financial system report summary

FSRystem

inancial

eport

Summary

October 2021Bank of Japan

Motivations of the October 2021 issue

1

Domestic credit risk: this Report presents a simulation of the impact of the pandemic onSMEs' probability of default (PD) through a change in liquidity and solvency, inconsideration of heterogeneity among individual firms' profits. This Report also analysesthe funding behavior and the medium-term developments in the PD of firms withvulnerable financial bases before the pandemic.

Securities investment risk: this Report measures the degree of portfolio overlap at thelevel of individual financial institutions (FIs) in Japan and investment funds by investmentproduct and region, and examines the impact of this overlap on the transmission ofmarket shocks.

Foreign currency funding risk: this Report examines the impact of adjustment in globalfinancial markets on Japanese FIs' foreign currency funding instruments and fundingrates, based on the event study including of the global financial crisis (GFC) and themarket turmoil in March 2020. In the analysis, the nature of changes in global marketconditions and the difference of the characteristics of foreign currency funding profiles forindividual FIs are taken into account.

Macro stress testing: the resilience of Japan's FIs and financial system is examinedunder three downside scenarios.

Current assessment of the stability of Japan's financial system Japan's financial system has been maintaining stability on the whole, while COVID-19 continues to have a significant impact on

economic and financial activity at home and abroad.

The Japanese government and the Bank of Japan, in close cooperation with overseas authorities, swiftly implemented large-scalefiscal and monetary policy measures and took flexible regulatory and supervisory actions to support economic activity and maintainthe functioning of financial markets. Firms that are significantly affected by the pandemic experience funding difficulties. However,underpinned by the financial soundness of FIs on the whole, the policy responses have been effective and the financialintermediation function is being fulfilled smoothly. In financial markets, with risk sentiment remaining favorable on the whole, therehave been continuing inflows of funds to the stock market and emerging market economies.

Future risks and caveats Japan's financial system is likely to remain highly robust even in the case of future resurgence of COVID-19 or adjustment in global

financial markets and emerging economies due to a rise in U.S. long-term interest rates.

However, in the event of a substantial and rapid adjustment in global financial markets, a deterioration in FIs' financial soundness andthe resultant impairment of the smooth functioning of financial intermediation could pose a risk of further downward pressure on thereal economy. In this regard, the following three risks warrant particular attention: (1) an increase in credit costs due to a delay ineconomic recovery at home and abroad; (2) a deterioration in gains/losses on securities investment due to substantial adjustments infinancial markets; and (3) a destabilization of foreign currency funding due to the tightening of foreign currency funding markets.

Even after the pandemic subsides, it is likely that the low interest rate environment and structural factors will continue to exertdownward pressure on FIs' profits. Against this backdrop, attention should be paid to the risk of a gradual pullback in financialintermediation, or on the contrary, to the possibility that the vulnerability of the financial system increases, mainly as a result of FIs'search for yield behavior.

Executive summary

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１．Introduction

２．Domestic credit

３．Overseas credit

４．Securities investment

５．Foreign currency funding

６．Macro stress testing

Contents

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Apr.-June2008

Apr.-June09

Apr.-June10

Oct.-Dec.19

Oct.-Dec.20

OtherExportsPrivate consumptionReal GDPAs of the previous

indexCurrent phasePeriod during the GFC

Report

Apr.-June2008

Apr.-June09

Apr.-June10

Oct.-Dec.19

Oct.-Dec.20

Current phasePeriod during the GFC

Apr.-June2008

Apr.-June09

Apr.-June10

Oct.-Dec.19

Oct.-Dec.20

CurrentphasePeriod during the GFC

Note: Indexation with the real GDP in the April-June quarter of 2008 is set at 100 for the period during the GFC and that in the October-December quarter of 2019 is set at 100 for the current phase. "As of the previous Report" indicates the average forecasts of professionals and markets in March 2021.

Source: BEA; Cabinet Office; Eurostat; IMF; Japan Center for Economic Research, "ESP forecast."

Due to the spread of COVID-19, domestic and overseas economies experienced a significant downturn in the first half of 2020.

Thereafter, the Japanese and European economies have generally recovered in line with the average forecasts by research institutions and markets at the time of the previous Report and the pace of recovery in the U.S. economy has been faster than forecasted.

Developments in GDP in Japan, the U.S., and Europe

Chart IV-1-1: GDP levels in current phase and during GFCJapan EuropeUnited States

1. Introduction

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The sales of large firms for fiscal 2021 are expected to recover to a level comparable to that in fiscal 2019. SMEs' pace of recovery is expected to be moderate.

The pace of recovery in the transportation and postal services as well as face-to-face services industries is expected to be sluggish. Heterogeneity across firms within the face-to-face services industry will remain high.

The DI of financial positions generally has improved slightly, but many firms in the face-to-face services industry continue to regard their financial positions as "tight."

Firms' sales forecasts and financial positions

Chart IV-1-5: Sales changes by industry (from fiscal 2019)Large firms SMEs

2. Domestic credit 1/8

5

Note: 1. The solid linesindicate weightedaverages. The bands indicate 10th-90th percentile points.

2. "Face-to-face services" consistsof food, accommodation, and consumer services. The same applies tosubsequent charts.

3. The data for fiscal 2021 indicate the forecasts.

Source: Nikkei Inc., "NEEDS-Financial QUEST"; BOJ, "Tankan."

Chart IV-1-4: DI of financial positions (all firm sizes and by industry)

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June 2021Dec. 2020Dec. 2019

"easy" - "tight", % pts

Note: The figures for"Face-to-faceservices" and "Other nonmfg."are weighted averages by the number of firms that responded to the question in each industry.

