Prepare for a Japanese Banking Meltdown?

Published on
July 25th, 2019
50 minutes

Prepare for a Japanese Banking Meltdown?

The Interview ·
Featuring Shannon McConaghy

Published on: July 25th, 2019 • Duration: 50 minutes

Shannon McConaghy of Horseman Capital paints a dour picture of the Japanese banking system. He reveals the accounting tricks that have allowed these banks to survive in a predominantly negative-interest-rate world, and discusses why credit costs are finally rising. Shannon warns of a potential meltdown that could have far-reaching ramifications, in this conversation with Real Vision's Roger Hirst. Filmed on July 11, 2019 in London.



  • DS
    David S.
    2 August 2019 @ 06:33
    Great interview and research as I would be expected from anyone from Horseman Capital. I am sure the research is correct, but the Japanese citizen is unlike anyone else in the world. They are tremendous savers and a very cohesive group. Unlike many other countries in the world, I believe that the Japanese citizen will do everything possible to get out of this problem, including taxing themselves. The Japanese government and the Bank of Japan have sinned in many areas trying to help get Japan out of its financial problems. I feel the citizens will go as far as possible not to lose face with themselves and the rest of the world. Keep your powder dry until the citizens of Japan say no. DLS
    • AH
      Anthony H.
      28 January 2020 @ 18:32
      agree. Highly unlikely they will quit their banking system.
  • AH
    Anthony H.
    28 January 2020 @ 18:30
    This sounds too bearish to me. For a domestically funded system like Japan, a complete banking meltdown sounds very unlikely, unless there is substantial capital flight (which is unlikely). If the smaller regional banks fail the assets will be taken over by the major banks, probably with some help from the regulator and the government, and the banking industry will just consolidate etc. The system is certainly leveraged, but to me an outright crisis is unlikely. The Japanese bubble already burst in the 90s.
  • MW
    Marcus W.
    10 August 2019 @ 04:41
    I found this one fascinating. And I can personally validate everything he says. I'm based in Japan and I have a friend here that gets hassled by banks to borrow 30,000,000 yen - 50,000,000 yen (30m - 50m USD). The loans are: Non-recourse No deposit 0.4 - 0.6% interest rate fixed. He can go out and buy real estate with not one dollar of his own money. So for him, any deal cash flows. For the rest of us it's more like 1.5% to borrow up to 2%. Banks just throwing money at him to invest. In the past he'd have to personally guarantee everything against every loan. The banks have no allowed him to withdraw all of this and refinance. All the debt he now carries is non-recourse and at rates around 0.5% Why would banks bother with other people borrowing 300k USD. Right now he's looking at leasing jets. I wish I could borrow on those conditions but no chance. My 2 cents worth.
    • MW
      Marcus W.
      10 August 2019 @ 04:44
      My trade right now is long JPY against everything including the USD. I think the Yen could get to 100 and I'll move back into USD at that point. I wonder if the USD will outperform the JPY for the next few years? Either way I am long, JPY, USD, Silver, Short the SPX500 a tad, adding to the position around 3000. Like Pal says, you can get cut up shorting indices. And yeah I feel that. But for some fun I'll keep topping up my short at 3000 levels.
    • cs
      cat s.
      9 September 2019 @ 04:04
      I think you will find that non recourse is only availiable on entrusted assets and that will require 1-2bn yen min of asset/loan and then it would be highly likely that you could get ltv higher than 80% , so hes your friend is probably able to get a 30-50m yen loan at 100% ltv but no it will not be non recourse and he would have strict rules on what he can buy and would also need to show sufficient income to repay and other assets. Since the Seruga bank scandal lending terms have tightened although rates for good standing borrowers may be lower ...
  • PK
    Patrik K.
    28 August 2019 @ 17:13
    Great interview. Thanks!
  • AE
    Abou E.
    16 August 2019 @ 10:55
    Very interesting interview. Thank you RV!
  • LK
    Lee K.
    16 August 2019 @ 05:51
    As President Bush put it "This sucker is going down" However, some clarification on the topic of the "moratorium bill". This was actually the "Bill on Provisional Measures for the Facilitation of Financing to Small and Medium Sized Businesses" implemented in Dec 2009 for 2 years, extended twice to finally expire in 2013. The Bill required Financial Institutions to make "best efforts" to accommodate requests for extension, interest deferment etc. Approx 400K of SMEs took advantage of the scheme (around 10pct of total) In total 97.3 pct of all application were approved by banks. Why? Any loans so treated were eligible for inclusion in the Emergency Credit Gty Program, covering 100pct of the loan extended. Thus Banks could reduce non performing loan ratios, reduce credit costs and transfer credit risk to local/central governments (backers of the ECG scheme). Regional banks are on the way to zero, but the moratorium bill is a bit of red herring, once understood. Source:RIETI Discussion Paper Series 17-E-086 ONO Arito.
