Banks more vulnerable to risks from credit investments, says BoJ

The Bank of Japan said the nation’s yield-starved banks have grown more vulnerable to global credit markets as they increase investments in products overseas, a side effect of its unprecedented monetary easing.“These financial institutions have become more susceptible to the impact of a widespread repricing of risky assets stemming from a possible downturn in the global economy,” the central bank said in its semiannual financial system report yesterday.Major banks have also been increasing holdings of foreign bonds recently, while at home a gauge of real estate lending reached the highest since the aftermath of Japan’s 1980s property bubble, it said.The Bank of Japan is facing growing scrutiny of its three-year-old negative interest-rate policy, which is eroding lending income and prompting banks to seek higher returns by investing in risky products abroad. Profitability of domestic lending activities has continued to decline, it said in the report.Read more about the side effects of BoJ policy on banks and bonds Some banks have been piling into bundled overseas corporate loans, known as collateralised loan obligations.Agricultural lender Norinchukin Bank has led the charge, holding ¥6.8tn ($61bn) of the securities as of December. Japan Post Bank Co doubled its holdings since last March to ¥1tn at the end of the year.CLO defaults have been rare over the past two decades, and Japanese banks have been buying the highest-rated slices. But some observers worry that the structured products could be vulnerable during the next economic slump. Japan’s financial regulator has stepped up scrutiny of the biggest CLO holders, and this year introduced a rule that increases the obligations of investors. On foreign bonds, the central bank said that transactions have been fuelled by fluctuations in US interest rates amid speculation over the Federal Reserve policy outlook. “There has been a mixture of bond sales aimed at cutting unrealised losses and bond purchases motivated by easing concerns over future interest rate hikes,” it said.Japanese Bankers Association chairman Makoto Takashima this month warned the central bank against deepening negative rates, signalling such a move could spur risky investment and put further pressure on lenders’ profits.Underscoring those risks, Mizuho Financial Group Inc last month announced a ¥150bn write-down charge to restructure its foreign bond portfolio. Moody’s Investors Service said the move was primarily the result of unrealised losses caused by higher US interest rates.The BoJ said an increase in property lending at home warranted attention, particularly as it’s been driven by local banks with low capital buffers. A “heat map” of the ratio of real estate loans to gross domestic product turned red for the first time since 1990, the central bank said, while adding that the market can’t be seen as overheating.The central bank kept its assessment of Japan’s financial system, saying it “has been maintaining stability on the whole.” To strengthen profitability, banks need to diversify services, increase business efficiency and have options for merging or forming alliances, it added.