Capitalization remains under pressure for UFG, SMFG, and Mizuho.

Japan’s three largest banking groups—Mitsubishi UFJ Financial Group (MUFG), Sumitomo Mitsui Financial Group (SMFG), and Mizuho Financial Group (Mizuho)—all saw their net profits decline in the first half of the fiscal year ending March 2021 compared to the same period in FY2020, a report by Moody’s Japan KK noted.

The three giants allotted higher credit costs to provision for potential bad loans, which offset their higher revenue.

"Credit costs had been low in Japan over the past few years, supporting banks' profitability. But with the onset of COVID-19, credit costs increased to an annualized 0.38% of gross loans in H1 fiscal 2020 from 0.07% in H1 fiscal 2019," said Tetsuya Yamamoto, a Moody's vice president and senior credit officer.

"Although we expect credit costs to decline again, they are unlikely to return to pre-pandemic levels for a while,” Yamamoto added.

Capitalization remains under pressure due to increases in risk-weighted assets resulting from downgrades of banks' internal credit ratings for borrowers. Growing subordinated loans to large Japanese corporations seeking to strengthen balance sheets also weighs on capitalization.

Furthermore, earnings accumulation is forecasted to slow as banks keep dividend payouts unchanged despite deteriorating profitability, Moody’s added.

On the upside, the three banks' liquidity is expected to remain strong, backed by large amounts of cash and highly liquid securities holdings.

During the first half of fiscal year 2020, deposits growth outpaced loans growth at the three banks, because most of the new loans originated in response to the coronavirus outbreak and a large share of government subsidies for individuals and businesses were deposited.