Monday October 27 in Tokyo started out sunny and clear, but by around 4pm ominous black clouds filled the sky and by 5pm there was total dark before the first flashes of lightning began to strike over the city’s skyscrapers. As a metaphor for the country’s fortunes over the last few months this would be hard to improve on: after a period in which Japan’s banks seemed to have risen above their stricken peers, that Monday saw the Nikkei 225 index fall to a 26-year low.
The banks’ fortunes plummeted almost in sync: their fates are, to a degree perhaps unparalleled elsewhere among sophisticated markets, tied to the domestic stock market. Hajime Kitano, an equity strategist at JP Morgan in Japan, estimates their collective average beta — that is, sensitivity to stock market fluctuations — to be between 1.3 and 1.4, much higher than their peers in the US or Europe.
Now Mitsubishi UFJ Financial Group, last of the big three banks to make an overseas splash during the good times with its $9 billion investment in Morgan Stanley, is the first to seek new capital in the form of up to $990 million in common and preferred shares to be issued over the next twelve months. Its two competitors, SMFG and Mizuho Financial Group, are thought to be considering similar measures.
There is genuine cause for concern: a research note from Fitch Ratings on October 10 warned as stocks fell that as the Topix (the index of all Tokyo stocks) fell below 900, the major Japanese banks’ unrealised gains were being wiped out. Fitch cautioned that a fall below 800 could see the banks’ “somewhat weak” Tier 1 capital positions eroded; at the time of writing at the end of October the Topix was at 728. It is worth noting that the megabanks are in a stronger position than their much smaller regional rivals, many of which are struggling in the current environment.
The Japanese government has responded to the situation by mirroring measures taken in the US and Europe to ban short selling — in Japan both naked and seemly versions of the practice will be forbidden outright — and by seeking to ease the restrictions on capital requirements for banks. This is the prescription offered by JP Morgan’s Kitano — but there is a snag: there is some doubt as to whether Basle II regulations allow the suspension of the rules governing how much of their losses from stockholdings banks must subtract from Tier 1 capital calculations. For now the easing of capital requirements will apply to Japanese banks with domestic businesses only: the troubled regional banks, but not the megabanks.
More help will be needed. The government has already set aside Y2 trillion ($20 billion) of relief to inject into the banks, with plans to increase that amount to Y10 trillion being considered at the time of going to press. If markets worsen further and the government dallies over a capital injection, their outlays of that most precious resource in the current crisis — cash in hand — may make Japan’s notoriously conservative financial institutions feel that they have been uncharacteristically rash. Government action intervention should help them weather the storm, as it has elsewhere in the world, long enough for Japan’s battered stocks recover to something like their true value. Then the banks’ recent bouts of overseas spending on troubled US institutions may start to resemble again the smart long-term bets that they must have seemed at the time.
