Japan: Financial Sector Stability Assessment Update

International Monetary Fund

doi:10.5089/9781475506358.002.A001

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Japan

Financial Sector Stability Assessment Update

Author: International Monetary Fund

Publication Date:: 01 Aug 2012

eISBN:: 9781475506358

Language:: English

Keywords:: ISCR; CR; central bank; balance sheet; financial system; banking sector; interest rate; sensitivity analysis; equity holding; U.S. dollar; asset quality; liquid asset ratio

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The macroeconomic environment of Japan has constantly been under pressure owing to rising public debt and fiscal deficits. Credit demand has been limited and has shown weak profitability. Growing risks have heightened concerns about a possible feedback to financial stability. This report summarizes the findings of the financial sector stability assessment of Japan. The Executive Board recommends a broad-based financial reform plan that could contribute to private sector growth. Suggested measures included allocating market-based credit to SMEs, improving the framework for capital markets, and consolidating and streamlining of regional banks.

Abstract

Table 1.

Japan FSAP—High Priority Recommendations^1/

^{^1/}High Priority items need immediate attention and implementation within three years. These should be read along with Table 2 that lists other Medium Priority recommendations where implementation is recommended over a three to five year horizon.

Table 1.

Japan FSAP—High Priority Recommendations^1/

Recommendations	FSSA/RAM
Objective: Bolstering oversight of systemic risk
Develop the framework for regular thematic risk assessments (across types of financial institutions) and bottom-up stress tests for macroprudential purposes	¶29,36
Intensify monitoring and oversight of systemically relevant financial institutions, markets, and infrastructures	¶36,44
Consider more regular arrangements for more intensive and continuing interagency cooperation in systemic risk monitoring and contingency planning	¶30
Monitor closely sovereign-financial stability interlinkages and ensure that risk management frameworks are sufficiently robust to deal with stress situations	¶25, RAM(1)
Objective: Enhancing the quality of prudential and supervisory framework
Review the FSA's regulatory mandate and evaluate the adequacy of its supervisory skills and resources	¶31,36
Move towards a more formalized risk-based framework for assessing financial institutions' vulnerability and for prioritizing supervisory intensity	¶30,31
Raise minimum capital ratios for domestically-active banks closer to those required of internationally-active banks and align capital buffers with the materiality of risks	¶26,35, RAM(1,2)
Strengthen supervisory requirements on large exposure limits for banks	¶35, RAM(4)
Encourage stronger risk management by financial institutions, including through improved internal governance, and enhanced role for company auditors and audit committees	¶36,37,39
Strengthen securities firm oversight through expanded and more risk-based inspection programs, extended auditing requirements, and improvements to the registration process	¶41,42
Objective: Strengthening crisis management arrangements
Explore further improvements to ensure the orderly resolution of systemically- important nonbank financial firms	¶49,51,52, RAM(4)
Consider expanding the scope of recovery and resolution plans for all systemically-relevant bank and nonbank financial institutions, consistent with key attributes of an effective resolution regime	¶52
Objective: Supporting private sector growth
Unwind and better target selected public support measures, including some credit guarantees and SME support measures, as economic recovery takes hold	¶58-60
Develop an effective strategy to establish a stronger regional and cooperative bank sector, including through private sector-led consolidation	¶10,59, RAM(1,2)

Table 1.

Japan FSAP—High Priority Recommendations^1/

Recommendations	FSSA/RAM
Objective: Bolstering oversight of systemic risk
Develop the framework for regular thematic risk assessments (across types of financial institutions) and bottom-up stress tests for macroprudential purposes	¶29,36
Intensify monitoring and oversight of systemically relevant financial institutions, markets, and infrastructures	¶36,44
Consider more regular arrangements for more intensive and continuing interagency cooperation in systemic risk monitoring and contingency planning	¶30
Monitor closely sovereign-financial stability interlinkages and ensure that risk management frameworks are sufficiently robust to deal with stress situations	¶25, RAM(1)
Objective: Enhancing the quality of prudential and supervisory framework
Review the FSA's regulatory mandate and evaluate the adequacy of its supervisory skills and resources	¶31,36
Move towards a more formalized risk-based framework for assessing financial institutions' vulnerability and for prioritizing supervisory intensity	¶30,31
Raise minimum capital ratios for domestically-active banks closer to those required of internationally-active banks and align capital buffers with the materiality of risks	¶26,35, RAM(1,2)
Strengthen supervisory requirements on large exposure limits for banks	¶35, RAM(4)
Encourage stronger risk management by financial institutions, including through improved internal governance, and enhanced role for company auditors and audit committees	¶36,37,39
Strengthen securities firm oversight through expanded and more risk-based inspection programs, extended auditing requirements, and improvements to the registration process	¶41,42
Objective: Strengthening crisis management arrangements
Explore further improvements to ensure the orderly resolution of systemically- important nonbank financial firms	¶49,51,52, RAM(4)
Consider expanding the scope of recovery and resolution plans for all systemically-relevant bank and nonbank financial institutions, consistent with key attributes of an effective resolution regime	¶52
Objective: Supporting private sector growth
Unwind and better target selected public support measures, including some credit guarantees and SME support measures, as economic recovery takes hold	¶58-60
Develop an effective strategy to establish a stronger regional and cooperative bank sector, including through private sector-led consolidation	¶10,59, RAM(1,2)

I. Background

5. Japan confronts a challenging macrofinancial operating environment (Table 4, Figure 1). On the macroeconomic front, deflationary pressures remain, growth is sluggish, public debt and deficits are large, and the external environment is highly uncertain. The financial system (Figure 2, Annex IV) faces limited credit demand, a flat yield-curve, and weak profitability. At the same time, some policies and market practices in the financial system may have limited risk-taking and posed bottlenecks on credit intermediation, in turn contributing to low growth and structural challenges.

Table 2.

Japan FSAP—Medium Priority Recommendations

Notes: These are Medium Priority recommendations to be implemented before the next FSAP update. This should be read along with Table 1 on the High Priority recommendations.

Table 2.

