Japan regulator urges banks to brace for Fed hike, market volatility

By Sumio Ito and Leika Kihara

TOKYO (Reuters) – Japan’s financial regulator is urging banks to strengthen safeguards against potential market turbulence from a U.S. interest rate hike expected later this year, according to a document seen by Reuters.

Policymakers believe Japan’s banking system remains sound with no immediate signs of financial imbalances or excessive risk-taking.

But with massive holdings of Japanese government bonds (JGB) and increased exposure to overseas lending, Japanese banks remain vulnerable to losses if interest rate hikes by the Federal Reserve, expected to begin this year, trigger a spike in global bond yields.

The Financial Services Agency, the country’s financial regulator, is warning banks to be ready to cope with market volatility that may heighten from the Fed rate hike – as well as from the Greek debt crisis and China’s shadow banking woes.

“Such overseas developments … may not directly affect Japanese banks,” FSA Commissioner Kiyoshi Hosomizo told regional bank executives in a meeting earlier this month, according to the minutes of the meeting.

“But they will undoubtedly have (spill-over) effects via the economy and markets,” he said. “It is therefore important (for banks) to take appropriate risk-management measures,” such as conducting stress tests and holding ample capital and liquidity at hand.

An FSA spokesman declined to confirm Hosomizo’s remarks.

Policymakers around the world are bracing for some bouts of market volatility as the Fed embarks on its first rate hike in nearly a decade on signs of strength in the U.S. economy.

The Bank of Japan’s aggressive money printing has crushed market interest rates – the 10-year JGB yields barely 0.5 percent – and prodded banks to unload 34 trillion yen ($28 billion) in JGBs in the past two years.

Still, Japanese banks hold roughly 125 trillion yen in JGBs and 50 trillion yen in foreign securities, BOJ data show.

Reflecting such changes in money flow, the FSA and the BOJ have jointly stepped up their “macroprudential” oversight – looking to identify and minimize risks to the financial system amid broad shifts to the economy.

The BOJ estimates that most banks have capital buffers to withstand a 2 percentage-point rise in long-term interest rates. But a 1-point rise would hit banks with 7.5 trillion yen in valuation losses on their JGB holdings.

(Additional reporting by Takahiko Wada and Taiga Uranaka; Writing by Leika Kihara; Editing by William Mallard and Richard Borsuk)