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Japan’s bloated retail banks need to downsize

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SWEEP past the cash machines at the Sumitomo Mitsui bank in Tokyo’s Sangenjaya shopping district and instead enjoy the personal service. Uniformed concierges welcome every customer with a bow. A dozen tellers are watched over by a manager who leaps up to meet elderly patrons. Transactions are concluded with carved signature seals stamped on paper contracts, and another round of bows.

Japan’s high-street banks are not just overstaffed. They are also overbranched. According to the World Bank, high-income countries have on average 17.3 commercial-bank branches per 100,000 adults. Japan has 34.1. If you include branches of the post office, a popular place for people to save, the Bank of Japan (BoJ) reckons the country is the world’s most overbanked.

Retail banks across most rich countries struggled to make money after the financial crisis. But Japan has been close to or in deflation for most of the past two decades. The result, according to a report last year by the BoJ, is “strikingly” low profitability. Return on assets for the 12 months ending in March 2017 was 0.3%, compared with 1% for those in America. “The entire banking system has to drastically shrink,” says Naoyuki Yoshino of the Asian Development Bank Institute, a think-tank.

A lingering culture of jobs for life is one reason it hasn’t done so yet. The nation’s biggest banks are, however, finally starting to act. The IMF warned last autumn that Japan’s big three, MUFG, Sumitomo Mitsui and Mizuho, are among nine global banks that suffer from persistently low profitability. Last year all three announced the closure of hundreds of branches and the elimination of 32,000 jobs between them in the coming decade. Mizuho will shed a quarter of its workforce. MUFG says it expects to replace thousands of employees by automating up to 100 of its branches. All that sends a signal to the rest of the industry, says Shinobu Nakagawa of the BoJ.

The megabanks are well-placed to find alternative sources of growth by expanding abroad, says Masamichi Adachi of J. P. Morgan Securities. Reckless lending in Japan in the 1980s and 1990s was followed by a round of mergers. Recapitalisation was complete by the mid-2000s. The result was that big Japanese banks were in a position to snap up some of the business left behind as American and British banks retrenched in Asia after the financial crisis. A spending spree began in 2012. MUFG bought stakes in banks in Vietnam, the Philippines and Thailand. Since 2012 the share of foreign loans by the big three has risen from 19% to 33%. As they retrench at home, this share will probably rise further.

The country’s 105 regional banks are worse-placed, says Mr Yoshino. Some are barely profitable and more than half are losing money on lending and fees. As the population has shrunk and aged, these banks’ problems have been exacerbated by young people moving to the big cities. Not only is their customer base being whittled away, but the customers they are left with are older people who are most likely to want personal service. The Fair Trade Commission, which regulates competition, has approved 15 regional bank mergers in the past decade and the pace is accelerating. But the Financial Services Agency (FSA), their regulator, is reluctant to put them under too much pressure. Many provide a lifeline to ageing communities and help prop up struggling companies.

The government thinks banks should start offering more funding to startups and smaller firms. It hopes that would stimulate economic growth more broadly, but also thinks it would help the banks themselves by creating new, profitable clients. Nudging risk-averse banks away from calcified business practices while trying to avoid a major shock to the system is a tricky line to tread. “We want them to realise that profitability is low so their business is not sustainable,” says an FSA official. “Mergers are one option but there is still plenty of room for increased productivity.”

As if all this was not hard enough, Japanese banks, like those elsewhere, must also cope with new, low-cost competition. China’s largest fintech company, Ant Financial, has recently set up an office in Tokyo. Line, a messaging service with 75m monthly users in Japan, wants to expand into financial services. SBI Sumishin, an online bank set up by SoftBank Group and Sumitomo Mitsui Trust Bank a decade ago, has quickly become Japan’s most popular mortgage lender, which Noriaki Maruyama, its president, attributes mainly to costs that are a fifth of its lumbering rivals’. It has shaved interest rates on home loans to 1.17% a year, compared with an average for major banks of 1.28%, by streamlining operations (using artificial intelligence to process loan applications, for instance).

Mr Maruyama says the front-office clutter of high-street banks can be stripped away, leaving only cash machines. Most transactions can be done on mobile phones, he says. It is not an uncommon vision for a banker. But other countries do not have such cosseted customers.

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Japan still has great influence on global financial markets

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IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.

“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.

This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.

One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).

But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.

Tokyo storm warning

These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.

Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.

What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.

Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.

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