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Financial System Report (April 2015)

April 22, 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 continued to adopt more proactive lending attitudes both at home and abroad. In Japan, they are now geared toward taking more risks in their business operations, and are increasingly engaged in the fostering of growing businesses and the revitalization of firms. In this situation, financial institutions' domestic loans have continued to increase moderately, particularly loans to firms, and the increase in the outstanding amount of lending is gradually spreading out across various firm sizes, industries, and regions. The rate of increase in overseas loans has remained high, as financial institutions have been demonstrating a strong interest in expanding overseas lending with a view to supporting the global expansion of Japanese firms and capturing the financial needs of Asian or other countries with high growth potential. As for securities investment, financial institutions have gradually been enhancing their risk-taking stance by diversifying their asset investments, such as foreign bonds and investment trusts, while maintaining a high level of yen-denominated bond investment. Meanwhile, major institutional investors, having invested mainly in domestic long-term bonds, are also increasing their share of investment in risky assets. Regarding financial intermediation through financial markets, favorable issuing conditions have been maintained, as evidenced by sustained high levels of equity financing. Under these circumstances, financial conditions among firms and households have become more accommodative. Meanwhile, deposits have been central to household financial assets. Recently, however, the share of risky assets in household financial assets has gradually been increasing, as seen particularly 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.

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 decreased somewhat since the time of the previous Report, mainly reflecting the fall in the amount of credit risk, and financial institutions have achieved higher levels of capital mainly due to their accumulation of profits. Under these circumstances, a fine balance has been 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. However, careful attention should be paid to the possibility that economic or financial shocks will affect the stability of the financial system, depending on their speed and extent, as well as the factors behind them. In terms of funding liquidity, financial institutions have sufficient funding liquidity in yen funds. As for foreign currency-based funding, they have funding structures with a large proportion of market funding, but hold a liquidity buffer that can cover funding shortages even if market funding becomes difficult for a certain period.

Meanwhile, commodity prices declined substantially, and volatility in global financial markets has risen across a wide range of instruments. The rise in market volatility has spilled over into the domestic markets to some extent.

Toward ensuring financial stability in the future

Japan's financial system has been maintaining stability. In order to ensure the 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 risks that might become the source of future fragility for the system.

Points to which attention should be paid in view of the accumulation of macro risks are: (1) the expansion of international operations among financial institutions, an increase in overseas exposure; and (2) the increased importance of market investment in asset-liability management (ALM), an increase in market exposure. Points to focus on in view of structural changes in risks are: (3) the increased systemic importance of large financial institutions; and (4) the decline in profitability with regard to domestic deposit-taking and lending operations, especially for regional financial institutions. In addition, attention needs to be paid to developments in (5) changes in households' asset portfolio choices; and (6) the implementation of international financial regulations, as they may influence the stability of the financial system.

Based on the above considerations, points that can be raised as key management tasks and challenges for individual financial institutions are: (1) strengthening their ability to respond to risks in areas in which financial institutions are actively enhancing their risk-taking stance, overseas operations and investment in markets in particular; (2) appropriately dealing with the systemic importance of large financial institutions; and (3) responding to the decline in core profitability among regional financial institutions.

The Bank of Japan will continue to grasp facts and to analyze the situation surrounding the financial system, including the accumulation of macro risks and structural changes among them, as well as examine resilience against stresses. Based on these activities, it will work to share a common understanding and to hold discussions with a wide range of stakeholders in the financial system, presenting specifics on matters including where risks lie and what issues to tackle, thereby responding appropriately to given circumstances. Alongside these efforts, while following a broad range of proactive financial intermediary activities that utilize the accommodative conditions brought about by QQE, the Bank will exchange views with financial institutions while strengthening its grasp of the actual situation regarding the following points, particularly from the perspective of responding to the aforementioned tasks: (1) international operations; (2) ALM and investment in markets; (3) large financial institutions' systemic-risk characteristics and their business management; (4) regional financial institutions' profitability; (5) financial institutions' efforts to increase industrial strength and those toward enhancing the vitality of their client firms; and (6) market-related businesses conducted by financial institutions and securities firms as well as developments in sales of financial products.

Notice

This Report basically uses data available as of March 31, 2015.

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Inquiries

Financial System Research Division, Financial System and Bank Examination Department

E-mail : post.bsd1@boj.or.jp