Source: BOJ, "Tankan."

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GFCCurrent crisis

changes in cash reserves ratio, %

operating cash f low ratio, %

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GFCCurrent crisis

amount of funding ratio, %

operating cash f low ratio, %

Funds in excess of their negative cash f low

Funding conditions of firms SMEs that experienced a larger decline in operating cash flow tend to increase their funding to a greater degree. This

pattern is more pronounced during the current crisis, thanks to proactive measures to support corporate financing. During the current crisis, cash reserves have increased even among firms with negative operating cash flows. This may

suggest that they are borrowing precautionary loans on the back of significant uncertainty. Chart B1-4: Operating cash flow and changes

in cash reserves (all industries)


6

Note: 1. Left panel: Amount of funding ratio = (loans at the end of the fiscal year - loans at the beginning of the fiscal year) / total assets at the beginning of the fiscal year(the same applies to the left chart on page 11). Right panel: Changes in cash reserves ratio = (cash reserves at the end of the fiscal year - cash reserves at the beginning of the fiscal year) / total assets at the beginning of the fiscal year (the same applies to the middle chart on page 11).Operating cash flow ratio = operating cash flow / total assets at the beginning of the fiscal year.

2. Firms are grouped into 2-percentile bins based on their operating cash flow ratios. The dots represent the median values for each group.3. The data for the "Current crisis" cover the currently available financial results for fiscal 2020 and those for the "GFC" cover the financial results for the one-year

period from October 2008 to September 2009.Source: CRD Association.

Chart B1-2: Operating cash flow and amount offunding (all industries)

Regular loans

Effectively interest-free

loans Cash

payments

Cashreserves

Debt repayment capacity

Short term

Medium term

Trade-off between liquidity and solvency

Yes

Short termSlightly

NoMedium term

Yes

Trade-off between liquidity and solvency

To examine the impact of changes in cash reserves (liquidity) as well as in debt repayment capacity (solvency) on the PD of SMEs, this Report conducts a medium-term simulation of the developments in about 880 thousand SMEs' profits and balance sheets through fiscal 2023.

Steps and assumptions for medium-term simulation

Medium-term simulation on financial soundness and the PD of SMEs2. Domestic credit 3/8

7

: improve : worsen : somewhat worsenRepeat the steps above up to fiscal 2023(As the impact of COVID-19 wanes, the precautionary level of cash reserves is assumed to decline

to +5% at the end of fiscal 2021 and 0% at the end of fiscal 2022 and 2023)

Balance sheet at the beginning of fiscal 2021Cash reserves Financial leverage and interest payment capacity

Regular loans at the end of fiscal 2020Firms will take out additional loans if cash reserves fall below +10% larger amounts than at the beginning of

fiscal 2020, while they will repay existing loans if the cash surplus remains.

Probability of default as of fiscal 2020Cash reserves (liquidity) Financial leverage and interest payment capacity

(solvency)

Effectively interest-free loans in fiscal 2020 (up to 60 mil. yen)Firms will borrow to maintain +10% larger cash reserves than at the beginning of fiscal 2020.

Firms will use regular loans at the end of the year if the cash shortfall remains.

Corporate profits and capital investments in fiscal 2020Operating profits:

shown on the next pageCash payments:

based on actual gov. expenses Capital investments:

identical to depreciation levels

Balance sheet at the beginning of fiscal 2020Cash reserves Financial leverage and interest payment capacity

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Real GDP (lhs)Large firms' operating profits (rhs)SMEs' operating profits (rhs)

FY2019=100 FY2019=100

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Face-to-face servicesManufacturingConstruction and real estateWholesale and retail

%

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Face-to-face servicesManufacturingConstruction and real estateWholesale and retail

%

ratio of operating profits to sales(deviation from industry averages, % pts)

Chart IV-1-7: Assumptions on GDP and corporate profits for medium-term simulationReal GDP and corporate profits

by firm size

Assumptions on corporate profits Individual firms' profits are estimated taking into account differences in firm sizes and industries, as well as heterogeneity

among SMEs within the same industry. The estimates of aggregate corporate profits based on the future path of GDP and profits by firm size and industry are

calculated using financial data of fiscal 2020.


8

Distribution of SMEs' operating profitswithin industries

Operating profits of SMEsby industry

Note: The figures in the middle chart indicate changes in operating profits from fiscal 2019 as a percentage of sales in fiscal 2019. In the right chart, the horizontalaxis indicates operating profits divided by sales in fiscal 2021.

Source: Japan Center for Economic Research, "ESP forecast"; Ministry of Finance, "Financial statements statistics of corporations by industry."

Simulation results: SMEs' financial conditions Without the support measures, the share of SMEs making losses would increase. With the support measures, the

increase is contained significantly. Reflecting the outlook that the cash payments from the government decrease compared to fiscal 2020, and that profits

recover only moderately, the share of SMEs making losses increases in fiscal 2021, even when the support measures are taken into account. The share of SMEs with capital or cash shortage remains high.

Chart IV-1-10: Simulation results


9

Share of firmsfacing cash shortages

Share of firmsfacing capital shortages

Note: Firms facing capital shortages are defined as firms whose (net assets at the beginning of the fiscal year) + (current profit) * (1 - the effective tax rate) is negative. Firms facing cash shortages are defined as firms whose net operating cash outflow during the year exceeds their cash reserves at the beginning of the fiscal year.

Source: CRD Association.

