Institutional Asset and Liability Management at Resona Holdings - Example

• Introduction

The main objective of this report is to highlight a complete review of Resona Holdings, Inc., which is a Japanese banking group. This report will critically evaluate the macroeconomic variables which influence the bank’s core operations and profitability. The report will also conduct a strategic analysis of the group’s financial aspects to highlight the efficiency of current operations and risk management process. The report will assess the financial risk exposure of the group and recommend effective risk management strategies that will help the bank to improve efficiency and also mitigate various types of risks identified in the report.

• Background

Resona Holdings, Inc. is a financial services group which has three operating banks with consolidated assets over ¥45 trillion. The three banks operating under Resona Holdings are the Resona Bank, Saitama Resona Bank and Kinki Osaka Bank. Among the three banks, Resona is the core financial institution that offers various services related to real estate and trust management. Saitama Resona Bank holds principal shares in Saitama Prefecture and the Kinki Osaka Bank has over 120 mandated branches. The three banks under Resona follow a business structure that provides banking services to customers (Resona Holdings, 2015).

The Resona group aims to build strong relationships with small and medium enterprises and customers (both retail and corporate clients). The products and services of the group are catered to the responses and needs of the customer and society (Resona Holdings, 2015).

Figure 1: Product portfolio

(Source: Resona Holdings, 2015)

The main products and services of the company are discussed below:

Corporate banking – It includes supporting start-ups, fund raising activities for business development, fund settlement activities, supporting businesses in international expansion, and business succession.

Trust – The Resona Bank acts like a trustee which administers and manages financial assets on behalf of the customers.

Real estate – The bank provides term loans and working capital loans for real estate development.

Credit analysis – The bank analyses the credit worthiness of the customers in terms of timely repayment, previous defaults in loan, etc.

Compliance – The bank manages the financial reporting activities of organisations to ensure that, all compliances and regulatory obligations are duly followed by the institutions.

Card – The bank offers credit and debit facilities to its customers through Resona cards (Resona Holdings, 2015).

• Industry analysis

The Japanese government administers complete the banking industry, so as to propel the economic growth. The government regulates the banking industry in terms of interest rate, policies on deposits and loan disbursal process. The government ensures that the funds acquired by the banks are at low interest rates so that the banks will be able to provide loans to industries and corporate activities at minimum rates. Lower interest rates on loans will encourage companies to involve in economic development process (Yang and Morita, 2013).

The government of Japan manages flow of funds by clearly distinguishing the roles played by banks. For instance, banks which are located in cities or other developed areas are responsible for providing long-term credits to customers in addition to other services like mutual funds, regional development loans and trust activities. The long-term credits are generally collected by the bank through the issue of debentures. In contrast, the regional banks having excess cash can invest in these debentures and participate in money circulation process (Liu and Wilson, 2013).

After the Second World War, the government of Japan followed a low interest rate policy that will help the Japanese economy to revive in limited funds. When the Japanese Yen became a global currency, the government’s control over interest rates declined because domestic market also experienced an inflow of foreign capital. Liberalisation of interest rates adversely affected the earnings of banking industry which used to benefit from regulated interest rates. Another change in business paradigm was observed when corporate sector shifted their preference to raise funds from the capital markets instead of relying only on bank loans (Liu and Wilson, 2013).

• Competitor analysis

The competition in the financial sector depends on product portfolio and financial efficiency of the firm. Factors like market reputation, regulation standards, reputation of product, customer service, credit rating and timely delivery of service, etc. determines the overall competitiveness of banks in the industry. The main competitors of Resona Holding, Inc. are Mizuho Financial Group, Inc., Sumitomo Mitsui Financial Group, Inc. and Mitsubishi UFJ Financial Group (Bloomberg, 2016).

The Resona Holdings, Inc. operates in the financial services industry which is presently centralised into four major banks – The Bank of Tokyo-Mitsubishi Ltd, Mizuho Bank Ltd, Sumitomo Mitsui Banking Corp. and UF J Bank Ltd. (merger of Tokai Bank Ltd and Sanwa Bank Ltd). The rising non-performing assets of the bank are to create difficulties for individual banks to operate profitably; and therefore, many banks including the four major banks mentioned above have resorted to consolidation. The large scale consolidation in the banking industry is also prevalent in the small and medium sized banks. The main reason for the banks to merge with another bank is because of the directive of the Japanese government to reduce the increasing non-performing loans and improve financial health. The government has allowed banks to merge with one another so that they do not bankrupt while supporting industrial growth and development (Liu and Wilson, 2013).

