Costs of low Japanese interest rates for the banking industry

Introduction

Japan’s interest rates are still the lowest among the rich countries of the world. Hence, international investors have not failed to notice this and have been borrowing heavily in Japanese yen and investing the proceeds into government bonds which promise higher returns. The effect of this is that it has tended to cheapen the Japanese yen which has been a subject of intense debate among international financial analysts (The Economist, 2007). According to BY (1986) bank interest rates in Japan are fixed by the government. This control measure ensures a huge supply of long term funds to domestic investors to borrow to spur growth. The cost of these loans is also determined by the government and not market forces of supply and demand (BY, 1986).

Costs of low Japanese interest rates for the banking industry

One of the main costs of the low Japanese interest rates for the banking industry is the likelihood of a fall in the amount of saving by younger foreign educated Japanese professionals in the long run. According to BY (1986) many young Japanese professionals who have been educated and/or worked in the west have a dislike for saving money in Japanese banks because of the low interest rates that they earn. Even though the Japanese still consider saving money in the banks as very crucial, the consistent low interest rates is turning away quite a number who prefer to use their money in other activities such as going on vacations (BY, 1986). These urban Japanese professionals who have studied or worked in western countries have witnessed the impact of financial liberalization on US economy and other European countries. They have seen how this liberalization has benefited US investors by creating numerous opportunities for them; most keep on agitating for easing of government control on Japanese banking industry (BY, 1986).

According to The Banker (1994) most Japanese banks give loans at rates of between 0.25% and 0.5% which is below the average loan funding costs. For the banks to cover the average funding costs The Banker (1994) noted that they should charge a minimum of 2.75% to cover average funding costs; which does not even include the operating costs. This scenario has led to many banks operating on very thin profit margins and many others operating at a loss. The effect of this has seen most Japanese banks dropping to “E” on Moody’s credit rating scale which has adverse implications on the concerned banks credibility and reputation on the international financial arena (The Banker, 1994).

The other cost of Japanese low interest rates has been a fall in overall lending. Due to rising non-performing loans due poor state of the general economy, most Japanese banks have reduced lending and some have even resulted to credit rationing to minimize loan default (FARRANT, MARKOVIC and STERNE, 2003). The rise in non-performing loans saw the Central bank of Japan adjust the ratio of bank capital to non-performing loans which in effect reduced the ability of banks to extend loans resulting in reduced lending and credit rationing. The other cost has been increased competition for small business loans. Banks have been competing fiercely for clients in the small business loans sector to increase absolute volumes of loans given out to beat the low margins due to the low interest rates.

It is important to note that most banks generate most of their revenues from interest charged on loans and so when the interest rates are low so is the amount of revenue they forecast to generate. Most banks in Japan have been unable to write down bad loans to improve their credit rating because of the low interest rates. In fact according to NORTON (2001) the rates are so low that most banks cannot earn their way out of their problems in the foreseeable future. The low interest rates devalue the banks and also their value at the stock market which erodes shareholder value and the value of the related collateral (NORTON, 2001).

References

A real mess. 1994. The Banker, 144(823), pp. 61.

BY, J.L., 1986, Dec 01. Young Japanese Executives Becoming Reluctant to Park Savings in the

Bank. Wall Street Journal, 1. ISSN 00999660.

FARRANT, K., MARKOVIC, B. and STERNE, G., 2003. The macroeconomic impact of

revitalising the Japanese banking sector. Bank of England.Quarterly Bulletin, 43(4), pp. 439-451.

Finance And Economics: A hiker’s guide to Japan; Japanese interest rates. 2007. The Economist,

382(8517), pp. 82-86.

NORTON, L.P., 2001. Asian trader: It’s bite-the-bullet time for Japan’s banks. Barron’s, 81(46),

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