Financial System Report (October 2025)
October 23, 2025
Bank of Japan
Motivations behind the October 2025 issue
At the beginning of April 2025, asset prices fluctuated significantly in global financial markets due to heightened uncertainties regarding trade policies in each jurisdiction. Currently, uncertainties remain high regarding the formulation of economic policies in each jurisdiction, and regarding geopolitical risks and developments in global financial markets. This Report analyzes the following four points.
First, this Report analyzes the effects of changes in trade and other policies in each jurisdiction on domestic corporate sector and banks' credit costs. As a result of changes in trade and other policies in each jurisdiction triggered by, for example, the materialization of geopolitical risks, global trade volume could fall substantially, adversely affecting corporate profits. This Report also provides an analysis of the resilience of the financial system if such tail risks were to materialize.
Second, with regard to stock and real estate prices, the transaction environment in each market is examined, thereby providing an analysis of potential future risks.
Third, this Report explores the possibility that foreign non-bank financial intermediaries (NBFIs), such as hedge funds, which have been increasing their presence both domestically and internationally, may have an effect on Japanese financial markets, particularly through the rapid unwinding of investment positions.
Fourth, this Report provides updates on the effects of changes in the interest rate environment on banks, households, and firms. With regard to developments in deposits, this Report examines the effects of structural factors such as demographic changes and the spread of digital channels, and those of other factors that affect bank deposits amid rising interest rates.
Executive summary: Stability assessment of Japan's financial system*
Japan's financial system has been maintaining stability on the whole.
In the loan market, financial intermediation has continued to function smoothly as firms' demand for loans has continued to rise and banks' lending stance has remained active. Under such circumstances, no major financial imbalances have been seen in current financial activities.
Japanese banks have sufficient capital bases and stable funding bases to withstand significant stresses, including those equivalent to the global financial crisis that would cause major corrections in financial markets and the real economy at home and abroad, as well as those with compound factors particularly resulting from the materialization of geopolitical risks that would cause a substantial decline in global trade volume, and lead to global increases in inflation and interest rates. However, uncertainties remain high regarding the formulation of economic policies in each jurisdiction, and regarding geopolitical risks, and developments in global financial markets. Financial institutions need to be vigilant against the materialization of various risks. From a long-term perspective, if structural factors remain, such as a decline in firms' loan demand reflecting the shrinking population and other factors, banks' profitability and loss-absorbing capacity could decline, depending on the supply and demand balance in the loan market, and this could lead to a contraction of financial intermediation activities or an overheating, such as excessive search for yield. From the perspective of maintaining stability in Japan's financial system, close attention is warranted on future developments in the financial system, while examining both overheating and contraction risks (Chart I-1).
Developments in asset prices
In global financial markets, at the beginning of April, stock prices fell substantially as market sentiment became significantly cautious, reflecting the heightened uncertainties regarding trade policy in each jurisdiction. Since then, prices of risky assets have risen, with market sentiment improving, reflecting factors such as progress in trade negotiations. The heat map shows that stock prices has been "red," which signals an upward deviation from the trend (Chart I-1). In terms of stock valuations as of the end of September, price-earnings (P/E) ratios remain generally at historical average levels while risk premiums indicated by the equity yield spreads, i.e., the difference between expected equity yields and 10-year Japanese government bond (JGB) yields, have declined somewhat (left panel of Chart I-2). Given that uncertainties regarding the formulation of trade and other economic policies in each jurisdiction remain high, sentiment in global financial markets could become cautious. Given that Japanese banks have a certain amount of market risk associated with stockholdings, close attention should be paid to developments in risky asset prices, including stock prices.
Real estate prices have been rising, particularly in major metropolitan areas (Chart I-3). The rise in property prices is primarily driven by supply-side factors due to the surge in material costs and labor shortages. In addition, robust property demand supported by a moderately recovering economy, coupled with demand for investments, including condominium transactions and commercial real estate purchases by foreign investors, also likely contributes to this trend. While rents have been rising, the yield spread, an indicator of the real estate risk premium, has continued to decline (right panel of Chart I-2). If market participants' view on future real estate demand changes, a correction in real estate prices could occur. Given that banks' real estate-related exposures have been on an uptrend, developments in real estate markets continue to warrant attention.
The effects of developments in the foreign non-bank financial intermediary (NBFI) sector on domestic financial markets
With the increasing trend in investment in domestic financial markets by the foreign NBFI sector, including investment funds, and in domestic banks' exposure to the foreign NBFI sector, the link between the domestic financial sector and the foreign NBFI sector has strengthened.
