Japan Post Bank fund reallocations seen slow

By Chikako Mogi

TOKYO, Sept 28 (Reuters) - The bank unit of Japan Post will seek to diversify operations when it starts its long path to privatisation on Monday, potentially having a huge impact on markets, but it is expected to avoid any major shift in asset allocations right away.

Japan Post [JP.UL], which runs the world's largest savings bank and had some $3 trillion in assets as March 2007 in the form of "yucho" postal savings and "kampo" postal insurance, will be split into four entities under a holding firm fully owned by the government.

The privatisation is to be completed 10 years from now.

Japan Post Bank, or Yucho Bank, will take over the "yucho" postal savings operation, which had assets of 231.6 trillion yen as of end-March 2007.

Japan Post Bank is distinctly different from commercial banks as its funding is predominantly reliant on postal savings, which stood at some 186 trillion yen as of end-March, with its investments largely limited to securities, primarily yen bonds.

Most Japanese household money has been parked in postal savings.

Of the savings, more than 80 percent is invested in Japanese government bonds, with the postal savings accounting for 21 percent of Japanese government bonds outstanding.

The bank faces such challenges as securing a more stable source of funding as deposits have been falling steadily, albeit moderately, while seeking to diversify businesses to boost profitability and raise returns from investments other than JGBs.

But any significant fund reallocation is likely to take place over a long period of time and in a way that would have limited impact on the financial markets, analysts say.

In its privatisation process, the bank must put priority on "safe" investments. Market players and analysts expect the bank to keep the current asset allocations largely unchanged, not only because of the huge size of the assets and the market impact of making changes, but also because it would be hard for the bank to take on new businesses promptly.

"The bank faces a risk-management challenge, tackling the issues of assets concentrated in JGBs and extremely high exposure to interest rate risks because their investments are in fixed income," said a senior analyst at a big Japanese securities firm.

"The bank has no choice but to stick to investing in mostly fixed-income securities, as entering the loan business is very tough given an already intensively competitive environment," he said.

The analyst said the bank could start with managing risk through shortening the duration of its bond holdings closer to an average 1.5 to two years for commercial banks' bond portfolios.

On the liability side, the bank must seek ways to attract more deposits or boost funding in interbank markets, he said.

While shortening the duration on its assets helps enhance flexibility in responding to volatile swings in deposit flows, funding may become fixed once interest rates start to rise.