Share of firms with current losses

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05 07 09 11 13 15 17 19 21 23

Actual Without support measures With support measures

%

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Simulation

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% pts

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Without the support measures, the PD would increase substantially in fiscal 2020. Such an increase in the PD gradually becomes smaller thereafter, reflecting the recovery of corporate profits, but the deterioration in creditworthiness, led by the increase in borrowing, continues to push up the PD.

With the support measures, the PD falls substantially in fiscal 2020 due to the increase in cash reserves. In fiscal 2023, when interest subsidies for effectively interest-free loans end, the PD slightly exceeds the simulated level without the outbreak of COVID-19 through an increase in interest payments. The PD of the face-to-face services industry is pushed up considerably from fiscal 2021 under the assumption of the slow recovery in demand and the large heterogeneity across firms.

Simulation results: SMEs' PD

Charts IV-1-12,13: Decomposition of the deviation of PDWithout support measures


10

With support measuresFace-to-face services Other industriesAll industries

Note: The charts indicate thedeviation of PD from the simulation without the COVID-19 outbreak (firms' profits are unchanged and precautionary loans are not obtained, etc.).

All industries

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Portfolio change factorSolvency factorLiquidity factorDeviation of PD

% pts

FY

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GFCCurrent crisis

PD before the crisis, %

changes in cash reserves ratio, %

-4-202468

1012141618

0 1 2 3 4 5 6 7

GFCCurrent crisis

PD before the crisis, %

amount of funding ratio, %

Firms with a higher PD before the outbreak of COVID-19 tend to obtain more funding after the outbreak. This leads to an increase in cash reserves.

The PD for fiscal 2020 is contained to a larger degree for firms with a higher PD before the pandemic, thanks to the increase in cash reserves. However, the PD for these firms is estimated to become higher in fiscal 2023 due to the assumption about the moderate recovery in corporate profits.

Funding behavior of firms with vulnerable financial bases before pandemic

Chart IV-1-14: Changes in PD by the PD for fiscal 2019


11

Note: 1. Based on all industries. With support measures.2. Firms are grouped into 2-percentile bins

based on their PD, which is estimated by the BOJ. The horizontal axes show the median values for each group and the vertical axes show the averages for each group.

Chart B1-3: Amount of funding by PDbefore the crisis

Chart B1-5: Changes in cash reservesby PD before the crisis

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FY2020FY2023

changes in PD, % pts

PD for FY2019, %Note: 1. Based on all industries.

2. Firms are grouped into 2-percentile bins based on their PD before the crisis. The dots represent the median values for each group. The PD before the crisis indicates the estimated PD based on the financial results forfiscal 2019 for the "Current crisis" and for the one-year period from October 2007 to September 2008 for the"GFC."

Source: CRD Association.

CY

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21DI of lending attitudes of financial institutions

Growth rate of M2

Equity weighting in institutional investors' portfolios

Stock purchases on margin to sales on margin ratio

Private investment to GDP ratio

Total credit to GDP ratio

Household investment to disposable income ratio

Household loans to GDP ratio

Business fixed investment to GDP ratio

Corporate credit to GDP ratio

Real estate firms' investment to GDP ratio

Real estate loans to GDP ratio

Stock prices

Land prices to GDP ratio

Real estate

Asset prices

Financialinstitutions

Financialmarkets

Privatesector

Household

Corporate

Heat map The five "red" Financial Activity Indexes (FAIXs) can be regarded as the result of FIs responding to the demand for

working capital, including precautionary demand, caused by the impact of the pandemic. They do not signal overheating of financial activities but represent vigorous financial intermediation activities to underpin firms' operating liquidity as a result of measures to support corporate financing.


12

Chart III-3-1: Heat map

Note: The latest data for stock prices are as at the July-September quarter of 2021. The latest data for the land prices to GDP ratio are as at the January-March quarter of 2021.The latest data for the other indicators are as at the April-June quarter of 2021.

Source: Bloomberg; Cabinet Office, "National accounts"; Japan Real Estate Institute, "Urban land price index"; Ministry of Finance, "Financial statements statistics of corporationsby industry"; Tokyo Stock Exchange, "Outstanding margin trading, etc."; BOJ, "Flow of funds accounts," "Loans and bills discounted by sector," "Money stock," "Tankan."

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Default rates of corporate bonds in overseas markets Although the corporate bond default rates in overseas markets rose following the outbreak of COVID-19, especially in the

retail and energy industries, they have declined to below pre-pandemic levels on the whole in the first half of 2021. The downgrade rate from investment grade (IG) to non-investment grade (non-IG) and the default rate of non-IG

corporate bonds are now clearly below historical average levels.

3. Overseas credit 1/2

13

Note: 1. Default rates areon the issuer basis, including bond and loan issuers.

2. Energy covers oil and natural gas development.

Source: Moody's.

Chart IV-2-2: Default rates of corporate bondsChart IV-2-1: Default rates of corporate bondsby industry

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85 90 95 00 05 10 15 20

Default rates of non-IGDowngrade rates from IG to non-IG

%

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Note: 1. Default rates and downgrade rates are calculated quarterly for each2-quarter long window on the issuer basis, including bond and loan issuers. Latest data as at January-June of 2021.

2. The thin solid line and the thin dotted line indicate the historicalaverages of default rates and downgrade rates, respectively.

Source: Moody's.

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bil. U.S. dollars bil. U.S. dollars

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Overseas corporate loans outstanding The quality of Japanese banks' overseas corporate loan portfolios has remained high. Compared with before the pandemic, it has deteriorated for some industries, including the transportation and postal

services as well as processing industries. There has not been any significant increase in non-IG loans outstanding recently.

