BOJ warns of rising financial vulnerability as banks hunt for yields
Japanese commercial banks are loading up on complex financial products and risky loans in their hunt for yields, the central bank said on Thursday, warning of the accumulating cost of prolonged ultra-low interest rates.
Faced with narrowing margins and a dwindling population, regional banks have increased loans for property investment and to companies with low profitability, the central bank said in a twice-yearly report analysing Japan’s banking system.
Despite continued improvements in the economy, some of the loans have turned sour due to lax lending standards and a rising number of firms falling behind in restructuring, it said.
“Credit costs remain low but have recently started to rise, particularly for regional financial institutions,” the BOJ said.
“As they have not been able to secure adequate returns relative to the risks involved, their capital adequacy ratios have continued to decline moderately,” the report said.
If such conditions persist, regional banks could lose the capacity to absorb losses from soured loans in the event of a major shakeout in financial markets, it said.
Big banks have expanded overseas lending and investment in complex financial products, which make Japan’s banking system more susceptible to global risks, the BOJ’s report said.
The number of collateralised loan obligations (CLOs), a form of securitisation which pools bank loans to companies, has ballooned in recent years as investors hunt for higher returns by buying into loans to lower-rated and riskier companies.
Japanese banks have also piled in. CLOs make up about 20 percent of their investment in overseas credit products, the BOJ said.
Their holdings account for approximately 15 percent of the total global CLO market, though most of the investment is in tranches with the highest credit rating, it said.
Stress tests show that Japanese banks’ holdings of CLOs are resilient to credit risks, the BOJ said.
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