Japan FSAP—Medium Priority Recommendations

Recommendations	FSSA/RAM
Objective: Upgrading Systemic Risk Monitoring
Deepen cross-border risk monitoring arrangements and make active use of memoranda of understanding with foreign supervisory authorities	¶29,36
Consider expanding the dissemination of the encouraged set of FSIs for banks and, as relevant, for the insurance and securities firms sectors	¶27,29
Strengthen the formal basis for data and information sharing among supervisory agencies given confidentiality provisions in different financial sector-related laws	¶31
Objective: Enhancing Effectiveness of Regulation and Quality of Supervision
Explore mechanisms to strengthen governance arrangements for the selection of auditors and the protection of their independence	¶35,37,39
Strengthen disclosure requirements for nonbanks, including on assumptions used to measure assets/liabilities and on risk exposures including cross holdings, cross-border, and concentration risks	Annexes II–III
Review the prompt corrective action framework for banks and examine the desirability of raising the trigger points for action	¶35
Provide for explicit supervisory approval of major investments by banks or of changes in their controlling ownership	Annex I
Clarify the co-decision process for institutions co-supervised by FSA and a Ministry, and strengthen FSA supervision of government-owned financial institutions	Annex I
Enforce the existing provisions on exposures to related parties more vigorously	Annex I
Enhance the required solvency margin for insurers to account for all material risks	¶11,37, Annex II
Revise corporate governance and suitability requirements to strengthen independent oversight of banks and insurers	Annexes I–II
Revise the valuation method for insurance liabilities to account for risks over the full time horizon of insurance contracts	¶37, Annex II
Complete the development of a methodology for risk-rating insurers and adopt a more formalized system for the internal review of risk assessments	¶37, Annex II
Establish more comprehensive assessments of individual securities firms (risk scoring or profiling) to guide supervisory intensity and on-site inspections	¶41,42
Further develop and clarify cooperation arrangements among domestic authorities with respect to FMIs in normal circumstances and in times of stress	¶44
Further improve clarity of assessments against the CPSS-IOSCO standards	¶44
Strengthen pension supervision in cooperation with other financial supervisors on risks that could affect both the pension system and financial stability more broadly	¶38,39
Objective: Bolstering Crisis Management
Refine further the existing bank resolution framework in order minimize its costs (e.g., through earlier triggers and speedier administrative procedures)	¶48-52
Rebalance the roles of the FSA/DICJ and the judiciary so that a range of resolution decisions may be implemented by the FSA/DICJ subject to ex post judicial review	¶50-51
Amend the governance structure of the DIC to make it more independent and to place greater emphasis on minimizing resolution costs	¶50-52
Explore mechanisms to strengthen custody arrangements for collective investment schemes	Annex III
Investigate the need to implement segregation and portability of customers’ positions and collateral in JGBCC	¶44
Consider including in the licensing criteria for exchanges a detailed assessment of the robustness of IT systems by independent experts	Annex III
Objective: Supporting Private Sector Growth
Advance the momentum for full privatization of GFIs (including Japan Post); strengthen GFI supervision, including inspection frequency	¶58
Strengthen credit discipline by introducing a schedule for gradually reducing the coverage of credit guarantees, in line with international norms	¶59
Encourage SME restructuring through wider use of debt-equity swaps and more flexibility in the release of personal guarantees in voluntary workouts and debtor-in-possession bankruptcies procedures	¶60
Encourage further market-based financing (including venture capital) to improve risk assessments and access to capital by start-up companies	¶60-61
Strengthen credit infrastructure by encouraging broader use of collaterals and asset-based lending, and develop a wider coverage and information sharing on current credit registries	¶60-61
Consider further improvements to the framework for new products and capital markets in order to support growth-enhancing sectors	¶61

Notes: These are Medium Priority recommendations to be implemented before the next FSAP update. This should be read along with Table 1 on the High Priority recommendations.

Table 2.

Japan FSAP—Medium Priority Recommendations

Recommendations	FSSA/RAM
Objective: Upgrading Systemic Risk Monitoring
Deepen cross-border risk monitoring arrangements and make active use of memoranda of understanding with foreign supervisory authorities	¶29,36
Consider expanding the dissemination of the encouraged set of FSIs for banks and, as relevant, for the insurance and securities firms sectors	¶27,29
Strengthen the formal basis for data and information sharing among supervisory agencies given confidentiality provisions in different financial sector-related laws	¶31
Objective: Enhancing Effectiveness of Regulation and Quality of Supervision
Explore mechanisms to strengthen governance arrangements for the selection of auditors and the protection of their independence	¶35,37,39
Strengthen disclosure requirements for nonbanks, including on assumptions used to measure assets/liabilities and on risk exposures including cross holdings, cross-border, and concentration risks	Annexes II–III
Review the prompt corrective action framework for banks and examine the desirability of raising the trigger points for action	¶35
Provide for explicit supervisory approval of major investments by banks or of changes in their controlling ownership	Annex I
Clarify the co-decision process for institutions co-supervised by FSA and a Ministry, and strengthen FSA supervision of government-owned financial institutions	Annex I
Enforce the existing provisions on exposures to related parties more vigorously	Annex I
Enhance the required solvency margin for insurers to account for all material risks	¶11,37, Annex II
Revise corporate governance and suitability requirements to strengthen independent oversight of banks and insurers	Annexes I–II
Revise the valuation method for insurance liabilities to account for risks over the full time horizon of insurance contracts	¶37, Annex II
Complete the development of a methodology for risk-rating insurers and adopt a more formalized system for the internal review of risk assessments	¶37, Annex II
Establish more comprehensive assessments of individual securities firms (risk scoring or profiling) to guide supervisory intensity and on-site inspections	¶41,42
Further develop and clarify cooperation arrangements among domestic authorities with respect to FMIs in normal circumstances and in times of stress	¶44
Further improve clarity of assessments against the CPSS-IOSCO standards	¶44
Strengthen pension supervision in cooperation with other financial supervisors on risks that could affect both the pension system and financial stability more broadly	¶38,39
Objective: Bolstering Crisis Management
Refine further the existing bank resolution framework in order minimize its costs (e.g., through earlier triggers and speedier administrative procedures)	¶48-52
Rebalance the roles of the FSA/DICJ and the judiciary so that a range of resolution decisions may be implemented by the FSA/DICJ subject to ex post judicial review	¶50-51
Amend the governance structure of the DIC to make it more independent and to place greater emphasis on minimizing resolution costs	¶50-52
Explore mechanisms to strengthen custody arrangements for collective investment schemes	Annex III
Investigate the need to implement segregation and portability of customers’ positions and collateral in JGBCC	¶44
Consider including in the licensing criteria for exchanges a detailed assessment of the robustness of IT systems by independent experts	Annex III
Objective: Supporting Private Sector Growth
Advance the momentum for full privatization of GFIs (including Japan Post); strengthen GFI supervision, including inspection frequency	¶58
Strengthen credit discipline by introducing a schedule for gradually reducing the coverage of credit guarantees, in line with international norms	¶59
Encourage SME restructuring through wider use of debt-equity swaps and more flexibility in the release of personal guarantees in voluntary workouts and debtor-in-possession bankruptcies procedures	¶60
Encourage further market-based financing (including venture capital) to improve risk assessments and access to capital by start-up companies	¶60-61
Strengthen credit infrastructure by encouraging broader use of collaterals and asset-based lending, and develop a wider coverage and information sharing on current credit registries	¶60-61
Consider further improvements to the framework for new products and capital markets in order to support growth-enhancing sectors	¶61

Notes: These are Medium Priority recommendations to be implemented before the next FSAP update. This should be read along with Table 1 on the High Priority recommendations.