The demand for banking products and services are closely related to economic activities in the sense that when the economic activities increase, the banking activities also increase. The profitability of the individual banks depends on prompt services, marketing skills and excellent risk management policies (Beatty and Liao, 2014).

• PEST analysis

Political – In the early 2000, Japanese economy witnessed a number of mergers and acquisitions in a short period of time, which led to the creation of Mega Banking Groups. The government was responsible for facilitating consolidation in the banking sector through a series of measures including changes in tax system and easing legal hurdles. These initiatives helped the banks to undertake large-scale organisational change. The government’s decision to keep the interest rates of banks low also influences the credit disbursal process, which helps in economic development of the country (Frieden, 2015). Some of the measures taken by the government to stabilise the financial system include,

• Increasing the level of information disclosure
• Relaxation of capital adequacy ratio
• Reduction of interest rates
• Suspending shares sold by the Bank of Japan
• Facilitating corporate lending to SMEs (Japanese Banking Association, 2016).

Economic – In terms of nominal Gross Domestic Product (GDP) and Purchasing Power Parity (PPP) Japan is the 3rd largest economy in the world. The Japanese economy is very developed in automobiles and electronic goods industry. Japan has over 13 percent of world’s financial assets under management, which is estimated to be over US$13 trillion. The agricultural sector constitutes about 1.3 percent of country’s GDP because only 13 percent of the land in Japan is suitable for cultivation. The government of Japan protects and subsidises the agriculture sector. The services sector in Japan, contributes almost two-third of its economic output which covers retail, real estate, banking, transportation and telecommunication. In 2013, the unemployment rate in Japan declined by 1.6% from previous year due to faster than expected economic recovery (Lockwood, 2015).

Social – The demography of Japan is dependent on factors like ethnicity, economic status, and population density. The Japanese population density is 335 people per square kilometre and it ranks 37th position in the world in this respect. One of the opportunities for industries in Japan is that over 70 percent of population in Japan resides in urban areas, because most of the Japanese land is made out of mountains. Majority of the population in Japan falls under the age group between 14 and 65 years (approximately 64 percent of population). The estimated sex ratio in Japan (male/ females) is 0.95 at birth, which shows that the country is not male dominated. Person aged between 14 and 64 years has sex ratio of 1.02 while the same for population above 65 years is 0.74 (Coulmas et al, 2008).

Technological – Japanese government has focused on developing the technology in the country through investments in research and development. The existing policies of the country encourage diffusion and adoption of foreign technologies in private in public sector. The Japanese banking industry also used technology to improve service quality. Internet banking is widely used by the country and local population to conduct business and personal transactions (Krause, Handfield and Tyler, 2007).

• SWOT analysis

Strength

• Decreasing interest expense
• Strengthening cash flows
• Strong selling and distribution network
• Government’s assistance and monetary support is available
• Strong customer base
• Reputable brand image

Weakness

• High debt-to-equity ratio
• Highly competitive market reduces profitability
• Credit ratings need to be improved
• Low penetration in global markets
• Excess focus on domestic market

Opportunity

• Innovative product portfolio
• Reviving economy is expected to improve consumer sentiments and spending
• There is opportunity to expand services in growing economies like India
• Increasing cash flows can help the firm to expand services to customers in rural and semi-urban areas

Threat

• Increasing NPA
• Poor risk management policies
• High debt-to-asset ratio can increase financial risk
• Increasing operational cost

(Source: Authors’ creation)

• Financial ratio analysis

The financial statements of Resona Holdings, Inc. are available in the annual reports of the group. The main financial statements of the group are consolidated statement of income, consolidated statement of cash flows and consolidated balance sheet. The operational efficiencies of the bank can be analysed with the data represented in the income statement. The income statement highlights the performance of the bank in terms of generating earnings from core operations. The main items in the income statement are total revenues, gross earnings, operating income and net income. The balance sheet shows the position of assets, equities and liabilities of the group on a given date. The statement of cash flows helps to analyse the actual position of cash and cash equivalents available with the group. The main significance of cash flow statement is that the bank can show net profits, even if it does not have sufficient liquidity. This could happen due to accounting principles like depreciation charges, credit sales, provisions, and revenue recognition policies (Beatty and Liao, 2014).

One of the most commonly used tools for financial analysis is the ratio analysis. The flowing ratios have been used to analyse the financial performance of Resona Holdings, Inc.:

• • Performance analysis

One of the most concerning issues faced by the banking industry is the non-performing assets (also known as the NPA). In general, a banking organisation provides loan to individuals and industries. The banks profit from the interest earned on advanced loans. When the interest becomes due for a period of over 90 days, then the banks can classify that particular asset(s) as NPA (Agarwal et al, 2007).

