## 1jpnea2024001 ## Source details **Canonical URL:** [1jpnea2024001](https://www.imf.org/-/media/files/publications/cr/2024/english/1jpnea2024001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2024/english/1jpnea2024001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2024/english/1jpnea2024001.pdf.json) --- ### Executive summary — macrosystem resilience and trajectory - The Japanese financial system "has remained resilient through a series of shocks including the COVID-19 pandemic." - Credit provision to the private sector has remained robust, supporting a steady recovery. - The financial system is at a critical juncture following the end of the BOJ negative interest rate policy and yield curve control amid sustained inflationary pressures. ### Executive summary — key vulnerabilities and structural challenges - Three main sources of vulnerability: - Sizable domestic and foreign security holdings of financial institutions under mark-to-market accounting. - Notable foreign currency (FX) exposure of some banks. - Signs of overheating in parts of the real estate markets. - Structural transformations that could accentuate risks: climate change, digitalization, and an aging population. ### Executive summary — scenario-based systemic risk analysis (summary findings) - Overall: "the financial system remains broadly resilient to a range of adverse macrofinancial shocks, with some areas of susceptibility." - Banks: - Aggregate solvency: banks "are, in aggregate, well able to maintain their solvency position" under a hypothetical adverse scenario, though some banks may be susceptible. - Liquidity: "contained at the system level due to ample liquidity in Japanese Yen (JPY)," but some banks are susceptible due to liability-side FX exposures and undrawn FX commitments. - Insurers: - Life insurers are sensitive to increases in domestic and foreign interest rates; aggregate capital remains well above regulatory requirement. - Liquidity: "not significantly exposed to liquidity risk, but some may face pressure under stress." - Investment funds: - "Generally well positioned to accommodate plausible-sized investor redemption shocks"; less-liquid funds could contribute to market volatility under more severe shocks. - Nonfinancial private sector: - Smaller firms are particularly susceptible to higher default risk under the adverse scenario. - Households: defaults would rise from a very low level; the industry practice (5-year/125-percent rule) could mitigate a sharp increase in mortgage payments. - Systemic contagion: - "Systemic contagion risks are limited by the strong capital positions of major financial institutions, but some institutions appear vulnerable to contagion risks." ### Executive summary — climate risk analysis - Under a net zero GHG emissions by 2050 transition scenario: - "Banks are generally resilient to a transition to net zero greenhouse gas (GHG) emissions by 2050." - Banks’ exposure to emission-intensive sectors constitutes, on average, about one-fifth of their assets. - Impact on capital positions varies across banks in the sample. ### Executive summary — financial sector oversight and crisis management (developments and gaps) - Progress since 2017 FSAP: - FSA adopted a more modern, risk-based bank supervision approach. - Basel III capital and liquidity tools phased in for internationally active and D-SIBs. - Insurance macroprudential supervision improved; ComFrame guidelines and supervisory colleges established for four internationally active insurance groups. - Investment funds’ oversight enhanced; cyber capacity and crisis management frameworks strengthened. - Remaining and recommended actions (high-level): - Significantly increase staffing resources, with emphasis on regional banks and insurance supervision. - Strengthen systemic risk monitoring: fill data gaps for contagion analysis, introduce stress testing for investment funds, conduct comprehensive liquidity risk analysis for banks and insurers, perform more granular nonfinancial private sector risk analysis. - Banking supervision: continue risk-based approach; "Set minimum liquidity requirements for all banks."; give FSA power to set and adjust individual bank capital ratios above the minimum; "Explicit provision needs to be made in the law to ensure the priority of financial stability in the mandate of the FSA." - Insurance oversight: delegate licensing powers to the FSA; review FSA budgetary independence; establish a proactive risk-based supervisory framework; ensure suitability requirements apply to all key persons; "The economic value-based solvency framework should be introduced as expected in fiscal year 2025." - Investment funds: enhance onsite supervision with more frequent inspections. - Digitalization and cyber: bolster cyber resilience, update FSA guidelines and Business Continuity Plan, strengthen cyber supervision of FMIs, monitor fintech developments. - Climate oversight: "Develop and publicize a clear plan towards formalizing supervision of climate-related risks." - Macroprudential policy: "Assign a formal mandate to the Council for Cooperation on Financial Stability (CCFS) and expand the policy toolkit." - Crisis management: protect BOJ’s financial soundness from ELA operations and mitigate moral hazard; "Expand ELA eligibility to systemic nonbank financial intermediaries (NBFIs), prioritizing central counterparties (CCPs)."; extend RRP requirements gradually to all banks that could be systemic at failure; increase minimum loss-absorbing capacity for more banks; ensure effective RRP for insurers and CCPs. ### FSAP key recommendations (select highlights and timelines) - Cross-cutting - Increase staffing resources significantly and strengthen skills (Government, FSA; ¶66-67). Timeline: ST - Systemic risk monitoring and macroprudential policy framework - "Further broaden and deepen systemic risk analysis" (FSA, BOJ; ¶68-69). Timeline: C - "Strengthen the governance of interagency decision-making on macroprudential policy by assigning a formal mandate to the CCFS" (FSA, BOJ; ¶63). Timeline: ST - "Expand the macroprudential policy toolkit with targeted borrower-based tools" (FSA, BOJ; ¶64). Timeline: MT - Banking sector regulation and supervision - Continue to strengthen risk-based supervision and develop the Early Warning System (FSA; ¶44). Timeline: I - Make explicit provision in the law to ensure the priority of financial safety and stability in the mandate of the FSA (Government; ¶45). Timeline: ST - Provide the FSA with the power to set and adjust individual bank capital ratios above the minimum (Government; ¶46). Timeline: ST - Establish a minimum liquidity requirement for domestic banks (FSA; ¶47). Timeline: ST - Insurance sector regulation and supervision - Establish a comprehensive risk-based, proactive supervisory framework (FSA; ¶50). Timeline: ST - Ensure suitability requirements apply to all key persons and strengthen control functions (FSA; ¶50). Timeline: ST - Delegate licensing powers to the Commissioner of the FSA and review FSA independence for budget/expenditure (Government, FSA; ¶51). Timeline: ST - Cyber resilience and financial stability - Update supervisory guidelines, methodologies, and tools for cybersecurity (FSA; ¶71). Timeline: MT - Enhance cyber supervision/oversight of FMIs (FSA, BOJ; ¶71). Timeline: ST - Investment funds and fintech - Broaden onsite supervisory approach to include more firms and larger asset managers (SESC; ¶54). Timeline: ST - Intensify monitoring of FTSPs and PPI issuers; consider reviewing regulatory framework (FSA; ¶56). Timeline: I/ST - Climate-related oversight - "Develop and publicize a clear plan towards formalizing supervision of climate-related risks" (FSA; ¶73). Timeline: MT - Financial safety net and crisis preparedness - Protect BOJ financial soundness and mitigate ELA moral hazard (BOJ, MOF, FSA; ¶76). Timeline: C - Expand ELA eligibility to some NBFIs, prioritizing CCPs (BOJ; ¶77). Timeline: MT - Gradually expand RRP to all banks that could be systemic at failure (FSA; ¶79). Timeline: ST - Execute a multi-year interagency crisis simulations program under the FCRC (All; ¶81). Timeline: C - Ensure effective recovery and resolution planning for insurers and CCPs (FSA, Government; ¶82). Timeline: MT --- ### Macroeconomic performance and inflation - Real GDP growth has averaged about two percent during 2021–2023 aided by strong policy support. - Headline and core inflation (excluding fresh food) have exceeded the BOJ’s 2 percent target since April 2022. - Real wages have declined since the pandemic; unemployment rate remained stable. - BOJ monetary policy shift: - Abolished YCC and QQE frameworks in March 2024 and ended the negative interest rate policy while maintaining gross JGB purchases broadly at the current pace. - BOJ decided to guide overnight rate as primary policy tool, encouraging the rate to remain at around 0-0.1 pct. ### Financial conditions, credit, debt, and markets - Domestic financial conditions generally easy recently: equity prices rose and corporate/interbank spreads declined. - Credit to private sector robust, driven by lending to NFCs and the real estate sector. - Sovereign debt to GDP has risen notably and is the highest among advanced economies. - Stock prices: TOPIX and Nikkei 225 rising by 25 percent and 28 percent in 2023 (y/y), respectively. - Japan’s financial system total assets nearly seven times GDP at end-2023. - Banking sector accounts for 60 percent of the financial system; one-third of banking assets held by three G-SIBs. - Insurance sector accounts for 12 percent of the financial system. - Investment funds account for 8 percent; pension sector (GPIF) 8 percent. - Tokyo Stock Exchange market capitalization: USD 6.2 trillion (146 percent of GDP) at end-2023. - NFC bond market capitalization: 16 percent of GDP in 2023. ### Real estate and household burden - Residential real estate (RRE) prices have risen; CRE prices increased though momentum slowed since end-2022. - About one-tenth of the population spend over 40 percent of disposable income on housing (cost overburden rate). - Housing loans increased notably since the pandemic; household loan-to-income and debt service ratios have been rising. ### External sector, interest rate differentials, and FX - Elevated interest rate differentials vis-à-vis other major economies implied persistent JPY depreciation pressures. - USD funding cost for Japanese firms rose with U.S. rate increases; banks’ USD liabilities constitute 30 percent of total liabilities. --- ### Overseas exposures, FX funding, and asset composition - Banks and NBFIs increased share of foreign assets to seek higher returns amid prolonged low domestic rates. - Most banks’ foreign assets are loans and debt securities; insurers hold sizable foreign debt and equities. - Banks’ liabilities in USD terms constitute 30 percent of total liabilities and mostly take the form of FX swaps and unsecured wholesale funding. - Banks’ LCR in USD terms rests below 100 percent (no minimum requirement currently in place). - Undrawn FX commitments through credit and liquidity lines amounted to two-thirds of total commitments at end-September 2023. - On average, about one-fifth of banks’ assets constitute securities (held under mark-to-market accounting). ### Key vulnerabilities and amplification channels (numeric highlights) - Securities exposure: about one-fifth of banks’ assets are securities held under mark-to-market accounting. - FX exposure: USD liabilities equal 30 percent of total liabilities; undrawn FX commitments = two-thirds of total commitments at end-September 2023. - Real estate overvaluation estimates: - RRE markets overvalued by, on average, 17 percent. - CRE markets overvalued by, on average, 30 percent. - CRE loans: about 11 percent of banks’ outstanding credit. - Retail mortgage loans: about 15 percent of banks’ outstanding credit. - Floating-rate mortgages: more than three-fourth of retail mortgage loans. - Loan-to-income (LTI) at origination: 4.2 at end-March 2022. --- ### Banking sector resilience — solvency and liquidity stress testing (selected results) - Banking solvency stress test scope: 23 banks (internationally active and domestic), covering 82 percent market share in total assets. - Aggregate CET1 ratio falls by 510 basis points in the first year of the adverse scenario but remains above regulatory minimum. - Bank-specific shortfalls: - Three (four) banks face capital shortfalls under the adverse scenario considering CET1 (total capital) as the reference metric. - Capital shortfall of these banks amounts to 0.04-0.05 percent of 2022 nominal GDP. - Four banks represent five percent of total assets of banks in scope. - Interest-rate sensitivity analysis: - Number of banks with CET1 (total capital) below hurdle rate rises to five (eight). - System-wide total capital shortfall rises to 0.3 percent of GDP. - Banking liquidity stress test: - Five banks, including three regional banks, representing 7 percent of total assets in the sample, would face a liquidity shortfall on an all-currency basis. - FX liquidity counterfactual: all-currency LCR remains above 100 percent for some banks, but USD LCR would fall by 30-40 percentage points for banks with large committed yet undrawn lines. - USD funding cost rise scenario: capital ratios fall by 0.5-1.2 ppt for a small number of banks. --- ### Insurance sector resilience — solvency and liquidity stress testing (selected results) - Coverage: 12 life and 10 non-life insurers (about 70 percent and 90 percent of respective segments). - SMR results under adverse scenario: - Life insurers: average SMR declines by 372 ppt; two of twelve life insurers do not meet statutory SMR requirement of 200 percent. - Non-life insurers: average SMR declines by 154 ppt; all ten remain above hurdle rate. - ESR results under adverse scenario: - ESR decreases on average by 67 ppt for life insurers and 41 ppt for non-life insurers; ESR remains above the hurdle rate of 100 percent for all insurers. - Liquidity stress test approaches and findings: - Margin calls on interest rate swaps could be met by drawing on about 20 percent of cash equivalents at system level; cash positions of at least two insurers could be inadequate under severe one-day moves. - Liquid assets ratio of life insurers is about 70 percent in the adverse scenario under stock-based approach. - Flow-based approach: large outflows, especially for life insurers, and reactive management (including asset sales) limit net outflows and allow meeting them by liquid assets in many cases. - Encumbrance levels for life insurers’ high-quality sovereign bond holdings are not trivial. --- ### Investment funds and liquidity - Japan-domiciled investment funds resilient to severe but plausible redemption shocks from historical data. - Under more severe shocks in the adverse scenario: - The share of funds with liquidity shortfalls could reach up to 18 percent of total asset value. - Depletion of liquid buffers larger among equity funds than mixed-allocation or fixed-income funds. - Note: stress tests did not consider liquidity management tools. --- ### Household and corporate sector risk analysis - Household mortgage risk under