TOKYO -- Japan's financial watchdog is launching audits of regional banks seen saddled with significant paper losses after shifting from Japanese government bonds to higher-yielding foreign debt and complex instruments.
The Financial Services Agency will first conduct on-site inspections of asset-management divisions at around three regional banking groups, widening the probe if needed. The targets will likely be banks owning a large proportion of foreign bonds.
The FSA has conducted multiple inquiries whenever issues emerged over the past few years, but this will be the first time it focuses solely on asset-management divisions. The agency will unearth details concerning risk-management mechanisms in place and the financial products in which the banks have invested.
The lenders have been shying away from JGBs since the Bank of Japan instituted its negative interest rate policy, opting instead for foreign bonds and other instruments that offer higher yields. But rising interest rates result in shrinking portfolio valuations. At some regional banks, paper losses have ballooned to as much as 1.5 times their annual income due to the recent spike in U.S. Treasury yields.
Normally such problematic securities would be sold off at a loss, but some banks have allegedly held on to the debt and unrealized losses have kept growing.
The FSA probe will also determine how personally involved the president and other senior managers at regional banking groups have been in the decision-making process at asset-management segments. The institutions will be asked to make improvements if such segments are taking on excessive risks, such as owning a large volume of complex securitized products without having sufficient ability to manage such assets.
Compared with judging the creditworthiness of lending clients, forecasting the fluctuating market risks accompanying asset management is less precise. The exposure could even escalate sharply, such as during the 2008 global financial crisis.
Long-term U.S. yields hovered around 1.8% before the November U.S. presidential election, then jumped to the 2.6% range after Donald Trump's victory. That trend has put the squeeze on Japan's regional banks. Shizuoka Bank, serving the central Japanese prefecture, recorded 25 billion yen ($218 million) in capital losses after selling Treasurys and other securities during the three quarters through December 2016.
For the same period, 60 out of 82 regional banks and groups reported smaller profits. Although American yields have settled somewhat as of late, the higher rates will likely impact earnings for the full year ending this month.