Japanese banks’ addiction to government bonds is proving hard to break, potentially undermining Prime Minister Shinzo Abe’s plans to revive the world’s third-largest economy.
Lenders, which loaded up on debt as loan demand stagnated in recent years, want to reduce the risk of losses on their 151 trillion yen ($1.5 trillion) in holdings as the bond market gyrates and yields climb following efforts by the government and central bank to spark inflation.
Yet more than six months after Abe took office, even as banks try to trim their bond holdings, households and companies aren’t taking out enough loans, saddling lenders with record excess deposits. Abe’s vision for ending deflation, stoking loan demand and creating economic growth -- termed Abenomics -- remains “far removed from the current reality,” said Satoshi Yamada, a debt-trading manager for Okasan Asset Management Co., which oversees the equivalent of $11 billion in assets.
“There’s no other place than JGBs where banks can park their cash,” said Teruyoshi Sotome, a Tokyo-based senior bond strategist at Mizuho Securities Co., one of Japan’s 25 primary dealers obliged to bid at government debt sales. “I believe they will resume buying them once volatility calms.”
Regional banks are more vulnerable to swings in yields than larger lenders because they hold bonds with a longer duration. Credit demand in rural areas may pick up too slowly to stop local banks from relying on interest income from the securities, the International Monetary Fund said in May.
Bank of Japan Governor Haruhiko Kuroda, handpicked by Abe this year, is stepping up government bond purchases to achieve 2 percent inflation and free up lenders to deploy more funds into the economy. His policy spurred an increase in long-term interest rates, which have remained elevated as U.S. Treasury yields (USGG10YR) climb after the Federal Reserve indicated it may start tapering its monthly bond buying later this year.
Yields on Japan’s benchmark 10-year notes swung between a record low of 0.315 percent on April 5, the day after the Bank of Japan announced its plan to double bond purchases, to as high as 1 percent in May. The securities yielded 0.89 percent at 3:41 p.m. in Tokyo.
Lenders including Tokyo-based Mitsubishi UFJ Financial Group Inc., Sumitomo Mitsui Financial Group Inc. (8316) and Mizuho Financial Group Inc. cut their sovereign note holdings for a second month to 151.3 trillion yen in May, Bank of Japan data show. Banks’ stockpiles of sovereign debt peaked at a record 171 trillion yen in March 2012.
An auction of 2.2 trillion yen of 10-year government bonds today attracted bids valued at 2.41 times the amount available, the weakest demand since March, according to Ministry of Finance data.
Still, Mitsubishi UFJ (8306) President Nobuyuki Hirano said May 15 that Japan’s biggest bank will remain a stable holder of the nation’s debt, which the IMF estimates will swell to 245 percent of the economy this year. Masaaki Tani, chairman of the Regional Bankers Association of Japan, told reporters June 12 that government bond investment is still important for local lenders and that he expects yield fluctuations to subside.
“Banks have been swamped in JGBs, so it’s hard for them to get out,” said Yamada of Okasan, based in Tokyo. “As long as the economic outlook remains uncertain, banks have no choice but to channel their excess funds into bonds, which could bog down Abe as well.”
Lenders increased government bond holdings about fivefold over the past 15 years as loans shrank and deposits swelled amid deflation. Price declines dissuaded borrowers by increasing the real value of debt, and the Bank of Japan’s policy of keeping benchmark interest rates close to zero made loans less profitable.
The gap between deposits and credit continues to widen even as Abe seeks to beat deflation with his three-pronged strategy of fiscal spending, monetary stimulus and deregulation.
Excess deposits over loans surged to an unprecedented 185.1 trillion yen in May, according to central bank data. Deposits rose 3.7 percent from a year earlier, the most in 11 years, outpacing a 2.1 percent increase in lending. Japanese companies’ stockpile of cash reached a record 225 trillion yen in the first quarter, an amount bigger than Italy’s economy, Bank of Japan figures show.
“Japanese banks already have more deposits -- at almost no cost -- than they know what to do with,” said David Marshall, an analyst at research firm CreditSights Inc. in Singapore. “The main problem in Japan is the lack of loan demand, not that banks are unwilling or unable to lend.”
Japan’s notes maturing in more than a year lost 1.8 percent in the March-June period, the worst quarterly performance since the three months ended September 2003. Historical volatility for the bonds climbed to a five-year high of 3.98 percent on June 25, based on a 60-day reading, according to data compiled by Bloomberg and the European Federation of Financial Analysts Societies.
Swings in the government bond market have “cast a shadow” over lenders’ investments in the securities, and there are few other places to put deposits, Standard & Poor’s said in April.
