After almost three decades of near-zero, zero, and now negative interest-rate policies, Tokyo has pushed its banking system to its limit.
The country’s smaller lenders in particular are facing an existential threat to their business models. Located in aging and shrinking prefectures, they lack the ability to increase fee-related incomes that major banks can raise.
Since March 2016, shortly after the country’s negative interest rate policy was introduced, net income at major banks has declined by a fifth. At regional banks, the decline has been steeper: Net income is a third below its level three years ago.
Practically all of Japan’s regional banks have seen their share prices fall in the past 12 months. More than half have had declines exceeding 30%. They have underperformed the broader Japanese market for decades.
At the beginning of 1995, just before the Bank of Japan cut its benchmark policy rate to 0.5%, loans by commercial banks with interest rates of below 1% were practically nonexistent. Over 90% of outstanding loans carried an interest rate of 3% or more. Today, 90% of Japanese loans carry an interest rate of less than 2%. The fastest-growing segment is the paltry 0.25% to 0.5% bracket, which has expanded by almost a 10th in the past year.
The interest offered to Japanese depositors, however, shifted much more quickly to very nearly zero. The upshot of this is that profitability held up for a while but now the 1.5 percentage point spread between interest rates on new loans and new time deposits that prevailed in the 1990s has declined to just 0.5 percentage point. Even with the country’s rock-bottom default rates, the resulting profits simply aren’t sufficient to run a bank.
Some of Japan’s major banks have found an apparent workaround, but one with its own serious risks. Those with the expertise and ability to do so have ventured overseas, acquiring assets and lending in currencies without such low interest rates.
The precarious position of Japanese banks isn’t an example of negative interest rates failing but of them working perfectly well. Central bankers often complain about problems with monetary transmission—often a byword for banks not passing on interest-rate cuts—but Japan’s have done so.
Critics of Japan’s monetary policy would be wrong to imagine that higher interest rates would help either. As with lower rates, the change would take years to filter through, during which time defaults would rise and economic growth would stall.