In Tough Japanese Banking Market, SMFG Looks Like the Best Bet for Future Returns

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Thematic (Sector/Industry)

<div class="content-highlight"><p style="text-align: left;"><em>Better regulations and technology benefits will increase disparity among Japanese banks; <a href="https://www.smartkarma.com/entities/218" target="_blank" data-smartkarma-citation="entities:218:1">Mitsubishi UFJ Financial Group (8306 JP)</a> remains our top pick.</em></p></div><hr><h2>Investors Should Change Their Focus in Evaluating Banks</h2><p>For most banks, digital banking means lower revenue, lower margins, and more competition. We have outlined six drivers for understanding competition against new industry players that will benefit from building cost advantages and intangible assets backed by better technology adoption and flexible business formats. Japan's proactive regulatory initiatives to promote digital banking and cross-industry collaboration, as well as competition, will likely accelerate the race for cost advantages.</p><h2>Key Takeaways</h2><ul><li>We expect fewer big winners among banks over the next decade. The new digital banking platform will require business scale as more processes will be automated in the middle to back office, leaving just customer-facing functions at many banks.</li><li>Valuation drivers have changed for banks with shifting business models. The new industry landscape is likely to see more pricing pressure, but hyperscale banks can still improve the status quo via improving cost advantages and generating intangible assets through complementary partnerships.</li><li>We still think <a href="https://www.smartkarma.com/entities/218" target="_blank" data-smartkarma-citation="entities:218:1">Mitsubishi UFJ Financial Group (8306 JP)</a>, or MUFG, maintains sustainable competitive advantages. Japan's largest bank is set to maintain high barriers to entry with its technology leadership and raise switching costs from a more comprehensive product offering. MUFG can benefit the most from high sensitivity to asset gains. Furthermore, we think the group’s cost-saving targets from digital banking initiatives are also understated, aiming for only 0.64% reduction per year against a peer average of mid-3%.</li><li>Among the banks under our coverage, we prefer MUFG, <a href="https://www.smartkarma.com/entities/217" target="_blank" data-smartkarma-citation="entities:217:1">Sumitomo Mitsui Financial Group (8316 JP)</a>, <a href="https://www.smartkarma.com/entities/838" target="_blank" data-smartkarma-citation="entities:838:1">Japan Post Bank Co Ltd (7182 JP)</a>, Resona, <a href="https://www.smartkarma.com/entities/19450" target="_blank" data-smartkarma-citation="entities:19450:1">Sumitomo Mitsui Trust Holdings (8309 JP)</a>, <a href="https://www.smartkarma.com/entities/219" target="_blank" data-smartkarma-citation="entities:219:1">Mizuho Financial Group Inc (8411 JP)</a>, and <a href="https://www.smartkarma.com/entities/16897" target="_blank" data-smartkarma-citation="entities:16897:1">Shinsei Bank Ltd (8303 JP)</a> in that order, according to the scale of available cost-saving opportunities during our forecast horizon. Operating outside the banking platform, <a href="https://www.smartkarma.com/entities/31" target="_blank" data-smartkarma-citation="entities:31:1">Rakuten Inc (4755 JP)</a> will continue to benefit from better earning opportunities in financial services, leveraging low-cost advantages and increased network effects arising through its dominant e-commerce platform.</li></ul><p><em>Analysts: Mari Kumagai and Michael Wu</em></p>

Better regulations and technology benefits will increase disparity among Japanese banks; Mitsubishi UFJ Financial Group (8306 JP) remains our top pick.Investors Should Change Their Focus in Evaluating BanksFor most banks, digital banking means lower revenue, lower margins, and more competition. We have outlined six drivers for understanding competition against new industry players that will benefit from building cost advantages and intangible assets backed by better technology adoption and flexible business formats. Japan's proactive regulatory initiatives to promote digital banking and cross-industry collaboration, as well as competition, will likely accelerate the race for cost advantages.Key TakeawaysWe expect fewer big winners among banks over the next decade. The new digital banking platform will require business scale as more processes will be automated in the middle to back office, leaving just customer-facing functions at many banks.Valuation drivers have changed for banks with shifting business models. The new industry landscape is likely to see more pricing pressure, but hyperscale banks can still improve the status quo via improving cost advantages and generating intangible assets through complementary partnerships.We still think Mitsubishi UFJ Financial Group (8306 JP), or MUFG, maintains sustainable competitive advantages. Japan's largest bank is set to maintain high barriers to entry with its technology leadership and raise switching costs from a more comprehensive product offering. MUFG can benefit the most from high sensitivity to asset gains. Furthermore, we think the group’s cost-saving targets from digital banking initiatives are also understated, aiming for only 0.64% reduction per year against a peer average of mid-3%.Among the banks under our coverage, we prefer MUFG, Sumitomo Mitsui Financial Group (8316 JP), Japan Post Bank Co Ltd (7182 JP), Resona, Sumitomo Mitsui Trust Holdings (8309 JP), Mizuho Financial Group Inc (8411 JP), and Shinsei Bank Ltd (8303 JP) in that order, according to the scale of available cost-saving opportunities during our forecast horizon. Operating outside the banking platform, Rakuten Inc (4755 JP) will continue to benefit from better earning opportunities in financial services, leveraging low-cost advantages and increased network effects arising through its dominant e-commerce platform.Analysts: Mari Kumagai and Michael Wu

Sumitomo Mitsui Financial Group (8316 JP)

Mitsubishi UFJ Financial (MUFG) (8306 JP)

Japanese Banks: Silver Lining in Digital Banking Lies in Cost Savings