Table 3.

Japan FSAP—Risk Assessment Matrix

Table 3.

Japan FSAP—Risk Assessment Matrix

Overall Level of Concern
Main Sources of Risks	Likelihood (over next one to three years)	Impact on Macrofinancial Stability
	Low	High
1. Surge in market yields	Despite high public debt levels, yields are currently low for various reasons, including safe haven inflows, ample domestic private savings, limited foreign JGB holdings, and room to raise taxes. However, going forward the risks of a yield surge could increase owing to several factors, including: Delays in implementing credible fiscal consolidation plan and continued slow economic growth that undermine confidence in fiscal sustainability. A reversal of safe haven inflows once global conditions improve and/or renewed risk appetite by Japanese investors as the domestic or global economies recover, leading to reduced demand for JGBs. Demographic changes are expected to reduce private saving, making government financing more dependent on foreign investors at the margin.	Stress tests show a modest effect of a moderate 100 bps shock for banks and insurers, due to solid capital buffers and unrealized gains on JGB holdings. However, the negative impact from sovereign-financial-real economic linkages and feedback effects could be more severe and pervasive: Larger interest rate shocks could result in disproportionally severe impact, for instance through non-linear effects on indirect credit costs, fiscal debt dynamics, and market confidence. The impact would be even more severe if it were coupled with less favorable macroeconomic circumstances, e.g., in the context of a protracted growth slowdown.
	Medium	Medium
2. Protracted growth slowdown and deflationary pressures	Medium-term economic growth could weaken relative to baseline projections due to several factors: Prolonged impact of earthquake-related factors (e.g., energy shortages) may exacerbate “hollowing out” of industrial sectors. Continued global economic downturn and sharp and sustained yen appreciation due to safe haven inflows. Demographic pressures reducing potential growth rate through combination of reduced labor input and negative wealth effects from falling asset prices.	Bank stress test shows that this is one of the key risks for smaller regional banks, due to its impact on credit quality. However, the medium-term nature of the risk provides time to take corrective actions. Also, only a small part of the banking system would undergo severe distress. Larger banks appear better placed, because of their higher earnings and their decision to curb dividend payments to prepare for Basel III capital requirements. Financial institutions’ efforts to seek profits abroad may pose new risks (e.g., due to higher funding costs relative to global competitors and to the taking on of unfamiliar risk exposures).
	Medium	Medium
3. Severe global double dip, reducing Japan’s GDP growth	Sovereign distress in Europe and the U.S. may trigger a global double-dip recession, possibly combined with monetary tightening in emerging market (EM) economies. This may in turn spill over to global financial institutions and/or increase risk aversion, depress asset prices globally and domestically, and tighten global funding conditions. Such shocks (financial and real) could disrupt Japan’s recovery, especially given the limited room for fiscal support.	Global exposures of Japanese financial institutions are, at this moment, small and in less distressed countries (sovereign securities in U.S., Germany, U.K., and France), potentially limiting direct losses. Exposures to from Asia, including China, are also still limited. Stress tests indicate that the direct impact from overseas exposures (securities and loans, including those to Asia) is likely to be manageable. The main vulnerability stems from the indirect impact through weaker domestic economic growth (raising credit costs from domestic exposures) and domestic asset prices. Banks appear able to withstand renewed USD funding pressures, including disruption in cross-currency swap markets, but higher funding cost could weigh on their profitability.
	Medium (nonfinancial), Low (financial)	Medium
4. Distress of large financial or nonfinancial institutions	Major corporate bankruptcies could materialize if the economy is hit by a severe downturn. Stress tests and risk profile analysis indicate that large Japanese financial institutions are well capitalized and likely to withstand major shocks.	The BCP assessment pointed out major deficiencies with Japan’s regulation on large exposures (Annex I), which raise concerns regarding the potential implications of concentrated credit risk exposures.

Table 3.

Japan FSAP—Risk Assessment Matrix

Overall Level of Concern
Main Sources of Risks	Likelihood (over next one to three years)	Impact on Macrofinancial Stability
	Low	High
1. Surge in market yields	Despite high public debt levels, yields are currently low for various reasons, including safe haven inflows, ample domestic private savings, limited foreign JGB holdings, and room to raise taxes. However, going forward the risks of a yield surge could increase owing to several factors, including: Delays in implementing credible fiscal consolidation plan and continued slow economic growth that undermine confidence in fiscal sustainability. A reversal of safe haven inflows once global conditions improve and/or renewed risk appetite by Japanese investors as the domestic or global economies recover, leading to reduced demand for JGBs. Demographic changes are expected to reduce private saving, making government financing more dependent on foreign investors at the margin.	Stress tests show a modest effect of a moderate 100 bps shock for banks and insurers, due to solid capital buffers and unrealized gains on JGB holdings. However, the negative impact from sovereign-financial-real economic linkages and feedback effects could be more severe and pervasive: Larger interest rate shocks could result in disproportionally severe impact, for instance through non-linear effects on indirect credit costs, fiscal debt dynamics, and market confidence. The impact would be even more severe if it were coupled with less favorable macroeconomic circumstances, e.g., in the context of a protracted growth slowdown.
	Medium	Medium
2. Protracted growth slowdown and deflationary pressures	Medium-term economic growth could weaken relative to baseline projections due to several factors: Prolonged impact of earthquake-related factors (e.g., energy shortages) may exacerbate “hollowing out” of industrial sectors. Continued global economic downturn and sharp and sustained yen appreciation due to safe haven inflows. Demographic pressures reducing potential growth rate through combination of reduced labor input and negative wealth effects from falling asset prices.	Bank stress test shows that this is one of the key risks for smaller regional banks, due to its impact on credit quality. However, the medium-term nature of the risk provides time to take corrective actions. Also, only a small part of the banking system would undergo severe distress. Larger banks appear better placed, because of their higher earnings and their decision to curb dividend payments to prepare for Basel III capital requirements. Financial institutions’ efforts to seek profits abroad may pose new risks (e.g., due to higher funding costs relative to global competitors and to the taking on of unfamiliar risk exposures).
	Medium	Medium
3. Severe global double dip, reducing Japan’s GDP growth	Sovereign distress in Europe and the U.S. may trigger a global double-dip recession, possibly combined with monetary tightening in emerging market (EM) economies. This may in turn spill over to global financial institutions and/or increase risk aversion, depress asset prices globally and domestically, and tighten global funding conditions. Such shocks (financial and real) could disrupt Japan’s recovery, especially given the limited room for fiscal support.	Global exposures of Japanese financial institutions are, at this moment, small and in less distressed countries (sovereign securities in U.S., Germany, U.K., and France), potentially limiting direct losses. Exposures to from Asia, including China, are also still limited. Stress tests indicate that the direct impact from overseas exposures (securities and loans, including those to Asia) is likely to be manageable. The main vulnerability stems from the indirect impact through weaker domestic economic growth (raising credit costs from domestic exposures) and domestic asset prices. Banks appear able to withstand renewed USD funding pressures, including disruption in cross-currency swap markets, but higher funding cost could weigh on their profitability.
	Medium (nonfinancial), Low (financial)	Medium
4. Distress of large financial or nonfinancial institutions	Major corporate bankruptcies could materialize if the economy is hit by a severe downturn. Stress tests and risk profile analysis indicate that large Japanese financial institutions are well capitalized and likely to withstand major shocks.	The BCP assessment pointed out major deficiencies with Japan’s regulation on large exposures (Annex I), which raise concerns regarding the potential implications of concentrated credit risk exposures.