3. Overseas credit 2/2

14

Note: 1. Covers the three major banks' lending.2. Energy covers oil and natural gas

development.3. Based on internal rating of each banks.

Source: BOJ.

Chart IV-2-3: Overseas corporate loans outstanding (by industry and rating)End of March 2021 Changes from end of September

2019 to end of September 2020Changes from end of September

2020 to end of March 2021

Asset sales(Q)

(2) Portfolio adjustment rate(3) Price impactHow much an entity sells assets when prices fall.

How much the amount of asset sales of an entity affects market prices.

How similar portfolios are between different entities in terms of market value fluctuations.

Price decline(P)

(1) Portfolio overlap

Priceshock

Interlinkage effect of securities The "interlinkage effect" refers to the effect of an external shock to asset prices amplified and transmitted through

transactions among each entity in the financial network. The degree of interlinkage effect depends mainly on (1) the degree of portfolio overlap, (2) the portfolio adjustment rate, and (3) the degree of price impact.

The analysis in this Report (a) measures the degree of portfolio overlap between individual FIs in Japan and investment funds, (b) breaks the level of investment funds down by investment product and region, and (c) examines to what extent the degree of portfolio overlap amplifies the transmission of market shocks.

15

4. Securities investment 1/3

Interlinkage effect of the securities

1: Before the GFC2: Before the market turmoil in March 2020L: Large financial institutionsR: Regional banksS: Shinkin banks

Secular changes in portfolio overlap The degree of portfolio overlap between individual FIs in Japan and investment funds by investment product and region is

estimated in terms of the correlation of market values of the portfolios. The degree of portfolio overlap between the two just before the market turmoil in March 2020 was higher than before the GFC.

16


1: Before the GFC(January 2005 – January 2007)

2: Before the market turmoil in March 2020(January 2018 – January 2020)

Note: Gray hexagons indicate approximately 50 types of investment funds by investment region and product. A line is drawn whenthe overlap between a financial institution's securities portfolio and AUM (assets under management) of an investment fund ishigh (i.e., correlation of price changes is 0.5 or higher). Shapes are larger the more they are connected.

Source: EPFR Global; Haver Analytics; BOJ.

Charts IV-3-6,7: Portfolio overlap between Japanese financial institutions and investment fundsOverlap by types of

financial institutions and funds

Red▲: Large financial institutions, Blue■: Regional banks、Green●: Shinkin banks, Gray hexagon: Investment funds

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L R S L R S

Bond funds Equity funds

10th-90thpercentileAverage

number of correlations 0.5or higher / total, %

Summary by types of FIs and funds

Note: "Before the GFC" and "Before the market turmoil in March 2020" periods are the same as in the left chart.


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Rise in the long-termU.S. interest rate

Increase in fundredemption rate

Widespreaddeterioration in

financial conditions(increase in FCI)

price changes of securities portfolios, %

Degree ofoverlap:Low

High

Note: 1. This figure summarizes the estimation results of mainly Chart IV-3-9 in the main text.2. The length of arrows shows the impact of market shocks (rise in the U.S. interest

rate: +0.6% pts <equivalent to the Taper Tantrum>; increase in fund redemption rate: +6% pts <the market turmoil in March 2020>; widespread deterioration in financial conditions: +1% pts <the GFC>), on price changes of securities portfolios. FCI represents the Financial Conditions Index.

3. The high (low) degree of overlap with investment funds represents financial institutions with a correlation that is at least one standard deviation higher (lower) than the full-sample average.

Source: Bloomberg; EPFR Global; Federal Reserve Bank of Chicago; Haver Analytics; ICI; BOJ.

Portfolio overlap and transmission of market shocks In the March 2020 market turmoil, the higher an FI's overlap just before the turmoil, the larger the decline in the market

value of the FI's securities portfolio tended to be. A deterioration in the market values of securities portfolios is significantly larger for FIs with a higher degree of overlap

with investment funds for all factors causing market shocks.

17

Portfolio overlap with investment funds and transmission of market shocks


Chart IV-3-8: Portfolio overlap with investment fundsand securities portfolio price changesin the March 2020 market turmoil

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price changes of securities portfolios as of March 2020,m/m chg., %

correlation w ith investment funds as of Jan. 2020Note: Correlation with investment funds is calculated as the average across all bilateral

correlations. The intercept and slope of the regression line are both statistically significant at the 1% level.


Funding instruments（Sources） Description

Foreign currency-denominated BS of

major banks(BOJ)

・Long-term time-series data from 2003

Big data

CDs and CPRepos

(Crane Data)

・Level and volatility of funding rates, and the characteristics of each transaction (volume, CDS, etc.)

・Transaction data・Number of observations:

about 200 thousand(CDs&CP, and repos)about 10 thousand(cross-currency basis swaps)

Cross-currency basis swaps

(OTC Derivative Transaction Data)

Deposits(FDIC, FED)

・Deposits by types in U.S. branches

・Number of observations:about 900 thousand

Event study of foreign currency-denominated balance sheets of major banks (1) Japanese major banks have been increasing foreign currency-denominated assets. Looking at the composition of their

foreign currency funding, the share of deposits has been increasing over the medium to long term, indicating progress in building a stable funding basis.

However, there were periods of stress in which large fluctuations in the composition were observed, such as the market turmoil in March 2020 and the GFC.

The following analyses examine the impact of changes in global market conditions on major banks' funding conditions and assess their strategies for building a stable funding basis by using big data.

