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Profits and Balance-Sheet Developments of Japanese Banks in Fiscal 1998

  • The full text can be obtained from the November 1999 issue of the Quarterly Bulletin.

November 30, 1999
Bank of Japan

Click on ron9911a.pdf (285KB) to download the full text.

I. Overview

Operating profits of Japanese banks in fiscal 1998 amounted to 3.8 trillion yen, down from 5.1 trillion yen in fiscal 1997.1 Operating profits from core business -- which show the basic profitability of financial institutions -- however, maintained a relatively high level, recording 4.8 trillion yen, a slight increase from the 4.7 trillion yen of the previous year.2 On the other hand, recurring losses and net losses marked record levels of 7.2 trillion yen and 4.5 trillion yen, respectively. This was due mainly to the disposal of nonperforming loans amounting to 13.5 trillion yen.

The average risk-based capital adequacy ratio of internationally active banks rose significantly from the previous year, increasing to 11.46 percent at end-March 1999 from 9.55 percent at end-March 1998 (weighted average on a consolidated basis). This was mainly due to the injection of public funds into banks such as city banks, long-term credit banks, and trust banks. In addition, as a result of the introduction of accounting for effects of income taxes in nonconsolidated financial statements, deferred tax assets of as much as 8.9 trillion yen were newly recorded.

Important tasks for Japanese banks drawn from an analysis of the profits and balance-sheet developments in fiscal 1998 are summarized below.

  1. "Japanese banks" refers to All Banks, comprising the nine city banks, the three long-term credit banks, seven trust banks (excluding foreign-owned trust banks and trust banks that started business after October 1993), the 64 member banks of the Regional Banks Association of Japan (hereafter regional banks), and the 61 member banks of the Second Association of Regional Banks (hereafter regional banks II). Figures in this report exclude data for the following failed banks: Long-Term Credit Bank of Japan, Nippon Credit Bank, Kokumin Bank, Tokyo Sowa Bank, and Kofuku Bank. They also exclude those for Namihaya Bank and Midori Bank, which were the subject of measures taken under the Deposit Insurance Law in fiscal 1998.
  2. In order to see the basic profitability of financial institutions, it is appropriate to exclude the impact on operating profits of net bond-related gains/losses, write-offs in trust accounts, and net transfer to the allowance for possible loan losses. Therefore, in this report, operating profits from core business are used as a measure of basic profitability, and are derived from the following formula:

Operating profits from core business =
operating profits - net bond-related gains/losses + (loan write-offs in trust accounts - write-back of the special reserve funds in trust accounts) + net transfer to the allowance for possible loan losses.

Net bond-related gains/losses =
gains on bond-selling operations + gains from redemption of bonds - losses from bond-selling operations - losses from redemption of bonds - write-downs of bonds.

A. Disposal of Nonperforming Loans

Fiscal 1998 saw the largest-ever amount of loan write-offs and provisioning for loan losses, the disposal of nonperforming loans being the most urgent task for Japanese banks. It even surpassed the amount in fiscal 1995, when nonperforming loans to jusen (housing loan companies) were disposed of, and that in fiscal 1997, when banks started write-offs and loan-loss provisioning based on the results of their self-assessment of assets. The disposal of nonperforming loans in fiscal 1998, when banks faced persistent economic deterioration and a continued downtrend in the prices of collateral, was characterized by two factors. The first was banks' attempts to increase the accuracy of self-assessment of assets, motivated by the intensive on-site examination by the Financial Supervisory Agency (FSA) and the Bank of Japan and the preparation of the "Final Report of the Working Group on Financial Inspection Manuals" (hereafter referred to as "Financial Inspection Manuals") by the FSA. The second was a rise in the ratio of loan-loss provisions to nonperforming loans accomplished in line with "The Viewpoint on the Write-offs and Allowances in Association with the Capital Injection" (hereafter referred to as "The Viewpoint") released by the Financial Reconstruction Commission (FRC).3

As described above, considerable progress was made in the disposal of nonperforming loans in terms of loan write-offs and loan-loss provisioning in fiscal 1998. Nevertheless, the situation continued to warrant close attention since the future course of the Japanese economy may change borrowers' financial condition and consequently increase nonperforming assets. Further, various tasks remain before nonperforming loans can be finally removed from banks' balance sheets, such as settlement of collateralized assets and liquidation of nonperforming assets.

The financial statements for fiscal 1998 reflected banks' efforts to improve their disclosure of nonperforming loans by establishing an appropriate link between self-assessment of assets, accounting treatment, and disclosure practice. It is important that such efforts be continued with a view to showing the accurate status of nonperforming loans.

  1. 3The "Financial Inspection Manuals" was released by the FSA on April 8, 1999. "The Viewpoint" was released by the FRC on January 25, 1999. The latter recommended that internationally active banks receiving an injection of public funds set aside the following proportion of each asset category as loan-loss provisions:
  1. (1) about 70 percent of assets whose borrowers are categorized as being "in danger of bankruptcy" and which are not covered by collateral or guarantees (banks that have made adequate allowances based on the collectibility of each asset are not required to follow this ratio);
  2. (2) about 15 percent of assets whose borrowers are categorized as requiring "special attention" and which are not covered by collateral or guarantees; and
  3. (3) an appropriate proportion of assets whose borrowers are categorized as those that "need attention" (excluding those requiring "special attention") calculated from the historical loan-loss ratio taking into account the average remaining maturity of such assets.

B. Introduction of Accounting for Effects of Income Taxes

The capital account of Japanese banks on a nonconsolidated basis at end-March 1999 amounted to 33.7 trillion yen, an increase of about 10 trillion yen from 23.0 trillion yen at end-March 1998.

However, it should be noted that almost 30 percent of the capital account corresponded to deferred tax assets worth 8.9 trillion yen, which were generated as a result of the introduction of accounting for effects of income taxes in nonconsolidated financial statements. Deferred tax assets represent the estimated amount of future tax reduction that can be expected as a result of the existence of temporary differences and loss carryforwards at the end of the current fiscal year. However, in order to enjoy the tax benefit in the future, banks must earn enough taxable income within the carryback period stipulated in the tax law. Thus, it is necessary to recognize these assets based on rational forecasts of future taxable income following the guidance of the Japanese Institute of Certified Public Accountants (JICPA).

C. Efforts to Improve Profitability

In the past, the earnings of Japanese financial institutions depended heavily on interest income from domestic operations, and the amount of such income basically depended on the volume of lending. However, as demonstrated in plans for restoring sound management released by financial institutions that received public funds, in the future increases in income are expected to come from an improved interest margin on lending rather than from quantitative expansion of loans. Nevertheless, the earnings of Japanese banks in fiscal 1998 revealed that there had only been a modest expansion in the interest margin on lending. Therefore, in order to fundamentally strengthen their profitability, banks should (1) secure lending spreads commensurate with the credit risk involved, (2) focus their management resources on areas in which they are highly competitive, and (3) find new sources of profits and reduce general and administrative expenses through the outsourcing of business and a reconstruction of delivery channels.4

For those that received public funds, strengthening profitability is an especially urgent task in order for them to grow out of the support from public funds as soon as possible. To achieve higher profitability, banks must adequately control risks, and to this end, they need to have an accurate grasp of their risk profiles and to upgrade their risk management systems.

  1. 4Delivery channels are means by which financial products and services are delivered to customers. Branch networks used to be the dominant delivery channels, but technological innovations have created many new channels that might replace them: such as mini branches using automatic teller machines (ATMs), telephone banking, and Internet banking.