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Financial System Report (March 2009)

March 2009
Bank of Japan

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An Assessment of the Current State of Japan's Financial System: An Overview

An assessment of the current state of Japan's financial system

1. As the strains in global financial markets are continuing and economic conditions are changing rapidly at home and abroad, Japan's financial system, which maintained stability on the whole, is gradually influenced in terms of financial intermediation function and robustness, mainly through the growing losses on securities and the rise in credit costs.

Since the autumn of 2008, financial conditions for firms' funding have been severe as seen in the declining function of CP and corporate bond markets. Against such a backdrop of the firms' severe financial conditions on the whole, Japan's financial institutions have retained the financial intermediation function accordingly, by supporting firms which have difficulty funding from capital markets. So far, the Japanese banks have shown robustness to a certain degree amid the turbulence of the global financial system, partly because they had been fortifying their financial bases, and also because they had limited investments to overseas structured credit products. Looking ahead, however, there is growing concern over the level of profits of financial institutions, and it is necessary to monitor closely how the banking sector will carry out the financial intermediation function adequately while it achieves sufficient robustness.

2. In terms of profits, a downtrend for the major banks and the regional banks has become obvious, reflecting the deterioration in the domestic and global economic environments. Looking at net income for the first half of fiscal 2008, the major banks posted their second consecutive declines year-on-year, and the regional banks recorded their third if the extraordinary factor was set aside.

The decline in profits became even more pronounced when the books were closed for the October-December quarter of 2008. Several factors were behind this deterioration in profits, including the increase in credit costs because of the economic downturn, significant deterioration in gains/losses on securities, and the declines in non-interest income. Meanwhile, banks' capital adequacy ratios as of end-September 2008 remained more or less unchanged.

Developments in the financial intermediation function

3. The funding conditions for firms through capital markets have continued to be daunting, as witnessed by a substantial decline in the issuance of CP and corporate bonds and their widening spreads. Against a backdrop of the rapid fall in corporate sales and profits, the financial indicators concerning short-term debt or ability to pay interest have been deteriorating rapidly.

4. Bank lending to large firms has recently been increasing in response to increased funds demand, as those firms faced difficulties including the decline in the functioning of capital markets. Meanwhile, the funding conditions of small and medium-sized firms have continued to tighten, with the shrinkage in trade credits and a cautious lending stance by banks that have been concerned over the rise in credit costs associated with worsening business conditions. In this environment, financial institutions have been receptive to the expansion of the emergency guarantee system and other measures.

As such, with supporting firms' funding in the face of the declining function in capital markets, Japan's financial institutions have retained the financial intermediation function accordingly under the firms' severe financial conditions. Whether they will be able to respond properly to changes in firms' funds demand amid the worsening economy in the period ahead warrants careful monitoring.

Robustness of the financial system

5. In terms of the risks held by the banking sector, there has been an increase in credit risk, which had previously been in decline, for the major banks and the regional banks. In addition, market risk associated with stockholdings has increased for the major banks, and interest rate risk has increased for the regional banks. With declining stock prices, a substantial amount of both realized and unrealized losses on stockholdings has been reported amid a leveling off in the outstanding amount of banks' stockholdings. In the face of unstable stock prices at present, the management of market risk associated with stockholdings remains an important challenge for banks.

6. The banking sector's expected losses, estimated on the assumption of future economic downturns with different degrees of severity, are not likely to substantially lower banks' Tier I capital ratios, although they may temporarily but substantially exceed operating profits from the core business. This shows that Japan's financial system remains robust on the whole. However, if both an economic downturn and stagnating stock prices occur simultaneously, there are risks that banks' Tier I capital ratios, especially the ratios of banks whose capital strength is relatively weak, might decline and remain at similar or lower levels, compared with the levels in the late 1990s and early 2000s. Against such a backdrop, if banks become more conscious of capital constraints in the future, there might be a case in which the financial intermediation function would not be carried out smoothly from a macro perspective.

7. As Japan's economy has significantly deteriorated and the financial environment has continued to be severe, it has become increasingly important for financial institutions to have a sufficient capital base and carry out properly their financial intermediation function. In that regard, Japan's financial institutions have been seeking to fortify their capital strength through various measures including capital reinforcement and refined credit exposure management. In the long run, financial institutions will face a critical challenge of securing stable profitability as a source of capital from a viewpoint of ensuring the stability of the financial system.

Initiatives to stabilize the financial system

8. Japan carried out various policy measures on the financial system front in response to the turmoil in the global financial markets. First, in terms of capital reinforcement of financial institutions, the act for strengthening financial functions was amended to establish a framework for public funds utilization. In addition, a partial relaxation of capital adequacy requirements, an expansion of the emergency guarantee system aiming at supporting firms' funding, and revisions of accounting standards regarding fair value evaluation and reclassification of holding bonds were put into effect.

9. The Bank of Japan, in view of the need to support the economy from the financial front, not only cut the policy rate but also introduced measures to stabilize financial markets and special funds-supplying operations to facilitate corporate financing. Specifically, the target uncollateralized overnight call rate was cut by 0.2 percentage point in October and December 2008, respectively, to 0.1 percent. To stabilize financial markets, U.S. dollar funds-supplying operations were initiated, and, aiming at further permeating the effects of monetary easing, a variety of measures were taken to expand liquidity provision. In addition, taking into account the increasingly severe environment surrounding corporate financing, special funds-supplying operations to facilitate corporate financing were introduced and expanded, and outright purchases of financial products including CP and the range of collateral regarding private corporate debt that was eligible for the Bank's open market operations was expanded. Furthermore, the Bank decided to resume its purchases of stocks held by financial institutions to support financial institutions' future endeavors to reduce market risk associated with stockholdings and to ensure financial system stability.

The Bank of Japan will make the maximum contribution as a central bank to ensure financial system stability and to help Japan's economy return to a sustainable growth path with price stability.


Unless otherwise stated, this document uses data available as of February 27, 2009.

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Financial Analysis and Research
Financial Systems and Bank Examination Department, Bank of Japan