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The Asia Times Online reported today that the latest annual report of the Bank for International Settlements praised the improving Japanese banking sector but data still shows that profit generation is a challenge. Since Japanese banks already have lower operating costs than global rivals, "the key to stronger profitability is not reducing costs but widening interest spreads."

Data from the annual report puts Japan behind the U.S. and U.K. in terms of both pretax profits percentage of total average assets:

    • U.S. 2.06%
    • U.K. 0.99%
    • Japan 0.84% (versus 0.11% in 2003)

and net interest margin:

    • U.S. 2.65%
    • U.K. 1.40%
    • Japan 1.07%

Obviously the Bank of Japan's expected beginning of rate hikes later this summer or at least by the end of the year will help banks expand their spreads. The only problem is that higher rates may result in reduced borrowing volume. Based on strong recent CAPEX data it is reasonable to assume firms are borrowing ahead of anticipated rate hikes. That means banks might have to wait until 2007 before being able to enjoy scale benefits from lending at higher rates and thus spreads.

Lastly, I want to mention that I haven't looked at the BIS report but it is possible the data could be misleading because of the number of banks used in reporting the data. For instance, 15 Japanese banks were reviewed whereas 12 were from the U.S. and 9 from the U.K.

Click here to read the full-text Asia Times Online article.

Click here to visit the Bank for International Settlements annual report overview page.

Source: Japanese Banks Improving but Lag in Profitability (MTU)