adverse scenario (without 5-year/125 percent rule): - Mortgage loan PDs rise to 2 percent. - Mortgage LGDs rise to 45 percent. - Nonfinancial corporations (NFCs): - Aggregate (debt-weighted) PD for firms rises by 0.6 ppt in the first year of the shock. - Small and medium-sized firms are more affected than large firms. - Industry practice: 5-year/125 percent rule could contain rise in PDs and LGDs; monthly payment amounts change infrequently (every 5 years) and increase capped at 25 percent. --- ### Interconnectedness, contagion, and cross-border spillovers - Interbank claims average 35 percent of sectoral capital buffers. - Banks’ claims on securities firms and insurers’ claims on banks amount to 9 percent and 13 percent of total sectoral capital buffers, respectively. - Contagion simulation: shock to G-SIBs/D-SIBs would result in losses of about 10 percent of system-wide capital buffers transmitted primarily through the credit channel. - Average vulnerability to contagion from other institutions: on average, up to one percent of sectoral capital buffers. - Cross-border spillovers: Japanese banks would, on average, lose more than 16 percent of their capital in an assumed scenario where their claims on U.S. banks were written off. Model assumptions: LGD = 0.65; discount rate = 0.2; funding shortfall rate = 0.35. --- ### Climate risk analysis — transition and physical risk (selected findings) - Transition risk scenarios: NGFS Phase IV scenarios (Net Zero 2050, Fragmented World, Current Policies). - Net Zero 2050 scenario: - Banks’ aggregate capital ratio estimated to decrease by 0.6-0.7 ppt by 2040 (0.03-0.04 ppt per year) relative to the current policies scenario. - Internationally active banks modestly impacted; regional banks more pronouncedly impacted. - Physical risk (flood): - Approximately one-third of physical assets across Japan are at risk of flooding, with significant variations across prefectures. - Average damage rate of a 1000-year flood hazard for commercial/industrial buildings increases by 5 percentage points. - Banks’ loan-to-asset ratios tend to be lower in vulnerable prefectures, indicating limited direct exposure though indirect impacts remain possible. - Data and uncertainty: substantial uncertainty around firms’ emission intensities affects confidence in results. --- ### Financial sector oversight — findings and supervisory recommendations (selected) - Banking supervision: - FSA has shifted to a more modern, risk-based approach since 2018. - Recommendation: develop more forward-looking metrics in the Early Warning System (EWS), especially for credit and liquidity risks; set minimum liquidity requirements for all banks; provide FSA with Pillar 2 powers to set additional capital and the ability to require banks to raise capital before breaching minima. - Insurance supervision: - Observance of ICPs: six Observed, twelve Largely Observed, six Partly Observed. - Recommendation: undertake fundamental reform to focus on supervision of individual insurers, ensure suitability requirements apply to all board members and senior managers, introduce ESR in fiscal year 2025, and delegate licensing powers to the FSA. - Investment funds: - Recommendation: broaden onsite inspection program and strengthen offsite risk monitoring; expand investment fund survey coverage and frequency. - Fintech, digital payments, and CESPs: - Cashless payments reached 36 percent of total payments in 2022 (up from 21 percent in 2017); usage rate of online financial services is 20 percent. - As of November 2023: 29 registered VASPs and about 5 million active accounts with total balance JPY 1.8 trillion (2.8 percent of GDP). - Recommendation: systematic data gathering for fintech, consider requiring wind-down plans for FTSPs, review PPI issuer fund-retention requirement (currently 50 percent). - CESPs: comprehensive framework since 2017; recommendation to enhance public education and maintain strong enforcement. - FMIs: - Progress on CCP risk management since 2017; Comprehensive Guidelines revised in 2022 reducing PFMI gaps. - Recommendation: JSCC consider mechanisms to ensure customers’ interests are systematically considered (e.g., increasing customer presence on committees). - AML/CFT: - FSA moved to more risk-based supervision; "Travel Rule" under FATF Recommendation 15 came into force for all VASPs in June 2023; FSA set March 2024 deadline for revised AML/CFT Guidelines implementation. - Recommendation: ensure non-compliant FIs are appropriately sanctioned; consider proportionate and dissuasive sanctions. - Macroprudential policy: - CCFS operates without a clear formal mandate. - Recommendation: provide formal mandate to CCFS and expand the macroprudential toolkit (including borrower-based tools like caps on LTV, DTI, DSTI). - Recommendation: monitor LCRs by currency and consider imposing LCRs-by-currency. - Cross-cutting resources and cyber: - Finding: staffing resources need significant increases across FSA, BOJ, and SESC; cyber supervisory resources constrained. - Recommendation: devote more resources to cybersecurity supervision; update Comprehensive Supervisory Guidelines on cyber risk; prioritize cyber supervision of FMIs; deepen cyber mapping and run cyber simulations. --- ### Crisis management, ELA, and resolution (selected findings and recommendations) - ELA practices: many aspects robust; sound internal guidelines exist. - ELA safeguards: recommendation to improve public disclosure of solvency requirements and eligibility criteria; require sufficient collateral and measures to protect BOJ balance sheet if collateral insufficient. - ELA eligibility: consider expanding to systemic NBFIs (Article 33) prioritizing CCPs. - RRP and resolution: - Since 2017: TLAC requirements introduced; RRP requirements expanded to include one D-SIB and three G-SIBs; FSA RRP Office established. - Recommendation: expand RRP gradually to more banks; require more banks to maintain TLAC; operationalize resolution framework with manuals and playbooks; execute a multi-year interagency crisis simulations program under the FCRC. - Insurers and FMIs: plan for insurer failure and further RRP regime for FMIs, prioritizing CCPs. - Staffing: increase staffing and skillsets at FSA as lead resolution authority. --- ### Key quantitative indicators (selected FSIs, 2017–2023) - Regulatory capital to risk-weighted assets: - 2017: 16.0 - 2018: 17.1 - 2019: 17.2 - 2020: 16.4 - 2021: 16.6 - 2022: 15.4 - 2023: 14.9 - Regulatory tier 1 capital to risk-weighted assets: - 2017: 13.5 - 2018: 14.9 - 2019: 15.1 - 2020: 14.3 - 2021: 14.6 - 2022: 13.8 - 2023: 13.4 - Capital-to-total assets: - 2017: 4.9 - 2018: 5.2 - 2019: 5.2 - 2020: 4.7 - 2021: 4.6 - 2022: 4.3 - 2023: 4.1 - Non-performing loans (NPL) to total loans ratio: - 2017: 1.3 - 2018: 1.1 - 2019: 1.1 - 2020: 1.1 - 2021: 1.2 - 2022: 1.3 - 2023: 1.2 - Return on assets: - 2017: 0.2 - 2018: 0.2 - 2019: 0.1 - 2020: -0.1 - 2021: 0.1 - 2022: 0.1 - 2023: 0.2 - Return on equity: - 2017: 5.1 - 2018: 5.4 - 2019: 2.3 - 2020: -1.3 - 2021: 3.5 - 2022: 2.6 - 2023: 5.8 - Liquid assets to total assets: - 2017: 28.7 - 2018: 29.6 - 2019: 29.4 - 2020: 29.5 - 2021: 34.4 - 2022: 35.8 - 2023: 33.3 - Customer Deposits to Total (Non-interbank) Loans: - 2017: 136.5 - 2018: 139.4 - 2019: 139.5 - 2020: 139.1 - 2021: 147.6 - 2022: 148.6 - 2023: 146.9 - Gross derivative asset to capital: - 2017: 43.8 - 2018: 35.8 - 2019: 35.2 - 2020: 55.8 - 2021: 43.3 - 2022: 57.1 - 2023: 75.9 - Gross derivative liability to capital: - 2017: 42.3 - 2018: 33.2 - 2019: 33.7 - 2020: 52.0 - 2021: 42.7 - 2022: 59.9 - 2023: 79.9 ### FSAP Risk Assessment Matrix — selected risks, likelihoods, and expected impacts - Intensification of regional conflict(s) and geo-economic fragmentation - Overall Level of Concern: High - Likelihood: High - Expected impacts: abrupt global/domestic slowdown, commodity price volatility, sharp increase in foreign and domestic interest rates, valuation losses on debt securities, higher funding costs, deterioration in borrower debt service ability. - Abrupt global slowdown or recession - Overall Level of Concern: Medium - Likelihood: High - Expected impacts: lower domestic GDP growth, deterioration in asset quality, erosion of bank capital buffers, strains in offshore USD funding. - Bond market stress from reassessment of sovereign risk - Overall Level of Concern: Medium - Likelihood: High - Expected impacts: worse public debt dynamics and transmission to financial sector via sovereign-financial nexus. - Extreme climate events / disorderly energy transition - Overall Level of Concern: Medium - Likelihood: High/Medium - Expected impacts: large credit losses, collateral devaluations, transition risks depending on policy ambition and exposure to carbon-intensive firms. - Cyberthreats - Overall Level of Concern: Medium - Likelihood: High - Expected impacts: threats to macrofinancial stability via disruption of services and confidence. *Source: EXECUTIVE SUMMARY and selected chapters, FSAP Japan (1jpnea2024001).* ### EXECUTIVE SUMMARY _______________________________________________________________________ 8 ### EXECUTIVE SUMMARY ### Macrosystem resilience and trajectory - The Japanese financial system "has remained resilient through a series of shocks including the COVID-19 pandemic." - Japan’s large and globally well-integrated financial system withstood the pandemic, aided by strong capital and liquidity buffers, and extensive policy support. - Credit provision to the private sector has remained robust, supporting a steady economic recovery. - The financial system is at a critical juncture following the end of the Bank of Japan (BOJ) negative interest rate policy and yield curve control amid sustained inflationary pressures. ### Key vulnerabilities and structural challenges - Three main sources of vulnerability: - Sizable domestic and foreign security holdings of financial institutions under mark-to-market accounting. - Notable foreign currency (FX) exposure of some banks. - Signs of overheating in parts of the real estate markets. - These risks could be accentuated by structural transformations from climate change, digitalization, and an aging population. ### Scenario-based systemic risk analysis — summary findings - Overall assessment: "the financial system remains broadly resilient to a range of adverse macrofinancial shocks, with some areas of susceptibility." - Banks - "Banks are, in aggregate, well able to maintain their solvency position under a hypothetical adverse scenario comprising an increase in foreign and domestic interest rates and a decline in economic growth and asset prices, though some banks may be susceptible to the stress." - Liquidity risks: "contained at the system level due to ample liquidity in Japanese Yen (JPY), but some banks appear susceptible due to notable liability-side FX exposures and undrawn FX commitments." - Insurers - "Insurers, especially life insurers, are sensitive to an increase in domestic and foreign interest rates though in aggregate, their capital remains well above the regulatory requirement." - Liquidity: "not significantly exposed to liquidity risk, but some may face pressure under stress." - Investment funds - "Appear generally well positioned to accommodate plausible-sized investor redemption shocks, though less-liquid funds could contribute to market volatility under more severe shocks." - Nonfinancial private sector - "Smaller firms are particularly susceptible to an increase in default risk under the adverse scenario." - Households: "Household defaults would rise from a very low level, but the impact could be lessened by the industry practice (5-year/125-percent rule) that could mitigate a sharp increase in mortgage payments." - Systemic contagion - "Systemic contagion risks are limited by the strong capital positions of major financial institutions, but some institutions appear vulnerable to contagion risks." ### Climate risk analysis - Under a net zero GHG emissions by 2050 transition scenario: - "Banks are generally resilient to a transition to net zero greenhouse gas (GHG) emissions by 2050." - "Banks’ exposure to emission-intensive sectors constitutes, on average, about one-fifth of their assets." - "Notwithstanding the uncertainty around firms’ emission intensities, banks generally appear resilient under the net zero 2050 scenario, though the impact on the capital position varies across banks in the sample." ### Financial sector oversight and crisis management — developments and gaps - Progress since the 2017 FSAP: - FSA adopted a more modern, risk-based bank supervision approach. - Basel III capital and liquidity tools phased in for internationally active and domestic systemically important banks (D-SIBs). - For insurers, FSA adopted more effective macroprudential supervision, developed ComFrame implementation guidelines, and established supervisory colleges for four internationally active insurance groups. - Investment funds’ oversight enhanced. - Cyber capacity and crisis management frameworks strengthened. - Remaining and recommended actions: - Significant increase in staffing resources to enhance financial oversight and crisis preparedness, with emphasis on: - Regional banks (more resources than currently devoted). - Insurance supervision (acute resource needs). - Supervision of cyber risks and bank recovery and resolution. - Systemic risk monitoring enhancements: - Leverage recent data collection, fill data gaps for contagion analysis, introduce stress testing for investment funds, conduct comprehensive liquidity risk analysis for banks and insurers, and perform more granular nonfinancial private sector risk analysis. - Continue monitoring risks from sizable security holdings and banks’ FX liquidity needs. - Banking supervision: - Continue development of the risk-based approach. - "Set minimum liquidity requirements for all banks." - Give FSA the power to "set and adjust individual bank capital ratios above the minimum in response to a bank’s risk profile." - "Explicit provision needs to be made in the law to ensure the priority of financial stability in the mandate of the FSA, in keeping with current policy and practice." - Insurance oversight: - Delegate licensing powers to the FSA and review FSA budgetary independence. - Establish a proactive and comprehensive risk-based supervision framework. - Ensure suitability requirements apply to all key persons in control functions. - "The economic value-based solvency framework should be introduced as expected in fiscal year 2025." - Investment funds: Enhance onsite supervision with more frequent on-site inspections. - Digitalization and cyber: - Bolster cyber resilience by updating FSA supervisory guidelines, methodologies, and tools; improve information collection; update Business Continuity Plan. - Strengthen cyber supervision/oversight of FMIs. - Monitor fintech developments and enhance supervision of relevant players. - Climate-related oversight: "Develop and publicize a clear plan towards formalizing supervision of climate-related risks in consideration of the work of international bodies." - Macroprudential policy framework: - "Assign a formal mandate to the Council for Cooperation on Financial Stability (CCFS) and expand the policy toolkit." - Crisis management: - Better protect the BOJ’s financial soundness from Emergency Liquidity Assistance (ELA) operations and mitigate moral hazard arising from ELA operations. - "Expand ELA eligibility to systemic nonbank financial intermediaries (NBFIs), prioritizing central counterparties (CCPs)." - Gradually subject all banks that could be deemed systemic at the time of failure to recovery and resolution planning (RRP) requirements. - Increase minimum loss-absorbing capacity for more banks and prioritize resolution strategies that allocate losses to shareholders and creditors. - Ensure an effective RRP regime for systemic-in-failure insurers and CCPs consistent with international standards and guidance. ### FSAP Key Recommendations (select highlights and timelines) - Cross-Cutting - Increase staffing resources significantly and strengthen skills (Government, FSA; ¶66-67). Timeline: ST - Systemic Risk Monitoring and Macroprudential Policy Framework - "Further broaden and deepen systemic risk analysis" (FSA, BOJ; ¶68-69). Timeline: C - "Strengthen the governance of interagency decision-making on macroprudential policy by assigning a formal mandate to the CCFS" (FSA, BOJ; ¶63). Timeline: ST - "Expand the macroprudential policy toolkit with targeted borrower-based tools" (FSA, BOJ; ¶64). Timeline: MT - Banking Sector Regulation and Supervision - Continue to strengthen risk-based supervision and develop the Early Warning System (FSA; ¶44). Timeline: I - Make explicit provision in the law to ensure the priority of financial safety and stability in the mandate of the FSA (Government; ¶45). Timeline: ST - Provide the FSA with the power to set and adjust individual bank capital ratios above the minimum (Government; ¶46). Timeline: ST - Establish a minimum liquidity requirement for domestic banks (FSA; ¶47). Timeline: ST - Insurance Sector Regulation and Supervision - Establish a comprehensive risk-based, proactive supervisory framework (FSA; ¶50). Timeline: ST - Ensure suitability requirements apply to all key persons and strengthen control functions (FSA; ¶50). Timeline: ST - Delegate licensing powers to the Commissioner of the FSA and review FSA independence for budget/expenditure (Government, FSA; ¶51). Timeline: ST - Cyber Resilience and Financial Stability - Update supervisory guidelines, methodologies, and tools for cybersecurity (FSA; ¶71). Timeline: MT - Enhance cyber supervision/oversight of FMIs (FSA, BOJ; ¶71). Timeline: ST - Investment Funds and Fintech - Broaden onsite supervisory approach to include more firms and larger asset managers (SESC; ¶54). Timeline: ST - Intensify monitoring of FTSPs and PPI issuers; consider reviewing regulatory framework (FSA; ¶56). Timeline: I/ST - Climate-related Oversight - "Develop and publicize a clear plan towards formalizing supervision of climate-related risks" (FSA; ¶73). Timeline: MT - Financial Safety Net and Crisis Preparedness - Protect BOJ financial soundness and mitigate ELA moral hazard (BOJ, MOF, FSA; ¶76). Timeline: C - Expand ELA eligibility to some NBFIs, prioritizing CCPs (BOJ; ¶77). Timeline: MT - Gradually expand RRP to all banks that could be systemic at failure (FSA; ¶79). Timeline: ST - Execute a multi-year interagency crisis simulations program under the FCRC (All; ¶81). Timeline: C - Ensure effective recovery and resolution planning for insurers and CCPs (FSA, Government; ¶82). Timeline: MT *Source: EXECUTIVE SUMMARY, FSAP Japan (excerpt).* ### 1. The Japanese economy continues to grow after the COVID-19 pandemic, with broad- ### 1. The Japanese economy continues to grow after the COVID-19 pandemic, with broad- ### Macroeconomic performance and inflation - Real GDP growth has averaged about two percent during 2021–2023 aided by strong policy support. - Headline and core inflation (excluding fresh food) have exceeded the BOJ’s 2 percent target since April 2022. - Real wages have declined since the pandemic, while the unemployment rate has remained stable. - Contributions to Real GDP Growth panels show private consumption, private investment, government spending, and net exports components (figures not reproduced here). ### Monetary policy shift - The BOJ incrementally relaxed its YCC framework over time, allowing for greater flexibility in 10-year JGB yields. - With confidence that the inflation target can be sustainably achieved, the BOJ abolished the YCC and the Quantitative and Qualitative Easing (QQE) frameworks in March 2024, and ended the negative interest rate policy, while maintaining its gross JGB purchases broadly at the current pace. - The BOJ decided to guide overnight rate as primary policy tool, encouraging the rate to remain at around 0-0.1 pct. - NIRP=negative interest rate policy; QQE=quantitative and qualitative easing; YCC=yield curve control. ### Financial conditions, credit, and debt - Domestic financial conditions have remained generally easy in recent months on the back of an increase in equity prices, and a decline in corporate and interbank spreads. - Credit to the private sector has remained robust, driven by lending to nonfinancial corporates (NFCs) and the real estate sector. - Gross debt of NFCs and households (relative to GDP) has increased since the pandemic, though they also hold sizable liquid assets. - Sovereign debt to GDP has risen notably and is the highest among advanced economies. - Stock prices: TOPIX and Nikkei 225 rising by 25 percent and 28 percent in 2023 (y/y), respectively. - NFC cash and liquid assets and household cash and deposits are shown as percent of GDP in Figure 2 (exact series in source figures). ### Real estate markets and household burden - Residential real estate (RRE) prices have risen owing to strong demand amid low mortgage interest rates. - Commercial real estate (CRE) prices have also increased steadily, though the momentum has slowed down since end-2022. - Strong demand for residential property amid low mortgage rates and tight supply have contributed to price pressures. - About one-tenth of the population spend over 40 percent of their disposable income on housing (cost overburden rate). - Housing loans have increased notably since the pandemic; household loan-to-income and debt service ratios have been rising. ### External sector, interest rate differentials, and exchange rates - Elevated interest rate differentials vis-à-vis other major economies have implied persistent JPY depreciation pressures. - Low interest rates in Japan and aggressive monetary policy tightening in the U.S. and euro area since 2022 contributed to notable yield differentials and JPY depreciation pressures. - Higher prices of key imported goods (e.g., oil) may have contributed to JPY depreciation. - The increase in U.S. interest rates has raised U.S. dollar (USD) funding costs for Japanese firms. - Long-run JGB yields have been rising recently as the YCC framework was relaxed, but yield differentials with U.S. Treasury bonds remain significant. - Policy and money market rates have remained at historical lows even as other yields moved. - USD funding cost for JP banks and 3-month USD Libor trends are highlighted in the source figures. ### Financial sector landscape and structure - Japan has one of the largest financial systems in the world with total assets nearly seven times GDP at end-2023. - The banking sector accounts for 60 percent of the financial system, with one-third of its assets held by three global systemically important banks (G-SIBs). - Japan’s insurance sector—dominated by life insurers—accounts for 12 percent of the financial system and ranks fourth in the world by total written premiums (in USD terms). - Investment funds account for 8 percent of the financial system. - The pension sector, dominated by the Government Pension Investment Fund (GPIF), amounts to 8 percent of the financial system. - The market capitalization of the Tokyo Stock Exchange stood at USD 6.2 trillion (146 percent of GDP) at end-2023. - The NFC bond market capitalization was 16 percent of GDP in 2023. - Japan houses three CCPs, one among the top-10 worldwide. - Fintech and digital payments: - Cashless payments reached 36 percent of total payments in 2022, up from 21 percent in 2017. - Usage rate of online financial services is 20 percent. - Stablecoin initiatives are underway by several entities although there has been no issuance yet. - The financial system is characterized by a high degree of interdependence; financial institutions have large exposures to each other and to the nonfinancial private sector. - Banks and NBFIs hold a notable share of their assets in JGBs, though their exposure has declined by about 15 and 10 percentage points, respectively, in the last decade. *Source: IMF staff summary of the PDF chapter "1. The Japanese economy continues to grow after the COVID-19 pandemic, with broad-"* ### 10. Financial institutions have expanded their overseas exposures in search of higher ### 1jpnea2024001 - 10. Financial institutions have expanded their overseas exposures in search of higher ### Overseas exposures and FX funding - Amid ultra-low domestic interest rates and subdued economic growth during the last decade, banks and NBFIs have increased the share of foreign assets in total assets to seek higher returns. - Most of banks’ foreign assets are in the form of loans and debt securities, while insurers hold sizable foreign debt and equities. - To obtain FX funding, banks mostly rely on unsecured wholesale funding and FX swaps, making them highly sensitive to an increase in foreign interest rates. - The exposure of Japanese financial institutions to foreign debt securities has declined since 2022 due to the sharp rise in U.S. interest rates and FX funding costs. - Banks’ liabilities in USD terms constitute 30 percent of total liabilities and mostly take the form of FX swaps and unsecured wholesale funding. - Banks’ liquidity coverage ratio (LCR) in USD terms rests below 100 percent (no minimum requirement currently in place). - Undrawn FX commitments through credit and liquidity lines amounted to two-thirds of total commitments at end-September 2023. ### Asset composition, valuation effects, and recent trends - On average, about one-fifth of banks’ assets constitute securities (held under mark-to-market accounting); the share is higher for domestic banks. - Insurance companies, especially life insurers, hold a sizable share of assets in securities. - Banks have seen some recent decline in capital ratios due to valuation losses from overseas securities holdings. - Nonperforming loan (NPL) ratios have remained low since the pandemic. - Retail and insured deposits represented about 60 percent of total deposits in December 2022. - The GPIF and corporate pension funds constitute 5 percent and 3 percent of the financial system, respectively. ### Financial soundness: capital, liquidity, profitability, insurers - Banks entered the pandemic with generally strong capital and liquidity positions; these deteriorated only modestly due to policy support. - Banking sector profitability has been weak in a low interest rate, subdued growth environment; ultra-low interest rates since 2016 have put downward pressure on net interest margins and profitability, particularly for domestic and regional banks. - Profitability of internationally active banks, particularly G-SIBs, was aided in 2022 by a rise in foreign interest rates and JPY depreciation. - Insurers’ capital metrics in the stress test sample (March 2023): - Major life insurers: solvency margin ratio (SMR) = 956 percent; economic value-based solvency ratio (ESR) = 226 percent. - Major non-life insurers: SMR = 840 percent; ESR = 212 percent. - Banks maintain sizeable JPY liquidity buffers; about one-third of assets are liquid. ### Real estate and household loan metrics - Real estate markets show signs of overvaluation in some areas: - Residential real estate (RRE) markets estimated overvalued by, on average, 17 percent. - Commercial real estate (CRE) markets estimated overvalued by, on average, 30 percent. - About 11 percent of banks’ outstanding credit constitutes CRE loans; about 15 percent constitutes retail mortgage loans. - More than three-fourth of retail mortgage loans are floating-rate mortgages. - The loan-to-income (LTI) ratio at origination reached 4.2 at end-March 2022 (driven primarily by young-age borrowers). - The share of housing loans with debt-service-to-income (DSTI) ratios exceeding 30 percent has increased. ### Key vulnerabilities and amplification channels - Three primary vulnerabilities: - Significant exposure to domestic and foreign securities held under mark-to-market accounting (about one-fifth of banks’ assets are securities). - Notable FX exposure: USD liabilities equal 30 percent of total liabilities; reliance on FX swaps and unsecured wholesale funding; LCR in USD below 100 percent; large undrawn FX commitments (two-thirds of total commitments at end-September 2023). - Real estate market overvaluation: RRE overvalued by ~17 percent; CRE overvalued by ~30 percent. - Potential adverse scenario channels: - Sudden increase in foreign and domestic interest rates and financial market volatility could produce valuation losses on securities, increase defaults among leveraged borrowers, and trigger significant real estate price corrections. - Rise in foreign interest rates could raise banks’ overseas credit risk and FX liquidity risk. - The share of foreign loans in major banks’ total loans has nearly doubled over the last decade and is up by about 5 ppt since the last FSAP. ### Structural and emerging risks - Climate-related transition risks are highly relevant: Japan is among the largest carbon emitters and has set targets to reduce GHG emissions by 46 percent from 2013 levels by 2030 and to achieve net zero by 2050. - Bank loans to emission-intensive sectors account for almost one-fifth of nonfinancial corporate loans, exposing the system to transition risks. - Growing digitalization and fintech expansion increase efficiency but also competition and cybersecurity risks; the number of cyberattacks has increased significantly (e.g., more than 200 cyberattacks on critical infrastructure in 2021). - Demographics: an aging and shrinking population poses a long-term challenge to macrofinancial stability and regional banks’ profitability. *Source: IMF staff calculations.