  • KD
    Kaj D.
    29 July 2019 @ 04:15
    Another excellent interview. Shocks me that we heard all about the dodgy financial practices in the 90’s – can remember reports vividly. But I guess politicians trying to get re-elected / doing the popular thing rather than the right thing, is a problem across the world.
    • JV
      Jens V.
      6 August 2019 @ 10:57
      It's easier to kick the can down the road than to solve problems. The US refinanced it's banking system after the GFC, but Europe and Japan didn't to the same extent. In my view that's one reason why the US has done better since the GFC.
  • JV
    Jens V.
    6 August 2019 @ 10:55
    Brilliant. Combining this with the possibility of a CNH devaluation, as suggested by Russell Clark and others, I've shorted CNHJPY.
  • LP
    Lauri P.
    25 July 2019 @ 17:02
    My god, I had no idea Japanese banks is where all the CLOs are being funnelled. I suppose makes sense that banks need to search yield form abroad in increasingly risky assets when their economy has been flat for two decades. I have hard time wrapping my head around the yen thesis or single stock equity though... if the banking sector melts down, certainly it will affect the whole economy negatively, and force BOJ / gov into even more aggressive stimulus? Seems like there could be lots of unexpected knock-on effects around the globe. All in all, absolutely fantastic interview!
    • AM
      Andrew M.
      25 July 2019 @ 22:12
      if the banking sector melts down then banks will be forced to liquidate their gigantic yen carry trade, is what he's getting at. and given how undervalued the yen is on the metrics he cites and how banks are positioned, the move could be violent and akin to a bad short squeeze. BOJ would be pretty hapless too. As Shannon says, Kuroda has basically admitted than they can't weaken the Yen any further, while BOJ already owns 50% of JGBs and interest rates are negative. And, perhaps more importantly, any further "stimulus" is only likely to hurt banks even more, with their margins turning even more negative. this is why the situation is so dire - it's a perfect storm.
    • NS
      Nico S.
      27 July 2019 @ 20:21
      Yes, but aren’t they only buying AAA CLO’s? Sounds like a dump that turns into huge buying opportunity for CLO’s.
    • AM
      Andrew M.
      2 August 2019 @ 09:02
      they are the world's largest creditor, so are buying everything lol (tho less USTs now that they have negative yields on fx-hedged basis). they've already stopped buying CLOs, and pensions and other US institutional investors have stepped in. But there's still EMD, Aussie mortgages, Italian and French govvies, airline and shipping leases, hedge funds and, increasingly, private equity. the main point is that all these trades are in other fx other than yen (hence the yen carry trade). I would say the majority of this would be $s, hence yen/usd cross, but could also be a material hit to aud and some other crosses too. and broadly speaking, the world does not need a skyrocketing yen lol
  • GC
    Gary C.
    2 August 2019 @ 01:25
    Shannon,great research and discussion. Looks like you may have a thyroid nodule in the left lobe.
  • JB
    Jack B.
    30 July 2019 @ 04:16
    I can't believe they have got themselves into such a mess
    • SB
      Stephen B.
      30 July 2019 @ 21:00
      There is ultimately a high price to be paid for perpetually kicking the can down the road.
  • KD
    Kaj D.
    30 July 2019 @ 06:16
    "prolonged downward pressure on financial institutions profits from low rates could destabilize financial system" - from today's BOJ quarterly report. Sure rhymes with Shannon's interview.
  • RP
    Raoul P. | Founder
    27 July 2019 @ 16:29
    This is an absolute stunning interview. My jaw hit the floor several times watching this. Incredible.
    • Hv
      Hannah v.
      27 July 2019 @ 20:58
      Absolutely. I think this is the keystone piece of the two weeks. Thanks so much for all the effort you’ve put in in giving back; you’re my college education. Now go get some ice-cream, my treat ;)
    • MC
      Mario C.
      28 July 2019 @ 09:40
      Agreed. So no jpy bearishness anymore Raoul ;-)
    • JM
      John M.
      30 July 2019 @ 04:38
      I have always assumed that negative interest rates is a toxic environment for banks to operate in (i.e., specifically those banks that earn most of their revenue from interest spread) so I was not really surprised - but it was a bit shocking.
  • Hv
    Hannah v.
    27 July 2019 @ 20:55
    “The yen is primed to strengthen.” @09:01 or Page 17 transcript: 3rd paragraph. Can anyone help me to see this relationship? Why would the yen strengthen when the country and the banking system approaches meltdown? Thanks in advance! Hannah
    • GS
      Gordon S.