In recent years, amid the growing presence of hedge funds in government bond markets on a global basis, foreign investors, including hedge funds, have increased transaction volume in JGB markets significantly (Chart I-4). Hedge funds have been increasing their leverage, primarily through repo financing. In the event of unexpected changes in market environment, hedge funds' rapid position adjustments accompanied by deleveraging can amplify volatility in asset prices. If such adjustments occur in government bond markets, this could affect a wide range of financial instruments in Japan. It is necessary that banks manage their risks associated with securities holdings while paying attention to the possibility of investment activities by the foreign NBFI sector causing stress in domestic financial markets.
Corporate bankruptcies and defaults and the effects of trade and other policies in each jurisdiction
Amid the continuing moderate economic recovery, corporate profits in Japan have been improving on the whole, and the proportion of firms that are either making operating losses with negative net worth or are making operating losses, which increased during the pandemic, has been falling. Corporate bankruptcies and defaults have been more or less unchanged, albeit with fluctuations (Chart I-5). However, it is necessary to bear in mind that labor shortages, rising labor costs and rises in raw material prices may be adding further pressure.
Japan's corporate sector appears to be reasonably resilient to the effects of changes in trade and other policies in each jurisdiction. The profit projections released by large firms reveal that, given that their financial positions leading up to the current stress are favorable, large firms' debt repayment capacity seems to be maintained overall despite the effects of changes in trade and other policies in each jurisdiction (left panel of Chart I-6). As for small and medium-sized enterprises (SMEs), the effects on their profits and default rates are likely limited overall, as many SMEs have ample on-hand liquidity (middle and right panels of Chart I-6). However, if the stress caused by changes in trade and other policies turns out to have a larger impact on profits than assumed in the projections, debt repayment capacity could deteriorate significantly among firms whose financial positions are relatively vulnerable, including small and medium-sized supplier firms. In exporting industries, the proportion of large loans tends to be high; therefore, attention is also warranted to the fact that if individual firms were downgraded, the impact on credit costs could be significant.
Uncertainties regarding trade and other policies in each jurisdiction remain high, and there is a tail risk that global trade volume will fall substantially, adversely affecting corporate profits. It is necessary that banks be vigilant against the materialization of various risks.
Banks' profits and loss-absorbing capacity amid rising interest rates
With the Japanese economy continuing to recover moderately, banks' losses such as credit costs have been limited, and pre-provision net revenue (PPNR) excluding trading income, which shows banks' core profitability, has continued to improve owing to factors including past improvement in overhead ratios and rising yen interest rates (left panel of Chart I-7). Turning to banks' resilience to rising interest rates, yen interest rate risk in the banking book (IRRBB, in terms of the 100 BPV) relative to banks' capital has remained low, and banks overall have sufficient loss-absorbing capacity (right panel of Chart I-7). That said, downward pressure remains on banks' profitability from structural factors such as a decline in domestic loan demand -- due to the shrinking population and the falling number of domestic firms -- and uncertainty remains high regarding developments in domestic and foreign financial markets. Banks need to make various assumptions regarding such structural factors and market fluctuations, and also manage their portfolios appropriately, taking into account their loss-absorbing capacity.
Meanwhile, with regard to banks' deposits, the year-on-year growth rate in deposits from both individuals and firms has remained positive; however, the pace of increase has decelerated recently (Chart I-8). While financial assets held by households continue to increase overall and investments in stocks and stock investment trusts have increased, the rate of increase in households' deposits has recently slowed. By type of bank, the share of regional and shinkin banks in total deposits has remained on a declining trend, and most recently there has been a shift from demand deposits to time deposits. The effect on developments in deposits of structural factors such as demographic changes and the spread of digital channels needs attention, and the impact on interest rate risk of changes in the composition of deposits also needs attention.
The Bank will promote financial institutions' initiatives to address these potential vulnerabilities through on-site examinations and off-site monitoring. From a macroprudential perspective, it will continue to closely monitor the impact on the financial system of various risk-taking activities by financial institutions.
- See the Report for more details on the analyses as well as notes and sources of the charts.
Notice
This Report basically uses data available as of end-September 2025.
Please contact the Financial System and Bank Examination Department at the e-mail address below to request permission in advance when reproducing or copying the contents of this Report for commercial purposes.
Please credit the source when quoting, reproducing, or copying the contents of this Report for non-commercial purposes.
With regard to economic and financial variables of each stress scenario in the macro stress testing, please see the scenario tables [XLSX 21KB].
Inquiries
Financial System Research Division,
Financial System and Bank Examination Department
E-mail : post.bsd1@boj.or.jp