* ### 18. The FSAP assessed the financial sector’s resilience with a comprehensive scenario-based ### 18. The FSAP assessed the financial sector’s resilience with a comprehensive scenario-based risk analysis ### Overview - The FSAP used supervisory and commercial data to run top-down stress tests examining: - banks’ solvency and liquidity risks, including feedback of liquidity risks to solvency; - insurers’ solvency and liquidity risks; - investment funds’ liquidity risk; and - the solvency risk of NFCs and households. - Scenario-conditional risk parameter paths for households and NFCs fed directly into the bank solvency stress test. - Contagion risks across banks, insurers, and securities firms were analyzed using bilateral balance sheet exposures. - Climate-related risk analysis focused on banks’ transition risks. ### A. Macrofinancial Scenarios - A baseline and an adverse scenario spanning the horizon 2024–26 underpin the systemic risk analysis. - The baseline scenario is aligned with the IMF’s October 2023 World Economic Outlook (WEO). - The adverse scenario reflects an abrupt global and domestic economic slowdown, surge in inflation, and financial market downturn (see Risk Assessment Matrix). - Assumptions and key adverse-scenario parameter variants: - Short-term and long-term interest rates assumed to rise initially with high inflation, then contained by a wide output gap and gradual decline in inflation. - Sensitivity analysis (further adverse): - Short-term interest rate: rise to 1.5 percent in the first year (compared to 1 percent under the initial adverse scenario). - Long-term interest rate: rise to 3 percent in the first year (compared to 2.25 percent under the initial adverse scenario). - Real GDP growth: drop to -3.2 percent in the first year and -1 percent in the second year (compared to -1.8 percent and -0.5 percent in the initial adverse scenario, respectively). - Economic effects noted: - Fall in real wages, combined with higher interest rates, leads to a decline in real estate demand and a notable correction in real estate prices. ### B. Banking Sector Resilience — Solvency Stress Test - Scope: internationally active and domestic banks (23 banks in total), including regional banks. - Aggregate capital impact: - Aggregate Common Equity Tier 1 (CET1) ratio falls by 510 basis points in the first year of the adverse scenario but remains above the regulatory minimum. - The decline is more pronounced for domestic banks than internationally active banks, and for regional banks relative to the system-wide aggregate. - Drivers of capital ratio changes: - Sizeable valuation losses on securities and a rise in loan losses, partially offset by an increase in interest income. - Bank-specific shortfalls: - Three (four) banks face capital shortfalls under the adverse scenario considering CET1 (total capital) as the reference metric. - The capital shortfall of these banks amounts to 0.04-0.05 percent of 2022 nominal GDP. - Three of the four banks with total capital ratio below the hurdle rate are regional banks. - The four banks represent five percent of total assets of the banks in scope. - Interest-rate sensitivity analysis: - Implies additional capitalization pressures relative to the initial adverse scenario driven primarily by larger valuation losses on securities and further loan losses. - Number of banks with CET1 (total capital) below the hurdle rate rises to five (eight). - System-wide total capital shortfall rises to 0.3 percent of GDP. - Methodology notes: - For domestic banks, an “AFS filter” (valuation changes for securities held under AFS not affecting regulatory capital) was switched off to estimate economic valuation effects and allow comparison with internationally active banks. - Deferred tax assets and the 5-year/125 percent rule for mortgage lending were not considered in the analysis. - For domestic banks, the hurdle rate was 4 percent; for G-SIBs/D-SIBs, additional surcharges were included in hurdle rates. ### B. Banking Sector Resilience — Liquidity Stress Test - Cashflow-based results: - Japanese banks are generally resilient to a hypothetical, severe liquidity stress event. - Five banks, including three regional banks, representing 7 percent of total assets of the banks in the sample, would face a liquidity shortfall on an all-currency basis. - Feedback to solvency from forced sales of not marked-to-market securities is confined to a small number of banks but may be material for them. - FX liquidity risks: - Counterfactual assuming severe outflow of undrawn USD committed credit lines: - Liquidity pressure generally confined to internationally active banks with large committed yet undrawn credit and liquidity lines. - All-currency LCR of these banks would remain above 100 percent, but their USD LCR would fall by 30-40 percentage points. - Counterfactual assuming Japanese banks’ USD funding cost rises notably: - Suggests capitalization pressure for only a small number of banks (with capital ratios falling by 0.5-1.2 ppt) relative to the initial adverse scenario. ### C. Insurance Sector Resilience — Solvency Stress Test - Coverage: 12 life and 10 non-life insurers, covering about 70 and 90 percent of the respective segments. - Frameworks assessed: - Current Solvency Margin Ratio (SMR) and planned Economic Solvency Ratio (ESR). - Bottom-up stress tests were also run by insurers under the SMR with the same scenarios. - SMR results: - Life insurers: average SMR declines by 372 ppt under the adverse scenario. - Two of the twelve life insurers do not meet the statutory SMR requirement of 200 percent. - Key contributors: drop in equity prices and increase in interest rates. - Non-life insurers: average SMR declines by 154 ppt under the adverse scenario; all ten remain above the hurdle rate. - Bottom-up results broadly aligned with top-down results; inclusion of lapse risk and additional underwriting shocks yields aggregate post-stress capital somewhat lower in bottom-up exercise. - ESR results: - ESR decreases on average by 67 ppt for life insurers and 41 ppt for non-life insurers under the adverse scenario. - ESR remains above the hurdle rate of 100 percent for all insurers. - Changes mainly due to decline in equity prices and credit shocks; interest rate increase effects vary across insurers (life insurers may benefit due to decline in liabilities offsetting valuation losses). - Sensitivities: - Larger increase in domestic interest rates or appreciation of the JPY does not materially affect adverse-scenario results. - Solvency position resilient to several biometric shocks and catastrophic natural events considered individually. ### C. Insurance Sector Resilience — Liquidity Stress Test - Three approaches used: margining analysis on interest rate swaps, stock-based approach, and cashflow-based approach. - Margin calls analysis: - System-level cash margin calls on interest rate swaps after a sharp increase in domestic interest rates could be met by drawing on about 20 percent of cash equivalents. - Cash positions of at least two insurers could be inadequate under severe one-day market movements. - Stock-based approach: - Share of liquid assets remains considerable after calibrated haircuts; liquid assets ratio of life insurers is about 70 percent in the adverse scenario. - Flow-based approach: - Large outflows are projected under stress, especially for life insurers, and are not met by liquid buffers in all cases. - Reactive management actions, including asset sales, limit net outflows and allow them to be met by liquid assets (including tradable securities). - Additional notes: - Encumbrance levels for life insurers’ high-quality sovereign bond holdings are not trivial relative to the size of such exposures. - Stress tests did not consider the use of liquidity management tools, which could mitigate impacts. ### D. Investment Funds’ Liquidity - Japan-domiciled investment funds are resilient to severe but plausible redemption shocks derived from historical data. - Under more severe shocks in the adverse scenario: - The share of funds with liquidity shortfalls could reach up to 18 percent of total asset value. - Depletion of liquid buffers is larger among equity funds compared to mixed-allocation or fixed-income funds. - Equities held by less liquid funds are more susceptible to selling pressure due to larger investor redemptions. - Note: The stress test does not consider the use of liquidity management tools. ### E. Household and Corporate Sector Solvency - Scenario-conditional risk parameter paths for households and NFCs were used as direct inputs to the bank solvency stress test (detailed results and further analysis referenced in TN on SRA). *Source: IMF staff calculations and FSAP analysis as presented in the chapter.* ### 35. The risk analysis for households suggests that probabilities of default (PDs) and loss- ### 1jpnea2024001 - 35. The risk analysis for households suggests that probabilities of default (PDs) and loss- ### Household and Corporate Risk Analysis - Household mortgage risk under the adverse scenario (without the industry practice (5-year/125 percent rule)): - Mortgage loan PDs rise to 2 percent. - Mortgage LGDs rise to 45 percent. - The 5-year/125 percent industry practice could contain the rise in PDs and LGDs. - Note on industry practice: monthly payment amounts change infrequently (every 5 years) even under a sharp interest rate increase, while the increase is also capped at 25 percent. - Nonfinancial corporations (NFCs): - Aggregate (debt-weighted) PD for firms rises by 0.6 ppt in the first year of the shock. - Small and medium-sized firms are affected more relative to large firms due to their higher leverage and lower interest coverage ratio. - Sensitivity analysis: - The sensitivity analysis refers to an additional increase in interest rates and shows larger rises in PDs and LGDs. ### Interconnectedness and Contagion - System structure and exposures: - The financial system is highly interconnected, with G-SIBs and D-SIBs playing a central role. - Interbank claims average 35 percent of sectoral capital buffers. - Banks’ claims on securities firms and insurers’ claims on banks amount to 9 percent and 13 percent of total sectoral capital buffers, respectively. - Deposits, followed by loans, are the main source of bilateral exposures. - Simulation results and contagion metrics: - A shock to G-SIBs/D-SIBs would result in losses of about 10 percent of system-wide capital buffers and would transmit primarily through the credit channel. - Average vulnerability to contagion from other institutions appears moderate—on average, up to one percent of sectoral capital buffers. - Banks that failed the liquidity stress test did not rank high as sources of distress in the contagion analysis. - Cross-border spillovers: - Japanese banks would, on average, lose more than 16 percent of their capital in an assumed scenario where their claims on U.S. banks were to be written off. - Model assumptions for cross-border estimates: LGD parameter assumed to be 0.65; discount rate 0.2; funding shortfall rate 0.35. - Inward spillover results are governed primarily by the assumed level of LGD, given Japan’s creditor status. - Outward spillovers reflect loss of counterparty country banks, in percent of total regulatory Tier 1 capital. ### Climate Risk Analysis - Transition risk scenarios and results: - Scenarios align with NGFS Phase IV and include net zero 2050, fragmented world, and current policies scenarios. - Under the net zero 2050 scenario, banks’ aggregate capital ratio is estimated to decrease by 0.6-0.7 ppt by 2040 (0.03-0.04 ppt per year) relative to the current policies scenario. - Heterogeneity across banks: internationally active banks are modestly impacted; regional banks in the sample are more pronouncedly impacted. - Substantial uncertainty exists around firms’ emission intensities, affecting the confidence in results. - Physical risk (flood) findings: - Approximately one-third of physical assets across Japan are at risk of flooding, with significant variations across prefectures. - Average damage rate of a 1000-year flood hazard for commercial/industrial buildings increases by 5 percentage points. - Future flood depth is projected to rise in some scenarios; certain prefectures are more vulnerable to increased flood hazards. - Banks’ loan-to-asset ratios tend to be lower in vulnerable prefectures, indicating limited direct exposure though indirect impacts remain possible. ### Holistic Vulnerability Assessment of Banks - Composite vulnerability results: - Internationally active banks are generally more vulnerable than domestic banks. - The three most vulnerable banks based on a composite indicator represent five percent of total assets of the banks included in the sample. - Regional banks, as a separate cluster, are on average the most vulnerable. - Decomposition: internationally active banks are more vulnerable due to greater interconnectedness; domestic banks appear more vulnerable on solvency and liquidity stress test results. ### Financial Sector Oversight — Banking Sector (Findings and Recommendations) - FSA supervisory approach and gaps: - The FSA has shifted towards a more modern, risk-based approach to supervision since 2018, balancing “stability” and “effective financial intermediation.” - Recommendation: The FSA should explore the development of more forward-looking metrics in the Early Warning System (EWS), especially for credit and liquidity risks. - Recommendation: The FSA should enhance a baseline set of supervision activities to improve understanding of each bank’s risk profile and develop a revised risk methodology to draw a full risk profile of each institution, incorporating financial risks as well as governance, business, operational and strategic risks. - A more articulated and risk-based methodology would support resource allocation, identification of risk trends, and supervisory consistency and quality control. - Legal and powers gaps: - The FSA’s legal mandate should confirm the priority of financial safety and stability; multiple objectives can conflict and the primary objective should be promotion of financial safety. - Two important gaps related to capital adequacy persist in the FSA’s powers, making Japan an outlier among its peers: - The “Pillar ” powers to calibrate a capital requirement to a bank’s risk profile and risk management capability are still missing. - The FSA cannot order a bank to raise capital before breaching the minimum regulatory requirements, constraining proactive intervention. - Recommendation: Options for the supervisor to intervene directly by requiring more capital on a legal basis rather than through indirect but formal means (e.g., Business Improvement Orders) should be a minimum expectation. *Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1jpnea2024001.pdf* ### 47. The FSA should set appropriate minimum liquidity requirements for all banks. ### 47. The FSA should set appropriate minimum liquidity requirements for all banks. ### Banking liquidity requirements and supervisory alignment - Finding: Although internationally active banks are subject to the Basel LCR and Net Stable Funding Ratio standards, there is no quantitative minimum liquidity requirement for domestic banks. - Risk: The lack of minimum quantitative standards could create a potential prudential vulnerability that the FSA and, as needed, the BOJ would have to react to in a stress event, despite the largely stable, retail deposit base of banks. - Recommendation: The FSA should set appropriate minimum liquidity requirements for all banks. - Recommendation: The BOJ should update its practices and approach to remain broadly aligned with the FSA to make bank supervision more effective and efficient. ### Insurance sector — observance and supervisory gaps - Assessment: FSAP full assessment of Observance of the Insurance Core Principles (ICPs) found an overall good level of observance: six of 24 ICPs assessed as Observed, twelve Largely Observed, and six