June 28, 2017 2:02 pm JST

$1tn in dollar exposure has Japanese banks in deep water

Lenders, in reach for yield, make selves vulnerable to Lehman-like shock

MITSURU OBE, Nikkei staff writer

Japanese flags flutter in Tokyo's business district. © Reuters

TOKYO -- Japanese banks are pursuing a dangerous strategy of loading up on foreign assets with money borrowed from overseas, a global banking watchdog has warned.

Their net holdings of dollar assets have doubled to about $1 trillion since before the Lehman shock in 2008, according to data released this week by the Bank for International Settlements.

The amount is the difference between their holdings of dollar assets, worth about $3.5 trillion, and their dollar liabilities, around $2.5 trillion.

Their net holdings could be even bigger if assets denominated in other currencies, such as the euro, are included.

According to the Bank of Japan, Japanese banks' net foreign assets totaled as much as $2.27 trillion as of the end of March, an all time high.

Their growing appetite for foreign assets is fueled by the ultra-low interest rates in Japan, which has forced banks to look overseas for riskier -- but higher-yielding -- assets, the BOJ said in its analysis.

Small banks that serve sluggish rural economies appear to be especially reliant on foreign bonds for income. Hokuetsu Bank, for instance, ramped up its foreign bond purchases by 46% in the year through March 2016, perhaps partially because the BOJ had introduced negative interest rates during that span. During the next 12 months, however, Hokuetsu went in the opposite direction. As its profitability dropped, its foreign bond purchases fell 31%. "We will take due consideration of market risks and respond to changes flexibly," a bank spokesman said. 

Japan's increased exposure stands in contrast to a sharp drop in Germany's. Having suffered severe dollar shortages during the Lehman crisis, German banks have moved to cut their exposure to dollar assets, to zero from around $200 billion in 2007, according to the BIS.

Since Japanese banks do not have access to retail dollar funding, they borrow dollars on a short-term basis, such as through currency swaps, to pay for their investment, said the BIS, a Switzerland-based consortium of central banks around the world.

The reliance on short-term dollar funding raises rollover risks. Securing dollar funding may become difficult if a credit crunch hits the market, like the one in 2008.

"Global U.S. dollar funding markets are likely to be a key pressure point during any future market stress episode," the BIS said. "Non-U.S. entities' U.S. dollar funding needs remain large, posing potentially sizable rollover risks."

During the Lehman crisis, the U.S. Federal Reserve provided emergency loans to European banks to help ease their funding difficulties.

Such help may not be forthcoming in the next financial crisis, the BIS warned. Foreign banks these days often borrow dollars from outside the U.S., such as from oil-exporting nations. The Fed is unlikely to provide a backstop for such transactions.

To reduce the risks of a global financial crisis, regulators should step up their oversight of banks, including through stress tests on their reliance on currency swap deals, the BIS said.

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