Japan’s Financial Services Agency (FSA) is set to intensify its scrutiny of a booming market involving $67 billion in high-yield loans backed by government bonds, as concerns grow about the associated risks. These loans, which have gained traction among regional banks, are often repackaged Japanese government bonds (JGBs) bundled with derivatives, offering higher returns but potentially hiding substantial risks.
The FSA has expressed concerns that some regional banks may lack proper risk management strategies, potentially leading to significant losses if market conditions shift unfavorably. The products allow banks to avoid marking their holdings to market, sidestepping the potential for paper losses that would occur if they held JGBs directly, especially if interest rates rise. However, depending on the structure of the loans, the banks may still suffer from a negative spread, where the returns on the products fall short of the costs paid to depositors.
Toshinori Yashiki, the FSA’s Director-General of the Strategy Development and Management Bureau, revealed that the agency had observed an increase in the purchasing of these repackaged loans by regional banks, even after warnings were issued in January 2024. As of September 2024, the total value of repackaged loans, including those backed by assets other than JGBs, had surged by 20% to 30% year-on-year, reaching nearly ¥10 trillion ($67 billion). While the exact portion backed by JGBs remains unclear, it is known to be in the billions of dollars.
The market for these loans is attractive to regional banks, as they can count the loans as part of their lending portfolios, allowing them to avoid the volatility of bond markets while growing their balance sheets. However, the FSA has raised concerns about the transparency of these products, as there is no requirement for banks to disclose their holdings, leading to a lack of visibility into the risks involved. Yashiki emphasized that these loans often don’t contribute to the communities served by the banks, as they are more akin to bond investments rather than community-focused lending.
To address these risks, the FSA plans to examine whether aggressive marketing by securities firms and trust banks is contributing to the rising demand for these products. The agency also intends to work with the banking industry to improve disclosure practices, ensuring that banks provide greater transparency on their holdings of repackaged loans.
The crackdown highlights the growing concern over financial products that may be too opaque and risky, particularly for regional banks that may lack the expertise or scale to manage complex portfolios like those of Japan’s larger financial institutions. The FSA’s efforts aim to ensure that these products don’t jeopardize the financial stability of the banks or the broader economy.
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