Bank of Japan: Financial System Report (Oct 2021)

21 October 2021
Bank of Japan

  1. “Highlights” provides a brief summary of key analyzes in the October 2021 issue of the Report.

The motivations behind the October 2021 issue of Report

October 2021 Report provides a detailed analysis of the following key risks: domestic credit risk as well as the risks associated with investing in securities and financing in foreign currencies, and then uses a stress testing framework to examine the strength of the Japanese financial system. On the domestic credit risk linked to the spread of COVID-19, this Report presents a simulation of the financial strength of small and medium-sized enterprises (SMEs) while taking into account the degree of heterogeneity of corporate profits between companies and considering that the challenges facing companies gradually shift from a problem of financing to a solvency problem. On the risks associated with investing in securities and financing in foreign currencies, this Report examines the pass-through effects of an adjustment in global financial markets on the securities investment and financing conditions facing Japanese financial institutions, while considering the implications highlighted by the degree of overlap between the portfolios of securities of individual financial institutions and those of non-bank financial institutions. intermediaries (IFNB) and by the differences in funding profiles between financial institutions.

In macro stress testing, the resilience of financial institutions and the Japanese financial system is examined under three bearish scenarios that reflect the risks revealed by the analysis on the real economy and on financial markets.


Current assessment of the stability of the Japanese financial system

Japan’s financial system has maintained overall stability, while COVID-19 continues to have a significant impact on economic and financial activity at home and abroad.

The government of Japan and the Bank of Japan, in close cooperation with foreign authorities, quickly implemented large-scale fiscal and monetary policy measures and took flexible regulatory and supervisory measures to support economic activity and maintain the functioning of financial markets. Companies heavily affected by the pandemic are experiencing financing difficulties. However, underpinned by the financial strength of financial institutions on the whole, policy responses have been effective and the financial intermediation function is being performed smoothly. In the financial markets, as risk sentiment remains generally favorable, inflows of funds continued to the stock markets and emerging economies.

Future risks and caveats

According to the results of the macro stress tests, the Japanese financial system is expected to remain very robust even in the event of a future resurgence of COVID-19 or an adjustment in global financial markets and emerging economies due to a rise in interest rates to long-term Americans. However, in the event of a substantial and rapid adjustment in global financial markets, a deterioration in the financial strength of financial institutions and the resulting damage to the proper functioning of financial intermediation could present a risk of further downward pressures. on the real economy.

In this regard, the following three risks deserve special attention. The first risk is an increase in credit costs due to a delay in domestic and external economic recovery. A simulation of the impact of the pandemic on corporate financing and corporate debt repayment capacity suggests that the credit risk of domestic lending will be contained when the economy follows a recovery trend. Based on the fact that companies have generally maintained their financial strength, various measures to support business financing appear to be very effective in limiting this risk. However, as the impact of the pandemic varies widely among companies and sectors, if there is a delay in the recovery, there is a risk of a negative impact on the creditworthiness of loans to companies that are significantly affected by the downturn. pandemic and loans’ built-in vulnerabilities since before the epidemic. In this regard, attention should also be paid to developments in the real estate sector, which had increased its lending since before the pandemic, and to the profits of borrowers with a significant amount of borrowings which significantly increased their leverage.

The credit risk of foreign loans is generally contained as overseas economies generally recover. Nevertheless, signs of deterioration are appearing in some portfolios which appear to be severely affected by the pandemic. In addition, attention should be paid to energy-related exposure where the impact of global efforts to achieve a low-carbon economy could increase, and to air transport-related exposure where it is likely to increase. there is significant uncertainty about future industry demand.

The second risk is a deterioration of gains / losses on investments in securities due to substantial adjustments in the financial markets. In the prolonged low interest rate environment in Japan, Japanese financial institutions have actively invested, especially in domestic and foreign credit products and investment trusts, in search of yield. At the same time, the importance of non-bank financial intermediaries (NBFIs) such as investment funds in financial intermediation activities has increased in the global financial system. In recent years, there has been an increasing overlap in the securities portfolios of Japanese financial institutions and investment funds, as measured by the correlation of the market values ​​of the portfolios, and there appears to be a growing possibility that the risk of The market that Japanese financial institutions face in times of stress is amplified not only by their investment behavior, but also by the activities of NBFIs. The analysis in this Report shows that financial institutions with a higher degree of overlap with investment funds tend to be much more affected by shocks in global financial markets.

The third risk is a destabilization of foreign currency financing due to the tightening of foreign currency financing markets. As Japanese financial institutions increased their assets in foreign currencies, there were stressful events such as market turmoil in March 2020, where financial institutions were forced to significantly change their funding instruments. According to an analysis of the determinants of foreign currency financing instruments and their financing rates, financing conditions are not only significantly affected by changes in global market conditions such as interest rates and repayment rates investment funds, but also depend on the funding profiles of financial institutions, including the degree of diversification of funding counterparties. In view of the future risk of adjustment in global financial markets, attention should continue to be paid to the currency funding base and the management of funding.

Even after the pandemic is over, it is likely that the low interest rate environment and structural factors will continue to put downward pressure on financial institutions’ earnings. In this context, attention should be paid to the risk of a gradual decline in financial intermediation, or on the contrary to the possibility that the vulnerability of the financial system will increase, mainly due to the search for performance behaviors of financial institutions.

Challenges for financial institutions

Future developments in the spread of COVID-19 and their impact on domestic and foreign economies remain uncertain. In this context, the major challenge for financial institutions is to harmoniously fulfill their function of financial intermediation by reconciling financial soundness and risk taking. In this regard, (1) strengthened management of the three risks mentioned above, (2) support based on the sustainability of borrowers’ businesses and (3) sound capital planning in a context of considerable uncertainty are the keys. maintaining their financial strength.

In Japan, the environment surrounding its economy and society is undergoing major changes, for example, digital transformation and climate change, against a backdrop of declining and aging populations. In this context, financial institutions are expected to contribute to the establishment of a sustainable society by improving their services while maintaining their soundness.

The Bank of Japan, in close cooperation with the Japanese government and foreign financial authorities, will strive to ensure the stability of the financial system and the smooth functioning of financial intermediation. From a medium to long-term perspective, the Bank will actively support the initiatives of financial institutions by preparing the institutional frameworks of the financial system, taking measures to respond to climate-related financial risks and facilitating digital transformation.


This Report mainly uses data available at the end of September 2021.

Please contact the Department of Financial System and Banking Examinations at the email address below to request permission in advance when reproducing or copying the contents of this Report for commercial purposes.

Please acknowledge the source when quoting, reproducing or copying material from this Report for non-commercial purposes.

Regarding the economic and financial variables of each stress scenario in macro stress testing, please see the scenario table [XLSX 28KB].


Financial System Research Division,
Financial System and Banking Examination Department

Email: [email protected]


Bank of Japan published this content on 21 October 2021 and is solely responsible for the information it contains. Distributed by Public, unedited and unmodified, on October 21, 2021 06:13:04 AM UTC.

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Don F. Davis

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