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As Goldman enters fray, Japan banks face more growth worries

US-China trade war adds to credit costs, but megabanks continue overseas push

Japanese mega banks, Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group and Mizuho Financial Group, warn of a prolonged low-growth, low-rate environment. (Photo by Ken Kobayashi)

TOKYO -- Japan's three biggest bank groups on Wednesday warned of prolonged low profit growth after reporting weak annual earnings, no thanks to the U.S.-China trade row and intensifying competition from digitized services.

The three mega banks -- Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group and Mizuho Financial Group -- on Wednesday offered a cautious outlook for the fiscal year that started April, predicting a prolonged low-growth, low-rate environment and rises in loan provisions overseas. Keeping staff costs under control is a common theme through increased digitization and the closure of unprofitable branch offices among the three.

The banks still earned handsome profits, even as interest rates plunge, because of their scale and dominant positions. As such, despite the headwinds, the industry is attracting new entrants from outside the traditional banking sector, most recently from Goldman Sachs.

In the fiscal year ended March, MUFG, the largest of the three, reported a net profit of 872 billion yen ($8 billion), down 12% from a year ago. SMFG, the second largest, logged a profit of 726 billion yen, off 1% from the year before. Mizuho took a special restructuring charge of 695 billion yen and suffered a 83% profit decline at 96 billion yen.

"MUFG's recurring profitability continues to weaken," said Shunsaku Sato, senior credit officer at Moody's Japan. Its Morgan Stanley affiliate contributed 25% of pretax income, up from 17% in the previous year, which "highlights the weakness in MUFG's own core businesses," Sato said.

For the current fiscal year, MUFG is expecting a 9% increase in net profit, while SMFG warns of a 4% drop. Mizuho's net profit is set to bounce, but is expected to fall well short of the level before the announcement of restructuring charges.

"We are facing a more difficult business environment this year than last year," said Jun Ota, CEO of SMFG. He said the business environment was uncertain, because it was hard to predict the extent of the fallout of the U.S.-China trade war.

MUFG echoed the same view. CEO Kanetsugu Mike said: "The tariff war is escalating. It will hurt economic growth in China, making it more difficult for the Japanese central bank to end its monetary easing."

Even as the economic outlook darkens, there is no easing of competition. Goldman Sachs is the latest example of a new entrant into the Japanese banking business. The New York investment bank is believed to be looking at the possibility of providing cash management services for large corporations as early as next year and is expected to apply for a banking license in Japan.

A Goldman Sachs sign is seen above the floor of the New York Stock Exchange. The investment bank's push into Japan offers a challenge to the three megabanks.   © Reuters

Its cash management service would allow clients to make and receive payments online at a lower cost, a service that could potentially threaten the commercial banking business of the Japanese mega banks. Goldman already offers its Marcus retail banking service in the U.S. and U.K. and is planning to release a credit card with Apple.

The mega banks already face competition from technology startups that aim to cater to young generations with easy-to-use smartphone-based applications for retail payment, cash transfer, insurance and investment. Such services have the potential of making obsolete the branch networks of traditional banks.

Japanese bankers so far shrug off the challenge from Goldman. They said that large commercial transactions, such as trade finance and overseas remittances, are not as easy to digitize or automate as retail businesses, and are more based on long-term trust than cost. They do not think Japanese clients will easily defect to Goldman. Goldman declined to comment.

In April, the International Monetary Fund predicted that global growth would slow to 3.3% this year from 3.6% last year. The situation has deteriorated further over the past month, with the U.S. increasing tariffs on $250 billion of Chinese goods to 25% from 10% on Friday. This was met by a retaliatory move by China to raise tariffs on $60 billion worth of U.S. goods to as high as 25% from 5-10%.

Many Asian countries depend on exports to China for economic growth, and a deterioration in consumer and business sentiment in China is beginning to have knock-on effects on them. French credit insurer Coface said that corporate bond defaults in U.S. dollars quadrupled to $16 billion in China in 2018. According to its survey of 1,500 Chinese companies, 62% experienced payment delays in 2018.

To cushion the impact of any fallout from an overseas economic shock, the Bank of Japan is already pushing the pedal to the floor, keeping short-term interest rates below zero and long-term interest rates around zero. That has practically wiped out the credit spread, or the difference between the average yield on loans and the average cost of funding. All three banks are looking to overseas to generate profits going forward.

MUFG has recently turned Indonesia's Bank Danamon into a subsidiary, adding to the list of its overseas units that include Bank of Ayudhya in Thailand. Both Danamon and Ayudhya are big auto loan providers, making it necessary for MUFG to mark more provisions for possible loan losses, MUFG said.

Mizuho increased its balance of overseas loans by 18% in the past fiscal year, and said that an expansion will continue, albeit at a slower pace.

"Banks used to be able to earn enough returns by simply taking deposits and lending them to borrowers. But with interest rates as low as they are, (the traditional business of) lending money no longer earns enough profits," said Yasuyuki Fuchida, senior fellow at Nomura Institute of Capital Markets Research.

"Now, even the settlement business is facing competition from companies from outside the banking sector, such as nonbanks," Fuchida said.

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