Japanese banks' woes have been deepened by a strengthening of the yen and a drop in local stock prices, both catalyzed by the U.K.'s vote to leave the European Union, which sent reverberations throughout global markets and drove investors to less risky assets.
The surprise outcome of the June 23 referendum prompted investors to flock to safe-haven assets such as the yen. The TOPIX index, which covers all companies listed on the First Section of the Tokyo Stock Exchange, dropped 7.26% on June 24 from the previous day. The yen appreciated against the dollar to ¥102.09 on June 24 from ¥105.69 on June 23.
As of June 29, the TOPIX index was still 3.93% lower than June 23, and the yen has remained almost flat at ¥102.64.Japan's three biggest banks — Mitsubishi UFJ Financial Group Inc., Sumitomo Mitsui Financial Group Inc. and Mizuho Financial Group Inc. — have increased their overseas businesses in the past 20 years amid diminishing domestic interest rates. About 30% or more of their profits are earned overseas, and a stronger Japanese currency would erode the value of their overseas earnings in yen.
"A jump in the yen is not only negative to the Japanese economy but also negative to banks' earnings," said David Marshall, an analyst at CreditSights. "Recently, more and more banks' profits come from overseas and these profits are shrinking in yen terms. Also, the higher yen is pulling down stock prices, which is cutting the value of stocks they hold," he said.
The drop in stock prices in the aftermath of the Brexit vote has also reduced the value of Japanese banks' equity holdings. The TOPIX index has declined roughly 10% between late September 2015 and after the Brexit vote. The combined value of stocks held by Japanese banks was ¥25.303 trillion as of Sept. 30, 2015, according to data from the Japanese Bankers Association.
Assuming banks have held on to all of their stocks and the stocks are all traded on the Tokyo Stock Exchange, about ¥2.5 trillion in value may have been lost. In reality, some of these equity holdings have probably been sold and some are denominated in foreign currencies.A weak yen is an essential component of the Bank of Japan's economic stimulus measures, which has been placed into jeopardy by outcome of the Brexit vote. Banks are now closely awaiting the central bank's next move.
"Declining expectations of higher U.S. interest rates, and a general risk-off mentality, has put upward pressure on the yen and increased calls for the BOJ to respond, possibly with greater negative interest rates, which would be negative for banks' earnings," said David Threadgold, an analyst at Keefe Bruyette & Woods.
The Bank of Japan is unlikely to further expand its monetary easing policy on a significant scale, said Hideaki Kikuchi, an economist at the Japan Research Institute. "There can be some actions, but additional easing such as a deeper negative rate and quantitative and qualitative easing would not make much difference in the currency. The global financial situation has been changed by Brexit," Kikuchi said. "The U.S. Federal Reserve is now expected to take more time to raise its policy rate than previously expected."To mitigate the fallout from the Brexit vote on the Japanese economy, currency intervention would be the most efficient action, said Hideo Kumano, chief economist of Dai-ichi Life Research Institute. However, there is little the central bank can do to weaken the yen, he said. Additional purchases of Japanese government bonds by the BOJ and pushing the interest rate further into negative territory would do little to weaken the yen.
"Investors are buying the yen because they know there is little room for the BOJ to adopt new measures, which means there is only a small risk of surprise." Still, it is difficult to predict the BOJ's reaction because it may want to make some moves if they can have some impact, even if they are not big, Kumano said.
The BOJ's next policy meeting is scheduled for July 28-29. But Japanese media outlets have reported that an emergency meeting could be held earlier.