IMF warns on Japan’s sovereign-banking nexus

IMF says that Japan’s financial stability faces increasing risk because its domestic banks hold huge amounts of government debt.

“The rising concentration of government bond risk in the domestic banking system is a central financial stability concern in Japan,” says IMF (page 52/64).

Japan has been recently mentioned as the potential future financial turmoil spot due to its huge debt and anemic growth although some say that Japan’s heavy domestic ownership of the debt is a good thing.

However, IMF says that the “increase in exposure to government bonds would make bank capital even more susceptible to a major interest rate shock in the future, particularly in the case of regional banks.”

“According to estimates by the Bank of Japan (BOJ), a 100 basis point increase in interest rates across the yield curve would lead to mark-to-market losses of 20 percent of Tier 1 capital for regional banks, and of 10 percent for the major banks,” says IMF.

Regionals are even worse.

“A 100 basis point shock in 2017 would result in mark-to-market losses of 26 percent of regional banks’ Tier 1 capital,” says IMF.

Another potential negative is the increased involvement of foreign ownership of Japan’s debt. As the graph above shows, Europe and US own the largest share of this foreign ownership category so contagion out of Europe into US banks could adversely impact Japan.

“If severe enough, such a shock could derail the sustainability of Japan’s public debt and create sizable losses for banks, especially regional banks,” says IMF.

Japan eyes reconstruction boom

Japan’s chairman of the Reconstruction Design Council said that the country’s reconstruction plans will spark an economic boom in the country that will repay the reconstruction debt and make the country less reliable on long term debt.

The government is set to spend $250 billion rebuilding the country hit by a quake but it is still unclear where the money will come from. Resolving the funding issue pushes the reconstruction decision into the fall as politicians are squabbling between issuing bonds and hiking taxes.

Japan’s debt is 200% of the GDP and some argue that such a debt load makes Japan a candidate for a financial meltdown.

J. Kyle Bass, head of Dallas-based Hayman Advisors LP, says that shorting Japan is even “more compelling” then shorting the US sub-prime meltdown because the reconstruction spending would push the country over the edge as the government spends half its revenue on servicing the debt.

Bass argues that Japan “will be in the spotlight immediately” after Greece sparks sovereign domino defaults.

Others disagree, citing Japan’s postal system as an institution that is hoarding $15 trillion.