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Potential financial market gyrations on a Fed rate hike and continued pandemic disruption are in focus.
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Bank of Japan officials are concerned that Japanese funds and banks face a double whammy risk of falling values for equity investments abroad and domestic loan defaults by companies in the services sector, particularly restaurants, on continued pandemic disruptions and a likely U.S. Fed interest rate tightening cycle next year, MNI understands.
A slower-than-expected economic recovery from the pandemic even as a state of emergency ended in October and vaccination rates accelerate has become more uncertain with the Omicron variant and the possible effects on the global economy., see: MNI INSIGHT: BOJ On Guard Omicron Could Hit Economic Recovery.
As well, faster-than-expected inflation in the U.S. is driving rate hike expectations there forward.
Japanese financial institutions have steadily increased overseas financial asset holdings to seek higher returns amid prolonged low interest rates and low economic growth.
A rate hike in the U.S. next year could see offshore holding by funds and banks in Japan weaken in value and potentially increase unrealised losses on securities. That could affect their capital adequacy ratios, MNI understands. BOJ officials are concerned there are no clear-cut paths on how Japanese banks could preemptively cope with such risks.
The BOJ as well as the Japan Financial Services Agency has urged commercial banks to manage based on experience or data, but the central bank has warned that past data isn’t likely a sufficient guide on current risks.
Still, bank officials do not expect credit costs at banks to rise seriously before fiscal 2023 when smaller firms that have obtained liquidity through zero interest rate and no collateral loans start to repay their debts.
STRESS TESTS, LOANS
The BOJ in macro stress testing this year calculated the impact of a financial shock on the premise that the U.S. long-term interest rate rose 100 basis points, which is higher than when the 10-year rate rose at the QE tapering in 2013.
The tests did not result in a sharply weaker yen, a surge in bond yields or a plunge in stocks prices - as market conditions were favourable at that time. Bank officials however have judged that the results were underestimated.
But loan defaults at restaurants have already increased markedly in 2020, according to industry data, adding further pressure to the domestic financial outlook, MNI understands.
Already, the BOJ moved up its decision date to mid-December on whether to extend special corporate finance measures and add more help for smaller firms because of market volatility linked to the Omicron variant, and the Fed moving to tighter policy conditions.