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By Hiroshi Inoue
     TOKYO (MNI) - Volatile financial markets, banks' search for yield and
rising corporate credit costs triggering a rise in non-performing loans are all
seen as risks to profitability across the banking sector, with Bank of Japan
officials worried about a downward spiral caused by a slowing economy, MNI
understands.
     Japan's banks, regional banks especially, are increasing investment in
overseas securities, as they seek higher returns amid the prolonged low interest
rates environment at home, with BOJ officials concerned such moves leave the
banks -- and their profitability -- at the mercy of volatile global financial
markets.
     The "search for yield" has seen them increase exposure to overseas assets
and boost exposure to firms with higher credit risks domestically, pushing BOJ
Governor Haruhiko Kuroda to warn recently over the follow-through risk to
financial system stability.
     The BOJ believes some regional banks have boosted their investment in risk
assets without a sufficient corresponding buffer and their capital bases risk
gradual erosion. These financial institutions must pay attention to the
consequences of increased risk, strengthening their risk management against an
economic slowdown, officials bank feel.
     Overall, though, the BOJ feel capital bases at Japanese banks are currently
in reasonable shape, although being undermined by the continued low returns on
investment.
     --RISING NPLS
     There is concern that the lending Japan's banks implemented to companies
for capital investment will become non-performing loans as the economy slows.
     Bad loan provisions at some banks are currently low, with little recent
appetite to build them up as bankruptcies and credit costs sat at low levels as
the economy enjoyed a modest recovery.
     Credit costs are now picking up from the historical low levels of around
zero percent seen last year as corporate profits fell and the economy slowed,
which increased downward pressure on bank profits. Although first glance
suggests this is a boost for banks, it is also likely to further weigh on
indebted corporates, increasing the risk of bigger bad loan books at the banks.
     --SLOWER CAPEX WORRY
     The BOJ's January Outlook Report said capital investment is likely to
continue on its increasing trend, although the pace may slow.
     BOJ officials are increasingly concerned over the risk that bank lending
implemented for capital investment defaults, further weighing reserves and
through to the wider economy and the last policy meeting acknowledged that
downside risks to Japan's economic activity and prices are strengthening
     The BOJ maintains the baseline view that Japan's economy is expected to
expand moderately, which eases the sense of crisis somewhat as that will prevent
a worsening position for banks in the near-term.
     However, the central bank is well aware that it will be too late for banks
to address balance sheet problems if Japan's economy slows or even dips into
recession.
--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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