18

Chart B3-1: Event study of foreign currency-denominatedbalance sheets of major banks

Amount of foreign currency-denominated liabilities by major banks

5. Foreign currency funding 1/5

Note: Covers internationally active banks among major banks (based on all currencies). The event lines represent1: the GFC (September 2008),2: the European debt crisis(August 2011), 3: the TaperTantrum (April 2013), 4: theMMF reform (October 2016),and 5: the market turmoil inMarch 2020. "FX and currencyswaps, etc." in the liabilitiesshare includes corporate bonds. "U.S. dollar operations" represents mainly U.S. Dollar Funds-Supplying Operations. Thesame applies to subsequentcharts. There are somediscontinuities in the data aroundDecember 2009. Latest data asat April 2021.

Source: BOJ.

Liabilities share

0

10

20

30

40

50

03 05 07 09 11 13 15 17 19 21

% 1 2 3 4 5

CY

Deposits

Interbank fun-ding (CDs&CP, etc.)

FX and curren-cy sw aps, etc.

Repos

U.S. dollaroperations

0.0

0.5

1.0

1.5

2.0

2.5

03 05 07 09 11 13 15 17 19 21

tril. U.S. dollars

CY

1 2 3 4 5

Data used in the analyses

Other U.S. dollar operations

Interbank investments and funding(assets incl. reserves at central banks, liabilities incl. CDs and CP)

Securities (assets), repos (liabilities)

Medium- to long-term FX and currency swaps Short-term FX and currency swaps

Loans (assets), deposits (liabilities)

-150-100-50

050

100150200250300

Assets Liabilities Assets Liabilities Assets Liabilities Assets Liabilities

GFCJune 2007 → Dec. 2008

Market turmoil in March 2020Dec. 2019 → Apr. 2020

European debt crisisDec. 2010 → Oct. 2011

Taper TantrumJan. 2013 → July 2013

change in amounts, bil. U.S. dollars

Securities

Loans

Interbank

Securities

Loans

Interbank

Securities

Loans

Securities Repos

Dollar ope.Repos

FX&curren-cy swaps

DepositsCDs&CP, etc.

Dollar ope.

Repos

DepositsCDs&CP, etc.

CDs&CP, etc.Repos

FX&curren-cy swaps

Event study of foreign currency-denominated balance sheets of major banks (2) The GFC and the market turmoil in March 2020 are characterized by (1) an increase in market funding as a result of an

increase in lending that was not met by a corresponding increase in deposit funding, and (2) a large shift in market funding from CDs and CP to other market funding instruments such as repos and FX and currency swaps.

(1) was observed also in the European sovereign debt crisis. In the Taper Tantrum, neither (1) nor (2) prevailed.

19

Chart B3-1: Event study of foreign currency-denominated balance sheets of major banks


Source: BOJ.

Impact of changes in global market conditions on foreign currency funding instruments Three variables representing changes in global market conditions (the FCI, fund redemption rate, and U.S. interest rates)

have a large explanatory power on changes in the shares of funding instruments of major banks. (1) A deterioration in the FCI will widen the gap between loans and deposits through an increase in the loans by, for

example, drawing a commitment line, and will push up the share of FX and currency swaps. (2) A rise in the fund redemption rate reduces the share of funding through CDs and CP, etc., and especially increases the share of repo and short-term FX and currency swap funding. (3) A rise in U.S. interest rates reduces the share of deposits.

20


Chart IV-4-4: Impact of changes in global market conditions on foreign currency funding instruments

Explanatory power of changes in global market conditions on changes in sharesof foreign currency funding instruments

Funding instruments Adjusted R2

Deposits 0.83

Repos 0.62

Interbank funding(CDs and CP, etc.) 0.71

Medium- to long-termFX and currency swaps 0.46

Short-termFX and currency swaps 0.81

Other (U.S. dollar funds-supplying operations, etc.) 0.29

Note: 1.This figure summarizes the estimation results of Chart B3-2in the main text.

2. Adjusted R-squared is obtained by regressing shares of each funding instruments on the FCI, fund redemption rate, U.S. interest rates, etc. between January 2003 and April 2021.

Source: Bloomberg; Federal Reserve Bank of Chicago;Haver Analytics; ICI; BOJ.

1. Widespread deterioration in financial conditions (increase in FCI)

2. Increase in fund redemption rate

3. Rise in U.S. interest rates

Assets Liabilities

Deposits

Repos

CDs&CP, etc.

FX&curre-ncy swaps

Other(dollar ope., etc)

Loans

Other assets

Funding demand

Deposits

Repos

CDs&CP, etc.

FX&curre-ncy swaps


Assets

Assets Liabilities

Funding demand

Assets Liabilities

Deposits

Repos

CDs&CP, etc.

FX&curre-ncy swaps


Assets

Funding demand

: share increase, : share decrease, Red (with lines): main source of funding demand, Green: main funding instruments

Note: This figure summarizes the estimation results of Chart B3-2 in the main text. The up (down) arrows represent shareincreases (decreases) and the length of the arrows represents the degree of impact.

0

10

20

30

40

50

0102030405060708090

CDs&CP

Repos FX andcurrencyswaps

CDs&CP


Level (lhs) Volatility (rhs)

bps bps

Funding counterparties:Concentrated

Diversified

0

10

20

30

40

50

0102030405060708090

CDs&CP


CDs&CP


Level (lhs) Volatility (rhs)

bps bps

Market stress

Normal times

Impact of an increase in redemption rate and diversification of funding counterparties The rise in the fund redemption rate pushes up the level of funding rates of CDs and CP as well as FX and currency

swaps. The volatility of funding rates of all the instruments is increased. FIs with a larger number of funding counterparties tend to face a lower funding rate level and volatility, suggesting that a

diversification of funding counterparties leads to more stable funding.