      28 July 2019 @ 01:07
      Japan will have to sell their foreign assets (of which they own a lot), to stem the crisis. I.e. they will sell dollars to buy yen, putting upward pressure on the yen.
    • Hv
      Hannah v.
      28 July 2019 @ 17:43
      That makes sense.. thanks Gordon!
    • JM
      John M.
      30 July 2019 @ 04:23
      Gordon, If foreigners with investments in Japan think about liquidating their investments (in the event of a banking crisis/severe recession) and repatriating their funds could this be an offset to yen appreciation?
  • WM
    Will M.
    29 July 2019 @ 14:17
    Out of left field discussion........... Is there any good news out there or is that light at the end of the tunnel just a 4-6-4 hurtling toward us....
  • MC
    Mario C.
    28 July 2019 @ 09:37
    Great great interview! Coincidently (through my job in the Fin industry in Tokyo), I got a presentation fewweeks ago from a Tier #1 IB Analyst/Strategist that is 90% similar to this interview content. - JP Regional Banks: cf. this interview content - JP Insurers: similar fate that RBs expected in coming years (40Y JGB only provides them 0.40% coupons currently) Two obvious trades: - steepening of JPY yield curve: BoJ can crush the JGB10Y yield even more. But they can’t touch the 20Y and longer part of the curve without inflicting terrible lethal pain to RBs and Insurers - JPY ccy appreciation as talked in this interview My only doubt regarding the described scenario unraveling: BoJ and Gov intervention to save the JP Financial Institutions -> save troubled RBs via state recapitalization or via merging them with one of the 3 more powerful MegaBanks (that would be given the capital if needed, as the US did back in 2008).
    • ST
      Steven T.
      28 July 2019 @ 21:11
      Isn't the potential amount of steepening in the curve capped by the adoption of the yield curve control policy a few years back by the BOJ? I could be mistaken in my views on ycc by the BOJ, so correct where necessary. Under your scenario of steepening, the majority of the steepening would be due to the front end collapsing? I really wonder how negative central banks can push rates before depositors take their money out completely.
    • MC
      Mario C.
      29 July 2019 @ 05:33
      @steven t: YCC targets a yield range on the 10Y JGB = [-0.10%;+0.10%] (or -0.20%;+0.20%). Yes the steepening 10Y-30Y cannot grow huge, as it would be too good a carry. But it should work in both a bond rally scenario (10YJGB in even more neg territory, while 30Y rally limited to avoid killing Insurers), or a bond sell off scenario: so both bear steepening or bull steepening ok => low risk trade
    • ST
      Steven T.
      29 July 2019 @ 11:12
      Thanks for the explanation.
  • SP
    Stephane P.
    29 July 2019 @ 04:23
    It seems the Chinese Banking system is currently melting BEFORE the Japanese one.....
  • RC
    Ryan C.
    25 July 2019 @ 19:54
    So how do we trade this?
    • sB
      sylvain B.
      26 July 2019 @ 08:04
      easiest is long Yen/USD I guess.
    • AM
      Andrew M.
      27 July 2019 @ 09:56
      and short Nikkei or Topix would be the other simple trade. Japanese stocks usually do pretty badly in US slowdown and look like they're topping out. so Nikkei tends to track 10-30s spread widening, but also unemployment - which is trending up; usually a sign of a turn or cycle peak. you can read more on Horseman's Market Views page, with some great articles by Shannon. The major threat would be a dollar breakout, since Nikkei is highly correlated to USD/Yen. But I think a dollar breakout here is going to be very damaging and bad for all risk assets, so maybe it's not the same risk as years past. Japanese banks also have significant exposure to leveraged loans, Aussie RMBs and EMD. tough to know much about the latter, but leveraged loans is interesting, especially with new regulations that will make Japanese ownership harder. still, it's hardly a lay-up, and short USD/Yen and Nikkei seem like the easiest trades.
    • ST
      Steven T.
      27 July 2019 @ 20:01
      Instead of the USD/JPY cross, the more interesting crosses to me are Yen against AUD and EUR. USD/JPY seems much more range bound relative to what has been occuring with Yen against AUD and EUR.
    • MS
      Milind S.
      27 July 2019 @ 21:04
      I have reservations about going long JPYUSD is good, especially if Raoul's call of USD strengthening is accurate. I would probably go long JPYAUD.
    • GS
      Gordon S.
      28 July 2019 @ 01:05
      Or just go long JPY vol, it is - surprise surprise - at an all-time low.
  • GS
    Gordon S.
