Business / Financial Markets

BOJ says banks vulnerable to falling prices of corporate loans if global economy worsens

Bloomberg

Japanese banks, which have been rapidly accumulating bundled corporate loans abroad, are vulnerable to a steep drop in their prices if the global economy deteriorates, the nation’s central bank has warned.

The ratings and market prices of even top-rated collateralized loan obligations, or CLOs, held by Japanese banks “could fall substantially” if economic and market conditions change significantly, the Bank of Japan said Thursday in its semiannual financial system report.

Japanese banks now own about 15 percent of outstanding CLOs globally, the BOJ said. Still, about 99 percent of major firms’ holdings are rated AAA, and the risk of defaults in such tranches is “basically small,” the central bank added.

Norinchukin Bank and Japan Post Bank Co. are among firms that have sharply boosted their holdings of CLOs in recent years, in search of higher returns at a time of negative interest rates at home. Norinchukin alone holds ¥8 trillion ($74 billion) of such instruments, according to its latest financial report.

The growing attention on Japan’s exposure at a time of slowing U.S. economic growth prompted the BOJ and the Financial Services Agency to cooperate earlier this year in surveying financial firms on their purchases of overseas credit products.

While the quality of some loans included in CLOs is worsening, there has been no sign of damage to the highest-rated slices. Loans rated AAA are first to be repaid if the borrower gets into financial difficulty.

The BOJ also highlighted its concern that banks have been increasing loans to riskier companies at home, leading to a rise in credit costs. Still, it kept its assessment that the financial system has been maintaining stability on the whole.

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