Their smaller peers, on the other hand, rely more on offering rock-bottom rates to a customer segment that is more sensitive to interest rate changes, such as small local businesses.
"Major banks have high hopes interest rates will be raised," said Takahide Kiuchi, executive economist at Nomura Research Institute. "But regional banks have mixed feelings of hopes coupled with worries about the [potential] rate hike."
The Bank of Japan (BOJ) has maintained a cautious stance, tightening policy in effect by increasing its tolerance of higher long-term bond yields since December 2022. Still, the regulator kept its benchmark interest rate at minus 0.1%, sticking with a negative interest rate policy first introduced in 2016. The BOJ offered little indication on the timing of the possible end to negative policy rates, but most analysts expect the central bank to normalize its monetary policy within the first half.
Jacking up
Mitsubishi UFJ Financial Group Inc. (MUFG), Sumitomo Mitsui Financial Group Inc. (SMFG) and Mizuho Financial Group Inc. hope to start charging higher interest rates on loans from their customers soon after a policy change. MUFG and Mizuho Financial estimate that a 10-basis-point increase in short-term rates would boost their annual net interest income by ¥35 billion each, according to statements by the lenders at different times in 2023. SMFG expects to earn an additional ¥30 billion from a similar increase in interest rates, according to a statement in November 2023.
"We will be returning to a world of positive interest rates," Hironori Kamezawa, MUFG's chief executive, said at an earnings press conference in November 2023. "We are seeing light at the end of the long deflationary tunnel."
Net interest income at MUFG will likely rise to ￥2.600 trillion in the fiscal year ending in March 2025, from ¥2.380 trillion in the previous fiscal year, according to analyst estimates on the S&P Capital IQ Pro platform. SMFG may see net interest income increasing to ¥1.820 trillion from ¥1.780 trillion and Mizuho to ¥940 billion from ¥920 billion, according to current estimates.
Less flexible
Smaller banks have lesser flexibility on their spreads — the difference between the interest rate earned on lending versus that paid on deposits — than the megabanks. They focus on domestic customers, where an aging population that is also shrinking puts limits on consumer demand and spending.
"It could be harder for regional banks to raise lending rates as they have become intimately involved with local customers," said Hideo Oshima, a senior economist at Japan Research Institute. "Without increasing the rates enough, [local lenders] won't benefit much from higher rates."
Japan's 62 regional lenders reduced the average loan rates for local businesses to 0.814% in October 2023, compared with 0.966% in 2018, BOJ data shows. Over the same five-year period, the nation's 10 major banks raised their average lending rate to 0.64% from 0.51%.
For instance, Concordia Financial Group Ltd., one of the largest regional banks in Japan, cut loan rates to 0.95% in the first half of the current fiscal year ending March 31, 2024, from 1.01% in the six months ended March 2022.
While estimates for regional banks' net interest income (NII) are unavailable, aggregate NII at 62 domestic lenders declined 2.2% year over year, hit by the increasing cost of fundraising. This declined to ¥1.520 trillion in the first half to September 2023, according to the Regional Banks Association of Japan.
Smaller banks have allocated cash to long-term bonds as they seek to improve their returns on their investment, an advantage that is getting eroded as yields on Japanese government bonds rise. The yield on the benchmark 10-year Japanese government bond hit a decadal high of 0.975% in November 2023. The bonds traded at a yield of 0.603% on Dec. 27, 2023, up from 0.463% a year ago.
The interest rates that banks pay on may rise faster than the yields they earn from their investment, according to the Financial System Report
In addition, holding longer-term bonds would incur more latent losses than investing in shorter-term notes when yields rise, Nomura Research Institute's Kiuchi said.
"Banks can hold bonds to maturity to avoid making actual losses," Kiuchi said, "but making unrealized losses would lead to the detriment to capital at regional banks."
Bonds favored
Regional lenders favor longer-term bonds to improve their margins. The average maturity of bonds in their portfolio rose to 7.3 years by March 2023, from 4.6 years in March 2017. The average maturity of bonds held by major banks stayed around 3.2 years during the same period, the data shows.
A return to positive policy interest rates in Japan will underscore the significance of deposits for banks, analysts said. That would mark a departure from viewing retail banking as more of a challenge than an opportunity.
If the central bank raises interest rates, "that means the Japanese economy is healthy and funding needs are solid," Koichi Niwa, an analyst at Citigroup Global Markets Japan, said, shrugging off concerns that the rate hike would hamper the economy. That would prompt banks to increase outstanding loans and that should be a plus for a core business of banks, he added.
Banks can now earn higher spread by taking deposits and investing them in risk-free higher-yielding Japanese government bonds after the central bank loosened its grip on the long-term yields three times since December 2022. This is seen as the step to the exit from the minus rates policy.
"We will see the value in deposits in a world where interest rates are positive," Masahiro Kihara, Mizuho's CEO, said at an earnings press conference in November 2023. "We will make profits by collecting deposits."
MUFG increased the interest rate on the 10-year term fixed deposits to 0.2% on Nov. 6, 2023, from the previous 0.002%, a bank spokesperson told S&P Global Market Intelligence over the phone. SMFG followed on Nov. 9, 2023, and Mizuho on Nov. 13, 2023. Spokespersons at the three megabanks declined to offer more details or discuss their strategy on interest rates if the central bank raises rates.
"We will see competition among banks intensifying to raise rates on deposits and on loans to earn wider margins," Kiuchi said.
