MNI POLICY: BOJ Sees No Imminent Systemic Risk, But Vigilant

Although Japan's commercial banks, especially the regional lenders, are facing difficult trading conditions at present, the Bank of Japan doesn't see any signs of solvency issues and officials at the central bank don't expect any systemic risk problems any time soon, MNI understands.

BOJ officials are currently analyzing financial risks across the system as Covid-19 continues to impact the economy and will ramp up the work through to the semi-annually Financial System Report due in mid-October.

Commercial banks continue to be pressured by declining loan margins and falling returns on investments, along with increasing credit costs as the virus spreads.

HIGHER CREDIT COSTS

Although some banks are already suffering from the rise in credit costs, the BOJ doesn't expect a significant deterioration in the macro-financial system anytime soon, with many banks having strong capital bases, having taken steps to improve them in the decade following the Lehman Shocks

This will allow many banks endure a drop of profits and help under pin the system.

However, it would be wrong to suggest that there is parity across the banking system, with many lenders in a less favourable position.

Although some banks are already increasing their loan-loss contingency reserves, others are struggling as their profits remain sluggish – a situation that will worsen as the pandemic fall out deepens, although the extent will depend on the timing and the pace of economic recovery.

The worst case scenario for the BOJ is that banks will restrict their lending to businesses as credit costs rise, which will reduce intermediation across financial markets.

The BOJ is still of the view that Japan's economy is will improve gradually from the second half of this year but they are increasingly unnerved over the weaker-than-expected economic pickup.

Despite the heightened uncertainties over the consequence of the pandemic, BOJ officials working on the stability review will likely maintain that a large scale second wave of coronavirus will not occur and strict lockdowns across the economy will not be implemented.