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Increasing Portfolio Overlap of Japanese Regional Banks with Global Investment Funds and Its Financial Stability Implications

September 15, 2022
Yoshiyasu Koide*1
Yoshihiko Hogen*2
Nao Sudo*3

Abstract

While investment funds have grown rapidly in the global financial market, Japanese financial institutions have been increasing investments in foreign securities. This paper estimates the portfolio overlap - which we define as the correlation of changes in the market value of securities portfolios - between global investment funds and Japanese financial institutions in the last two decades and studies the time series properties and the financial stability implications. There are three main findings. First, the number of financial institutions with a high portfolio overlap with investment funds has increased since before the Global Financial Crisis (GFC). The increase is particularly prominent for the portfolio overlap between bond funds and regional banks. Second, financial institutions with lower capital ratios, loan-to-deposit ratios, lending margins tend to have a higher degree of portfolio overlap with investment funds. Third, financial institutions with a higher degree of portfolio overlap with investment funds tend to see a larger decline in the market value of the securities portfolio in response to global market shocks such as redemption waves to investment funds, rises in U.S. interest rates, or disruptions in the U.S. bond market. Our results indicate that as secular changes in structural factors such as a decline in the potential growth rate of the home country weigh on the long-term profitability, Japanese financial institutions in particular regional banks have increased investment in foreign securities, making themselves susceptible to global market shocks that arise from the activities of global investment funds even without direct exposure to these funds. Moreover, an increase in the number of financial institutions with a higher portfolio overlap suggests that the impact of such a global market shock may extend over wide areas of the domestic financial system.

JEL classification
G10; G11; G21; G23

Keywords
Interconnectedness; Global Investment Funds, Regional Banks, Securities Portfolio, DCC-GARCH

The authors are grateful to Koichiro Suzuki and colleagues at the Bank of Japan for comments and discussions. Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan.

  1. *1Financial System and Bank Examination Department , Bank of Japan
    E-mail : yoshiyasu.koide@boj.or.jp
  2. *2 Financial System and Bank Examination Department (currently at the Research and Statistics Department), Bank of Japan
    E-mail : yoshihiko.hougen@boj.or.jp
  3. *3Financial System and Bank Examination Department (currently at the Institute for Monetary and Economic Studies), Bank of Japan
    E-mail : nao.sudou@boj.or.jp

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