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Financial System Report (October 2015)

October 23, 2015
Bank of Japan

Executive summary: comprehensive assessment of the financial system

Japan's financial system has been maintaining stability. Financial intermediation has operated more smoothly than before.

Functioning of the financial system

Financial institutions have remained geared toward taking more risks in their business operations with regard to lending at home and abroad. For domestic loans, financial institutions have been actively meeting the demand for funds from large firms due to their merger and acquisition activities as well as their business expansion at home and abroad. In addition, wide-spreading efforts by financial institutions have been observed in extending loans to low-rated borrowers with prospects for future growth or business recovery and to borrowers under credible revitalization programs. In this situation, domestic loans have continued to increase moderately, led by loans to firms among various firm sizes, industries, and regions. Banks have also been active in overseas lending with a view to supporting the global expansion of Japanese firms while capturing the financial needs in countries with high growth potential. Moreover, some Japanese banks have purchased loan receivables with the aim of expanding their overseas borrowers, particularly non-Japanese firms. Under these circumstances, banks' overseas loans have continued to show relatively high growth, but the pace of growth has recently slowed somewhat due to the deceleration of the Asian economy. As for securities investment, financial institutions have gradually been enhancing their risk-taking stance by investing to risky assets further, such as investment trusts, while maintaining a high level of outstanding amount of yen-denominated bonds.

Major institutional investors such as life insurance companies and pension funds have continued to increase their amount of investment in risky assets. With regard to financial intermediation through financial markets, equity financing remains at a high level while issuing conditions for CP and corporate bonds have been favorable.

Against these backgrounds, financial conditions among firms and households have become more accommodative. As for the means of household savings, deposits have been central to household financial assets. However, the share of risky assets has been increasing, as seen in the continued net inflow to investment trusts.

Stability of the financial system

Regarding developments in the above-mentioned financial intermediation, signs of financial imbalances such as indications of overheating or excessively bullish expectations have not been observed. The real estate market does not appear to be in a state of overheating on the whole, although transactions are gradually being actively undertaken, albeit with regional differences.

Financial bases of financial institutions have been adequate on the whole. Their capital adequacy ratios are sufficiently above regulatory levels. The amount of risk that financial institutions bear has largely remained unchanged from the time of the previous Report, while financial institutions have increased their capital mainly due to their accumulation of retained earnings. Under these circumstances, a fine balance has continued to be kept between macro risks to which financial institutions are exposed and their financial bases, and the financial system generally has strong resilience against various stresses. In terms of funding liquidity, financial institutions have sufficient liquidity in yen funds. As for foreign currency-based funding, they continue to have funding structures with a large proportion of market funding, but progress has been made in banks' efforts to enhance their stable foreign-currency funding base. Banks hold a foreign-currency liquidity buffer that can cover funding shortages even if market funding becomes difficult for a certain period.

Meanwhile, from summer 2015 volatility rose in global financial markets amid growing concern about a slowdown in emerging economies, including Asia. Although the effects of developments in overseas markets -- including the decline in stock prices -- spread to Japan, effects on the financial bases of Japan's financial institutions and on the stability of Japan's financial system have been limited.

Challenges from a macroprudential perspective

In order to ensure financial system stability in the future, continued efforts are necessary to keep the fine balance between macro risks to which financial institutions are exposed and their financial bases, while steadily responding to structural changes in the financial system that might become a source of future fragility.

Financial institutions' macro risks have generally been restrained, even in a situation where these institutions have been geared toward taking more risks in their business operations in domestic and overseas lending as well as in securities investment. It should be noted, however, that this is largely attributable to the fact that benign financial conditions, i.e., low and stable credit costs and low market volatility, have been maintained in recent years. Meanwhile, exposure has continued to increase in various areas, such as credit, market, and funding liquidity. It is necessary for financial institutions to continue making efforts to strengthen their ability to respond to risks in areas in which they are actively enhancing their risk-taking stance. Of particular importance for overseas operations are financial institutions' efforts to enhance their stable foreign-currency funding base and strengthen credit management in response to the expansion of assets, and for market investment, a cross-sectional and multi-dimensional understanding as well as management of the profile of risks. The increased systemic importance of large financial institutions and the decline in core profitability among regional financial institutions, structural issues that were discussed in previous Reports, have been unchanged.

The Bank of Japan will tackle the above issues toward ensuring stability of the financial system, particularly through its off-site monitoring and on-site examinations.

Notice

This Report basically uses data available as of September 30, 2015.

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Inquiries

Financial System Research Division, Financial System and Bank Examination Department

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