Table 4.

Japan FSAP—Selected Economic Indicators, 2007–2013

Nominal GDP: US$5,867 billion (2011)

Population: 127.8 million (2011)

GDP per capita: US$45,900 (2011)

Quota: SDR 15,628.5 million

Sources: Global Insight, Nomura database; IMF, Competitiveness Indicators System; and Fund staff estimates and projections, as of February 21, 2012.

^{^1/}Annual growth rates and contributions are calculated from seasonally adjusted data.

^{^2/}Contribution to GDP growth.

^{^3/}Based on normalized unit labor costs; 2000=100.

Table 4.

Japan FSAP—Selected Economic Indicators, 2007–2013

Nominal GDP: US$5,867 billion (2011)

Population: 127.8 million (2011)

GDP per capita: US$45,900 (2011)

Quota: SDR 15,628.5 million

										Projected
					2007	2008	2009	2010	2011	2012	2013
Growth (percent change) ^1/
	Real GDP				2.2	−1.0	−5.5	4.4	−0.7	2.4	1.5
	Domestic demand				1.1	−1.3	−4.0	2.7	0.1	3.0	1.5
		Private consumption			0.9	−0.9	−0.7	2.6	0.1	2.7	1.7
		Residential investment			−9.8	−6.6	−16.6	−4.2	5.4	0.7	1.5
		Business investment			4.9	−2.6	−14.3	0.5	1.1	3.2	4.8
		Government consumption			1.1	−0.1	2.3	2.1	1.9	2.0	−0.5
		Public investment			−5.9	−7.4	7.0	0.4	−3.6	6.3	−12.5
		Stockbuilding ^2/			0.3	0.2	−1.6	0.8	−0.5	0.2	0.5
	Net exports ^2/				1.1	0.2	−1.5	1.7	−0.8	−0.5	0.0
		Exports of goods and services			8.7	1.4	−24.2	24.2	−0.1	3.1	5.0
		Imports of goods and services			2.3	0.3	−15.7	11.1	5.9	7.4	5.7
Inflation (annual average)
	CPI				0.1	1.4	−1.3	−0.7	−0.3	0.2	0.0
	GDP deflator				−0.9	−1.3	−0.5	−2.1	−2.1	−0.1	−0.1
Unemployment rate (annual average)					3.8	4.0	5.1	5.1`	4.6	4.5	4.4
Government (percent of GDP)
	General government
		Revenue			31.2	31.6	29.6	29.6	30.6	30.9	31.4
		Expenditure			33.3	35.7	40.0	39.0	40.7	40.9	39.9
		Balance			−2.1	−4.1	−10.4	−9.4	−10.1	−9.9	−8.6
		Primary Balance			−2.1	−3.8	−9.9	−8.7	−9.2	−8.8	−7.4
		Public Debt, gross			183.0	191.8	210.2	215.3	229.9	234.5	240.0
Money and credit (percent change, end−period)
	Base money				0.4	1.8	5.2	7.0	13.5		…
	M2 (period average)				2.1	1.8	3.1	2.3	3.2		…
	Domestic credit				−2.3	1.6	0.4	1.3	0.8		…
	Bank lending				0.7	4.6	−0.9	−1.8	0.7		…
Interest rate
	Overnight call rate, uncollateralized (end−period)				0.46	0.10	0.09	0.1	0.1		…
	Three−month CD rate (annual average)				0.51	0.51	0.33	0.3	0.3		…
	Official discount rate (end−period)				0.75	0.30	0.30	0.3	0.3		…
Balance of payments (in billions of US$)
	Current account balance				212.2	159.8	146.6	204.0	119.2	130.3	167.0
				Percent of GDP	4.9	3.3	2.9	3.7	2.0	2.2	2.7
		Trade balance			105.1	38.4	43.4	91.0	−20.5	−10.2	35.1
				Percent of GDP	2.4	0.8	0.9	1.7	−0.3	−0.2	0.6
			Exports of goods, f.o.b.		678.4	746.5	545.3	730.1	787.2	807.4	830.0
			Imports of goods, f.o.b.		573.3	708.0	501.9	639.1	807.7	817.6	795.0
				Oil imports (trade basis)	130.1	190.6	99.9	134.3	185.0	227.8	233.7
	FDI, net (percent of GDP)				−1.2	−2.2	−1.2	−1.1	−2.0	−1.3	−1.3
	Terms of trade (percent change)				−2.1	−9.6	19.5	−3.3	−7.9	3.9	7.0
	Change in reserves				36.5	30.8	27.3	44.3	177.0	…	…
Total reserves minus gold (in billions of US$)					952.8	1009.4	1022.2	1096.2	1258.2	…	…
Exchange rates (annual average)
	Yen/dollar rate				117.8	103.4	93.6	87.8	79.8	…	…
	Yen/euro rate				161.4	152.1	130.3	116.5	111.0	…	…
	Real effective exchange rate ^3/				83.6	93.7	110.5	118.2	126.2	…	…
	Real effective exchange rate (CPI−based)				83.2	90.1	101.5	102.7	104.4	…	…

Sources: Global Insight, Nomura database; IMF, Competitiveness Indicators System; and Fund staff estimates and projections, as of February 21, 2012.

^{^1/}Annual growth rates and contributions are calculated from seasonally adjusted data.

^{^2/}Contribution to GDP growth.

^{^3/}Based on normalized unit labor costs; 2000=100.

