BOJ Warns Banks Face Rising Credit Costs, Investment Losses

(Bloomberg) -- Japanese lenders must brace for rising bad-loan costs and investment losses even as the financial system shows resilience to the coronavirus-fueled economic slump, according to the central bank.

If the downturn is prolonged, more companies at home at abroad could face solvency problems, raising credit costs, the Bank of Japan said Tuesday in its semiannual Financial System Report. Losses on banks’ securities investment “could deteriorate” due to financial-market moves, and foreign-currency funding may become destabilized, it said.

The central bank left unchanged its assessment that Japan’s financial system has been “maintaining stability on the whole.” Banks have “considerable resilience” in terms of capital and liquidity, and the government and central bank have implemented “swift and powerful” policy measures, it added.

Read how BOJ sees pandemic causing credit crunch at small firms

The pandemic is adding to pressures on Japanese banks that have increased risk-taking to make up for declining profitability due to ultra-low interest rates and a shrinking population. To cushion the impact of the economic slump, the central bank has expanded asset purchases while the government has announced a record stimulus package.

Lenders around the world are preparing for a wave of soured loans as businesses shut and workers lose their jobs. In Japan, banks have been increasing loans to firms that are vulnerable to economic cycles in areas such energy -- a sector that’s now contending with an unprecedented oil slump.

‘More Cautious’

Japanese banks, which have been investing abroad in search of returns, shifted their stance since the market turmoil intensified last month, with an increasing number taking a “more cautious” approach, the BOJ said.

Unrealized losses “deteriorated substantially” due to plunging stock prices and a spike in overseas credit spreads, the central bank said. While these were mostly offset by improvements on bond holdings thanks to falling interest rates, there may be less scope for additional gains, it added.

“Given that there is less room for further decline in overseas interest rates, the negative impact could surpass these improvements,” the BOJ said. “Should there be further adjustments in prices of stocks and credit assets overseas, sales losses and impairment losses from related investments could become large,” it said.

Still, the central bank said the overall credit quality of Japanese banks’ portfolios is high. It pointed out that their holdings of overseas bundled leveraged loans -- known as collateralized loan obligations -- are almost entirely AAA rated.

The BOJ has previously warned that banks are vulnerable to the risk of falling prices of CLOs, which have slumped during the market turmoil. An index tracking top-rated CLO prices fell more than 7% last month before regaining some ground.

Dollar funding markets, which tightened since February, have regained stability thanks to expanded swap arrangements with central banks, the BOJ said. Japanese banks tapped the BOJ for cheap access to dollars through a facility with the U.S. Federal Reserve.

Still, the central bank said it is “too early to conclude that market functioning has fully recovered,” and developments in Japanese banks’ foreign-currency funding “warrant vigilance.”

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