Standard & Poor’s Ratings Services today upgraded the major Japanese banks and their group companies by one notch, “reflecting the stable business environment in Japan and, following the reduction in asset risks, expectations for improvement in the banks’ profitability and strengthened capitalization”.

The rating agency notes that over the past three fiscal years, Japan’s major banks have slashed their risk assets. “Meanwhile, lending demand is showing signs of recovery, with profits at Japanese corporates improving, while the long-term slump in land prices has eased in some metropolitan areas,” it adds.

The major banks still face the challenge of concentration risk in their lending portfolios, S&P says, but asset risks have been cut through the banks’ removal of nonperforming loans from their balance sheets and by boosting loan loss reserves.

It also observes that the major banks are also making steady progress in diversifying profit sources through relatively new products, including sales of asset management products, managing loan syndications, loans to individuals and small and midsize enterprises, and nonrecourse loans. “Although enhancing profitability remains a key challenge, the decrease in asset risk will allow them to allocate more management resources to strategic businesses,” it says.

Capitalization at major Japanese banks is still weaker than their overseas peers, particularly in terms of quality, S&P notes. “However, lower asset risks and net profit generation are helping to bring about a recovery,” it says. “Although an improvement in banks’ capital ratios will be limited for the next two to three
years, as some repay public funds, the quality of their capital is likely to improve, as the proportion of low quality capital, including deferred tax assets and preferred stocks, decreases.”

“The upgrades of the major banks also incorporate our expectations that the Japanese government would provide support if necessary, given their importance to the Japanese financial system,” S&P adds.