Partly Observed. - Areas of observance: licensing requirements; FSA approval of changes in control and portfolio transfers; preventive measures and corrective measures/sanctions; information sharing and confidentiality; domestic/cross-border supervisory cooperation; AML/CFT. - Reform: The FSA plans to apply the ESR to all insurers from fiscal year 2025, addressing shortcomings in existing solvency requirements. - Supervisory gaps and recommendations: - The FSA’s approach is largely reactive; most supervisory activities are industry-wide thematic and regular risk assessment of individual insurers is not undertaken as part of a supervisory cycle. - Recommendation: Undertake a fundamental reform focusing on supervision of individual insurers and larger intermediaries, with more forward-looking supervision to avoid intensive supervision only after risks crystallize. - Suitability (fit and proper) scope is not comprehensive. - Recommendation: Ensure suitability requirements apply to all board members, senior managers, and key persons in control functions, with appropriate guidance on qualifications. - Recommendation: Supplement general risk management and internal control requirements with clearer requirements for effective, independent, and well-resourced risk management, compliance, and actuarial functions, especially for individual insurers. - Solvency shortcomings pending ESR introduction: - Example: assets and liabilities are not valued on an economic basis; policy reserves do not include an explicit margin over the current estimate. - Expectation: ESR will be underpinned by economic valuation requirements, improving observance. ### Insurance institutional arrangements - Recommendation: Bolster FSA independence by delegating insurer licensing powers currently reserved to a minister. - Recommendation: Government should review whether the FSA can be provided increased freedom to determine its expenditure budget and to finance itself independently of other parts of the government. - Kyosai organizations: - Concern: Separate regulatory arrangements for kyosai organizations could lead to unjustified differences in approach and levels of protection for policyholders. - Recommendation: Increase cooperation between the FSA and ministries responsible for kyosai supervision, prioritize coordination on largest kyosai organizations, and in the medium term review regulatory and supervisory responsibilities for the kyosai business. ### Investment funds - Regulatory enhancement: Framework for Investment Management Business Operators amended with increased attention to liquidity risk management. - Supervisory approach: New approach relies on enhanced offsite monitoring; FSA increased data collection and launched targeted initiatives; onsite monitoring inspects a limited number of firms per year. - Recommendations: - Broaden coverage of onsite inspection program to improve overall risk assessment of firms. - Strengthen offsite risk monitoring: consider expanding coverage and increasing frequency of the new investment fund survey to identify risks in a timely manner. ### Fintech and digital payments - FSA arrangements: Fintech Policy Office coordinates fintech work, monitors via industry outreach, data analysis, engagement with self-regulatory organizations and study groups. - Regulatory changes: Amendments to the Payment Services Act, the Banking Act, and the Financial Instruments Exchange Act (FIEA) have been undertaken. - Recommendations: - Implement a more systematic approach to data gathering and analysis as fintech grows. - Intensify monitoring of digital payment services and enhance supervision of relevant players. - Consider requiring Fund Transfer Service Providers (FTSPs) to develop wind-down plans in the absence of specific capital requirements for FTSPs. - Analyze whether the requirement for third-party Prepaid Payment Instrument (PPI) issuers to retain only 50 percent of funds transmitted by clients remains adequate given rapid growth of digital PPIs. ### Crypto-asset Exchange Service Providers (CESPs) - Assessment: Japan has developed a comprehensive conduct and prudential regulatory framework for CESPs (framework introduced in 2017 and progressively tightened). - Features: strict asset segregation requirements and compulsory use of cold wallets; monitoring of non-regulated entities serving Japanese clients; issuance of warnings and public alerts. - Recommendation: Enhance public education on crypto asset risks and continue a strong enforcement approach. ### Financial Market Infrastructures (FMIs) - Progress: Notable progress in enhancing CCP risk management since 2017; Comprehensive Guidelines for Supervision of FMIs revised in 2022 reducing gaps with the PFMI. - Coordination: FSA and BOJ conduct joint hearings on JSCC risk management at least once a year and coordinate assessment and supervisory response. - Findings: - FIEA does not mirror PFMI language, but authorities’ risk assessment covers the full extent of the PFMI. - BOJ conducted detailed assessment for seven private-sector FMIs in 2020 and updates annually; FMIs perform self-assessments against PFMI. - Recommendation: JSCC should consider introducing additional mechanisms to ensure customers’ interests and views are systematically considered, e.g., increasing customer presence on JSCC committees. ### Financial integrity (AML/CFT) - Trend: FSA increased resources and moved to a more risk-based approach for AML/CFT supervision of financial institutions (FIs) and Virtual Asset Service Providers (VASPs). - Practice: AML/CFT Policy Office assesses annually individual residual ML/TF risk levels of FIs and VASPs; special ongoing attention to nine financial groups including the three G-SIBs. - As of November 2023: there were 29 registered VASPs and about 5 million active accounts with a total balance of JPY 1.8 trillion (2.8 percent of GDP). - Developments: “Travel Rule” under FATF Recommendation 15 came into force for all VASPs in June 2023; FSA began monitoring compliance off-site, focusing more on larger VASPs. - Recommendation: Ensure FIs non-compliant with AML/CFT requirements are appropriately sanctioned; consider imposing proportionate and dissuasive sanctions and review appropriateness of available sanctions. - Note: FSA revised its AML/CFT Guidelines and set a March 2024 deadline for implementation; since 2021 imposed administrative orders on two FIs for AML/CFT breaches. ### Macroprudential policy framework - Coordination: Inter-agency coordination has improved, including establishment of the Financial Monitoring Council (FMC); CCFS serves as collegiate to assess desirability of introducing macroprudential tools but operates without a clear mandate. - Recommendation: Provide a stronger institutional framework with a formal mandate for the CCFS to enhance accountability and transparency. - Toolkit gaps and recommendations: - Basel III capital and liquidity tools for internationally active banks and D-SIBs phased in. - Liquidity risk framework for NBFIs enhanced. - Recommendation: Expand perimeter of international standards (e.g., Capital Conservation Buffer (CCoB)) to domestic banks. - Real estate vulnerabilities: introduce borrower-based tools (e.g., caps on loan-to-value, debt-to-income, and DSTI ratios) to help contain rise in housing loan PDs and LGDs under the adverse stress testing scenario, complementing the industry 5-year/125 percent rule; introduce measures gradually and calibrate by sectoral developments. - Use granular loan and borrower data under the “Common Data Platform” to calibrate measures and conduct ex-post assessments. - FX liquidity monitoring recommendation: Monitor LCRs by currency of all banks and further enhance monitoring of net open FX positions; consideration could be given to imposing LCRs-by-currency on banks. ### Cross-cutting issues — Resources - Finding: Staffing resources need to be increased significantly to strengthen financial supervision. - Resource constraints affect banking supervision, insurance supervision (acute), and breadth of SESC onsite program. - Recommendation: Ensure adequate supervisory resources commensurate with potential risks, including for the growing investment fund sector. - Cybersecurity resourcing: - The FSA IT Cyber Monitoring Team supervises over 1,000 financial entities and is responsible for cyber strategy, guideline updates, incident management, and exercises; resource constraints have affected capacity for effective cyber regulation and supervision. - Recommendation: Devote more resources to strengthen cybersecurity supervision. ### Cross-cutting issues — Systemic risk monitoring and data - Progress: Upgrading systemic risk analysis, but framework could be enriched further. - Recommendations: - BOJ should continue enhancing macro stress testing framework, e.g., by further developing its credit risk module. - Enhance liquidity risk analysis for banks with stress testing tools and models for exposures in JPY and FX. - Broaden systemic risk analysis to cover stress testing of investment funds. - Formally assess contagion risks given strong interconnectedness. - Continue developing analytical capacity to analyze climate-related risks. - Data needs: - Progress on granular data collection under the Common Data Platform and surveys, but further enrichment and integration of databases is necessary for comprehensive risk assessment. - Remaining gaps related to climate data should be closed. ### Cross-cutting issues — Cybersecurity - Context: Rapid digitalization increases exposure to cyber risk; cyber incidents have surged. - Progress: Clear supervisory/examination processes with dedicated cyber teams at FSA and BOJ, but further strengthening needed. - Recommendations: - Update Comprehensive Supervisory Guidelines (CSG) on cyber risk for all supervised financial entities and implement a more structured, risk-based approach supported by adequate tools; align supervisory tools and methodologies with updated CSGs. - Prioritize cyber supervision of FMIs. - Deepen analysis of operational interconnectedness via “cyber mapping” to understand transmission channels for cyberattacks. - BOJ should strengthen cyber risk oversight of FMIs using the CPMI-IOSCO Cyber Guidance for self-assessments and cyber assessments. - Improve response and recovery capabilities: upgrade cyber scenarios, business continuity plans, and incident response/recovery plans; consider cyber simulations/table-top exercises with BOJ-NET participants and FMIs with BOJ-NET connections. *IMF staff report excerpt* ### 72. The FSA’s approach emphasizes the need for financial institutions to engage with ### 1jpnea2024001 - 72. The FSA’s approach emphasizes the need for financial institutions to engage with ### FSA approach to climate-related risks and transition finance - Paragraph 72: The FSA’s approach emphasizes the need for financial institutions to engage with clients to facilitate the decarbonization process and mitigate climate-related transition risks. - The government’s policies, including the FSA’s approach, focus on mobilizing transition finance and consider an important role for financial institutions to fund the transition. - The approach does not view the de-risking of individual banks and insurers through defunding certain companies as beneficial for the transition in the short term. - Paragraph 73: The FSA is at the early stages of establishing a systematic approach to supervision of climate-related issues. - The FSA published “Supervisory Guidance on Climate-related Risk Management and Client Engagement” in July as a non-binding discussion paper. - Current supervisory dialogues with banks and insurers are held on an ad-hoc basis as part of more general supervisory dialogues. - Recommendation: The FSA should consider and develop a systematic supervisory approach in consideration of the work of international bodies such as the BCBS, IAIS, and NGFS. ### Crisis management — Emergency Liquidity Assistance (ELA) - Paragraph 74: Many aspects of ELA practices in Japan are robust. - Sound internal guidelines exist for establishing solvency requirements to provide ELA for prudential purposes and for accidental causes under Articles 33 and 37 of the BOJ Act. - The level of collateral haircuts is subject to yearly review whereby haircuts may be adjusted depending on financial market conditions. - Paragraph 75: The ELA framework could be strengthened. - Public disclosure on the solvency requirement and eligibility criteria could be improved by explicitly noting these in the English version of the published principles. - Public documentation should clearly indicate that ELA can only be granted to solvent institutions, except in certain cases under crisis management measures (Article 38 as per Article 102 of the Deposit Insurance Act). - Paragraph 76: Need to strengthen ELA safeguards to mitigate moral hazard. - The BOJ’s publicly available ELA principles for Articles and 7 should clearly stipulate that ELA is conditional, discretionary, and granted basically at a specific margin above the policy rate. - Firms receiving ELA should be under the FSA and BOJ’s intensive monitoring and conditionality. - When providing ELA under Articles 37 and 38, the BOJ should request and mobilize as much collateral as needed to protect the BOJ’s balance sheet. - If ELA is granted without or with insufficient collateral, authorities should implement measures to safeguard the BOJ balance sheet (examples: preferential status of the BOJ in creditor hierarchy; arrangements with the government to cover potential losses such as fully or partially suspending distribution of profits to the national treasury). - Paragraph 77: Scope of ELA eligibility could be expanded. - The BOJ could consider including systemic NBFIs under Article 33 to access ELA for macroprudential purposes, prioritizing CCPs given their pivotal role in ensuring financial stability. ### Crisis preparedness framework and resolution regime - Paragraph 78: Progress since the 2017 FSAP. - The Japanese resolution framework distinguishes between non-systemic and systemic cases and allows distinct resolution measures, including public liquidity and (preemptive) capital support, underpinned by broad powers except for statutory bail-in powers. - Since 2017: introduced Total Loss-Absorbing Capacity (TLAC) requirements; expanded resolution planning to include one D-SIB along with the three G-SIBs; set up the FSA’s RRP Office; continued to elaborate guidelines for firms’ resolvability. - Paragraph 79: Need to expand recovery and resolution planning (RRP). - Current status: All seven SIBs (three G-SIBs and four D-SIBs) required to submit recovery plans. FSA prepares resolution plans for three G-SIBs and one D-SIB; these four SIBs are subject to TLAC requirements. - Rationale: Systemic resolution options and potential public financial support apply to all banks; several large deposit-taking institutions hold substantially more insured deposits than readily available deposit insurance funding. - Recommendation: Expand RRP requirements gradually — prioritize all major banks for recovery planning and all SIBs for resolution planning, then eventually cover all banks that could be deemed