21


Impact of an increase in fund redemption rate and diversification of funding counterparties on funding rates

Note: 1. This figure summarizes the estimation results of Charts B3-5 and B3-6 in the main text. 2. The left chart shows the impact of an increase in the fund redemption rate, corresponding to the market turmoil in March 2020 (+6% pts), on funding rates. Normal times

represent full-sample averages.3. The right chart shows the impact of HHI, which ranges from zero (i.e. the number of funding counterparties is infinity) to one (i.e. the number of funding counterparties is

one) on funding rates. 4. Signs of U.S. dollar funding premiums in cross-currency basis swaps are reversed.

Source: Bloomberg; Crane Data; FRB; FSA, "OTC Derivative Transaction Data"; Haver Analytics; ICI.

Increase in fund redemption rate Diversification of funding counterparties(Herfindahl-Hirschman Index)

0

5

10

15

20

25

30

35

92 94 96 98 00 02 04 06 08 10 12 14 16 18 20

Japanese banksEuropean banksU.S. banks

%

CY-1

0

1

2

3

4

5

6

0 1 2 3

Interest rate sensitivity Interest rate sensitivity (without transaction accounts)years later

cumulative chg. in the dollarw holesale funding ratio, % pts

-1

0

1

2

3

4

5

6

0 1 2 3years later


-1

0

1

2

3

4

5

6

0 1 2 3years later


Interest rate sensitivity of dollar wholesale funding The dollar wholesale funding ratio has a positive relationship with a rise in the U.S. interest rate, as existing studies have

pointed out that a rise in interest rates leads to a rebalancing of assets by depositors to MMFs and other assets. Japanese banks have a higher interest rate sensitivity of the dollar wholesale funding than European and U.S. banks, but

it is also the case that the existence of transaction account deposits restricts the shift to market funding to a certain extent. These findings support Japanese banks' strategies of an increase in the share of transaction account deposits.

22


Note: 1. Each figure represents the cumulative change in the dollar wholesale funding ratio in responseto a 1 percentage point rise in the U.S. 3-month interest rate. "Japanese banks" and "Europeanbanks" represent branches in the U.S.(the same applies to the right chart).

2. Dollar wholesale funding ratio = (large deposits <mainly CDs> + repos + other borrowings) / (other deposits + dollar wholesale funding <numerator> + borrowings from group companies, etc.).

Source: Bloomberg; FDIC; Federal Reserve Bank of Chicago.

Chart B3-7: Effects of transaction accounts on interest ratesensitivity of dollar wholesale funding

Japanese banks European banks U.S. banks

Chart B3-8: Transaction account ratio

Note:1. Latest data as at the January-March quarter of 2021. 2. The transaction account ratio is the ratio of transaction account

deposits to total deposits (the same applies to the left chart). Source: FDIC; Federal Reserve Bank of Chicago.

Real economy Financial variables

Baseline scenario

Moderate recovery in line with average forecasts of professionals and markets

Unchanged from the level at end-August 2021

Downside scenarios

Diverging business

conditions scenario

Downturn of domestic and overseas economies

with diverging firms' business conditions across and within industries

Historical average reaction to shocks on the real economy

Emerging markets stress

scenario

Significantly slower recovery in emerging economies

Financial shocks due to a rise in the U.S. long-term

interest rate (+100bps)

Financial stress

scenario

Severe downturn of domestic and overseas economies due to

financial shocks

Substantial and rapid financial shocks

comparable to the GFC

PropagationShocks

Shocks

Shocks

Propagation

Propagation

Note: Long- and short-term interest rates evolve in line with the forward rates under the baseline scenario while they fall to the lowest level observed until August2021 under the diverging business conditions scenario and the financial stress scenario. Under the emerging markets stress scenario, they are subject to the shocks due to a rise in the U.S. long-term interest rate (+100bps).

Scenarios for macro stress testing Macro stress testing examines the resilience of Japan's financial system under three downside scenarios.

6. Macro stress testing 1/6

23

Chart V-2-1: Scenarios for simulation

889092949698

100102104106

Oct.-Dec.19

Apr.-June20

Oct.-Dec.

Apr.-June21

Oct.-Dec.

Apr.-June22

Oct.-Dec.

Apr.-June23

Oct.-Dec.

Baseline scenarioDiverging business conditions scenarioEmerging markets stress scenarioFinancial stress scenario

Oct.-Dec. 2019=100Simulation period

9095

100105110115120125

Oct.-Dec.19

Apr.-June20

Oct.-Dec.

Apr.-June21

Oct.-Dec.

Apr.-June22

Oct.-Dec.

Apr.-June23

Oct.-Dec.

Oct.-Dec. 2019=100

Simulation period

859095

100105110115

Oct.-Dec.19

Apr.-June20

Oct.-Dec.

Apr.-June21

Oct.-Dec.

Apr.-June22

Oct.-Dec.

Apr.-June23

Oct.-Dec.

Baseline scenarioDiverging business conditions scenarioEmerging markets stress scenarioFinancial stress scenario

Oct.-Dec. 2019=100

Simulation period

859095

100105110115

Oct.-Dec.19

Apr.-June20

Oct.-Dec.

Apr.-June21

Oct.-Dec.

Apr.-June22

Oct.-Dec.