Table 4.

Japan FSAP—Selected Economic Indicators, 2007–2013

Nominal GDP: US$5,867 billion (2011)

Population: 127.8 million (2011)

GDP per capita: US$45,900 (2011)

Quota: SDR 15,628.5 million

										Projected
					2007	2008	2009	2010	2011	2012	2013
Growth (percent change) ^1/
	Real GDP				2.2	−1.0	−5.5	4.4	−0.7	2.4	1.5
	Domestic demand				1.1	−1.3	−4.0	2.7	0.1	3.0	1.5
		Private consumption			0.9	−0.9	−0.7	2.6	0.1	2.7	1.7
		Residential investment			−9.8	−6.6	−16.6	−4.2	5.4	0.7	1.5
		Business investment			4.9	−2.6	−14.3	0.5	1.1	3.2	4.8
		Government consumption			1.1	−0.1	2.3	2.1	1.9	2.0	−0.5
		Public investment			−5.9	−7.4	7.0	0.4	−3.6	6.3	−12.5
		Stockbuilding ^2/			0.3	0.2	−1.6	0.8	−0.5	0.2	0.5
	Net exports ^2/				1.1	0.2	−1.5	1.7	−0.8	−0.5	0.0
		Exports of goods and services			8.7	1.4	−24.2	24.2	−0.1	3.1	5.0
		Imports of goods and services			2.3	0.3	−15.7	11.1	5.9	7.4	5.7
Inflation (annual average)
	CPI				0.1	1.4	−1.3	−0.7	−0.3	0.2	0.0
	GDP deflator				−0.9	−1.3	−0.5	−2.1	−2.1	−0.1	−0.1
Unemployment rate (annual average)					3.8	4.0	5.1	5.1`	4.6	4.5	4.4
Government (percent of GDP)
	General government
		Revenue			31.2	31.6	29.6	29.6	30.6	30.9	31.4
		Expenditure			33.3	35.7	40.0	39.0	40.7	40.9	39.9
		Balance			−2.1	−4.1	−10.4	−9.4	−10.1	−9.9	−8.6
		Primary Balance			−2.1	−3.8	−9.9	−8.7	−9.2	−8.8	−7.4
		Public Debt, gross			183.0	191.8	210.2	215.3	229.9	234.5	240.0
Money and credit (percent change, end−period)
	Base money				0.4	1.8	5.2	7.0	13.5		…
	M2 (period average)				2.1	1.8	3.1	2.3	3.2		…
	Domestic credit				−2.3	1.6	0.4	1.3	0.8		…
	Bank lending				0.7	4.6	−0.9	−1.8	0.7		…
Interest rate
	Overnight call rate, uncollateralized (end−period)				0.46	0.10	0.09	0.1	0.1		…
	Three−month CD rate (annual average)				0.51	0.51	0.33	0.3	0.3		…
	Official discount rate (end−period)				0.75	0.30	0.30	0.3	0.3		…
Balance of payments (in billions of US$)
	Current account balance				212.2	159.8	146.6	204.0	119.2	130.3	167.0
				Percent of GDP	4.9	3.3	2.9	3.7	2.0	2.2	2.7
		Trade balance			105.1	38.4	43.4	91.0	−20.5	−10.2	35.1
				Percent of GDP	2.4	0.8	0.9	1.7	−0.3	−0.2	0.6
			Exports of goods, f.o.b.		678.4	746.5	545.3	730.1	787.2	807.4	830.0
			Imports of goods, f.o.b.		573.3	708.0	501.9	639.1	807.7	817.6	795.0
				Oil imports (trade basis)	130.1	190.6	99.9	134.3	185.0	227.8	233.7
	FDI, net (percent of GDP)				−1.2	−2.2	−1.2	−1.1	−2.0	−1.3	−1.3
	Terms of trade (percent change)				−2.1	−9.6	19.5	−3.3	−7.9	3.9	7.0
	Change in reserves				36.5	30.8	27.3	44.3	177.0	…	…
Total reserves minus gold (in billions of US$)					952.8	1009.4	1022.2	1096.2	1258.2	…	…
Exchange rates (annual average)
	Yen/dollar rate				117.8	103.4	93.6	87.8	79.8	…	…
	Yen/euro rate				161.4	152.1	130.3	116.5	111.0	…	…
	Real effective exchange rate ^3/				83.6	93.7	110.5	118.2	126.2	…	…
	Real effective exchange rate (CPI−based)				83.2	90.1	101.5	102.7	104.4	…	…

Sources: Global Insight, Nomura database; IMF, Competitiveness Indicators System; and Fund staff estimates and projections, as of February 21, 2012.

^{^1/}Annual growth rates and contributions are calculated from seasonally adjusted data.

^{^2/}Contribution to GDP growth.

^{^3/}Based on normalized unit labor costs; 2000=100.

6. Growing risks to fiscal sustainability have heightened concerns about possible feedback to financial stability. Gross public debt has grown sharply over the past decade, reaching 220 percent of GDP at end-FY2011, the highest ratio globally. An increasing share of the financial system’s balance sheet is invested in JGBs. Fiscal-financial sector linkages have also increased due to crisis-related financial support to the economy through credit guarantees and safety-net lending. However, household and corporate balance sheets appear sound, and continued demand for bank deposits has provided indirect support for government debt markets. BOJ purchases of JGB—through its step-up of existing bond purchases and recent asset purchase program—have also provided support and liquidity for the financial system.

7. The financial system has remained stable during the global financial crisis and the recent devastating earthquake (Tables 5–6). Temporary liquidity squeezes in the interbank and corporate debt markets at the peak of post Lehman crisis raised some funding costs, but financing conditions gradually returned to normal, including as a result of action by the authorities to support credit and liquidity. Banks were insulated from the subprime crisis partly due to their limited exposures to complex asset classes and derivative markets. Overall, the payment systems remained well-functioning, despite some short-lived surges in settlement fails. Only some regional banks had concentrated exposures to earthquake-hit areas, and nonlife insurers absorbed losses from the catastrophe by drawing down on their reserves. Specific steps were taken to ease funding conditions and avoid a tightening of financing conditions for SMEs, including U.S. dollar funds-supplying operations and special government credit guarantees.

Table 5.

Japan FSAP—Key Policy Measures by the FSA During the Global Financial Crisis and After the Great East Japan Earthquake

Sources: FSA, OECD (2009).

Table 5.