systemic at time of failure. - Recommendation: More banks should be required to maintain a minimum amount of TLAC. - Recommendation: Authorities should comprehensively articulate expectations of banks in improving recovery capabilities and addressing impediments to resolvability. - Paragraph 80: Operationalize resolution framework. - Recommendation: Complete documentation of internal arrangements, including manuals and playbooks with sufficient operational modalities. - Recommendation: Enhance decision-making and information-sharing arrangements to ensure prompt and effective resolution execution. - Recommendation: Adopt policies for key moments in the resolution process to guide, expedite, and increase predictability of future resolution decisions (example: provide more transparency on the choice between resolution regimes, with the Crisis Management Measures regime designated as a last-resort option). - Paragraph 81: Crisis simulation program. - Recommendation: Execute a multi-year interagency crisis simulations program for diverse failure scenarios, including fast-fail resolutions of systemic and mid-size banks and concurrent failures. - Recommendation: Agree on a multi-year program with regular exercises under the auspices of the Financial Crisis Response Council (FCRC). - Paragraph 82: Recovery and resolution planning for insurers and FMIs. - Current status: Internationally active insurance groups (IAIGs) are subject to recovery planning requirements; FSA deems none of the insurers—including the four IAIGs—systemically important and therefore does not undertake resolution planning for these firms. - Concern: All insurers are covered by the Orderly Resolution Measures regime that includes potential provision of public financial support. - Recommendation: Authorities should plan for the failure of insurers and further the RRP regime for FMIs, prioritizing CCPs. - Paragraph 83: Staffing resources. - Finding: Staffing resources need to be enhanced to further crisis readiness efforts. - Recommendation: Increase staffing levels and skillsets—particularly at the FSA as the lead resolution authority—to be commensurate with increasing ambitions. ### Authorities’ views (summary) - Paragraph 84: Authorities appreciated the FSAP engagement; agreed with broad thrust of findings and direction of recommendations; welcomed assessment of financial system resilience and policy framework improvements since the 2017 FSAP. - Paragraph 85: Authorities mostly concurred with systemic risk assessment but highlighted nuances. - They agreed the Japanese financial system is broadly resilient to severe adverse shocks. - They noted the loss in capital under the adverse scenario would be lessened by considering deferred tax assets for valuation losses of securities investments and correcting the overestimation of housing loan PDs. - They considered the stress test’s alternative scenario of an increase in domestic interest rates occurring concurrently with a decline in economic growth as highly unlikely. - They noted banks have been actively managing risks against rising interest rates through portfolio rebalancing and hedging tools; banks have been resilient to FX funding risks and cautious in expanding overseas lending recently. - They agreed on possible signs of overheating in parts of the real estate markets while office demand has been solid compared to overseas CRE markets; they do not assess risks to housing loans as an immediate concern given low historical credit cost and industry practice of 5-year/125-percent rule. - They considered climate risk analysis useful but emphasized high uncertainty and interpreted results with caution. - They welcomed recommendations to strengthen systemic risk analysis capacity and noted ongoing initiatives to broaden and deepen risk monitoring. - Paragraph 86: Commitment to strengthen regulatory and supervisory approaches. - Authorities noted the FSA’s legal mandate had not changed and does not include economic growth or international competitiveness as a policy goal; the FSA prioritizes financial safety and financial stability. - On macroprudential policies, authorities assess the current institutional framework as effective and do not see a need to assign a formal mandate to the CCFS. - They noted difficulties in calibration of borrower-based tools and potential adverse consequences for economic welfare. - Plans highlighted: implementation of the economic value-based solvency regulation and commitments to boost cyber resilience and strengthen policy frameworks in emerging areas such as climate and fintech. - On financial integrity, they are working to implement recommendations following the recent FATF/APG mutual evaluation report. *Source: 1jpnea2024001* ### 87. The authorities also welcomed the assessment of the financial crisis preparedness ### 1jpnea2024001 - 87. The authorities also welcomed the assessment of the financial crisis preparedness ### Authorities' assessment of crisis preparedness and safety nets - Authorities welcomed the assessment of the financial crisis preparedness framework and noted advances with TLAC requirements and RRP, while emphasizing the need to constantly enhance and update requirements (e.g., expand RRP requirements to more banks). - Authorities judged many aspects of the public sector liquidity framework and measures, including the BOJ’s ELA, to be robust due to continuous efforts to strengthen the financial safety net over the years. - Authorities agreed that the BOJ’s financial soundness against potential losses arising from ELA operations is important. ### Pandemic-related financial sector policy measures (selected highlights and dates) - March 17, 2020: FSA Notice allowed banks to assign zero-risk weight for loans guaranteed by credit guarantee associations or under emergency guarantee program; capital buffers were expected to be released in downturns. FSA and BOJ relaxed leverage-ratio exposure rules by exempting deposits at the central bank from leverage ratio exposure (April 8/17, 2020). This measure is scheduled to end at end-March (per the FSA’s Notice dated March 25, 2022). - March 17, 2020: FSA allowed banks to use their stock of High-Quality Liquid Assets (HQLA) and fall below the minimum during periods of distress; Net Stable Funding Ratio implementation postponed by 1 ½ year (became effective by September 2021 for internationally active banks). - March 17, 2020: FSA requested insurers to set grace periods on premium payments and renewals. - March 24, 2020 (and subsequent Notices April 7 and 27, May 8, June 10, 2020): FSA guidance requested FIs to inform customers about COVID-19 special loans, extend repayment periods, defer principal payments, provide bridge loans, offer mortgage payment deferrals, refrain from registering pandemic-affected modifications as arrearage, and refrain from charging fees for modification. Fully guaranteed 0/0 loans started to be phased out (September 2022), with rollovers expected to be mostly over by mid-2024. These pandemic-related guidelines are expected to be discontinued in 2024. - March 30, 2020: FSA announced a one-year deferral of national implementation date of finalized Basel III standards and later another year to end-March 2024; several banks opted for earlier adoption starting end-March 2023. - May 22, 2020: BOJ introduced “Special Funds-Supplying Operations to Facilitate Financing in Response to the Novel Coronavirus (COVID-1 )” supporting mainly micro enterprises and SMEs with interest-free and unsecured loans (0/0 loans). The total size of the scheme reached about ¥90 trillion at end-FY21 (equivalent to about US$740 billion at the time). The Policy Board of the BOJ decided to phase out the scheme at its meeting in September 2022. Loans through this scheme have completely unwound by June 2023. ### Key Financial Soundness Indicators (FSI) — selected series (2017–2023) - Regulatory capital to risk-weighted assets 2/,3/: - 2017: 16.0 - 2018: 17.1 - 2019: 17.2 - 2020: 16.4 - 2021: 16.6 - 2022: 15.4 - 2023: 14.9 - Regulatory tier 1 capital to risk-weighted assets: - 2017: 13.5 - 2018: 14.9 - 2019: 15.1 - 2020: 14.3 - 2021: 14.6 - 2022: 13.8 - 2023: 13.4 - Capital-to-total assets 2/,3/: - 2017: 4.9 - 2018: 5.2 - 2019: 5.2 - 2020: 4.7 - 2021: 4.6 - 2022: 4.3 - 2023: 4.1 - NPL net of provisions/capital 2/,4/: - 2017: 6.2 - 2018: 4.8 - 2019: 4.3 - 2020: 4.8 - 2021: 5.7 - 2022: 6.9 - 2023: 4.9 - Non-performing loans (NPL) to total loans ratio 2/,4/: - 2017: 1.3 - 2018: 1.1 - 2019: 1.1 - 2020: 1.1 - 2021: 1.2 - 2022: 1.3 - 2023: 1.2 - Return on assets 2/,4/: - 2017: 0.2 - 2018: 0.2 - 2019: 0.1 - 2020: -0.1 - 2021: 0.1 - 2022: 0.1 - 2023: 0.2 - Return on equity 2/,4/: - 2017: 5.1 - 2018: 5.4 - 2019: 2.3 - 2020: -1.3 - 2021: 3.5 - 2022: 2.6 - 2023: 5.8 - Interest margin: - 2017: 1.1 - 2018: 1.1 - 2019: 1.1 - 2020: 1.0 - 2021: 0.9 - 2022: 0.9 - 2023: 1.1 - Liquid assets to total assets 2/,4/: - 2017: 28.7 - 2018: 29.6 - 2019: 29.4 - 2020: 29.5 - 2021: 34.4 - 2022: 35.8 - 2023: 33.3 - Liquid assets to short-term liabilities 2/,4/: - 2017: 49.7 - 2018: 49.9 - 2019: 49.2 - 2020: 47.4 - 2021: 52.6 - 2022: 53.3 - 2023: 50.8 - Customer Deposits to Total (Non-interbank) Loans 2/,4/: - 2017: 136.5 - 2018: 139.4 - 2019: 139.5 - 2020: 139.1 - 2021: 147.6 - 2022: 148.6 - 2023: 146.9 - Gross derivative asset to capital 2/,4/: - 2017: 43.8 - 2018: 35.8 - 2019: 35.2 - 2020: 55.8 - 2021: 43.3 - 2022: 57.1 - 2023: 75.9 - Gross derivative liability to capital 2/,4/: - 2017: 42.3 - 2018: 33.2 - 2019: 33.7 - 2020: 52.0 - 2021: 42.7 - 2022: 59.9 - 2023: 79.9 ### FSAP Risk Assessment Matrix — selected risks, likelihoods, and expected impacts - Intensification of regional conflict(s) and geo-economic fragmentation - Overall Level of Concern: High - Likelihood: High - Expected Impact if Materialized: - Global trade and supply-chain disruptions and increased uncertainty leading to an abrupt global and domestic economic slowdown. - Significant commodity price volatility and upward pressure on inflation leading to a sharp increase in foreign and domestic interest rates. - Valuation losses from holdings of foreign and domestic debt securities under mark-to-market accounting. - Increase in sovereign risk premia, repricing of risky assets, and higher funding costs and lending rates leading to a sharp deterioration of financial conditions and increasing liquidity risks to financial institutions. - Nominal wage growth lags inflation, implying reduction in real wages and private sector borrowers’ debt service ability, raising credit risk for banks and NBFIs. - Abrupt global slowdown or recession - Overall Level of Concern: Medium - Likelihood: (noted as) High - Expected Impact if Materialized: - Lower domestic GDP growth leading to deterioration in domestic asset quality, bankruptcies, and erosion of bank capital buffers. - Deterioration in macroeconomic fundamentals leading to a reassessment of fiscal risk and higher sovereign risk premia, triggering a negative feedback loop between the sovereign and financial sectors. - Increase in credit risk from overseas exposures. - A rise in global risk premia and strains in offshore U.S. dollar funding markets, implying higher hedging/funding costs for the financial and nonfinancial sectors, impairing their profitability and investment. - Bond market stress from a reassessment of sovereign risk - Overall Level of Concern: Medium - Likelihood: (noted as) High - Expected Impact if Materialized: - An increase in sovereign risk premia would worsen public debt dynamics and transmit risk to the financial sector because of the sovereign-financial sector nexus. - Extreme climate events / disorderly energy transition - Overall Level of Concern: Medium - Likelihood: (noted as) High/Medium - Expected Impact if Materialized: - Economic damage leading to large credit losses in the financial sector, amplified by productivity losses and collateral devaluations, triggering a tightening of financial conditions. - Global and domestic decarbonization efforts to mitigate climate change, leading to side-effects, i.e., transition risks to the financial sector depending on global/domestic policy ambitions and degree of exposure to carbon-intensive firms and industries. - Cyberthreats - Overall Level of Concern: Medium - Likelihood: (noted as) High - Expected Impact if Materialized: - Cyberattacks on critical infrastructure and systemic financial institutions could threaten macrofinancial stability by undermining confidence and disrupting financial services and real activities. ### Balance-sheet composition and funding structure — banks and insurers (selected structural points) - Banks - Security holdings are significant for internationally active banks and domestic banks, and less so for the regional bank cluster; domestic sovereign and foreign bonds represent the largest share of overall security holdings. - Foreign currency funding is sizeable in particular for internationally active banks, representing about 30 percent of their total liabilities, while for domestic banks and regional banks it amounts to a rounded 10 percent. - Retail and wholesale unsecured funding dominates liabilities in JPY and currencies other than the USD; for USD funding, derivatives (largely FX swaps) and unsecured wholesale funding dominate at the banking system level. - Insurers (selected asset structure observations) - Insurance asset compositions show material holdings in Government Bonds, Corporate Bonds, Loans and mortgages, Collective Investment Undertakings, Listed Equities, and other categories. - Charts and firm submissions were used to analyze currency breakdowns, share of foreign bond and equity exposures, sovereign bond holdings, and corporate bond holdings for life and non-life insurers. ### Stress-testing insights (selected) - Bank solvency stress tests included interest rate sensitivity analysis with adjustments to account for accounting filters (e.g., AFS filter “switched off” for domestic banks to assess economic valuation effects). - Insurance stress tests combined instantaneous shock analysis with three-year company-provided projections under baseline and adverse scenarios; panels reported “Available Capital” and “Required Capital” in trillions of JPY and projected investment spread (percent) and projected net surplus (JPY Trillions) across 2023/24–2025/26. - Sensitivity analyses for life and non-life insurers examined changes in available capital and ESR/SMR sensitivity to market shocks, including increases in interest rates, currency appreciations, equity and real estate declines, and benchmarked catastrophic shocks (e.g., Great Kantō, The Ise Bay, Typhoon, 2018 cat events, overseas cat events, longevity shock, pandemic morbidity). *Source: IMF staff and Japanese authorities as presented in the source content.