MNI POLICY: BOJ FSR: No overheating; Credit Costs To Rise

     TOKYO (MNI) - Despite the prolonged accommodative financial conditions,

current financial and economic activities as a whole have not shown any signs of

overheating as observed during the bubble period in the late 1980s, the Bank of

Japan's Financial System Report maintained.

     However, the report warned, "Attention should continue be paid to the

accumulation of vulnerabilities under the continued expansion in the financial

cycle."

     The FSR will not push the BOJ board to unwind its easy policy, but

indicated that any further easing will increase pressure on financial

institutions -- and the report called for banks to take measures to increase

profitability in the future.

     The report added "On the domestic front, the total credit to GDP ratio has

continued to rise. Although the ratio remains lower than in the bubble period,

the upward deviation from its trend is getting close to the scale in that

period."

     The FSR said "Credit cost ratios have remained low but started to rise,

particular for regional financial institutions. Firms' default rate has risen

slightly."

     "The ratio was calculated when the economy was expanding moderately.

Looking ahead, if the economy slowed down or fell into recession, the ratio will

rise," a senior BOJ official in charge of the FSR told reporters.

     The FSR warned, "Financial institutions need to become even more aware of

the possible effects on credit costs associated with the materialization of

downside risks to the economy."

     --REAL ESTATE "RED"

     The real estate loans-to-GDP ratio, which turned "red" in the previous

report, has remained "red," it said.

     Among the other financial activity indexes that are currently "green," some

of them are getting closer to "red"; the diffusion index of lending attitudes of

financial institutions and the corporate credit to GDP ratio, the FSR said.

     It also said, "Loans to low-return borrowers with narrow profit margins

have been increasing. Credit costs remain low but have recently started to rise,

particularly for regional financial institutions."

     The total outstanding amount of real estate loans has been increasing and

has surpassed levels seen during the bubble period; moreover, the deviation of

the real estate loans-to-GDP ratio from its trend has marked a record high for

the post-bubble period.

     --OFFSHORE CONCERNS

     Overseas exposures of Japanese banks are increasing and Japan's financial

system, including banks' foreign currency funding conditions, is becoming more

susceptible to the effects of overseas financial cycles, it said.

     Japan's financial system remains stable on the whole, the report says.

     Regional financial institutions have been actively taking risks in domestic

lending and securities investment. However, they have not been able to secure

adequate returns relative to the risks involved and their capital adequacy

ratios have continued to decline moderately.

     Should this situation persist, any loss-absorbing capacity in the event of

stress would decrease, and downward pressure on the real economy through a

weakening of the financial intermediation function could intensify, the report

said.

--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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