Japanese lenders should take stress tests to assess their ability to withstand swings in bond prices as the central bank’s unprecedented monetary stimulus saps trading volumes, one of its former executives said.
A measure of price swings in government bonds briefly jumped to a five-year high two months after Bank of Japan Gov. Haruhiko Kuroda’s board boosted debt purchases last April. Since the BOJ’s buying reduces securities in circulation, volatility may rise again and heighten the risk of losses for domestic lenders who hold ¥132 trillion ($1.3 trillion) of the notes, according to Kenzo Yamamoto, formerly BOJ executive director in charge of financial system stability.
“If market rates continue to stay this low, financial institutions could be faced with behavior unseen in the past,” Yamamoto, now chairman of NTT Data Institute of Management Consulting Inc., said in an interview in April. “Financial institutions should conduct stress tests that go beyond historical data.”
Japan’s benchmark 10-year debt yield was at 0.61 percent Thursday, less than the 1.65 percent average over the last 20 years and the 2.66 percent in the United States. A BOJ report said that a 1 point increase in JGB yields would result in ¥7.5 trillion of capital losses for domestic financial institutions, double the combined annual net income of local banks. Central bank officials are concerned the bond market is failing to reflect emerging inflation, raising the risk of sudden surges in yields, people familiar with the matter said.
BOJ board members have predicted that inflation will accelerate to 1.9 percent in the 12-month period starting in April 2015 and to 2.1 percent the following year, excluding tax effects, in line with its 2 percent goal, according to a report released April 30. Their median estimates call for economic growth of 1.5 percent and 1.3 percent in fiscal 2015 and 2016, respectively.
Swings in bond market prices may return should the BOJ’s policy boost the economy’s performance and put upward pressure on interest rates, said Yamamoto.
Price volatility for JGBs was at 1.15 percent April 30, after surging to 3.98 percent in June 2013, the highest since July 2008, according to data compiled by Bloomberg based on 60-day readings.
Stress tests typically involve banks drawing up scenarios on how rising yields would affect their core capital, making calculations on the effect on capital ratios and drafting strategies for when to sell bonds according to developments in the economy as well as shares, Yamamoto said.
Regulators in the United States and Europe have imposed tests on local lenders to avoid a recurrence of the global financial crisis, which accelerated when Lehman Brothers Holdings Inc. collapsed after Bear Stearns in 2008. European Union banks will be ranked on how well they can withstand a 21.2 percent slump in home values, coupled with a surge in unemployment and plummeting economic growth, according to the European Banking Authority.
“Financial institutions are regularly conducting stress tests against the risk of surging interest rates,” Kazuto Uchida, an executive officer at Bank of Tokyo-Mitsubishi UFJ Ltd., said in an interview last month. “They’ve become essential for the governance of financial institutions since the Lehman collapse.”
The BOJ’s unprecedented stimulus policy since April 2013 to buy about ¥7 trillion of sovereign notes a month helped spur a 51 percent surge in the Topix share index last year. The gauge has dropped 10 percent so far in 2014. The yen traded at 101.73 per dollar as of 2:39 p.m. Friday in Tokyo, compared with around 93 before the BOJ boosted stimulus.
Bank lending rose 2.3 percent from a year earlier in March, the 30th straight month of increases, central bank data show.
Bank profits from the share rally and falling costs to clean up bad debt may not be sustainable because the stock market windfall could be temporary, while such credit expenses have already decreased to levels not seen since around 1991, Yamamoto said.
Lending is on a rising trend but harsh competition continues to depress rates, further shrinking profit margins, he said. “While the health of banks isn’t threatened now, there is a possibility that some banks may take on unbalanced risks.”
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