* ### Appendix I. Implementation Status of Key Recommendations in ### Appendix I. Implementation Status of Key Recommendations in the 2017 Financial System Stability Assessment (FSSA) — JAPAN ### Cross-cutting Issues - Recommendation: Further raise corporate governance standards to bolster independence of board and oversight functions from senior management across banking and insurance sectors (FSA). - Implementation status: Partially Implemented and Ongoing. - Key findings: - The FSA has been encouraging constant improvement of governance in the banking and insurance sectors, and some progress has been made. - Banking Sector: - Increased appointments of outside directors and establishment of board committees by banks (including risk committees not required by law). - Role of internal audit explicitly strengthened in the Corporate Governance Code and in the FSA’s Supervisory Guidance. - FSA remains highly focused on major banks and the scope of “fit and proper” assessments has not been broadened yet. - Insurance Sector: - Since 2016, Comprehensive Guidelines for Supervision for Insurance Companies require appointment of at least two outside directors. - Enhancement of corporate governance system of insurance companies has been a supervision focus. - Gaps remain relative to detailed requirements of ICP 7, including on board’s powers and resources. - FSA monitors governance taking into account scale, organizational structure, and business characteristics rather than applying a uniform corporate governance model. ### Risk-Based Supervision - Recommendation: Further develop internal processes to support full risk-based supervision for banks, insurers, and securities firms (FSA, SESC). - Implementation status: Partially Implemented and Ongoing. - Key findings: - Banking Sector: - Meaningful progress toward a flexible, more forward-looking, and risk-focused supervisory process that considers each bank’s risk, size, and scale. - Active supervisory judgement encouraged, but further improvements needed: increase intensity for regional banks, enhance the EWS, and introduce a comprehensive analytical framework for bank and banking-group risk profiles. - Insurance Sector: - Reforms undertaken, but prudential supervision remains thematic and reactive; regular risk assessment of individual insurers is not undertaken as part of a supervisory cycle. - Securities Firms: - 2024 FSAP conducted a focused review of supervision of investment funds rather than a full review of securities firms. - FSA and SESC have strengthened off-site and on-site supervision, but the approach may need to be more proactive to address emerging risks efficiently. - Cross-sectoral: - FSA conducts personnel training on prudence in a cross-cutting and comprehensive manner; training menus including videos by experts are prepared. - Regular personnel reshuffle at the FSA considers importance of developing expertise. ### Institutional Independence - Recommendation: Consider enhancing independence of the FSA and BOJ in key supervisory issues (PM, MOF, FSA, BOJ). - Implementation status: Not Implemented. - Key findings: - No structural or power changes to the FSA and BOJ since the 2017 FSAP. - Delegation to the Commissioner gives high operational independence, but reservation to a minister for key licensing powers and dependence on central government budgeting expose potential interference. - No fixed period of appointment for the Commissioner. - Thresholds for Prompt Corrective Regime (trigger points in Cabinet Order for Article 26(2) of the Banking Act) have not been raised. - Staffing decisions are not wholly within FSA’s purview; Commissioner authority limited to staff at or below Director level (Article 55-1, National Public Service Act). ### Systemic Risks and Stress Testing - Recommendation: Develop own supervisory stress testing model for solvency and liquidity for banks, and solvency for insurers; stress test large exposures periodically (FSA). - Implementation status: Partially Implemented and Ongoing. - Key findings: - The FSA and BOJ have been conducting guided bottom-up solvency stress tests with common’ scenarios for “major banks” since 1 , which cover percent of total sectoral assets, involving centrally defined scenarios set by the authorities. - Authorities compare bank-conducted tests with BOJ’s Financial Macro-econometric Model (FMM) results to explore differences. - FSA monitors FX liquidity of banks and observes liquidity stress tests conducted by the three mega banks; periodically requests information from the three mega banks regarding large exposures. - FSA has not developed supervisory stress testing models for solvency and liquidity risk for banks, nor formally stress tests large exposures. - For insurers: FSA conducts stress tests on all insurance companies based on submitted data, and periodically collects data on exposures and ratings of major insurance companies to identify large concentrations. - Recommendation: Continue conducting liquidity stress testing regularly for significant foreign currencies and require banks to hold sufficient counterbalancing capacity, particularly high-quality liquid assets (FSA). - Implementation status: Partially Implemented and Ongoing. - Key findings: - FSA closely monitors foreign currency liquidity risk management of mega banks via annual joint surveys with the BOJ and periodic detailed data collection. - FSA began collecting detailed foreign currency liquidity data of the three megabanks enabling foreign currency liquidity stress testing. - FSA has not developed or conducted full-fledged liquidity stress tests for significant currencies (neither JPY nor all-currency basis). - No formal minimum requirement for the LCR in foreign currencies; FSA aims to encourage better foreign currency LCR metrics through supervisory engagement. ### Financial Sector Oversight and Regulation - Recommendation: Give the FSA the power to set capital requirements for banks based on specific risk profiles (Gov). - Implementation status: Not Implemented. - Key findings: - Under current legal framework, FSA lacks complete Pillar 2 powers and cannot set a minimum capital ratio tailored to a bank’s risk profile; it lacks “ability to require banks to hold capital in e cess of the minimum.” - FSA requires major and regional banks to submit Internal Capital Adequacy Assessment reports; assesses ICAAP for the major 9 banks and engages in supervisory dialogue. - If FSA judges regulatory capital insufficient, it cannot formally require additional capital and must rely on persuasion. - Recommendation: Take further steps to implement an economic value-based solvency regime for insurers (FSA). - Implementation status: Implemented. - Key findings: - FSA has undertaken regulatory and supervisory reforms consistent with international standards and plans to introduce the ESR in fiscal year 2025. - ESR will apply to all insurers and is a far-reaching reform addressing shortcomings in existing solvency requirements. - Recommendation: Introduce more specific periodic reporting requirements and more proactive investigations into related party transactions (FSA). - Implementation status: Partially Implemented and Ongoing. - Key findings: - Related party risk management expectations strengthened for related corporate entities and directors, including concept of economic interdependence. - Corporate Governance Code emphasizes governance of related party risk. - Definition of related party needs broadening to capture other types of individuals beyond directors. - Recommendation: Ensure robust supervision of systemically important securities firms by ensuring access to experienced staff and onsite monitoring of overseas operations (FSA, SESC). - Implementation status: Implemented and Ongoing. - Key findings: - Dedicated Monitoring Office for Major Securities Firms operational since 2022 conducting continuous monitoring in cooperation with Securities Division and SESC. - On-site overseas monitoring resumed in November 2023 after pandemic interruption; remote interviews and supervisory-college communications with overseas authorities also conducted. ### Financial Market Infrastructures (FMIs) - Recommendation: Enhance recovery plan further by including extreme stress scenarios while ensuring continuity of critical services and mitigating contagion risks through clearing members (JSCC). - Implementation status: Implemented. - Key findings: - JSCC began submitting recovery plans voluntarily in 2018; since 2022 required to submit recovery plans per revised FSA guidelines. - Revised guidelines require recovery plans to address stress tests under more severe stress than regular stress testing, based on system-wide and firm-specific scenarios. - Recommendation: Address recovery planning issues on regulation for central counterparties (FSA). - Implementation status: Implemented. - Key findings: - June 2022 revised “Comprehensive Guidelines for Supervision of Financial Market Infrastructures” require JSCC to develop and submit a recovery plan once a year (or when important changes occur). - Guidelines list topics recovery plans must cover but do not elaborate on these topics. ### Macroprudential Policy - Recommendation: Clarify the mandate of the Council for Cooperation on Financial Stability (FSA, BOJ). - Implementation status: Not Implemented. - Key findings: - CCFS continues to operate without a clear, formal mandate; aims to facilitate macroprudential coordination including CCyB decisions. - Working-level liaison committee convenes quarterly and discusses CCyB necessity; has made no recommendation on CCyB rates as it has not confirmed necessity to activate CCyB rates. - Recommendation: Consider proactively enhancing the macroprudential toolbox, including sectoral tools (FSA). - Implementation status: Partially implemented and Ongoing. - Key findings: - Toolkit enhanced through phasing in Basel III capital and liquidity standards and other measures. - FSA implemented capital surcharges for designated systemically important financial institutions, enhanced insurers’ liquidity risk management framework, margin requirements for non-centrally cleared OTC derivatives, and risk retention rules. - Several domestic banks have started to apply finalized Basel III standards with remaining banks expected to apply by end-March 2025. - Certain standardized approach risk weights being revised to reflect sectoral risk metrics; risk weights for residential real estate loans will be linked to loan-to-value (LTV) rates at origination. - Targeted borrower-based tools (e.g., LTV, loan-to-income, debt-to-income, and/or DSTI caps) are not implemented in Japan. - Recommendation: Continue to broaden and deepen scope of systemic risk assessments (FSA, BOJ). - Implementation status: Partially Implemented and Ongoing. - Key findings: - FSA and BOJ have improved macro stress testing model (FMM) and covered topical issues in Financial Stability Reports. - FSA publishes “FSA Analytical Notes” to provide data analysis examples with system-wide views using granular data. - Macroprudential Policy and Data Strategy Office (current name Macro-financial Stability and Data Strategy Office) established and a Chief Data Officer appointed. - Data projects initiated, including Common Data Platform joint with BOJ in operation since FY 2023 and Investment Fund Survey currently in pilot phase. ### Crisis Management, Resolution, and Safety Nets - Recommendation: Strengthen resolution framework by removing ambiguities in choice of tools, introducing statutory bail-in power, clarifying triggers for early entry into resolution, and ensure courts do not hinder effective resolution (FSA). - Implementation status: Partially Implemented. - Key findings: - FSA revised supervisory guideline in December 2023 to ensure courts do not impede effective resolution; valuation guidelines require timely provision of financial information when filing for substituted permission involving the court. - No follow-up on other components (statutory bail-in, clarity on triggers) since 2017 FSAP. - Recommendation: Consider broadening perimeter of institutions to establish loss-absorbing capacity (FSA). - Implementation status: Implemented. - Key findings: - On April 1 , 18, FSA published “The Revisions to The FSA's Approach to Introducing the TLAC Framework.” - Since March 2019, TLAC requirements apply to the three G-SIBs: MUFG, SMFG, and MHFG. Since March 2021, Nomura (a D-SIB) is also subject to TLAC requirements. - Recommendation: Encourage earlier prompt corrective action and provide clearer path to resolution (FSA). - Implementation status: Not Implemented. - Key findings: - Corrective action triggers remain calibrated to minimum capital thresholds; no clarification adopted to ensure early commencement of resolution measures. - Recommendation: Enhance crisis preparedness and coordination via an interagency crisis management forum (MOF, Minister for FS, BOJ, FSA, DICJ). - Implementation status: Not Implemented. - Key findings: - Authorities continue to rely on informal arrangements for interagency cooperation on crisis preparedness. - Recommendation: Establish orderly resolution regime, following international guidance, for central counterparties and other FMI operators (FSA). - Implementation status: Not Implemented. - Key findings: - Authorities continue to rely on measures that aim to prevent failure of CCPs. - Recommendation: Strengthen framework for provision of emergency liquidity assistance and tighten preconditions for use of temporary public funding in resolution (MOF, BOJ). - Implementation status: Not Implemented. - Key findings: - BOJ’s ELA framework and preconditions for accessing public funding in resolution remain unchanged since 2017 FSAP. ### Financial Intermediation and Banking Sector Structural Issues - Recommendation: Continue engaging with banks on implications of macroeconomic and demographic trends and take timely actions when viability concerns are identified (FSA). - Implementation status: Implemented. - Key findings: - Early Warning System revised in June 2019 designed to identify possible concerns regarding banks’ sustainable profitability and future soundness. - Recommendation: Encourage banks to evolve risk management practices in line with new business activities (FSA). - Implementation status: Partially Implemented and Ongoing. - Key findings: - Supervisory Guidance enhanced and major banks established Board Risk Committees, but not a full requirement and does not apply to all banks. - FSA reviews business strategies, conducts on-site and off-site monitoring, and holds dialogues on business infrastructure, financial bases, governance, and risk management domestically and abroad. - Recommendation: Encourage regional and Shinkin banks to review cost reduction, consolidation, income diversification, and fee structures to address medium-term profitability concerns (FSA, Gov). - Implementation status: Implemented and Ongoing. - Key findings: - FSA initiated measures to support consolidation of regional banking sector to enhance efficiency and preserve viability. - Act on special measures for the anti-monopoly act provides a 10-year window for mergers/integrations between regional banks, exempting the merger from anti-monopoly act application if judged to better serve local communities. - Merging regional banks may benefit from a temporary grant scheme subsidizing some initial merger costs. - Recommendation: Lower coverage of credit guarantees (SME Agency). - Implementation status: Implemented. - Key findings: - Government reformed credit guarantee system in 17 to reduce excessive reliance by financial institutions, encouraging SMEs to improve business management and financial institutions to provide loans based on business evaluation and appropriate post-loan monitoring. - Safety Net Guarantee No. 5, previously 100 percent guarantee prior to the reform, was revised to 80 percent guarantee to create environment for SMEs to promote structural business improvement under financial institutions’ management support. *Source: IMF staff.