Japanese megabanks have been on a rollercoaster ride in the market over the past few days, with a sharp market correction partially offsetting nearly two years of share price improvement. Some correction was inevitable, given that share price improvements since 2022 have been driven largely by economic conditions that are beginning to unwind. However, the opportunity is not lost - the earnings generated by these economic tailwinds has been significant and the megabanks can leverage this strength to build lasting earnings power and a compelling case for global investors.
Skepticism persists among investors regarding the megabank miracle, as evidenced by the recent rapid downturn in stock prices. Even at the high point of market optimism, megabank shares were still trading at a significant discount to North American peers. Global investors are looking for evidence of structural change to re-rate shares.
Japanese megabanks can learn from the experience of their peers in North America and Europe, which have optimized capital, restructured business models, and crafted clear investor narratives around activities that command higher valuation multiples. The specific path that the megabanks follow will be different, but the playbook should be the same. Japanese megabanks will be expected to act.
Three key areas of action for Japanese Megabanks
Reduce complexity and inefficiencies in the operating model
Japanese megabanks have fragmented governance and sprawling legal entity structures that global investors struggle to analyze. For years, the megabanks have been exploring potential governance and structural simplification. To some extent, these structures are features of Japan’s legal, regulatory, and business environment. However, the current economic tailwinds provide an opportunity to convince investors that the megabanks can overcome this complexity to deliver stronger returns over an extended time horizon. Investors will focus on outcomes like profitability and returns, but a clear narrative on how the operating model is evolving to reduce complexity, control risks, and improve efficiency will show the way.
Build credible strategies in activities that investors reward
Investors tend to reward stable, profitable businesses supported by sustained economic tailwinds. The domestic wealth and asset management opportunity in Japan fits the profile, but the business model will need to evolve to capture its full potential. The recent transformation of the US wealth management industry offers a playbook for Japanese megabanks that we believe can deliver approximately 150% price-to-book improvement.
Leverage domestic scale on the global stage
Japanese megabanks are better positioned to take share and generate attractive returns outside Japan, driven in part by the strength of their domestic franchises, including sticky customer deposits and a flexible capital position. However, building a successful economic model demands more focused strategies with greater integration of international operating models and infrastructure. We believe that successful execution can potentially deliver approximately 115% in price-to-book improvements. Replicating the complexity of the domestic banking model in Japan will erode the fleeting advantage that megabanks have abroad.
Megabanks must act fast to avoid a potential crisis
Megabanks may find themselves stuck in a valuation trap if they do not capitalize on this moment. As it stands, the analyst consensus today is that Japanese megabanks will continue trading at a significant discount to their North American peers and remain below the price-to-book target set by the TSE.
There is also the risk of competition from international competitors, both domestically and overseas. The Japanese domestic market — and many of the international markets where Japanese megabanks have built market share in recent years — are increasingly attractive to international competitors. Time is of the essence for Japanese megabanks, as the window of opportunity to break out of the valuation trap may soon close.