“There was a dream in Abenomics that banks can increase lending as the economy recovers,” said Sotome of Mizuho Securities. “But the reality is that there’s so much uncertainty that makes portfolio rebalancing difficult.”
A Bank of Japan report in April examining potential losses at banks from rising yields found that if interest rates climb 1 percentage point across all maturities, Japan’s biggest lenders would incur 3.2 trillion yen of unrealized capital losses. A 3 percentage-point increase would lead to 8 trillion yen in capital losses, the central bank estimated.
Bonds are a relatively liquid asset that can be sold easily. Banks are unlikely to fuel a selloff in the bond market like one that took place in 2003, when prices plummeted, according to analyst Shogo Fujita of Bank of America Corp. Lenders, especially in big cities, have been containing risks by shortening the duration of their holdings.
In 2003, 10-year yields surged from about 0.4 percent in June to 1.7 percent three months later. That violated banks’ internal restrictions based on the so-called value-at-risk model for estimating potential JGB losses, triggering a further sell-off. The rout was dubbed the “VaR shock” by traders.
The average maturity of sovereign notes held by major banks was longer than three years at that time, compared with around 2.5 years at the end of last year, Bank of Japan data show.
“We’re a long way away from 2003’s VaR shock,” said Fujita, chief Japanese bond strategist at Bank of America Merrill Lynch in Tokyo. “In the short term, banks may have to sell JGBs as the high volatility that we’ve been seeing recently has made them risky assets. But at some point in the near future, banks’ money will find its way back into JGBs.”
Lenders have improved their risk management since 2003, according to Takeshi Kunibe, chairman of the Japanese Bankers Association, the country’s biggest banking lobby.
“The risk amount is much smaller now,” Kunibe told reporters on June 13. “The biggest difference is that we’ve already experienced that VaR shock.”
The IMF said in May that Japanese banks could become net sellers of government bonds in the next few years as the Bank of Japan snaps up notes, helping to reduce their sensitivity to a jump in yields.
Kuroda and his policy board members unveiled a plan in April to double monthly debt purchases to more than 7 trillion yen. That’s about 70 percent of planned issuance from the world’s most heavily indebted government.
While the monetary-policy shift may prompt major lenders to further expand overseas, regional banks will probably remain more exposed to interest-rate moves by keeping a portfolio centered on the securities, the IMF also said.
“One risk scenario we see is that credit demand in regional economies is slow to pick up, then regional banks may continue to rely on interest income from longer-duration JGBs, making them more susceptible to interest-rate risks,” said Serkan Arslanalp, a senior economist at the fund’s monetary and capital-markets department. “This may amplify especially in the absence of a growth strategy.”
The nation’s so-called megabanks -- Mitsubishi UFJ, Sumitomo Mitsui and Mizuho -- have been investing in lenders abroad, where loan profitability is higher. Sumitomo Mitsui agreed in May to buy Indonesia’s PT Bank Tabungan Pensiunan Nasional for about $1.5 billion. Mitsubishi UFJ is seeking to strike a deal for control of Thailand’s Bank of Ayudhya Pcl as soon as this month, two people with knowledge of the matter said. It bought a stake in Vietnam Joint Stock Commercial Bank for Industry and Trade this year for about $740 million.
In contrast, regional banks, which have less scope to expand overseas, are struggling to increase profit through lending. The average net interest margin among the 85 companies on the Topix Banks Index is 1.3 percent, the lowest in Asia, according to data compiled by Bloomberg. New long-term loan rates averaged 0.92 percent in May, BOJ data show, little more than the 10-year bond yield.
Some local lenders have yet to see signs that Abe’s growth policies are lifting their economies even as monetary easing weakens the yen, benefiting exporters.
In the southern prefecture of Kagoshima, Japan’s biggest beef and pork producer, a lower yen is “troublesome” because it boosts prices of imported feed grains for livestock, according to Kagoshima Bank Ltd. (8390) President Motohiro Kamimura.
“Abenomics is just giving local regions a hard time,” Kamimura said in an interview. “Banks want to lend badly, even if they have to take some risks, but the reality is that there is nobody to borrow.”
Kamimura said he wants to buy government bonds when yields rise after selling about 100 billion yen of the notes because of the recent increase in volatility. Kagoshima Bank forecasts lending income will remain unchanged at 45.8 billion yen for the year ending March 2014.
Regional banks bought a net 1.9 trillion yen of government bonds this year through May, while city lenders sold 12.2 trillion yen of notes, according to data from the Japan Securities Dealers Association. Local banks hold securities with an average maturity of four years, about double the duration for megabanks, said Tani of the regional banking lobby.
“The gap reflects differences in investment strategies,” Tani said. “For us, JGB investment is one of our core businesses.”
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