Japan's banks exposed to higher property risk as buffers dwindle

Property prices may collapse if supply exceeds actual demand.

The Japanese banking industry faces heightened asset risk from the rapid rise of real estate loans in the sector, which could lead to a collapse of property prices, reports Moody’s Investors Service.

Real estate loan growth has been consistently faster than economic expansion, Moody’s said in a note. This raises the risk of property supply exceeding actual demand, which in turn could result in a drop in property prices.

Apartment loans, which are identified as a key driver of growth in real estate loans, are prone to a sharp downturn in prices because individuals using such financing typically rent the apartments.

In addition, delinquencies will inevitably increase when loans mature after a prolonged period of rapid growth. Apartment loans generally have long terms of 20 years or longer, and many are far from maturity.

The ongoing coronavirus outbreak further compounds risks in the real estate market.

“For now, a sharp spike in losses from real estate loans is not likely because appreciation of land prices has been gradual, making a sudden, sharp decline in property values unlikely. However, the economic shock from the coronavirus outbreak increases the risk of defaults in the sector,” Moody’s wrote in the note.

However, Japanese regional banks' credit profiles can deteriorate even if defaults increase only marginally, on the back of their weakening pre-provision profitability. Stiff competition is driving down loan yields even though banks are taking more risks, leaving regional banks vulnerable to any increase in credit costs.

Further, regional banks' capital buffers are also waning because their risk-weighted assets (RWAs) are growing faster than retained earnings due to weak profitability and the shift to riskier lending. The average capital adequacy ratio of Japanese regional banks subject to domestic capital standards has been declining and is now below 10%.