Japan’s lenders have turned the corner #JapanFinance

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For years, Japanese banks have been the ultimate value trap — cheap on paper, flush with cash and backed by rock-solid balance sheets, yet consistently underwhelming for global investors.

The sector has long struggled with low profitability, a result of the country’s ultra-low interest rate environment and inefficient capital allocation. But that narrative is slowly starting to change.

Interest rates are rising in Japan. The Bank of Japan raised its key policy rate to the highest level since 2008 last month. Higher rates are boosting net interest margins, profits and share prices of Japan’s largest lenders

The early results are already compelling. Japan’s largest lender Mitsubishi UFJ Financial Group reported a 32 per cent surge in net profit for the December quarter this week. The second largest, Sumitomo Mitsui Financial Group, reported a 54 per cent surge in net profit to $2.7bn, putting it on track for a record annual profit, while peer Mizuho Financial Group’s 28 per cent rise in net profit meant its nine-month earnings had already surpassed its full-year forecasts. SMFG estimates that rate rises will boost net interest income by ¥90bn ($586mn) this fiscal year.

The outlook remains strong. BoJ governor Kazuo Ueda has pledged to raise rates further. With each increase, profitability is set to improve — SMFG estimates that any additional rise of 0.25 percentage point could generate an extra ¥100bn annually

Beyond interest rate dynamics, Japan’s banking sector is evolving in other critical ways. Online financial services and digital payments, once overlooked segments in the country’s cash-heavy economy, are steadily gaining traction among locals. Historically, Japanese consumers have been slow to embrace online banking, with the adoption rate at just around a third in 2019. That has nearly doubled in recent years, reflecting a significant shift in consumer behaviour.

Local lenders have been investing in artificial intelligence-driven financial services and digital banking platforms to reduce reliance on physical branches and cut operational expenses. As adoption accelerates and these efforts begin to pay off, that could provide a lasting boost to earnings.

Part of that has already started to be reflected in the sector’s valuations. Shares in SMFG are up more than 40 per cent in the past year and trade at 1.1 times tangible book, the highest level in more than a decade. The sector’s value-trap stigma may not fade overnight, but Japan’s banking sector is now looking more appealing than it has for many decades.

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