Apr.-June23

Oct.-Dec.

Oct.-Dec. 2019=100

Simulation period

Economic scenariosChart V-2-2: Economic scenarios for simulation (Japan)


24

Chart V-2-3: Economic scenarios for simulation (overseas)

Chart V-2-3: Economic scenarios for simulation (overseas)United States Asia and Pacific

Quarterly real GDP Quarterly real GDP

Source: BEA; Cabinet Office; Eurostat; Haver Analytics; IMF; Japan Center for Economic Research, "ESP forecast.“

0200400600800

1,0001,2001,400

07 09 11 13 15 17 19 21 23

bpsSimulation period

-0.5

0.0

0.5

1.0

1.5

2.0

07 09 11 13 15 17 19 21 23

Simulation period

%

60708090

100110120130140

07 09 11 13 15 17 19 21 23

yenSimulation period

CY

Baseline scenario

Diverging business conditions scenario

Emerging markets stress scenario

Financial stress scenario

0

500

1,000

1,500

2,000

2,500

07 09 11 13 15 17 19 21 23

Simulation periodpts

CY

Financial market scenariosChart V-2-4: Financial market scenarios for simulation


25

Exchange rate(USD/JPY)

U.S. corporate bond spread(BBB)

Japanese stock price(TOPIX)

Note: Long-term interest rate indicates 10-year government bond yield.Source: Bloomberg; FRB; Ministry of Finance, "Interest rate."

Long-term interest rate(Japan)

0

1

2

3

4

5

6

07 09 11 13 15 17 19 21 23

%

Simulation period

Long-term interest rate(United States)

0

1

2

3

Base

line

scen

ario

Dive

rgin

gbu

sine

ss c

ondi

tions

scen

ario

Emer

ging

mar

kets

stre

sssc

enar

io

Fina

ncia

lst

ress

scen

ario

%

0

1

2

3

Base

line

scen

ario

Dive

rgin

gbu

sine

ss c

ondi

tions

scen

ario

Emer

ging

mar

kets

stre

sssc

enar

io

Fina

ncia

lst

ress

scen

ario

%

0

1

2

3

Base

line

scen

ario

Dive

rgin

gbu

sine

ss c

ondi

tions

scen

ario

Emer

ging

mar

kets

stre

sssc

enar

io

Fina

ncia

lst

ress

scen

ario

Overseas

Domestic

%

Stress testing results: credit cost ratios In the baseline scenario, the average credit cost ratios for fiscal 2021-2023 (annualized) remain at about 0.2 percent for

all types of banks. In all three downside scenarios, they increase more than in the baseline scenario. For internationally active banks, the credit cost ratios reach similar levels in the "diverging business conditions" and

"emerging markets stress" scenarios, and increase further in the "financial stress scenario." For domestic regional banks and shinkin banks, they are relatively low in the "emerging markets stress scenario."

This difference between the types of banks stems from the divergence in the shares of overseas loans and loans to the face-to-face services industry.

Internationally active banks


26

Chart V-2-6: Credit cost ratios (3-year cumulative totals)Domestic regional banks Shinkin banks

Note: Credit cost ratios are cumulative totals of fiscal 2021 to 2023.

-2

-1

0

1

23

4

5

6

7

19 20 21 22 23Baseline scenario Diverging business conditions scenarioEmerging markets stress scenario Financial stress scenario

FY

y/y % chg.Simulation

-20

-15

-10

-5

0

5

10

15

20

19 20 21 22 23FY

y/y % chg.

Simulation

Stress testing results: domestic and overseas loans outstanding In the baseline scenario, domestic and overseas loans outstanding continue to show positive growth throughout the

simulation period as economic activity recovers at home and abroad. The growth in domestic loans outstanding in the downside scenarios falls below the baseline scenario. In the "financial

stress scenario" in particular, the annual rate of change turns negative in fiscal 2022.


27

Chart V-2-7: Loans outstanding (total of financial institutions)Overseas loansDomestic loans

10.4 9.5 9.8 8.8

0

5

10

15

20

25

Base

line

scen

ario

Dive

rgin

g bu

sine

ssco

nditi

ons

scen

ario

Emer

ging

mar

kets

stre

ss s

cena

rio

Fina

ncia

lst

ress

scen

ario

10th-90th percentile range

%

4.0%

12.7 11.8 12.1 11.5

0

5

10

15

20

25

Base

line

scen

ario

Dive

rgin

g bu

sine

ssco

nditi

ons

scen

ario

Emer

ging

mar

kets

stre

ss s

cena

rio

Fina

ncia

lst

ress

scen

ario


%

4.0%

12.310.9

9.67.2

0

5

10

15

20

25

Base

line

scen

ario

Dive

rgin

g bu

sine

ssco

nditi

ons

scen

ario

Emer

ging

mar

kets

stre

ss s

cena

rio

Fina

ncia

lst

ress

scen

ario


%

8.5%

4.5%7.0%

Internationally active banks Domestic regional banks Shinkin banks

Stress testing results: capital adequacy ratios and summary of stress testing

Note: 1. The left chart shows the CET1 capital ratios of internationally active banks. The middle and right charts show the core capital ratios of domesticregional banks and shinkin banks. The transitional arrangements for domestic regional banks and shinkin banks are taken into consideration.

2. Markers in the charts indicate the total of financial institutions for each type of bank.


28

Japan's financial system is likely to remain highly robust even in the case of future resurgence of COVID-19 or adjustment in global financial markets and emerging economies due to a rise in U.S. long-term interest rates.

