American First Republic Bank created waves with its bankruptcy. (© Getty via Kyodo)
Speculation abounds as to whether the United States interest rate hike that triggered the collapse of US banks and financial instability will also affect Japan. However, the impact is already manifesting in regional banks.
According to a survey, unrealized losses on foreign bonds and other assets held by 99 regional banks reached ￥1.5 trillion JPY (minus $11 billion USD) as of December 2022. This sudden spike represents a nine-fold increase from March of the same year.
The sharp rise in interest rates caused the price of foreign bonds to fall. In reaction to this precipitous decline, Kirayaka Bank in Yamagata City began considering applying for an injection of public funds in 2022. Then in April, it was announced that the bank would apply by September 2023.
If the Bank of Japan (BOJ) were to engage in a rash monetary tightening policy, unrealized losses on Japanese government bonds would mount. This could lead to the collapse or restructuring of regional banks.
In contrast, the market value of Bitcoin, a crypto asset, has skyrocketed. Bitcoin's reevaluation as a "safe asset" in times of crisis has also been gaining widespread credence. The current financial turmoil may be the first step toward a change in the way the financial system works.
Finance Minister's Perspective
On March 14, during the incipient stages of this financial uncertainty, Finance Minister Shunichi Suzuki held a press conference. "Japanese financial institutions have a strong capital base," he said. "The collapse (of Silicon Valley Bank and others) is unlikely to have a significant impact on the stability of Japan's financial system."
However, Suzuki's words are not particularly reassuring.
Japan Asset Management Platform (JAMP) is a consultation group that provides support to financial institutions. According to the organization, regional banks had ￥551.1 billion JPY ($4.05 billion USD) in unrealized gains on foreign bonds and other assets as of the end of March 2021. However, by the end of March 2022, this had turned into an unrealized loss of ￥162.7 billion JPY (minus $1.23 billion USD).
By the end of December 2022, this had increased to ¥1.515.9 trillion JPY (minus $11.13 billion USD). In order to curb severe inflation, the US, Europe, and other countries scrambled to raise interest rates. These rate hikes are what caused the prices of foreign bonds held by regional banks to plummet.
What Happened in Silicon Valley
Symptomatic of this financial climate is Silicon Valley Bank (SVB), which became the second US bank in history to fail in March of this year. The bank, which had been aggressively lending to startups, had invested most of its deposits in bonds, such as US Treasury bonds. Although the risk of default was low, as interest rates rose, prices fell, spelling a downturn.
The Federal Reserve Board (FRB) commenced interest hikes in 2022. In theory it sought to control the progression of inflation accompanying the economic recovery from the COVID-19 crisis. As SVB's unrealized losses grew, rumors of a looming crisis spread across social media. Customers subsequently began withdrawing their money en-masse, bringing the bank's business to a standstill.
Status of Japanese Government Bonds
Japanese government bonds have also been suffering considerable unrealized losses. This should be a cause for concern for Japan's regional banks.
According to JAMP, JGBs held by banks turned into unrealized losses of ￥1.996 billion JPY (minus $14.6 million USD) at the end of March 2022. Late December 2022 saw this figure jump to ￥1.525.9 trillion JPY (minus $11.2 billion USD).
One possible reason is that in December, the BOJ decided upon a "de facto interest rate hike" by increasing the upper limit on the range of fluctuation of long-term interest rates from 0.25% to 0.5%. As market interest rates rose, the price of JGBs held by regional banks also dropped.
Watching Ueda's Moves
The focus will now be on the pace and magnitude of the BOJ's moves to tighten monetary policy in response to the adverse effects of long-term, large-scale monetary easing. Governor Kazuo Ueda, who took office in April of this year, was cautious about an early interest rate hike. His comment was, "Large-scale monetary easing will continue under the current circumstances."
However, it is widely believed that tightening is inevitable. As Masayoshi Matsumoto, chairman of the Kansai Economic Federation, indicated, "Deep down, they (probably) see the current situation as problematic."
Regional banks have so far been inclined to invest in bonds and securities because they have been unable to earn money through loans. That is due to low-interest rates resulting from massive easing.
According to JAMP, as of the end of March 2022, regional banks had invested in the following securities:
- government bonds = 20%,
- municipal bonds = 22%,
- corporate bonds = 17%,
- stocks = 9%, and
- other securities such as foreign bonds = 32%.
The ratio of bonds is high, and if interest rates continue to rise, unrealized losses will increase. If the amount of unrealized losses becomes large enough, there is a risk of a significant reduction in profits or a loss of equity capital.
Other Upcoming Problems
There are also other budding crises. Take, for example, the case of Kirayaka Bank, a subsidiary of Jimoto Holdings (Sendai City). One of the reasons for its decision in May 2022 to consider applying for an injection of public funds is the growing valuation losses on securities holdings.
As of the end of March 2022, unrealized losses on "other securities," such as foreign bonds, totaled ￥12.1 billion JPY (minus $89 million USD). This is more than four times the amount the previous year.
If it were to secure a handout from the government in the form of public funds, the bank would be able to weather the storm. Without such help, however, weaker regional banks will suffer.
Should interest rates continue to rise in Japan and the US, unrealized losses on foreign and government bonds will increase further. The possibility that some regional banks will consequently be forced into bankruptcy as their operations are squeezed cannot be ruled out.
Bitcoin Value Surges to $30,000
Local economies still recovering from the COVID-19 pandemic will run out of money lenders. In turn, that will lead to bankruptcies among small and medium-sized businesses. Out of caution, regional banks are now restructuring through consolidation and mergers to avoid such a situation. As a result, the map of financial institutions' power may be redrawn.
Meanwhile, looking at the market, crypto assets are beginning to attract attention. A notable example is the value of Bitcoin. The cryptocurrency has skyrocketed in value since the collapse of Silicon Valley Bank, reaching $30,000 a share in April.
In a March report analyzing Bitcoin's price increase, ARK Invest, a US asset management firm, considered Bitcoin's value a "safe asset." The firm observed, "As US banks failed, Bitcoin became a haven for funds, surpassing the investment performance of government bonds and gold (regarded as safe assets)."
Subject as it is to wild value fluctuations, there remain many challenges for Bitcoin to overcome. However, a reappraisal of its role may transform the concept of financial assets into something entirely new.
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(Read the report in Japanese.)
Author: Nobuhiko Yamaguchi, Deputy Director, Economic News Department