The ratio of NPA-to-total revenues of the bank represents, what part of bank’s earnings converts into non-performing asset. A high value of this ratio is very concerning because a portion of the NPA could turn into bad debts. Bad debts are simply losses to the banking sector, which are already suffering from increasing NPAs because of economic downturns. A low value of this ratio is a good indicator of firm’s credit policies and reveals better asset management.

Figure 2: NPA-to-Total Revenues

(Source: Author’s creation)

The above graph shows that NPA of Resona has been steadily increasing by an annual rate of 4.5% from 2013 to 2015. In contrast, one of the competitors of Resona, Sumitomo Mitsui Financial Group Inc. (or Sumitomo) also experienced an increasing NPA at the annual growth rate of 4.8% during the same period. This is concerning issue because, the NPAs are rising and some portion of the NPS can turn into bad debts (Resona Holdings, 2015).

Another significant indicator of performance is the ratio of interest expense to EBIT (or Earnings before Interest and Taxes). The banking industry earns profit from interest on disbursed loans and the net interest margin is the difference between total interest earned and total interest expense. Therefore, a high interest expenses will reduce net profitability and vice-versa.

Figure 3: Total interest expense-to- EBIT ratio

(Source: Author’s creation)

The chart shown above indicates that, the interest cost of Resona has been declining at the annual rate of 11% from 2013 to 2015. This is a good indicator of performance because the bank is able to manage its interest expenses efficiently. In contrast, the interest cost of Sumitomo is more than that of Resona, but the same decreased from 2013 to 2014 and again increase in 2015. There is an urgent need for the banking companies like Resona to manage their interest expenses and improve profitability (Resona Holdings, 2015).

• • Profitability analysis

One of the key indicators of profitability is the net profit margin, which is the ratio of net income and total revenues of the bank. Higher value of this ratio signifies more profitability and vice-versa.

Figure 4: Net profit margin

(Source: Author’s creation)

The above chart shows that, net profitability of Resona is falling 10% compounded annual rate, which is not a good indication. Lower profitability will affect the cash generating abilities of the bank.

Another important indicator of profitability is the ratio of cash flows-to-total assets. This ratio indicates the liquidity of assets and ability to generate cash from assets. This ratio is important for the banking industry because when NPSs turn into bad debt, the banks can minimise the impact of losses by selling some non-core assets. A higher value of this ratio indicates that, current asset portfolio of the bank is capable of generating a sufficient income and vice-versa.

Figure 5: Cash flows-to-Total assets

(Source: Author’s creation)

The above chart shows that, cash position of the Resona bank has been improving at a compounded annual growth rate of 64% from 2013 to 2015. This is a very good sign for the bank, because in future it will be able to liquidate some of this assets if NPAs increase and turn into bad debts (Resona Holdings, 2015).

• • Solvency analysis

The banking industry plays a vital role in the economic development, as it helps other industries to raise capital for the expansion of business. However, many banks underestimate creditworthiness of corporate customers and provides unreasonably high amount of loans. When the customers are unable to repay the loans along with interest, then there are high chances that the bank could become insolvent and file bankruptcy. A similar phenomenon was observed by Drake, Hall and Simper (2009) during the global financial crisis which was triggered by irrational loans given by the banks to real estate industry.

The most vital solvency ratios are debt-to-asset ratio and debt-to-equity ratio. A higher value of these ratios indicates that, the capital structure of the bank is highly leveraged and it could increase the financial risk.

Figure 6: Debt-to-Equity ratio

(Source: Author’s creation)

Figure 7: Debt-to-Asset ratio

(Source: Author’s creation)

The charts shown above, indicates that the total debt-to-equity ratio of Resona Holdings increased by an annual growth rate of 6% from 2013 to 2015, whereas the same for Sumitomo declined by an annual rate of 8% during the same period. This is a very concerning matter for Resona Holdings, as the bank urgently requires reviewing risk management policies before financial risk becomes unmanageable (Resona Holdings, 2015).

• Risk evaluation
  • Credit risk

Resona Holdings, Inc. defines credit risk as the losses arising from a decline in the value of assets, which could be due to deterioration process financial position of the borrowers. The financial analysis of Resona Holdings shows that 95% of the total liabilities and equity is comprised of debt. This means that the bank is exposed to financial risk of the borrowers defaulting from debt repayment (Resona Holdings, 2015).

