MNI INSIGHT: BOJ Concerns On Banks' Capacity To Absorb Losses

By Hiroshi Inoue

     TOKYO (MNI) - Japan's financial institutions need to strengthen their

management of debt and credit risk as their future capacity to absorb losses is

weakening and that is concerning Bank of Japan officials, MNI understands.

     They are worried that any economic slowdown will increase corporate

bankruptcies and push up credit costs, prompting banks to withdraw funds set

aside against bad loans and capital surplus.

     This will eventually lower banks' capital bases and weaken provisions

against future losses, which would undermine the stability of the financial

system.

     BOJ officials are analyzing the costs of a prolonged easy policy -- such as

financial imbalances and excessive lending by banks -- ahead of the release of

the semi-annual Financial System Report due out mid-October. The quarterly

Outlook Report will then be published on Oct 31.

     --SOOTHING LANGUAGE

     It is unlikely that the BOJ will refer to either near-term critical risks

of a pullback in financial intermediation or destabilizing the financial system

in the FSR, as it doesn't want to cause instability in the financial system.

     The FSR will likely maintain the view "financial institutions have

sufficient capital bases" as any BOJ downgrade of the assessment would trigger

anxiety over the system.

     But October's FSR will likely repeat the view presented in April that the

"current sufficiency of banks' level of capital doesn't necessarily guarantee

the future stability of the financial system."

     "Since the measures of credit risk and market risk are calculated based on

actual past data, if the economic recovery period becomes prolonged and

volatility remains low, it is possible that those risk measures could

underestimate the amount of potential risks financial institutions bear,"

April's report added.

     The FSR is the analysis of the financial conditions and risks facing

financial institutions. It has been warning over the risks of a prolonged

ultra-loose policy, such as loans at low interest rates to "middle-risk firms"

and low loan-loss provisions.

     --PROLONGED POLICY COSTS

     BOJ officials believe the warnings against the costs of a prolonged easy

policy and the risks facing financial institutions are gradually being shared by

board members.

     According to the minutes of the June 14-15 meeting, "Many members pointed

out that it was important to continue to conduct a multifaceted monitoring and

assessment of the positive effects and side effects that could arise from the

continuation of powerful monetary easing, including those on the functioning of

financial intermediation and the financial system."

     In April, minutes showed those of a similar view was limited to "some

members."

     The "Strengthening the Framework for Continuous Powerful Monetary Easing"

decided in July is aimed at recovering bond market functionality and the BOJ

didn't address the side effects, such as financial imbalances and low bank

profits.

     The focus is now on how the board, in the wake of the next FSR, looks to

mitigate the side-effects of a prolonged easy policy at the Oct 30-31 policy

meeting.

     The BOJ board is unlikely to weaken the degree of its monetary policy

immediately, as Japan is still far from achieving the 2% inflation target.

     But if the board is confident that the inflation rate will rise in a

sustainable manner, it would consider adjusting the degree of its 'easy policy'

as it will be too late to take action after the economy worsens, which will

sharply increase losses that financial institutions absorb.

--MNI Tokyo Bureau; tel: +81 90-2175-0040; email: hiroshi.inoue@marketnews.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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