MNI STATE OF PLAY: BOJ More Watchful Over Policy Side Effects

By Hiroshi Inoue

     TOKYO (MNI) - The latest Bank of Japan (BOJ) Outlook Report showed that the

BOJ board has increased its vigilance against the side effects of its easy

policy, such as the risks of a gradual pullback in financial intermediation and

destabilizing the financial system, MNI understands.

     The BOJ board said these risks may not be significant now as financial

institutions have sufficient capital bases, but it is "necessary to pay close

attention to future development," according to the report released on Wednesday.

     In the previous report in July, the BOJ concluded its risk assessment that

"financial institutions have sufficient capital bases."

     The risk assessment in the latest Outlook Report is based on the BOJ's

Financial System Report (FSR) released on Oct 22, which warned that financial

institutions' core profitability and regional banks' capital adequacy are both

falling.

     The BOJ said in the FSR that "financial institutions that have actively

engaged in risk taking, in areas such as lending to mid-risk firms and the real

estate sector, as well as securities investment, could experience larger

declines in capital because of credit costs and losses on securities."

     --CAPITAL RATIOS DECLINE

     The BOJ also warned that "the core capital ratios for domestic banks have

gradually declined recently as banks haven't increased profits equivalent to

risks."

     The sentence "it is necessary to pay close attention to future development"

in the latest report means that the BOJ board is more worried about the side

effects of easy policy than before, a person familiar with BOJ's thinking said.

     The person, however, said that the latest assessment won't immediately

prompt the board to change the policy framework to mitigate the policy side

effects.

     Another person familiar with BOJ thinking said that the overall risk

assessment is unchanged from July, but the board is paying more attention to the

side effects as the risks are increasing with time.

     --NO SERIOUS PROBLEMS

     BOJ Governor Haruhiko Kuroda said Wednesday that serious problems haven't

arisen. He warned that downward pressure on banks' profits amid prolonged low

interest rates may risk destabilizing the financial system.

     Despite the accumulating side effects, Kuroda won't immediately adjust the

easy policy as he has made achieving the 2% price target top priority.

     Kuroda is responsible for separating monetary policies and prudence

policies regarding the measures to cope with the side effects and financial

imbalances.

     Kuroda has devoted monetary policies to an economic recovery and the price

stability target. He believes that financial imbalances and side effects should

be addressed by either micro- or macro-prudence policies.

     --PREEMPTIVE ACTION

     It may be too late for the BOJ to act after the risks including a worsening

of the financial system materialize. The BOJ needs to preemptively take

necessary action.

     However, BOJ officials realize that it is very difficult to justify policy

adjustment to mitigate the side effects before the financial system worsens.

     Monetary policies alone won't correct financial imbalances and banks'

excessive risk-taking activities. Raising the 10-year interest rate not only can

improve banks' profits but also reduce their risk-taking, the BOJ views.

     Raising long- and super long-term bond yields won't have serious adverse

impact on economic activity and banks' lending costs as lending rates are mainly

determined by 2 to 3-year interest rates.

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

--MNI Beijing Bureau; +86 10 8532 5998; email: william.bi@mni-news.com

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