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Banks too aggressive in risk-taking, says Bank of Japan

: Banks too aggressive in risk-taking, says Bank of Japan

The central bank implied in a report that lending at Japanese banks is showing hints that it is creeping towards overheating

It also added that ultralow interest rates were pushing lenders to grow even more aggressive with even less-profitable loans in real estate or small businesses.

The October edition of the Bank of Japan’s semiannual Financial System Report was however, upbeat on certain fronts. The nation’s financial system “has been maintaining stability on the whole,” it said, reusing April’s phrasing. Though the report is sometimes referenced in crafting monetary policy, its content “does not press for revising” it, according to a BOJ official.

In terms of financial activities, the central bank noted that “no signs of overheating was observed during the bubble period in the late 1980s” — a revision to April’s “no particular signs of overheating” that suggests cause for concern is gradually growing.

In index used to track financial activity in June, incorporating data from businesses and household finance as well as conditions in real estate and other areas, crept closer to the overheating line from the previous reading in March—- reaching the highest levels since December 1990.

A source of major concern was the increased low-interest lending to middle-risk companies as funding demand flags among more creditworthy borrowers. In a BOJ survey cited in Monday’s report, many regional lenders reported that “loan interest rates for middle-risk firms do not adequately match credit costs through the business cycle.”

The report also pointed out that real-estate-related lending has been increasing even as the quality of both borrowers and expected rental property returns has worsened.

Excessive lending usually gives the economy a push in the near term, but it can also leave banks with a lot of bad loans to dispose of– so the risk of a future downturn in gross domestic product growth increases as lending activity grows more aggressive.

The BOJ has employed an analytical approach called “GDP-at-risk” that calculates probability distributions for future growth.

A number of structural factors underlie banks’ toughening earnings environment, including the shrinking national population and intensifying competition among lenders, but there is also severe pressure from the country’s long-running monetary easing program, whose side effects are accumulating over time.

The BOJ intends to scrutinize the financial system from a range of perspectives. One official noted: “it’s becoming more necessary to keep watch for even small changes in vulnerability.”

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