(Adds quotes from former officials, context)
By Sumio Ito and Leika Kihara
TOKYO Aug 8 Japanese financial authorities are
joining forces to scrutinise for the first time banks' exposure
to a potential spike in interest rates, with a focus on the
risks to regional lenders when the central bank eventually ends
its massive easing.
Japan's 105 regional lenders hold 40.8 trillion yen ($400
billion) of Japanese government bonds as investment, equal to
about 8 percent of gross domestic product. Policymakers worry
that if economic growth picks up or investors think the central
bank is leaning towards tapering its JGB purchases, yields could
surge and the value of the JGBs held by the banks would fall.
Regional banks have been in a bind. With local economies
depopulating in this fast-ageing society, loan demand tepid, and
scant resources to seek profits overseas, they have little
alternative for their huge deposits - about half of the
country's - but to hold JGBs.
While the risks look small now with Japan's economy
recovering and interest rates extremely low, the country's
financial authorities are not letting down their guard. The
health of regional banks is key to the stability of the
financial system and the livelihoods of millions of people.
The Financial Services Agency and the Bank of Japan are
scrutinising the smaller lenders' interest-rate risk as they
jointly step up their "macroprudential" oversight - looking to
identify and minimise risks to the financial system amid broad
shifts in the economy, people involved in the process say.
"At present, interest rates are very low and stable, but we
don't know when or how the financial environment will change,"
the FSA's new commissioner, Kiyoshi Hosomizo, told regional bank
heads in a private meeting last month, according to a person who
attended the meeting.
Regional banks, which sit below the five major banks in
Japan's financial pyramid, have total deposits and loans roughly
equal to the biggest lenders but are largely tied to shrinking
local economies outside the vibrant big cities. They vary
greatly, with the market value of the listed banks ranging from
over $7 billion for the Bank of Yokohama Ltd just
outside Tokyo, to barely $50 million for Howa Bank Ltd
in the western city of Oita.
The FSA, the financial industry regulator, has been prodding
regional lenders to consider mergers and acquisitions for
greater efficiency to cope with the bleak economic outlook. So
far, the local bank chiefs have shown no willingness to give up
their local fiefdoms and consolidate.
"Regional banks just can't find any profitable bank loans in
their regions because regional economies are decaying with the
demography," said Takashi Kozu, former head of the BOJ's Bank
Examination Division and co-chair of a Basel Committee working
group on macroprudential supervision.
While stronger institutions could handle higher rates,
"those banks with thin capital buffers will suffer seriously,"
said Kozu, chief research fellow at the Ricoh Institute of
Sustainability and Business. "Therefore the FSA and BOJ are
trying to be vigilant" on rate risks.
The plan by Japan's public pension fund, the world's biggest
at around $1.24 trillion, to tweak its portfolio weightings and
invest in higher-yielding assets is also fuelling talk of a rise
in JGB yields. The fund will likely cut its weighting for JGBs
to around 40 percent from a current 60 percent target, two
people with knowledge of the allocation review told Reuters on
REGULATORS TEAM UP
The FSA and BOJ set up a joint task force in June to share
information on the nation's financial institutions, with a new
focus on systemic risks. The rate risk for regional banks was
highlighted in a July report by the bank regulator.
The FSA's future stress tests will include simulations of
higher rates on banks and the broader financial system, one
source said. Spokesmen for the FSA and BOJ declined to comment.
The FSA is expected to put more focus on macroprudential
oversight when it compiles its annual bank-inspection guidelines
in the next month or so, people familiar with the inspection
process say. It is unclear if the authorities will take new
The FSA, whose inspections have focused on the health of
individual banks, is tapping the BOJ's expertise on
financial-system stability to ensure a smooth transition out of
nearly two decades of deflation, the sources say.
While BOJ Governor Haruhiko Kuroda says it is too early to
discuss winding down the central bank's 16-month-old
"quantitative and qualitative easing", the recent attention on
interest-rate risk shows that in practical terms Japan's
financial authorities have begun eyeing the exit.
Kuroda's central bank has crushed Japan's market interest
rates - the 10-year JGB yields barely 0.5 percent - by
purchasing 70 percent of the government's debt issuance in an
unprecedented monetary easing.
The BOJ estimates that most banks have capital buffers to
withstand a 2 percentage-point rise in long-term rates. But a
1-point rise would hit regional banks with 3 trillion yen ($29
billion) in valuation losses on their JGB holdings, more than
the 2.6 trillion yen estimate for the more profitable major
LAGGING THE MAJORS
Regional banks hold less in JGBs than the major banks
relative to deposits or assets. But policymakers privately worry
that the smaller lenders have made little progress in trimming
their bond holdings while remaining reliant on longer-term debt
and lacking other outlets for their cash.
Since the global financial crisis, Japan's major banks have
greatly reduced their interest-rate risk by shortening the
duration of the debt they hold - making them less vulnerable to
rising long-term yields - and selling down their government bond
holdings, the FSA said last month in its Financial Monitoring
Report. Regional banks, by contrast, have offset their JGB
decreases by purchasing corporate debt, the report says.
Major banks slashed debt with more than five years to
maturity to 13 percent of their holdings by March 2013 from 23
percent in 2008, while regional banks held flat at about 50
percent in longer-term debt, according to data compiled by Japan
The BOJ and FSA believe Japan's banking system remains sound
with no immediate signs of financial imbalances.
"The authorities are always monitoring and they can take
precautionary steps like using administrative guidance behind
the scenes to get a weaker second-tier regional bank or savings
and loans to increase its capital," said former FSA commissioner
Hirofumi Gomi, an adviser to the law firm Nishimura & Asahi.
Still, the BOJ is becoming more mindful of the potential
drawbacks of its easing and the market volatility it may cause
when it starts to wind down the stimulus.
"In general, it's true that prolonged monetary loosening
could lead to future financial imbalances as markets engage in
excessive risk-taking," Deputy Governor Hiroshi Nakaso told a
news conference last month.
"There are various debates on what roles macroprudential
policies and monetary policy should play in addressing financial
imbalances," said Nakaso, who has played a key role in enhancing
macroprudential policies and is spearheading recent coordination
with the FSA. "Still, I think there's a certain role monetary
policy can play."
($1 = 102.1500 Japanese Yen)
(Additional reporting by Takahiko Wada, Ritsuko Ando and Taiga
Uranaka; Editing by William Mallard and Ryan Woo)