Japanese banks' risk controls under test following Archegos fallout

After Nomura and MUFG, other banks are likely to announce losses related to the US investment firm.

The risk controls of Japan’s financial institutions are being tested test following a slew of announced losses from local lenders related to transactions with a US client, notes Fitch Ratings.

To date, Nomura Holdings and Mitsubishi UFJ Financial Group (MUFG) have separately announced potential losses arising from transactions with a single client in the US—private investment firm Archegos Capital Management—calling into question their controls on concentrations risks, Fitch said.

Nomura, the country’s biggest broker, estimated $2b in losses from an "unnamed US client", which reporters said was likely Archegos; whilst MUFG has announced potential losses of about $270m.

Other Japanese financial institutions are expected to follow with announcements relating to similar losses, the ratings agency further warned.

“These financial institutions could face not only financial and reputational risks, but also regulatory scrutiny or redress if authorities determine there were material governance deficiencies or risk management weaknesses,” Fitch noted.

Banks have expanded overseas as the local business environment on banks remained subdued, what with the negative interest rate environment, declining population leading to stiff competition, and structural challenges, especially amongst regional banks. Expansion into offshore markets was one of the means of achieving higher profitability.

The regulator, Bank of Japan (BOJ), has signalled that it is conscious of the negative interest rate policy’s impact on the domestic banks’ core profitability. This was acknowledged through its recent policies—including the establishment of the Interest Scheme to promote lending, aimed at mitigating the effect on financial institutions' profit at a time of rate cuts.

However, the losses also bring into focus Japanese financial institutions’ risk appetite whilst in search of profit—and whether they are adequately compensated for the risks involved over economic cycles, Fitch noted.

Little impact on MUFG
Amongst the banks involved, Fitch zeroed in on MUFG, Japan’s biggest bank, assuring that the losses would likely not have a substantial impact on the bank’s financial profile.

The group announced potential losses of approximately $270m (JPY30 billion) incurred by MUFG Securities EMEA plc (MUSE), an indirectly wholly owned brokerage subsidiary, in relation to transactions with a US client. This make up less than 4% of MUFG’s annualised net profit for the nine months of the fiscal year ended March 2021, the ratings agency said.

Recently, MUFG raised its full-year net profit forecast for FY2021 to about $15.45b (JPY750b) from $12.36b (JPY600b), signaling overall good performance for the bank.

The decision to raise its forecasts came on the back of MUFG’s steady business performance and higher realised net gains on stocks. It does not yet include the loss at MUSE, however, which MUFG said will be reported in the next quarter’s results.

On the other hand, the loss could affect MUFG’s long-term earnings contribution from its securities business should it revise its risk appetite in the overseas securities business, Fitch added. Nonetheless, Fitch said that it is unlikely that MUFG will substantially change the business strategy of its securities business, although it does expect enhanced risk controls to avoid a similar incident.

Photo courtesy of Wikimedia Commons (by Lombroso)