Japan FSAP—Key Policy Measures by the FSA During the Global Financial Crisis and After the Great East Japan Earthquake

Key policy measures		Status
Stabilizing equity markets
	Temporarily relaxed market restrictions on listed companies’ purchases of own stocks.	Active until end−Oct 2012
	Strengthened disclosure and restrictions on short−selling.	Active until end−Oct 2012
	Allowed banks’ shareholding to exceed their Tier 1 capital with FSA approval.	Active
	Resumed activities of the Banks’ Shareholdings Purchase Corporation (up to ¥20 trillion).	Active until end−Mar 2017
Reactivating public capital injection schemes to depository institutions
	Ensured smooth financing by boosting capital base of financial institutions.	Active until end−Mar 2017
	Expanded the size of public funds available for capital injection.	Implemented for FY2009
	Relaxed conditions of capital injection through Act amendments after the Great East Japan Earthquake.	Active until end−Mar 2017
Enhancing bank lending to SMEs
	Encouraged financial institutions on their efforts in smoothing SME financing.	Implemented
	Introduced and extended the SME Financing Facilitation Act to allow smooth SME financing by financial institutions.	Active until end−Mar 2013
Temporarily relaxing capital adequacy requirements for banks
	Valuation losses from bonds without credit risks (internationally active banks) and securities (domestically operating banks) are not required in capital adequacy calculations.	Implemented
Improving transparency and reliability of credit rating
	Introduced new registration requirements for credit rating agencies.	Implemented

Sources: FSA, OECD (2009).

Table 5.

Japan FSAP—Key Policy Measures by the FSA During the Global Financial Crisis and After the Great East Japan Earthquake

Key policy measures		Status
Stabilizing equity markets
	Temporarily relaxed market restrictions on listed companies’ purchases of own stocks.	Active until end−Oct 2012
	Strengthened disclosure and restrictions on short−selling.	Active until end−Oct 2012
	Allowed banks’ shareholding to exceed their Tier 1 capital with FSA approval.	Active
	Resumed activities of the Banks’ Shareholdings Purchase Corporation (up to ¥20 trillion).	Active until end−Mar 2017
Reactivating public capital injection schemes to depository institutions
	Ensured smooth financing by boosting capital base of financial institutions.	Active until end−Mar 2017
	Expanded the size of public funds available for capital injection.	Implemented for FY2009
	Relaxed conditions of capital injection through Act amendments after the Great East Japan Earthquake.	Active until end−Mar 2017
Enhancing bank lending to SMEs
	Encouraged financial institutions on their efforts in smoothing SME financing.	Implemented
	Introduced and extended the SME Financing Facilitation Act to allow smooth SME financing by financial institutions.	Active until end−Mar 2013
Temporarily relaxing capital adequacy requirements for banks
	Valuation losses from bonds without credit risks (internationally active banks) and securities (domestically operating banks) are not required in capital adequacy calculations.	Implemented
Improving transparency and reliability of credit rating
	Introduced new registration requirements for credit rating agencies.	Implemented

Sources: FSA, OECD (2009).

Table 6.

Japan FSAP—Key Policy Measures by the Bank of Japan During the Global Financial Crisis and After the Great East Japan Earthquake

Source: BOJ.1/ Additional measures involves the relaxation of collateral requirements to include asset-backed CPs, coverage of corporate debts, debt issued by real estate investment corporations, government guaranteed CP, loans on deeds to the public sector, selected foreign government bonds, and standards of corporate debt in disaster areas such as eligible collaterals.

Table 6.

Japan FSAP—Key Policy Measures by the Bank of Japan During the Global Financial Crisis and After the Great East Japan Earthquake

Date	Policy Measures
Sep-08	Introduction of USD funds-supplying operations.
Oct-08	Extension of the security lending facility; suspension of selling stocks held by the BOJ. Expansion of the JGB purchases with repo agreements.
Oct-08	Introduction of the complementary deposit facility.
Dec-08	Introduction of special funds-supplying operations to facilitate corporate financing.
Dec-08 to Jan 09	Introduction of outright purchases of JGBs and CP, and corporate bonds.
Feb-09	Resumption of stock purchases held by financial institutions.
Mar-09	Provision of subordinated loans to banks.
Dec-09	Enhancement of Easy Monetary Conditions. Introduction of fixed rate funds supplying operations against pooled collateral.
May-10	Reestablishment of U.S. dollar funds-supplying operations.
Jun-10	Funds provisioning measure to support strengthening the foundations for economic growth.
Aug-10	Enhancement of Easy Monetary Conditions. Expansion of fixed rate operation (with a new six month term and expand the size).
Oct-10	Comprehensive Monetary Easing. Virtually zero interest rate policy (VZIRP), clarification of the policy time horizon on medium-term price stability and introduction of asset purchase program.
Apr-11	Provision of funds-supplying operation to support financial institutions in the disaster areas.
Jun-11	Special rules for equity investments and asset-based lending to enhance fund-provisioning measure.

Table 6.

Japan FSAP—Key Policy Measures by the Bank of Japan During the Global Financial Crisis and After the Great East Japan Earthquake

Date	Policy Measures
Sep-08	Introduction of USD funds-supplying operations.
Oct-08	Extension of the security lending facility; suspension of selling stocks held by the BOJ. Expansion of the JGB purchases with repo agreements.
Oct-08	Introduction of the complementary deposit facility.
Dec-08	Introduction of special funds-supplying operations to facilitate corporate financing.
Dec-08 to Jan 09	Introduction of outright purchases of JGBs and CP, and corporate bonds.
Feb-09	Resumption of stock purchases held by financial institutions.
Mar-09	Provision of subordinated loans to banks.
Dec-09	Enhancement of Easy Monetary Conditions. Introduction of fixed rate funds supplying operations against pooled collateral.
May-10	Reestablishment of U.S. dollar funds-supplying operations.
Jun-10	Funds provisioning measure to support strengthening the foundations for economic growth.
Aug-10	Enhancement of Easy Monetary Conditions. Expansion of fixed rate operation (with a new six month term and expand the size).
Oct-10	Comprehensive Monetary Easing. Virtually zero interest rate policy (VZIRP), clarification of the policy time horizon on medium-term price stability and introduction of asset purchase program.
Apr-11	Provision of funds-supplying operation to support financial institutions in the disaster areas.
Jun-11	Special rules for equity investments and asset-based lending to enhance fund-provisioning measure.

II. Current State of Financial Stability

A. Financial System—Performance and Soundness

8. The Japanese banking sector has become much better capitalized over the last decade (Tables 7–8, Figures 3–4). Since the last FSAP, Japanese banks’ capital adequacy ratio (CAR) and Tier 1 capital ratios have improved steadily, including as city banks issued equity in 2009–10. Their liquidity position also remains comfortable, as they hold large amounts of liquid assets as a share of both short-term liabilities (around 50 percent) and total assets (about 20 percent).

Table 7.

