BOJ Beat: Banks Becoming More Insulated Against Rate Jump

This post is by Tatsuo Ito from Real Time Economics

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Pedestrians walk past the Bank of Japan headquarters in Tokyo.
Bloomberg News

Japanese banks are becoming more insulated against losses that could emerge from a sudden rise in interest rates, a Bank of Japan report showed Wednesday.

Based on their portfolios as of December, the central bank estimates that the country’s major and regional banks could suffer a combined Y5.6 trillion ($54.5 billion) in losses if interest rates broadly surge by one percentage point. That’s less than the Y6.0 trillion in potential losses they faced as of June last year and much better than a peak of Y6.9 trillion in possible losses estimated for the end of 2012.

A two-percentage-point increase in rates would lift the potential losses to Y10 trillion and a three-percentage-point increase could result in Y14.4 trillion in losses, the BOJ projected.

Japan’s public debt-to-GDP ratio is well over 200%, the worst among the leading industrial nations, and the government is concerned that if its debt load becomes unsustainable it could send shockwaves through the broader economy.

Years of Japanese banks parking massive amounts of cash in safe-haven government bonds has led to a situation where the country’s financial system could be hurt by a rise in interest rates, even though the central bank views Japanese lenders as financially robust compared with their rivals in Europe and the U.S.

But since the BOJ launched its unprecedented easing a year ago, commercial banks, particularly major ones, have been wary of accumulating yen-denominated bonds partly on fears of losses when interest rates start to go up, a BOJ official said.

The official said this wariness suggests banks are becoming better at “managing” these type of risks even though the level of risk is still “historically high.”

Under the BOJ’s easing program, the central bank is buying Japanese government bonds through the market equivalent to over 70% of newly issued debt. Commercial banks have been a primary seller of those securities to the BOJ, with major banks selling about Y20 trillion in government bonds over an 11-month period that ended in February.

One of the effects that the BOJ is hoping to see through its easing campaign is for banks to move away from JGBs to risk assets such as stocks and lending.

The BOJ said banks are now taking greater risks with loans and stock holdings. Still, some critics say commercial banks shifting into risk assets has been limited so far.

Transferring bond exposure from private banks to the BOJ could be a daunting challenge for the central bank when it starts scaling back its purchases or selling what it has bought in the market, a factor that could trigger a spike in interest rates.

That would require a delicate balancing act as a rise in interest rates could exacerbate the nation’s already dire financial situation.

Apparently aware of such risks, BOJ Gov. Haruhiko Kuroda has repeatedly said that it is too soon to debate the BOJ’s exit strategy.

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