its annual ‘Banking System Outlook: Japan’, which expresses the CRA’s expectations for the fundamental credit conditions in the Japanese system over the next 12-18 months. The new report notes modest, but above-trend, economic growth, as assumed in Moody’s baseline scenario for the coming 12-18 months, contributing to the stable operating environment.

Moody’s also views asset quality and capital as stable, as the CRA does not expect non-performing loans (NPLs) to rise significantly, despite the expiration in March 2013 of government measures to support lending to

Small and medium-sized enterprises (SMEs). Indeed, the banks’ asset quality metrics are good relative to their global peers, and their capital ratios are also strong.

The report notes that the third factor, funding and liquidity, is a strength of the Japanese banking system, and expects private-sector demand for deposits to remain strong, while growth in overseas lending will result in only a minor increase, if any, in the banks’ reliance on wholesale funding. The current operating environment provides improved opportunities for growth in domestic and international loans. A return to above-trend positive growth in nominal gross domestic product (GDP) for Japan is supportive of a continued recovery in domestic loan growth.

At the same time, ongoing deleveraging by global competitors, particularly the European banks, has resulted in greater opportunities for Japanese banks to grow their overseas loan books.

However, the report sees several risks to Moody’s baseline economic scenario. These include the sensitivity of Japan’s exports to major uncertainties in global demand; the possibility that a planned rise in the consumption tax may lead to volatility in consumption; and apprehension that fundamental domestic concerns – ranging from energy security to the country’s ageing demographics – may exacerbate the hollowing out of Japan’s industrial base.

Furthermore, the low interest rate environment results in structurally weak net interest income, and although the banks are trying to increase non-interest income, they have not been successful in fully offsetting the decline in net interest income.

The annual outlook further notes that selective overseas expansion, both organic and through acquisitions, is increasing the diversity of revenue sources for the banks. For example, overseas lending now accounts for 15-20% of the three Japanese mega-banking groups’ total lending and is still growing.

Moody’s assessment of this growth so far is, on balance, positive as it recognises the potential for improved margins and improved contributions to asset diversification on a geographic basis.

The report notes the continued strong willingness and ability of the Japanese authorities to provide support to troubled banks – a credit positive. In this context, Japan has a comprehensive set of regulations and tool kit to provide public support to the financial system, when necessary.

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