IMF Warns Government Debt Holdings Risk Bank Stability in Japan

Japanese banks are placing the financial system at risk by putting too much of their money in government bonds, the International Monetary Fund said, echoing comments by Bank of Japan Governor Masaaki Shirakawa.

“The financial system’s massive holdings of government bonds leave it exposed to a spike in yields,” IMF staff wrote in their Financial System Stability Assessment report released today in Washington. Exposure to government debt “constitutes one of the central macrofinancial risks for the system.”

The report underscores concern at the Japanese central bank that banks including Mitsubishi UFJ Financial Group Inc. risk losing trillions of yen by hoarding near-record amounts of government bonds. Japan’s benchmark 10-year yields reached a nine-year low of 0.72 percent last week as global market volatility prompted investors to flock to the bonds even with a public debt more than twice the size of the economy.

A 2 percentage-point increase in benchmark Japanese government bond yields would cause valuation losses of about 7.3 trillion yen ($93 billion) on debt held by major banks and 6 trillion yen in losses for regional banks, Shirakawa said in parliament last week.

“While the stress tests show that an adverse macroeconomic scenario associated with a 100 basis point market yield shock would have a manageable impact, these exposures require close monitoring, enhanced risk management, and contingency planning,” the IMF’s staff wrote in the report.

Banks accumulating record deposits over loans have been using their excess cash to buy government bonds. Domestic banks held 166.2 trillion yen in government bonds at the end of May, Bank of Japan figures show, almost equivalent to Italy’s annual economic output in dollar terms. Their holdings reached a record 171 trillion yen in March.

Monetary Policy

In a separate staff report released today, the IMF called on the Bank of Japan to ease policy further to beat deflation. Expanding the central bank’s asset-purchase program would help spur lending and combat the strengthening yen, the report said.

The staff added that the bank’s other options include extending the maturity of the government bonds it holds, buying private assets such as equities and corporate bonds and clarifying that its inflation goal of 1 percent is not a ceiling. The Bank of Japan responded that its current policy is “appropriate,” according to the IMF.

The yen is “moderately overvalued,” and while the government should leave the markets to set the exchange rate, interventions to smooth volatility and disorderly moves could be used, the staff wrote. Japanese authorities said the overvaluation was “substantial” rather than “moderate,” the report said.

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