• • Market risk

The banking industry can suffer huge losses due to the market risk, because if the book value of asset is less than the current market value of asset, then it is a loss for the bank. The fluctuation in price of assets is very common in the marketplace as factors such as interest rates, currency exchange rates, and stock prices highly influence the value of assets. According to Imai (2007), it is not possible to eliminate market risk but it may be possible to reduce it through the process of hedging. The bank can take buying or selling position through hedging, in order to minimise the losses in falling price of assets. For example, if the value of assets of an airlines company is $100 million on book value and the current market price of the asset has fallen to $97 million due to a deteriorating value of asset then the bank can minimise losses through hedging. Suppose that the bank expects prices to fall further in future and sets strike price of $97 million when value of assets fall below this level then its maximum loss will be limited to $3 million. This way the bank will be able to minimise losses due to volatility in market price of the assets.

• • Liquidity risk

The bank identifies liquidity risk as the condition when one of the borrowers has difficulty in raising cash and cash equivalents from the market and is required raise funds at high rates from the market (Resona Holdings, 2015).

• • Operational risk

The operational risk arises from internal operations and inefficient management of resources of organisation. One of the most common operational risks in the banking industry is processing risks that occur, when the employee or management fails to execute any official work or commits frauds. However, there could be systematic failures when the system crashes or functions improperly. There is also legal and compliance risk, which could occur if the bank fails to comply with the legal compliances.

In case of Resona Holdings, another type of operational risk exists which the bank identifies as Trust asset management risk. Risk in Trust management occurs in case the trustee (or Resona) fails to fulfil fiduciary responsibilities. In case the trust manager causes financial losses to the customers, then appropriate compensation must be provided to the owners (Resona Holdings, 2015).

• • Reputational risk

Resona bank faces the threat of reputational risk when there are negative rumours, media reports, false reports, or allegations against the bank. The reputational risk affects the brand reputation and good image of the bank in the market. According to Fiordelisi, Soana and Schwizer (2014), the determination of financial impact of reputational risk is very difficult because intangible aspects are associated with goodwill.

• Risk management strategy

After critically assessing the financial condition of Resona Holdings, Inc. and evaluating current risk exposure of the bank, it can be said that a proper risk management strategy should be followed by the bank.

Stress test – The bank should conduct a stress test during economic downturns when the chances of default by the borrowers increase. The stress test on assets should be considered by including factors like volatility in financial markets, risk appetite of the consumers change in macroeconomic environment and capital adequacy. Hence, Resona can conduct the stress test when the economic conditions are unfavourable. The stress test will help the bank to examine whether or not it has sufficient capital to withstand negative impacts. Resona bank will have to first identify the major risks it is exposed to and then assign weights to them under different scenarios. The main advantage of stress test is that it will help Resona to assess the value of assets under different scenarios (Geithner, 2014).

Credit risk management – Resona can control its credit risk through capital infusion or incorporating prudent credit risk policies. Such credit policies should clearly describe and define the rules of credit operations of the bank. For example, many banks avoid providing loans to SMEs (Small and Medium Enterprises) because their operating profit is very low. However, Resona Holdings, Inc. has a significant exposure to SMEs and it can minimise the credit risk by limiting the amount of loan for a single party. The maximum limit will depend on the ability of the bank to identify and assess credit risk. The bank can calculate risk exposure by analysing the average credit amount loss from a particular customer and other various indicators like previous defaults or credit ratings with other banks (Duffie and Singleton, 2012).

Limiting equity exposure – Resona bank can limit equity and currency exposure which will help it to avoid stock market volatility and market risk. The bank is advised to limit its net equity exposure to maximum 40% of total asset portfolio. Instead of focusing on highly risky investment alternatives, Resona can switch the investment strategy to highly rated corporate securities, commercial papers and bonds which have a lower risk and the minimum chance for losses (Duffie and Singleton, 2012).

Capital adequacy – As discussed, one of the main issues of Resona Holdings, Inc. is increase of NPA. One way to control NPA is to maintain sufficient capital buffers. This can be achieved by focusing on quality of assets alongside maintaining minimum quantity (number of customers). According to Imai (2007), it is important for the banking industry to acquire customers but at the same time it is also important that the bank do not lend to less creditworthy customers who could default in future. By maintaining a good customer base, it will be possible for the bank to manage its reputational risk as well.