* ### Appendix II. Stress Testing Matrix (STeM) ### Appendix II. Stress Testing Matrix (STeM) ### Banking Solvency Stress Test — scope and data - Institutions included: 23 banks, which include internationally active banks and domestic banks. The Two specialized banks, Japan Post Bank and Norinchukin bank, are also included. - Market share: 82 percent in terms of total assets. - Data source and cut-off date: - Supervisory data provided by the FSA or obtained from banks. - Cut-off date: March 2023. - Scope of consolidation: solo level data for Japanese banks—including all foreign business through branches and foreign bond holdings—was deemed adequate; exposures through foreign subsidiaries are marginal at the banking system level. - Other data sources: commercial databases. - Coverage of sovereign exposures: domestic and main foreign countries exposures, by accounting classification. - Coverage of credit risk exposures: domestic and main foreign countries exposures, by economic sectors. ### Banking Solvency Stress Test — methodology and models - Overall framework: Dynamic bank balance sheet model. - Satellite models: - Credit risk: Parameter (PD, LGD, EAD) projections, including write-off rates and cure rates; analysis used as starting points the PDs and LGDs reported by banks. Historical supervisory data and largely structural models. - Net Interest Income: structurally-informed econometric pass-through equations for banks’ interest income and cost of funding; cost of funding model accounted for feedback from solvency and USD funding dependence; interest income models capture pass-through market rates and banks’ own cost of funding. - Net Fees and Commission income and other income/expenses: bank-panel regression model using a Bayesian Model Averaging (BMA) methodology. - Market risk: Modified duration model for bonds, including hedging and counterfactual analysis switching interest rate hedges off; equity investments revalued with equity price assumptions; FX net open position revalued in line with FX paths and accounting for FX hedges. Hedging data sourced from banks and may be incomplete. - Stress test horizon: 3 years: 2024-2026. ### Banking Solvency Stress Test — scenarios and sensitivities - Scenario analysis: - Baseline scenario from October 2023 WEO projections. - Adverse scenario: calibrated with at least 2 standard deviation shock relative to historical, and guided by GaR estimates; cyclical state dependency considered. - Adverse scenario modeled using MCM’s GFM simulations for Japan and main foreign countries, combining global layers (tightening of global financial conditions, sharp global downturn, geopolitical fragmentation) and domestic layers (rising inflation and domestic interest rates). - Sensitivity analysis: interest rate risks, interest rate hedging on vs. off, concentration risks. - Additional shock to adverse scenario (or stand-alone): - short-term interest rate: 1.5 percent in 2024, - long-term interest rate: 3.0 percent in 2024, - GDP growth rate: -3.2 percent in 2024. ### Banking Solvency Stress Test — risks, behavioral adjustments, buffers, calibration - Risks/factors assessed: Credit losses, profitability, funding costs, market risk, fixed income securities (interest rate, spreads, and FX), exchange rate, taxes. - Behavioral adjustment: - Dynamic balance sheet with growth informed by macro model outcome. - Write-offs calibrated; new business implied such that desired gross loan growth is matched. - Portfolio composition unchanged over time. - Hurdle rates: - Internationally active banks: 4.5 percent for CET1 ratios, 8 percent for total capital ratios. - Domestic banks’ core capital ratio: 4 percent. - Capital Conservation Buffer (CCoB) allowed to be consumed in the adverse scenario; separate analysis of extent of CCoB consumption under baseline and adverse scenarios. - Calibration of risk parameters: - PDs and LGDs and numerous other required risk parameters obtained from supervisory databases. - Regulatory risk parameters: downturn LGDs kept constant; pass-through from point-in-time PDs to through-the-cycle PDs assumed to be 20 percent. - Expected loss-based provisioning for performing exposures (as per JGAAP) accounted for; pass-through from PiT expected losses to provision coverage for performing exposures assumed to be 20 percent (informed by BOJ/FSA information). ### Banking Solvency Stress Test — reporting - Output presentation: - System-wide capital shortfalls. - Aggregated contributions to evolution of capital ratios (profit and loss, tax, dividends, post-P&L OCI effects, risk weighted asset contributions, etc.). --- ### Banking Liquidity Stress Test — scope and data - Institutions included: 23 banks (same as in banking solvency stress test). - Market share: 82 percent. - Data and cut-off date: - Supervisory data. - Reference date: March 2023. ### Banking Liquidity Stress Test — methodology and horizon - Overall framework: - Cash-flow stress test analyzing net cash balance, available unencumbered assets, contractual cash inflows and outflows, and behavioral flows. - Considers Basel III LCR and NSFR and stressed LCR and NSFR. - Scenarios of increasing severity (haircuts, outflows, FX swaps, etc.). - Accounts for solvency feedback through possible sale of securities held in investment categories not requiring continuous marking-to-market (e.g., HTM, and AFS for domestic Japanese banks with an AFS filter). - Stress test horizon: - 30 days for LCR-type analysis. - 180 days (6 months) for cash flow-based stress test simulations. ### Banking Liquidity Stress Test — scenarios, risks and buffers - Scenario analysis: baseline and various adverse scenarios with varying intensity of liquidity conditions. - Sensitivity analysis: higher, more severe, run-off rates. - Risks: - Funding liquidity risk: funding and asset roll-off rates, non-renewal of maturing assets. - Market liquidity risk: asset haircuts influenced by market movements, potential fire sales and collateral supply. - Buffers and behavioral assumptions: - Behavioral assumptions about counterparty willingness to transact based on banks’ solvency and liquidity conditions. - HQLA in different jurisdictions can be transferred without restrictions. - FX conversion risks assumed absent in the all-currency cash flow stress test. - Calibration of risk parameters: - Stress funding run-off rates informed by LCR calibration relevant for Japanese banks. - Valuation changes for bonds and equity aligned with macrofinancial scenario used for solvency stress test. ### Banking Liquidity Stress Test — regulatory standards and reporting - Regulatory/accounting and market-based standards: - LCR hurdle rate set at 100 percent at the aggregate currency level (per Basel III). - No regulatory minimum defined for foreign currency LCRs in Japan. - NSFR per Basel III; limit of 100 percent. - Output presentation: - Changes in the system-wide liquidity position and drivers. - Distribution of banks’ liquidity positions. - Number of institutions with LCR/NSFR below regulatory limits or with cash shortfalls. - Amount of liquidity shortfall. --- ### Insurance Stress Test — top-down and bottom-up approaches - Institutions included: Top life and non-life insurers to cover at least 70 percent of annualized new business premiums. - Data: - Top-down: statutory and voluntary reporting. - Bottom-up: voluntary reporting. - Reference date: March 31, 2023. ### Insurance Stress Test — methodology, horizons and scenarios - Methodology top-down: - Investment assets: market value changes after price shocks affecting solvency margin. - Stock-based assessment of liquidity sources and liquidity needs (BCBS, IAIS classifications). - Revaluation of interest rate swaps after interest rate shock. - Methodology bottom-up: - Investment assets: market value changes after price shocks affecting solvency margin ratio. - Sensitivity analysis: effect on available capital and solvency margin ratio. - Stock/flow assessment of liquidity sources and needs (optional). - Stress test horizon: - Instantaneous shock. - 3-year projection of profitability indicators (only in the baseline and adverse scenario). - Scenario analysis: - Baseline. - Adverse scenario (in line with narrative severity of the banking sector stress test). - Sensitivities: - Market risk variables and interest rate term structure. - Default of largest financial and nonfinancial counterparties. - Longevity shock, mortality shock, selected natural disaster events. ### Insurance Stress Test — risks, buffers, behavioral adjustments, reporting - Risks/factors assessed: - Market risks: interest rates, stock prices, property prices, credit spreads, currency. - Counterparty risks: default of largest financial and nonfinancial counterparties. - Underwriting risks: catastrophe events, lapses. - Liquidity risk: shocks including mass lapse, mortality, morbidity, increase of non-life cost of claims, shock to reinsurance inflows, reduction in written premiums. - Summation of risks, no diversification effects. - Buffers: - Top-down: None. - Bottom-up: Buffers inherent to product design and regulatory framework. - Behavioral adjustments: - Top-down: None. - Bottom-up: Management actions limited to non-discretionary rules in place at the reference date for solvency; reactive management actions allowed in parts of liquidity analysis. - Regulatory standards: J-GAAP; Economic value-based solvency ratio (ESR) regulation. - Output presentation: - Impact on solvency margins; contribution of individual shocks. - Dispersion measures of solvency ratios, liquid assets to liquid liabilities ratios, margin calls-to-liquid assets. - Impact on profitability (e.g., net income) in bottom-up exercises. --- ### Investment Funds Stress Test - Institutions included: Open-ended investment funds. - Data: commercial data (Bloomberg, FactSet, Lipper) and statutory and voluntary reporting. - Reference date: March 31, 2023. - Methodology: - Calibration of various redemption shocks and comparison to the level of highly liquid assets at the fund level. - Price impact on securities due to fund illiquidity. - Stress test horizon: Instantaneous shock. - Scenario analysis: - Adverse scenario (in line with narrative severity of the banking sector stress test). - Pure redemption shock: severe outflows based on historical distribution. - Risks/factors assessed: - Market risk: interest rates, share prices, credit spreads, volatility measures, exchange rates. - Liquidity risk: severe redemption shock. - Buffers: level of highly liquid assets. - Behavioral adjustments: - Choice of liquidation strategy: slicing (pro rata), waterfall (most liquid assets first), mixed approach (cash then slicing). - Liquidity Management Tools (LMT) are not considered in the stress test. - Output presentation: - Dispersion of liquidity shortfall; number of funds with highly liquid assets to redemptions ratio below one. - Aggregate price impact (for different asset classes). - Aggregate vulnerability of the investment fund sector. --- ### Interconnectedness and Contagion Analysis - Institutions involved: - Domestic spillovers: Banks (same set as bank solvency), major life insurers (same set as insurance), major securities firms. - Cross-border spillovers: Country-aggregate banking sector. - Data and starting position: - Domestic spillovers: confidential bilateral exposure data (supervisory): 2023Q1. - Cross-border spillovers: cross-border banking claims exposure data (BIS Consolidated/ultimate guarantor basis): 2016; bank regulatory Tier 1 capital data (Fitch Connect): 2016. - Methodology: - Domestic spillovers: Co-Map (Covi, Gorpe, and Kok, 2019). - Cross-border spillovers: Espinosa-Vega and Sole (2010). - Risks: credit and funding losses related to bilateral exposures, fire-sale of assets following sizeable deposit withdrawals, cross-border exposures. - Buffers: - Domestic spillovers: institution’s own capital and liquidity buffers. - Cross-border spillovers: banking sector’s aggregate capital buffers. - Size of shocks: default of institutions (flexibly reflecting institution-specific capital buffer thresholds). - Output/presentation: - Network mapping of the domestic financial system. - Entity-level contagion index, vulnerability index, and systemic risk map. --- ### Climate Risk Analysis — Transition Risk - Institutions included: The banking sector, the same coverage as in the banking solvency stress test. - Data and starting position: - Micro firm-level balance sheet and income statement data for 2005-2023 from Moody’s Orbis. - PDs of listed firms for 2005-2020 from Moody’s KM. - Firms’ reported emissions and industry-median emission intensities for Asia-Pacific region (scope 1) from ICE. - Individual banks’ loan exposures by sectors in March 2023: supervisory data and each bank’s financial summary reports. - Individual banks’ NPL coverage ratios by sectors. - Methodology (ENV-FIBA micro-macro simulation framework): - Step 1 (Macro module): IMF computable general equilibrium model derives aggregate and sectoral GDP paths, other environmental and macro variables, and carbon price paths consistent with NGFS emissions and temperature target paths. - Step 2 (Micro module): Macro impacts used to assess carbon taxes’ impact on firms’ balance sheets; firm-level credit risk indicators (PDs, LGDs, credit spread) are debt-weighted aggregated to sectoral-level risk indicators. - Step 3 (Bank module): Sectoral-level credit risk translated into impacts on individual banks’ capital based on industry exposures; deleveraging and leveraging of industries accounted for. - Scenarios: NGFS Phase IV scenarios (Net Zero 2050, Fragmented World, Current Policies). - Time horizon: Up to 2040. - Risks/factors assessed: - Impact of carbon taxes on firms’ balance sheets and income statements via changes in GVAs of sectors (macro channel) and direct emission costs (micro channel). - Foregone interest income (dynamic balance sheet channel). - Behavioral adjustments: - Micro module: econometric stock-flow Merton model-inspired PD panel model and Frye-Jacobs LGD modeling; Monte Carlo simulation over firm-level emission intensity using estimated kernel density function for Japan. - Bank module: individual banks’ sectoral loan exposures assumed to vary at growth rates of sectoral GVAs to account for foregone/expected interest income from deleveraging/leveraging. - Output presentation: - Delta PDs, delta LGDs, and delta credit spreads by sector. - Individual banks’ capital ratio impacts and loss contributions from underlying industry segments. *Source: Appendix II. Stress Testing Matrix (STeM), Japan FSAP (cut-off/reference dates and parameters as specified above).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1jpnea2024001.pdf_