Here's why Japanese banks' domestic loans need to beat the past three years' 3% growth rate

Domestic loans would need to have grown at least 5%.

Overall performance of the Japanese banking system remains stymied despite sound domestic asset quality and credit costs, says Fitch Ratings. Fitch's Special Report on the Japanese 'mega' banks, published today, summarises the challenges of Abenomics and Japanese mega banks' multiple headwinds under the current operating environment.

Here's more from Fitch:

Fitch sees the Japanese government's policy launched in 2012 as at a crossroads, which has triggered the authorities' introduction of unconventional policies - Qualitative-Quantitative Easing (QQE) and Negative Interest Rate Policy (NIRP).

We view NIRP as holding back the banking system's net interest revenue, while having little impact on Japan's real economy. We estimate a 10bp reduction in the market-linked lending rate would hit the mega banks' aggregate gross operating profit by JPY100bn in fiscal year (FYE17, ending March 2017), although there is little room for the base rate to fall further.

To offset the decline in net interest income in FYE17, domestic loans would need to have grown at an annual rate of 5%-6%, higher than the past three fiscal years' average growth rate of 3%.

The mega banks' domestic loan balances have changed little since the introduction of Abenomics, given weak credit demand and the banks' focus on overseas expansion. Asset quality in their portfolio has improved, and is likely to remain sound, while the growth in risk-weighted assets (RWA) is in line with the banks' asset growth, indicating no significant increase in risk appetite in recent years. However, we believe overseas expansion would add challenges in credit risks and competition.

Fitch still expects the contribution from the banks' overseas business to rise further in the medium term, largely through growth in the US. Overseas expansion also exposes them to challenges in funding - the shift of funding sources to relatively longer-term funding sources (initially spurred by changes in US money-market fund (MMF) regulation) is likely to exert further pressure on the banks' foreign-currency funding costs.

Fees and commission-based revenue - specifically from security subsidiaries - have significantly contributed to the growth of the banking groups. Yet we view market volatility as limiting the sustainability of earnings. Such volatility is also a limiting factor in the quality of capital improvements at banks exposed to fluctuations in unrealised gains - mainly from equity holdings.

Fitch also expects the banks' greater struggles to sustain stronger profitability will limit further improvement in the groups' CET1 ratio to 30bp-40bp on average in FYE17 from around 50bp in the last three years.