Godzilla is Waking Up: The increasing profitability and risk taking at Japanese Banks.

Summary

After three decades of hibernation, Japan’s banks are finally stirring—and they’re hungry. As the Bank of Japan (BOJ) pivots away from its ultra-loose monetary regime, an entire financial system long confined to the sidelines is preparing to rejoin the global game. The story is not just one of rate normalization and earnings recovery. It’s a tale of capital unleashed, of risk appetite returning, and of Japanese money preparing to flow—not just at home, but across Asia. This is the moment Japanese banks have been waiting for. With interest rates finally creeping above zero, deposit spreads are widening for the first time in decades. Earnings are rising, balance sheets are strengthening, and capital is building. These sleeping giants—Sumitomo Mitsui Financial Group (SMFG), Mitsubishi UFJ Financial Group (MUFG), and Mizuho—are regaining their footing. But the real story isn’t just about profits. It’s about what happens next. What do giant, under-levered, increasingly profitable banks do when they start to believe in growth again? They lend. And the next leg of this story stretches far beyond Tokyo. Japan’s megabanks are setting their sights on Southeast Asia and India—young, under-banked, fast-growing economies hungry for capital. If this thesis plays out, we could be witnessing the beginning of a major regional power shift—not just in finance, but in the trajectory of emerging Asia’s asset markets.

Thesis

1. The Yield Curve Awakens For years, Japanese banks operated in a twilight world. The BOJ’s negative interest rate policy (NIRP) turned deposits into liabilities, punished duration, and destroyed margins. Even the best-run banks could barely scrape together a return on equity above 6–7%. The system became risk-averse by design—hoarding JGBs, minimizing credit exposure, and retreating from growth. That era is ending. In March 2024, the BOJ ended its negative interest rate policy, raising its short-term policy rate from -0.10% to +0.10%. More importantly, Governor Ueda signaled that this is not a one-off. Inflation is back, wage growth is rising, and the BOJ is preparing the public for a return to positive real rates. For banks, the effects are immediate and powerful: • Deposit spreads widen: A 0.25–0.50% increase in short-term rates on trillions of yen in retail deposits means billions in net interest income. • Bond losses fade: As rates normalize, the unrealized losses on bank-held JGBs start to unwind. • Risk appetite returns: Rising rates allow banks to price credit risk again—sparking a shift from liquidity hoarding to credit creation. This is the monetary equivalent of reoxygenating the soil after decades of drought. The banking system is breathing again. 2. Capital Builds… and Looks for a Home Japan’s megabanks are already highly capitalized. MUFG and SMFG have Common Equity Tier 1 (CET1) ratios above 12%—well above regulatory minimums. With rising earnings, those capital buffers are set to grow even faster. In the short term, some of this surplus capital may be returned to shareholders via buybacks. But structurally, Japanese banks are preparing for something bigger. The key insight here is that banks don’t hoard capital forever. They lend it. The question is: where? 3. Domestic Lending: The Real Estate Reawakening Japan’s domestic market is still deeply conservative, but it is beginning to shift. One area to watch closely is real estate. For decades, Japan’s property sector has been frozen by demographic stagnation, deflationary expectations, and falling land values. But as inflation returns and interest rates rise, this dynamic is shifting. • Residential real estate is seeing increased mortgage activity, especially in the Tokyo metro area where supply is constrained. • Commercial real estate is benefiting from a wave of re-urbanization, infrastructure projects, and increased tourism. • Cap rate spreads are still wide relative to bond yields, making Japanese real estate attractive to both domestic and foreign investors. Japanese banks—especially regional lenders—are starting to cautiously ramp up their exposure. SMFG and Mizuho have both highlighted domestic CRE (Commercial Real Estate) lending as a focus area. This could be the beginning of a broader re-rating of Japanese real estate as a whole. 4. The Asian Pivot: Growth Beyond Borders Perhaps the most exciting (and overlooked) part of the story lies outside Japan. MUFG, SMFG, and Mizuho have all spent the last decade quietly buying stakes in Asian banks and building regional platforms: • MUFG owns 20% of Vietnam’s VietinBank, 20% of Bank of Ayudhya in Thailand, and a significant stake in Security Bank in the Philippines. • SMFG has invested in Rizal Commercial Banking Corp (Philippines), and full control of Indonesian bank BTPN. • Mizuho has a smaller presence, but is expanding via corporate lending and trade finance. These investments—once seen as long-term strategic hedges—now look like springboards. The Southeast Asian financial system is still young, fragmented, and under-banked. Credit-to-GDP ratios are low, capital markets are thin, and regulatory frameworks are evolving. It is precisely this developmental gap that presents an opportunity. As Japanese banks accumulate surplus capital and search for yield, they are likely to lean into these Asian subsidiaries and joint ventures. The advantages are clear: • Higher margins than domestic Japan • Structural loan growth in consumer and SME segments • Currency diversification and long-term FX appreciation potential This is not just about foreign asset accumulation. It’s about exporting the Japanese model of patient, conservative banking into emerging Asia—at a time when Western capital is pulling back. 5. Valuation: Still Cheap, Still Ignored Despite the improving fundamentals, Japanese banks remain deeply undervalued: • MUFG and SMFG trade at 1x Price-to-Book • ROEs are trending towards 12%, with upside • Dividends are sustainable and growing, with payout ratios around 30% In a world starved for value, these metrics stand out. And yet, the global investment community remains largely absent from Japan’s financials—still scarred by decades of stagnation and overcapitalization. This creates an opportunity for forward-looking investors. The story is still early. The re-rating has just begun.

Risks

1. BOJ Reversal The most immediate risk is a policy reversal by the BOJ. If inflation falls back below target, or if global conditions deteriorate, the central bank may delay further rate hikes. This would stall the deposit spread story and dampen earnings momentum. However, inflation expectations are becoming more entrenched, and labor shortages are structurally pushing up wages. A full return to zero or negative rates looks increasingly unlikely. 2. Credit Risk Missteps in Asia As Japanese banks expand lending in Southeast Asia and India, they will face unfamiliar credit environments. Regulatory frameworks, collateral enforcement, and borrower transparency vary widely. A single major misstep in Vietnam or Indonesia could damage confidence in the regional strategy. And eventually there could be another asset bubble crash in Asia, but that is years away and first we have to have the bubble. 3. Structural Deflationary Headwinds Japan’s long-term demographic and productivity challenges haven’t gone away. An aging population, low immigration, and sluggish real wage growth still weigh on the domestic economy. A full-blown return to high-growth lending is unlikely. The bull case hinges on moderate growth and incremental capital deployment—not a boom.

📈 Price Targets

• Mitsubishi UFJ Financial Group, Inc. – Target: JPY 2900.00 for 2027
• Sumitomo Mitsui Financial Group, Inc. – Target: JPY 5300.00 for 2027
• Mizuho Financial Group, Inc. – Target: JPY 6500.00 for 2027

Tags

• Banks
• Japan
• Financials