Japan FSAP—Banking Sector Soundness: All Banks, 2001–2011

Sources: Japanese authorities and IMF staff calculations.1/ Including city banks, regional banks and shinkin banks (consolidated basis for banking groups).

^{^2/}Aggregated with the unconsolidated basis data.

^{^3/}Include the figures of Credit cooperatives and National Federation.

^{^4/}Capital defined as net asset on the balance sheet.

Table 7.

Japan FSAP—Banking Sector Soundness: All Banks, 2001–2011

				2001 Mar.	2002 Mar.	2003 Mar	2004 Mar	2005 Mar	2006 Mar	2007 Mar	2008 Mar	2009 Mar	2010 Mar	2011 Mar	2011 Sep
				(In percent)
*Capital adequacy*
	Total capital ratio ^2/			10.5	10.5	10.9	11.2	11.6	11.5	12.6	12.0	12.6	13.6	14.1	N/A
	NPL net of provisions/capital ^2/			41	51	43	33	24	18	17	16	16	16	16	N/A
*Asset quality*
	NPL ratio ^2/			6.7	8.7	7.8	6.3	4.6	3.5	3.1	2.9	2.8	2.9	2.9	N/A
	Sectoral distribution of loans ^3/
		Residents		…	93	94	95	94	94	93	93	94	95	94	94
			Deposit-takers	…	6	7	7	7	7	8	7	7	8	8	8
			Central bank	…	0	0	0	0	0	0	0	0	0	0	0
			Other financial corporations	…	12	13	14	13	12	12	12	11	11	10	11
			General government	…	4	4	5	6	6	6	6	7	7	8	8
			Nonfinancial corporations	…	41	38	35	34	33	32	33	36	34	33	33
			Other domestic sectors	…	31	32	33	35	35	34	34	34	35	35	34
		Nonresidents		…	7	6	5	6	6	7	7	6	5	6	6
*Earnings and profitability*
	ROA			0.0	−0.6	−0.6	−0.1	0.2	0.5	0.4	0.2	−0.2	0.2	0.3	0.3
	ROE			−0.8	−12.1	−13.9	−2.1	4.6	13.1	10.1	5.8	−5.2	5.0	6.3	6.7
	Interest margin			1.8	1.8	1.9	1.9	1.8	1.8	1.7	1.7	1.7	1.6	1.6	1.5
	NII/gross income			73	103	113	76	77	70	70	75	97	76	73	72
	Noninterest expenses/gross income			59	80	90	61	62	56	59	64	84	65	65	65
	Personnel cost/operating cost			50	49	49	49	46	46	44	43	45	48	48	…
*Liquidity*
	Liquid assets/total assets			13	14	18	19	20	18	16	16	16	20	21	22
	Liquid assets/short-term liabilities			44	37	40	44	44	39	36	36	38	47	48	50
	Loan/deposit			71	64	64	66	66	63	64	66	66	69	69	70
*Other*
	Capital/total assets ^4/			4.6	4.2	4.3	4.2	4.4	4.3	4.6	4.2	3.6	4.4	4.7	4.7
	RWA/total assets			44	40	39	38	38	37	37	35	29	32	33	N/A
	Equity exposures/Capital ^4/			105	100	77	83	75	79	75	65	56	49	42	38
	Gross derivative asset/capital			35	36	44	34	29	28	28	59	95	61	53	60
	Gross derivative liability/capital			33	34	41	30	26	28	28	53	88	56	49	54
*Indicators for city and regional (tier 1 and 2) banks*
	Total capital ratio			11.1	10.5	9.5	10.5	11.1	11.6	12.2	11.6	11.8	14.1	14.9	15.4
	Tier 1 ratio			7.0	6.4	5.8	6.5	7.0	7.3	8.0	8.1	8.1	10.5	11.5	12.0
	NPL net of provisions/capital ^2/			34	43	35	27	18	13	12	11	12	12	12	11.6
	NPL ratio ^2/			6.3	8.4	7.4	5.8	4	2.9	2.5	2.4	2.4	2.5	2.4	2.4
	ROA			−0.1	−0.6	−0.6	−0.1	0.2	0.5	0.4	0.3	−0.2	0.2	0.3	0.3
	ROE			−1.2	−13.9	−16.4	−3.0	4.9	15.1	11.4	6.7	−5.7	5.5	6.9	7.3
	Equity exposures/capital ^4/			121	117	93	99	88	89	85	74	64	55	48	42.7

Sources: Japanese authorities and IMF staff calculations.1/ Including city banks, regional banks and shinkin banks (consolidated basis for banking groups).

^{^2/}Aggregated with the unconsolidated basis data.

^{^3/}Include the figures of Credit cooperatives and National Federation.

^{^4/}Capital defined as net asset on the balance sheet.

Table 7.

