Aging Japan Puts a Strain on the Financial System

IMF Blog, August 10, 2017

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Authors: Gaston Gelos, Sònia Muñoz
Date: August 10, 2017
Summary: Japan’s shrinking and aging population weighs on growth and interest rates, pressures profits of banks and insurance companies, and is changing the structure of the financial system. The IMF’s Financial Sector Assessment Program for Japan assessed these effects on financial resilience, regulatory and supervisory frameworks, and crisis management capacity.

Declining and aging population reduces role of banks and increases role of market finance.
Analysis across 34 countries shows the size of the banking sector relative to nonbank financial intermediaries is negatively associated with aging.
About 40 percent of the increase in the size of market finance in Japan since 1990 can be explained by aging.
Increasing longevity raises demand for longer-term securities, contributing to a flatter yield curve and compressing banks’ interest margins.

Smaller regional banks that rely on lending to local markets are particularly vulnerable due to falling demand from households and firms.
Projection: Over the next two decades some regional banks could see their loan-to-deposit ratios fall by 40 percentage points.
Banks responding to profitability pressures by seeking higher yield:
- Increasing real estate lending, contributing to higher housing prices in some areas.
- Condominium prices appear moderately overvalued in Tokyo, Osaka, and several outer regions.
- Increasing investment in securities abroad where growth is faster than Japan’s.
Life insurance companies are investing more in riskier overseas markets to obtain yields needed to meet interest guarantees.
Many banks and insurers lack full capacity to manage risks associated with these newer investment strategies.

Stress tests indicate increasing market risks and some vulnerabilities among regional and shinkin (cooperative) banks and life insurers.
Bank liquidity is generally ample, but some regional banks are exposed to foreign-currency funding risks.
The resilience of government bond market liquidity appears to have declined as the share of Bank of Japan holdings has increased.

The Bank of Japan has adapted monetary policy to low “natural” rates and pursued large-scale asset purchases to stimulate demand.
These purchases have strained markets and adversely affected liquidity in Japanese government bond markets.

Modernize supervision to keep pace with more sophisticated activities across banks, insurers, and securities firms.
- Tailor capital requirements to individual bank risk profiles.
- Implement a framework that appropriately recognizes the financial conditions of insurers.
Strengthen corporate governance across the banking and insurance sectors to manage new risk-taking.
Further strengthen the macroprudential framework to better identify and address any buildup of systemic risks.
Encourage timely action from banks, particularly regional banks facing increased pressure, in response to viability concerns.
Encourage regional banks to:
- Augment fee-based income,
- Reduce costs,
- Consolidate where appropriate.
Sustain productivity growth by supporting new, innovative firms and easing constraints to financial access for small and medium enterprises and start-ups through:
- Further promotion of risk-based lending,
- Further encouragement of alternative forms of financing for young businesses.
Reinforce a strong crisis management and resolution framework given long-term business-model challenges and existence of large systemic institutions.

Source: IMF blog post “Aging Japan Puts a Strain on the Financial System” (Gaston Gelos, Sònia Muñoz; August 10, 2017).

日本老龄化给金融体系带来压力; IMF博客; 2017年8月10日
- 日本老龄化给金融体系带来压力; IMF博客; 2017年8月10日 (Markdown version)
- 日本老龄化给金融体系带来压力; IMF博客; 2017年8月10日 (PDF)
日本の高齢化、金融システムの重しに; 2017年8月10日
- 日本の高齢化、金融システムの重しに; 2017年8月10日 (Markdown version)
- 日本の高齢化、金融システムの重しに; 2017年8月10日 (PDF)