Profitability
Although the Japanese banks are the biggest in terms of assets and the most valuable in terms of stock-market capitalization, they are definitely not the most profitable. As noted in Table 9.5, most of the most-profitable banks in the world are U.S. and European.
In 1989, however, the earnings of a number of large international banks fell as a consequence of a new round of massive losses on Latin American loans. The banks were affected by loans to developing countries because
many of them are holding loans on which no principal and interest are being
paid. New banking regulations in the United States require banks to identify
the amount of their nonaccrual loans at the end of each quarter. A nonaccrual loan is one for which principal or interest is 90 days past due or for which payment of interest or principal is determined to be doubtful. The non-accrual concept relates to domestic as well as foreign loans, and many banks have had as many problems with domestic loans as with foreign loans.
As a result of massive difficulties in collecting on loans to the developing countries, the major U.S. banks have gradually been building huge loan-loss reserves in order to protect themselves from a major default. The first major protective move came in 1987 when Citicorp added $3 billion to its loan-loss reserves, thereby boosting its reserves to 25 percent of Latin American loans and 100 percent of its nonperforming loans.39 In 1989 J.P. Morgan & Co. added $2 billion to its reserves, representing 100 percent of its portfolio of medium- and long-term developing-country debt. Most banks' reserves have hovered in the 25 percent range, but in recent years international banks have been increasing their reserves to the 35-50 percent range. Having reserves of that size allows the banks to hedge against a default in a given year.40
The new BIS requirement that banks must have a capital/asset ratio of at least 8 percent by March 1993 is causing some banks to try to add to their capital base through profitability. Banks in each country are affected by different circumstances. In the United States, risky real-estate dealings and the problems of leveraged buy-out loans are added to the Latin American debt situation as sources of pressure on profits. In addition, the Japanese banks
that are competing in the United States and operating on such thin margins are making it difficult for U.S. banks to increase margins and enhance profits.
The Japanese banks have been hurt by conditions in both Japan and the United States. An example is the stepping down of the Chairman of Sumitomo Bank in Japan in 1990. The leadership change was a function of several factors. Although the direct factor was a stock-manipulation scandal, Sumitomo was heavily involved in the runup of the stock and securities markets in Japan in the latter half of the 1980s. From the beginning of 1985 to the end of 1989, the Nikkei index in Japan rose 237 percent, and property values in Japan's three major cities rose an average of 126 percent. Thus the banks began to get involved in both of those high-growth markets in order to fatten profit margins. However, the collapse of the stock market in 1990 and the tapering off of property values severely hurt the Japanese banks.41 As the banks move back into traditional project and retail lending, their margins will fall even more, making it difficult for them to achieve the 8 percent capital/ assets ratio by 1993. As the leveraged buy-out market in the United States becomes even riskier, Japanese banks are pulling out from financing many of the buy-outs of U.S. firms.42 This should help the margins of the Japanese banks but cause problems for firms that will have more difficulty borrowing money to effect an LBO.
In 1989, however, the earnings of a number of large international banks fell as a consequence of a new round of massive losses on Latin American loans. The banks were affected by loans to developing countries because
many of them are holding loans on which no principal and interest are being
paid. New banking regulations in the United States require banks to identify
the amount of their nonaccrual loans at the end of each quarter. A nonaccrual loan is one for which principal or interest is 90 days past due or for which payment of interest or principal is determined to be doubtful. The non-accrual concept relates to domestic as well as foreign loans, and many banks have had as many problems with domestic loans as with foreign loans.
As a result of massive difficulties in collecting on loans to the developing countries, the major U.S. banks have gradually been building huge loan-loss reserves in order to protect themselves from a major default. The first major protective move came in 1987 when Citicorp added $3 billion to its loan-loss reserves, thereby boosting its reserves to 25 percent of Latin American loans and 100 percent of its nonperforming loans.39 In 1989 J.P. Morgan & Co. added $2 billion to its reserves, representing 100 percent of its portfolio of medium- and long-term developing-country debt. Most banks' reserves have hovered in the 25 percent range, but in recent years international banks have been increasing their reserves to the 35-50 percent range. Having reserves of that size allows the banks to hedge against a default in a given year.40
The new BIS requirement that banks must have a capital/asset ratio of at least 8 percent by March 1993 is causing some banks to try to add to their capital base through profitability. Banks in each country are affected by different circumstances. In the United States, risky real-estate dealings and the problems of leveraged buy-out loans are added to the Latin American debt situation as sources of pressure on profits. In addition, the Japanese banks
that are competing in the United States and operating on such thin margins are making it difficult for U.S. banks to increase margins and enhance profits.
The Japanese banks have been hurt by conditions in both Japan and the United States. An example is the stepping down of the Chairman of Sumitomo Bank in Japan in 1990. The leadership change was a function of several factors. Although the direct factor was a stock-manipulation scandal, Sumitomo was heavily involved in the runup of the stock and securities markets in Japan in the latter half of the 1980s. From the beginning of 1985 to the end of 1989, the Nikkei index in Japan rose 237 percent, and property values in Japan's three major cities rose an average of 126 percent. Thus the banks began to get involved in both of those high-growth markets in order to fatten profit margins. However, the collapse of the stock market in 1990 and the tapering off of property values severely hurt the Japanese banks.41 As the banks move back into traditional project and retail lending, their margins will fall even more, making it difficult for them to achieve the 8 percent capital/ assets ratio by 1993. As the leveraged buy-out market in the United States becomes even riskier, Japanese banks are pulling out from financing many of the buy-outs of U.S. firms.42 This should help the margins of the Japanese banks but cause problems for firms that will have more difficulty borrowing money to effect an LBO.
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