However, in the event of a substantial and rapid adjustment in global financial markets, a deterioration in FIs' financial soundness and the resultant impairment of the smooth functioning of financial intermediation could pose a risk of further downward pressure on the real economy.

Chart V-2-11: Capital adequacy ratios (fiscal 2023)

Appendixes

29

-4.0

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

Base

line

scen

ario

Dive

rgin

g bu

sine

ssco

nditi

ons

scen

ario

Emer

ging

mar

kets

stre

ss s

cena

rio

Fina

ncia

lst

ress

scen

ario

Bonds excluding credit productsDomestic credit productsOverseas credit productsEquities and fundsTotal

%

Note: 1. Relative to risk-weighted assets at the end of fiscal 2020.

2. "Total gains/losses on securities holdings" is the sum of cumulative totals of realized gains/losses on securities holdings from fiscal 2021 to 2023 and changes in unrealized gains/losses on securities holdings from the end of fiscal 2020 to fiscal 2023. Unrealized gains/losses on securities holdings take tax effects into account.

Stress testing results: total gains/losses on securities holdings and lending margin In the "diverging business conditions" and "financial stress" scenarios, the total gains/losses on securities holdings for

internationally active banks are pushed down by equities and funds as well as overseas credit products, while bonds underpin them due to a decline in interest rates. In the "emerging markets stress scenario," bonds inflict a loss due to a rise in long-term interest rates.

In the "diverging business conditions" and "emerging markets stress" scenarios, the lending margins for internationally active banks remain at the same level as in the baseline scenario because the increase in domestic lending margins is offset by the contraction in overseas lending margins. In the "financial stress scenario," the further contraction in overseas lending margins due to higher foreign currency funding costs leads to a decline in overall lending margins.

Total gains/losses on securities holdingsfor internationally active banks

Appendix 1

30

Funding rate, lending rate, and lending marginfor internationally active banks

19 20 21 22 23Lending margin Funding rate Lending rate

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

19 20 21 22 23

%

Simulation

FY 19 20 21 22 2319 20 21 22 23

SimulationSimulation Simulation

Baseline scenario

Diverging business conditions

scenarioEmerging markets

stress scenarioFinancial stress

scenario

12.3

10.9

6

7

8

9

10

11

12

13

14

15

Base

line

scen

ario

Incr

ease

in u

nrea

lized

loss

eson

sec

uriti

es h

oldi

ngs

Incr

ease

in c

redi

t cos

tsD

ecre

ase

in P

PNR

(exc

l. tra

ding

inco

me)

Impr

ovem

ent i

n re

aliz

edga

ins/

loss

es o

n se

curit

ies

hold

ings

Incr

ease

in ri

sk-w

eigh

ted

asse

tsO

ther

fact

ors

Dive

rgin

g bu

sine

ssco

nditi

ons

scen

ario

%CET1 capital ratioIncreasing factorDecreasing factor

12.3

9.6

6

7

8

9

10

11

12

13

14

15

Base

line

scen

ario

Incr

ease

in u

nrea

lized

loss

eson

sec

uriti

es h

oldi

ngs

Incr

ease

in c

redi

t cos

tsD

ecre

ase

in P

PNR

(exc

l. tra

ding

inco

me)

Det

erio

ratio

n in

real

ized

gain

s/lo

sses

on

secu

ritie

s ho

ldin

gsIn

crea

sein

risk

-wei

ghte

d as

sets

Oth

er fa

ctor

s

Emer

ging

mar

kets

stre

ss s

cena

rio

%CET1 capital ratioIncreasing factorDecreasing factor

12.3

7.2

6

7

8

9

10

11

12

13

14

15

Base

line

scen

ario

Incr

ease

in u

nrea

lized

loss

eson

sec

uriti

es h

oldi

ngs

Incr

ease

in c

redi

t cos

tsD

ecre

ase

in P

PNR

(exc

l. tra

ding

inco

me)

Det

erio

ratio

n in

real

ized

gain

s/lo

sses

on

secu

ritie

s ho

ldin

gsIn

crea

sein

risk

-wei

ghte

d as

sets

Oth

er fa

ctor

s

Fina

ncia

l stre

ss s

cena

rio

%CET1 capital ratioIncreasing factorDecreasing factor12.5 12.3

6

7

8

9

10

11

12

13

14

15

End

of F

Y20

20U

nrea

lized

loss

eson

sec

uriti

es h

oldi

ngs

Cre

dit c

osts

PPN

R(e

xcl.

tradi

ng in

com

e)R

ealiz

ed g

ains

/loss

eson

sec

uriti

es h

oldi

ngs

Incr

ease

in r

isk-

wei

ghte

d as

sets

Oth

er fa

ctor

s

End

of F

Y20

23

%

CET1 capital ratioIncreasing factorDecreasing factor

Stress testing results: decomposition of CET1 capital ratioCharts V-2-12, 13: Decomposition of CET1 capital ratio (internationally active banks)

31

Appendix 2

Note: 1. The left chart indicates the contribution of each factor to the difference between the capital adequacy ratios at end-March 2021 and the end of the simulationperiod (as at end-March 2024) under the baseline scenario. The other charts indicate the contribution of each factor to the difference between the capitaladequacy ratios at the end of the simulation period (as at end-March 2024) under the baseline and downside scenarios.

2. "Unrealized losses on securities holdings" takes tax effects into account.3. "Other factors" includes taxes, dividends, and CET1 regulatory adjustments.

Baseline scenario Diverging business conditions scenario

Emerging markets stress scenario

Financial stress scenario

financial system report summary

Documents