• Conclusion

This report conducted industry analysis, financial analysis of Resona Holdings, Inc. and also assessed the various risks to which the group is exposed. The industry analysis reveals that, the banking industry is currently getting the support of the government to revive economic growth and the monetary authority is also keeping the interest rates low, so that the bank can disburse loans to corporate and individual clients at a low cost. The industry is influenced by political, economic, social and technological factors. The main strength of the company is brand awareness and increasing cash flow. The main weakness of the bank is deteriorating profitability (Haiss, 2013). The financial analysis of the bank shows that, there is an increasing trend in NPAs which increases chances of bad debt and financial risk. The report has also identified a number of risks associated with the bank like credit risk, operational risk, reputational risk, etc. These risks can be efficiently managed by maintaining an adequate capital and following prudent credit policies. It is advised that Resona Holding, Inc. not only focus on asset quantity but should also consider asset quality.

• Reference list

Agarwal, S., Chomsisengphet, S., Liu, C. and Rhee, S.G., 2007. Earnings management behaviors under different economic environments: Evidence from Japanese banks. International Review of Economics & Finance, 16(3), pp.429-443.

Beatty, A. and Liao, S., 2014. Financial accounting in the banking industry: A review of the empirical literature. Journal of Accounting and Economics, 58(2), pp.339-383.

Bloomberg, 2016. Resona Holdings Inc. [online] Available at: <http://www.bloomberg.com/quote/8308:JP> [Accessed 14 May 2016]

Coulmas, F., Conrad, H., Vogt, G. and Schad-Seifert, A. eds., 2008. The demographic challenge: A handbook about Japan. Leiden: Brill.

Drake, L., Hall, M.J. and Simper, R., 2009. Bank modelling methodologies: A comparative non-parametric analysis of efficiency in the Japanese banking sector. Journal of International Financial Markets, Institutions and Money, 19(1), pp.1-15.

Duffie, D. and Singleton, K.J., 2012. Credit risk: pricing, measurement, and management. New Jersey: Princeton University Press.

Fiordelisi, F., Soana, M.G. and Schwizer, P., 2014. Reputational losses and operational risk in banking. The European Journal of Finance, 20(2), pp.105-124.

Frieden, J., 2015. Banking on the world: the politics of American international finance. London: Routledge.

Geithner, T.F., 2014. Stress test: reflections on financial crises. Canada: Crown.

Haiss, P., 2013. Cultural influences on strategic planning: empirical findings in the banking industry. Springer Science & Business Media.

Imai, M., 2007. The emergence of market monitoring in Japanese banks: Evidence from the subordinated debt market. Journal of Banking & Finance, 31(5), pp.1441-1460.

Japanese Banking Association, 2016. Changing Banking Industry. [online] Available at: < http://www.zenginkyo.or.jp/en/banks/changing/> [Accessed 14 May 2016]

Krause, D.R., Handfield, R.B. and Tyler, B.B., 2007. The relationships between supplier development, commitment, social capital accumulation and performance improvement. Journal of operations management, 25(2), pp.528-545.

Liu, H. and Wilson, J.O., 2013. Competition and risk in Japanese banking. The European Journal of Finance, 19(1), pp.1-18.

Lockwood, W.W., 2015. Economic development of Japan. New Jersey: Princeton University Press.

Resona Holdings, 2015. Resona Holdings, Inc. Annual Report 2015. [pdf] Available at: < http://resona-gr.co.jp/holdings/english/investors/financial/annual/hd/pdf/14/ar15_all.pdf> [Accessed 14 May 2016]

Yang, X. and Morita, H., 2013. Efficiency improvement from multiple perspectives: an application to Japanese banking industry. Omega, 41(3), pp.501-509.

• Appendix

Table 1 – NPA/ Total revenues ratio

NPA/ Total revenues

2013

2014

2015

Resona

1.07

1.13

1.17

Sumitomo

1.00

1.06

1.10

Table 2 – Interest expense/ EBIT ratio

Interest expense/ EBIT

2013

2014

2015

Resona

0.07

0.06

0.05

Sumitomo

0.13

0.10

0.11

Table 3 – Net profit margin ratio

Net profit margin

2013

2014

2015

Resona

0.56

0.47

0.45

Sumitomo

0.95

0.89

0.87

Table 4 – Cash flows/Total assets ratio

Cash flows/Total assets

2013

2014

2015

Resona

0.08

0.14

0.20

Sumitomo

0.07

0.20

0.22

Table 5 – Debt-to-equity ratio

Debt-to-equity

2013

2014

2015

Resona

19.89

23.61

22.54

Sumitomo

21.30

19.63

18.19

Table 6 – Debt-to-asset ratio

Debt-to-asset

2013

2014

2015

Resona

0.95

0.96

0.96

Sumitomo

0.13

0.10

0.11