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Japanese banks are in a bind — again.

Sitting on record levels of excess cash, lenders are turning to riskier investments that need complex foreign exchange hedges, such as U.S. Treasuries, to make a return on deposits that ballooned during the pandemic. Many will be seeking to avoid past mistakes.

The surplus, calculated by subtracting bank loans from deposits, stands at ¥323 trillion, Bank of Japan data show. Deposits at the nation’s top three banks alone grew by ¥41 trillion in the year ending in March, with Mitsubishi UFJ Financial Group Inc. accounting for more than half.

“A growth in our deposits is proof of customers’ trust in us,” MUFG Chief Executive Officer Hironori Kamezawa told reporters in May. “But to be honest, it’s a tough challenge how to manage it.”

With households around the world using the pandemic to pay down debt and rein in spending, and massive government handouts exacerbating mounting cash piles at banks, Japanese firms aren’t alone in facing this unwanted consequence of the virus — U.S. banks just saw the same metric hit another record. In Japan it’s a problem that they’re all too familiar with.

Now, some Japanese lenders are turning to riskier assets, such as foreign bonds, just as expectations ratchet up for higher interest rates in places like the U.S. The companies, which often rely on domestic fixed-income investments, now need to consider a variety of higher-yielding assets — but that comes with potentially larger risks.

Banks are likely to invest more in “non-traditional areas,” including real estate assets through investment trusts, said Nana Otsuki, expert director and chief analyst at Monex Inc. “Illiquid assets have relatively higher returns but more attention will be needed for the risks. It’s important that they won’t invest in assets with risks that are hard to understand,” she said.

MUFG said it will consider investing in alternative assets such as private equity and real estate funds in the U.S. and other places. Concordia Financial Group Ltd., one of Japan’s largest regional banking groups, is going to invest in Treasuries and mortgage bonds this year, given the lower returns on Japanese bonds, President Yasuyoshi Oya said last month.

Riskier investments haven’t always paid off. Mizuho Financial Group Inc. booked a ¥150 billion charge in 2019 to write down losses on its foreign bond holdings following a sharp rise in Treasury yields.

Japan Post Bank Co. drew scrutiny from the central bank in recent years for sharply ramping up investments in collateralized loan obligations, or CLOs, which got hit when the pandemic spread around the world early last year. The postal bank, which used to invest most of its roughly ¥220 trillion in JGBs, now counts those at just 23% of its portfolio.

The large loan-deposit gap isn’t likely to wither any time soon even as the economic recovery builds. Deposits do not decrease that easily and the gap could even widen further if government handouts are extended amid the prolonged pandemic, said Tsuyoshi Ueno, a senior economist at NLI Research Institute in Tokyo.

Otsuki at Monex says the sharp increase in deposits is a big challenge for bank management teams and it isn’t yet clear how they will overcome it. They will need more staff prioritizing the problem though, she added.

“The role of securities portfolio management is only likely to get bigger for banks,” she said. “They need to allocate more resources in that area,” she said.

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