Japanese megabanks should capitalize on their recent strong performance. Economic tailwinds have boosted returns and replenished capital buffers, providing these institutions more room to maneuver and the opportunity to pursue substantive strategic moves.

However, skepticism persists among investors regarding the megabank miracle. Despite a strong rally over the past 18 months, shares still trade at a significant discount compared to North American peers. Furthermore, they do not meet the targets set by the Tokyo Stock Exchange (TSE) for all listed companies to maintain price to book ratio (P/B) greater than 1x.

Global investors seek 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 their capital, structured 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 ~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 ~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.