Academic journal article The McKinsey Quarterly

A World-Class Challenge for Japanese Banking

Academic journal article The McKinsey Quarterly

A World-Class Challenge for Japanese Banking

Article excerpt

Japan's banks are still struggling, and international benchmarks show just how far they have to climb before they become globally competitive (Exhibit 1). To match their rivals in the United States and Germany, McKinsey research suggests, these banks would have to change radically, tripling their earnings and cutting their expenses and assets by 25 and 55 percent, respectively. [1]

In the five years leading up to 1996, US banks posted an average return on assets (ROA) of 1.64 percent, German banks an ROA of 0.85 percent.

Meanwhile, Japan's banks averaged only 0.19 percent. Their return on equity (ROE) was poor as well: they posted average returns of only 4.28 percent, compared with US and German banks at 20.84 and 11.22 percent, respectively (Exhibit 2). And Japan's banks spent far more to generate earnings: a multiple of 9.9 times, compared with 2.85 times for US banks and 2.27 times for the Germans (Exhibit 3, on the next page).

The problem is that Japanese banks have historically relied heavily on loans to generate profits. But in the five years to 1996, the average profit margin of these loans was only 1.11 percent, as against 2.04 percent for German banks and 3.57 percent for US ones. Japanese banks might look to their US rivals for lessons in diversifying income streams to broaden their earnings base. Risk-management skills at US banks, for example, are now well developed, and this allows them to earn higher returns by lending at rates that vary with the level of risk. Japanese banks could also increase their earnings by focusing more on the retail market and on small businesses, whose lending margins are higher. Moreover, Japan's banks haven't made as much progress in the home loan market as have their British, German, and US counterparts. Default rates are generally low, so the Japanese should improve their performance in this area. But the national Housing Loan Corporation, which has half of this market, charges less than comm ercial banks do, thus preventing them from expanding their business.

Japan's banks have an enormous asset base, but their ROAs will improve very slowly indeed if they rely solely on increasing profits: at current levels, earnings would have to rise some 6. …

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