Bank Profits in Japan from the Perspective of ROE Analysis

Bank profits in Japan have improved substantially in recent years. In fiscal 2004, the major banks recorded positive net income for the first time in four years. The regional banks marked positive net income for the first time in ten years. In particular, their profits increased substantially in fiscal 2005, with both the major banks and the regional banks posting record-high net income. It is the case, however, that temporary factors strongly contributed to the improved profits for fiscal 2005. One major temporary factor was a sharp reduction in credit costs arising from the reversal of the allowance for loan losses recorded in previous years. In this paper we develop an adjusted ROE (hereafter, core ROE), a profit indicator that excludes factors behind fluctuations in credit costs and gains and losses on securities, to assess the outcomes of the recent efforts by banks to improve income from core businesses. Analysis results show that (1) core ROE for the major banks has improved, albeit to a limited degree, and (2) core ROE for the regional banks has remained consistently low relative to that for the major banks, with no notable improvement. If the profits of banks are to be improved, the banks must adopt more sophisticated approaches for managing credit risk and restrain the large increases in credit costs. We believe, meanwhile, that it is important to improve profit generating capability by reinforcing fee businesses and ensuring sufficient interest margins on lending.