Credit Suisse Reinforces Japan’s Offshore Anxiety

The crisis at Credit Suisse (CS) has traders wondering who’s next. Japanese lenders, with their staid depositor bases, look like unlikely targets for bank runs. Yet their collective overseas bond portfolio is in focus. So it should be.

For years the country’s ultra-low interest rates encouraged deposit-taking institutions, lenders, and other investors to borrow yen and buy higher-yielding but relatively safe assets. This helped Japan overtake China as the top foreign owner of U.S. Treasuries in 2019; they owned an estimated $2 trillion of foreign bonds as of last year. On paper, the sequence of rate hikes in Western economies make such positions even more profitable.

Yet the rising cost of short-term dollar and euro credit, combined with extreme yen volatility, have made hedging much more expensive. As Brad Setser and Alex Etra at the Council on Foreign Relations explain, the inversion of the American yield curve makes it unprofitable to borrow short-term dollars and buy long-term Treasuries. Japan Inc was reducing positions well before Silicon Valley Bank imploded.

One worry is that the Japanese will liquidate their massive overseas portfolios in concert, should domestic sovereign bond prices suddenly fall. Nomura puts that value of that larger bucket, including equities, at $6 trillion, with half of that hedged.

Domestic commercial lenders alone held $600 billion of international debt securities at the end of 2022, and some look overexposed. Take Japan Post Bank, a $32 billion institution whose parent is partly owned by the Ministry of Finance. Foreign bonds make up 34% of its assets and overseas securities generated two-thirds of its gross interest income in the nine months ending in December. Its net interest margin was a parlous 0.4% during that period.

Market uncertainty makes it difficult for the Bank of Japan’s incoming Governor Kazuo Ueda to normalize rates, which is bad news for lenders but also reduces the risk they will be forced to sell to cover losses on their domestic holdings. This counterbalance, plus reassurance from Japanese officials, has eased shareholders’ concern to some extent. The Topix banks index is back where it was in December, neatly reversing a rally driven by anticipation of imminent BOJ rate hikes, which seems fair.

Regardless, given how much riskier once safe-looking foreign bonds are to trade, Japan is certain to keep cutting exposure.

Context News

Japan’s top government spokesperson said on March 20 that the domestic banking system was stable. Chief Cabinet Secretary Hirokazu Matsuno welcomed the decision by top central banks, including the Bank of Japan, to bolster the global flow of cash by expanding an existing swap line to ensure lenders have sufficient dollars needed to operate. In coordination with central banks elsewhere, the U.S. Federal Reserve offered daily currency swaps to ensure banks in Canada, Britain, Japan, Switzerland, and the eurozone would have the dollars needed to operate. Japanese financial institutions have sufficient capital buffers to absorb losses caused by various external factors, including risks caused by the collapse of U.S. lender Silicon Valley Bank, the Bank of Japan said on March 14.

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