Moody's: Japanese banks only marginally affected by negative interest rate policy

Moody's Japan K.K. says that Japanese banks will see only a limited deterioration in their profitability following the introduction of a negative interest rate policy (NIRP) by the Bank of Japan (BOJ) in late January, and the subsequent introduction of a so-called yield curve control policy in September.

"The greatest impact on profitability from NIRP is through spread loans, with the regional banks more exposed due to their limited geographic diversification and high reliance on domestic interest-earning income," says Tetsuya Yamamoto, a Moody's Vice President and Senior Analyst.

"The impact of NIRP on deposits at the BOJ has been limited, and the banks currently still earn interest on approximately 70% of these deposits," adds Yamamoto.

Moody's conclusions are contained in its just released report, titled "Banks -- Japan: Impact from Negative Interest Rates Is Marginal".

Moody's has carried out both a bottom-up analysis and a top-down analysis to assess the impact of NIRP on the profitability of Japanese banks.

Under its bottom-up analysis, focused on the loan assets directly exposed to the lower rates, Moody's estimates that the system would see a 4%-7% decline in net income from the level reported in the fiscal year ended March 2016 (FYE3/2016).

Specifically, Moody's report points out that not all loan reference rates, which are used to price the banks' loan assets, have declined in response to the introduction of the NIRP.

Spread loans, which account for nearly half of the major banks' loans and 42% of the regional banks' loans, has been most affected, as the 3-month TIBOR -- used to price these loans -- declined 11 basis points between January and August 2016.

Meanwhile, the short-term prime rate, the most common rate for loans to small- and medium-sized enterprises (SME) and floating-rate mortgages, has remained unchanged. SME and mortgage loans accounted for 27% and 35% of total loans at the major and regional banks, respectively, in 2016.

And while the long-term prime rate fell by a sharp 20 basis points between February and July 2016, only 1% of loans are priced off this benchmark.

As such, the major transmission mechanism for NIRP on loan profitability has been through spread loans. As the regional banks derived 50% of ordinary income from interest income on loans in 2016, with almost all loans domestic, they are more exposed to NIRP than the major banks, which rely for only 36% on interest income, of which 40% is derived overseas.

These findings were further confirmed by Moody's top-down analysis, which is based on a statistical analysis of the relationship between bank profitability and the prevailing sovereign interest rate curve.

Specifically, Moody's scenario analysis estimates a 0-3 basis point decline in net interest margins at the major banks, and a 3-9 basis point decline at the regional banks. A 3 basis point decline in turn would equate to 8% of the regional banks' net income for FYE3/2016, in line with the findings of its bottom-up analysis.

Various other factors further mitigate the impact of NIRP on bank profitability, says Moody's, including increased fee and commission income and -- in the case of the three megabanks -- ongoing trading income through the purchase and sale of Japanese government bonds to the BOJ.