MNI INSIGHT: BOJ Report To Show No Change in Risks From QQE

--Bank Expected To Say It Sees No Signs of Financial Overheating 

--Bank Lending Standards Still As Accommodative As During Bubble Period

By Hiroshi Inoue

     TOKYO (MNI) - In a key report due later this month, the Bank of Japan will

note that both excessive risk-taking in real estate and foreign bond investments

-- as well as the risk that banks have become unwilling to lend because of low

profit margins -- have not improved or worsened since April, when the BOJ warned

about these side effects of its aggressive monetary easing, MNI understands.

     In its twice-annual Financial System Report due out Oct. 23, the BOJ will

also say that commercial banks have not become any more aggressive in their

lending than they were six months ago, indicating it sees no risk of a financial

bubble forming because banks are looking for higher returns from their

investments amid zero interest rates.

     In the previous FSR released in April, the BOJ warned that given "the

continued low interest rate environment, banks have adopted the most

accommodative lending stance since the bubble period," referring to Japan's late

1980s economy, when asset prices surged amid relatively tame consumer prices.

     The burst of the asset bubble led to bankruptcies of financial firms and

years of deflation as the working population continued to decline. It took many

years before banks returned to financial health after they reduced their huge

inventories of non-performing loans.

     The BOJ is likely to maintain the view presented in April that "signs of

overheating in a large part of financial and economic activities have not been

observed."

     But the central bank is also expected to repeat its warning that excessive

competition among financial institutions can reduce their profitability, thereby

undermining their business stability.

     Financial institutions continue to face low profitability due to low

lending rates that have resulted from the BOJ's negative interest rate policy,

which has been in place since early 2016. The low profitability is making it

hard for banks to increase their capital bases, BOJ officials believe.

     The BOJ is expected to repeat the overall risk assessment of the financial

industry it presented in April.

     "Regarding potential vulnerabilities due to the declining profitability of

financial institutions, it is necessary to examine both the risk of overheating

-- excessive accumulation of macro risks and exuberant asset prices, reflecting

financial institutions' shift toward excessive risk-taking to maintain

profitability -- and the risk of a gradual pullback in financial intermediation

due to a persistent decline in profits," it said in the last report.

     But the bank will also note that these risks haven't materialized.

     In other areas of concern, the BOJ warned in its April FSR that smaller

regional banks were taking unnecessary risks in local real estate, including

construction of apartments for housing rental businesses.

     "Some regional banks have increased their real estate loans by considerably

more than economic conditions would warrant," the central bank warned in April.

     The BOJ's report revealed that 58% of regional banks and credit unions

didn't check the going rate for rents in a neighborhood before making a real

estate loan there, 68% didn't conduct research on vacancy rates and 76% failed

to assess the supply and demand balance in the real estate market based on

demographic changes.

     In its October report, the BOJ is expected to state that regional banks'

loans for investment in apartment buildings have not accelerated much since

April, MNI understands.

     Some regional banks have avoided posting losses by selling assets with

unrealized profits. But many regional banks are having trouble generating

profits because they can't raise service charges, the central bank has learned

through its interactions with those banks.

     BOJ officials have acknowledged it will take more time to achieve the

bank's 2% inflation target than it had initially expected, meaning the

side-effects of its large-scale monetary stimulus will continue to accumulate.

     However, the FSR, which is compiled by the BOJ Financial System and Bank

Examination Department, is unlikely to highlight the negative side-effects of

the bank's massive asset purchases and policy stance to keep bond yields around

zero to slightly negative.

     The department operates separately from the Monetary Affairs Department,

which drafts policy measures for the board. This means, if necessary, it could

warn of the risks of the side-effects from aggressive easing, instead of

analyzing financial conditions in a way that supports the easing stance.

     The FSR is released after the BOJ policy board approves its contents,

including the risk assessment.

     The risk assessment in the next report will be incorporated into the

"conduct of monetary policy" section in the bank's quarterly Outlook Report due

out after the next BOJ policy meeting on Oct. 30-31.

     In the previous Outlook Report issued in July, the BOJ said, "Examining

financial imbalances from a longer-term perspective, there is no sign so far of

excessively bullish expectations in asset markets or in the activities of

financial institutions."

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

--MNI Tokyo Bureau; tel: +81 90-4670-5309; email: max.sato@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

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