    28 July 2019 @ 01:04
    Excellent interview! I was surprised that the fact that Softbank represents 50% of the Japanese corporate market was not mentioned in the interview. C.f.:
  • NS
    Nico S.
    27 July 2019 @ 20:18
    Interesting comment about the Japanese banks owning CLO’s. However, haven’t they been buying the AAA’s which are (were) bullet proof (even during financial crisis). POINT: not a single AAA CLO defaulted during or after the crisis?!?! Sounds like a HUGE BUYING opportunity for US buyers (or anyone else) when they dump them. I will LOVE THAT TRADE when it happens as I’m an insurance co buyer! Or am I missing something? Anyone help me through this thought process?
    • NS
      Nico S.
      27 July 2019 @ 20:25
      If anyone wants to see the analysis of CLO’s breakevens just contact me.
  • JH
    Joe H.
    27 July 2019 @ 13:05
    This was so good. I knew the BOJ and Japan broadly was a basket case but I never even thought about the regional banks and the knock on effects discussed here. Excellent content!
  • sB
    sylvain B.
    26 July 2019 @ 08:06
    that was brilliant ! Japanese capital repatriation risk has been also highlighted as a key upside risk for the Yen by Morgan Stanley FX strategist Hans Redeker.
    • JW
      Joseph W.
      27 July 2019 @ 07:07
      i love Redeker's accent LOL
  • RY
    Roy Y.
    26 July 2019 @ 18:35
    Spot on!
  • AB
    Avik B.
    26 July 2019 @ 10:38
    • PW
      Phil W.
      26 July 2019 @ 18:18
      Just watched the video.......and yes...............WOW
  • GF
    George F.
    26 July 2019 @ 14:38
    I checked the composition of Japan ETF EWJ. If I got things right Financial Services + Realestate are reported to be 10% 15% depending on how you count, which looks like those businesses are not a large part of portfolios. . Maybe banks aren't that big a problem as investors have given up on them?
  • GF
    Gordon F.
    25 July 2019 @ 20:32
    When you combine this interview with the previous one with Michael Oliver, the economic situation starts to look dire, and possibly very soon. Michael is simply looking at technicals, while Shannon looks at the banking situation in Japan, with a side-note that Europe could happen even sooner. Both are seeing high levels of risk with a likely short time-horizon. I'm not ready to just get out of the market, but I am going to seriously look at more insurance against a rapid market decline.
    • WS
      William S.
      26 July 2019 @ 01:25
    • JF
      John F.
      26 July 2019 @ 05:45
      You might want to get out. Watch out for FOMO.
  • Hv
    Hannah v.
    26 July 2019 @ 04:26
    I’m speechless. Thank you!
  • OT
    Omar T.
    26 July 2019 @ 04:03
    Wow. Very well done
  • EO
    Elena O.
    26 July 2019 @ 04:00
    What the impact will be on Japanese insurance companies? And impact on yen status as one of the global reserve currencies? What trade or positioning is recommended in this scenario of melt down?
  • PB
    Pieter B.
    26 July 2019 @ 03:34
    Would you mind sharing any names of the worst regional Japanese banks Shannon? ;)
  • PB
    Pieter B.
    26 July 2019 @ 02:43
    This is real quality! Massive thanks for sharing!
  • LH
    Laurent H.
    26 July 2019 @ 02:14
    One of my favorite interviews of the year (Not just because Shannon is a fellow Aussie), he talks about a left of field event - Regional Japanese Banks going under, sparking a global recession and this causing the Yen to strengthen (Contrarian).
  • SS
    Shanthi S.
    25 July 2019 @ 20:08
  • gg
    georgy g.
    25 July 2019 @ 18:25
    Best ever. Very educational
  • JM
    JP M.
    25 July 2019 @ 12:06
    Fantastic interview. I am interested in Shannon's view on the potential for a Japanese debt jubilee, perhaps after the banks' NPLs have been nationalized, and its knock-on effect on the Yen.
    • NP
      Ni P.
      25 July 2019 @ 18:19
      You think they're in the best position to do so? If so - long yen in the global reset.
  • EJ
    Edward J.
    25 July 2019 @ 16:52
    Superb interview - well done RV - this is exactly why I subscribe
  • JS
    John S.
    25 July 2019 @ 15:02
    Brilliant. This is the question that needed answered and we’ve heard it from a few RV interviews...consequence of central bank tightening is failing banking sector in Japan and Europe. That’s why the utopia perception to easing is a mirage. Excellent interview!
  • NA
    N A.
    25 July 2019 @ 13:35
    Brilliant interview and very well explained
  • PJ
    Peter J.
    25 July 2019 @ 10:17
    It's getting boring commenting as I just say the same thing. Another exceptional interview, just keep them coming.