Japan FSAP—Banking Sector Soundness: All Banks, 2001–2011

				2001 Mar.	2002 Mar.	2003 Mar	2004 Mar	2005 Mar	2006 Mar	2007 Mar	2008 Mar	2009 Mar	2010 Mar	2011 Mar	2011 Sep
				(In percent)
*Capital adequacy*
	Total capital ratio ^2/			10.5	10.5	10.9	11.2	11.6	11.5	12.6	12.0	12.6	13.6	14.1	N/A
	NPL net of provisions/capital ^2/			41	51	43	33	24	18	17	16	16	16	16	N/A
*Asset quality*
	NPL ratio ^2/			6.7	8.7	7.8	6.3	4.6	3.5	3.1	2.9	2.8	2.9	2.9	N/A
	Sectoral distribution of loans ^3/
		Residents		…	93	94	95	94	94	93	93	94	95	94	94
			Deposit-takers	…	6	7	7	7	7	8	7	7	8	8	8
			Central bank	…	0	0	0	0	0	0	0	0	0	0	0
			Other financial corporations	…	12	13	14	13	12	12	12	11	11	10	11
			General government	…	4	4	5	6	6	6	6	7	7	8	8
			Nonfinancial corporations	…	41	38	35	34	33	32	33	36	34	33	33
			Other domestic sectors	…	31	32	33	35	35	34	34	34	35	35	34
		Nonresidents		…	7	6	5	6	6	7	7	6	5	6	6
*Earnings and profitability*
	ROA			0.0	−0.6	−0.6	−0.1	0.2	0.5	0.4	0.2	−0.2	0.2	0.3	0.3
	ROE			−0.8	−12.1	−13.9	−2.1	4.6	13.1	10.1	5.8	−5.2	5.0	6.3	6.7
	Interest margin			1.8	1.8	1.9	1.9	1.8	1.8	1.7	1.7	1.7	1.6	1.6	1.5
	NII/gross income			73	103	113	76	77	70	70	75	97	76	73	72
	Noninterest expenses/gross income			59	80	90	61	62	56	59	64	84	65	65	65
	Personnel cost/operating cost			50	49	49	49	46	46	44	43	45	48	48	…
*Liquidity*
	Liquid assets/total assets			13	14	18	19	20	18	16	16	16	20	21	22
	Liquid assets/short-term liabilities			44	37	40	44	44	39	36	36	38	47	48	50
	Loan/deposit			71	64	64	66	66	63	64	66	66	69	69	70
*Other*
	Capital/total assets ^4/			4.6	4.2	4.3	4.2	4.4	4.3	4.6	4.2	3.6	4.4	4.7	4.7
	RWA/total assets			44	40	39	38	38	37	37	35	29	32	33	N/A
	Equity exposures/Capital ^4/			105	100	77	83	75	79	75	65	56	49	42	38
	Gross derivative asset/capital			35	36	44	34	29	28	28	59	95	61	53	60
	Gross derivative liability/capital			33	34	41	30	26	28	28	53	88	56	49	54
*Indicators for city and regional (tier 1 and 2) banks*
	Total capital ratio			11.1	10.5	9.5	10.5	11.1	11.6	12.2	11.6	11.8	14.1	14.9	15.4
	Tier 1 ratio			7.0	6.4	5.8	6.5	7.0	7.3	8.0	8.1	8.1	10.5	11.5	12.0
	NPL net of provisions/capital ^2/			34	43	35	27	18	13	12	11	12	12	12	11.6
	NPL ratio ^2/			6.3	8.4	7.4	5.8	4	2.9	2.5	2.4	2.4	2.5	2.4	2.4
	ROA			−0.1	−0.6	−0.6	−0.1	0.2	0.5	0.4	0.3	−0.2	0.2	0.3	0.3
	ROE			−1.2	−13.9	−16.4	−3.0	4.9	15.1	11.4	6.7	−5.7	5.5	6.9	7.3
	Equity exposures/capital ^4/			121	117	93	99	88	89	85	74	64	55	48	42.7

Sources: Japanese authorities and IMF staff calculations.1/ Including city banks, regional banks and shinkin banks (consolidated basis for banking groups).

^{^2/}Aggregated with the unconsolidated basis data.

^{^3/}Include the figures of Credit cooperatives and National Federation.

^{^4/}Capital defined as net asset on the balance sheet.

Table 8.

Japan FSAP—Soundness of Banking Sector and Selected Balance Sheet Components, 2001–2011

Sources: Japanese authorities, Japanese Bankers Association, CEIC, IMF staff calculations.

^{^1/}Aggregated with the unconsolidated basis data. City + regional bank columns include trust bank data

^{^2/}Capital defined as net asset on the balance sheet.

Table 8.

Japan FSAP—Soundness of Banking Sector and Selected Balance Sheet Components, 2001–2011

			2001 March						2011 March						2011 September
			All	City + region	City	Tier 1 retion	Tier 2 region	Shinkin	All	City + region	City	Tier 1 retion	Tier 2 region	Shinkin	All	City + region	City	Tier 1 retion	Tier 2 region	Shinkin
			(In percent, unless otherwise mentioned)
*Capital adequacy*
	Total capital ratio ^1/		10.5	11.1	11.6	10.1	8.1	10.5	14.1	14.9	17.5	12.0	10.3	14.0	N/A	15.4	18.2	12.4	10.6	N/A
	Tier 1 ratio ^1/^2/		…	7.0	6.7	7.5	6.4	…	…	11.5	12.9	9.8	8.0	…	…	12.0	13.6	10.3	8.3	…
	NPL net of provisions/capital ^1/		41	34	14	10	4	7	16	12	4	5	2	4	N/A	12	4	5	2	N/A
*Asset quality*
	NPL ratio ^1/		6.7	6.3	8.7	7.0	8.2	9.6	2.9	2.4	1.8	3.1	3.7	6.0	N/A	2.4	1.9	3.1	3.9	N/A
*Earnings and profitability*
	ROA		0.0	−0.1	0.0	0.0	−0.9	0.1	0.3	0.3	0.4	0.2	0.1	0.2	0.3	0.3	0.4	0.3	0.2	N/A
	ROE		−0.8	−1.2	0.9	−0.6	−25.5	1.7	6.3	6.9	8.8	4.6	2.6	3.0	6.7	7.3	8.4	5.8	5.0	N/A
	Interest rate margin		1.8	1.7	1.5	2.1	2.4	2.5	1.6	1.5	1.3	1.7	1.9	2.1	1.5	1.5	1.2	1.6	1.8	N/A
	NII/gross income		73	71	61	84	91	90	73	70	61	82	86	89	72	69	59	82	85	N/A
	Trading income/total income		…	15	17	8	5	…	…	9	11	5	7	…	…	…	…	…	…	N/A
	Noninterest expenses/gross income		59	57	50	66	74	73	65	63	58	68	75	76	65	63	58	69	76	N/A
	Personnel cost/operating cost		50	47	42	53	55	61	48	45	39	50	52	59	…	…	…	…	…	N/A
*Liquidity*
	Liquid assets/total assets		13	14	14	13	13	7	21	23	27	17	15	9	22	24	27	17	16	N/A
	Liquid assets/short-term liabilities		44	45	47	40	51	34	48	50	59	35	38	29	50	52	61	36	41	N/A
	Customer loans/deposits		71	64	52	84	90	121	69	61	57	63	75	126	70	62	59	64	75	N/A
*Other*
	Capital/total assets ^2/		4.6	4.7	4.2	5.2	4.4	4.6	4.7	4.7	4.4	5.1	4.4	4.6	4.7	4.7	4.4	5.1	4.4	N/A
	RWA/total assets		44	42	36	51	54	44	33	32	25	43	43	33	N/A	31	24	41	42	N/A
	Equity exposures/Capital ^2/		105	121	153	58	44	11	42	48	56	34	28	10	38	43	52	30	25	N/A
	Gross derivative asset/capital		35	41	62	0	0	0	53	61	97	5	2	0	60	70	110	6	2	N/A
	Gross derivative liability/capital		33	39	57	2	2	0	49	57	89	5	2	0	54	63	100	5	2	N/A
*Selected components of balance sheet, in percent of total assets 1/*
Assets
	Cash		4	5	6	4	3	1	5	5	6	4	4	1	…	…	…	…	…	…
	Money market 4/		4	2	2	4	4	17	5	3	4	1	2	21	…	…	…	…	…	…
	Securities		22	22	21	22	17	19	30	31	33	27	23	27	…	…	…	…	…	…
		JGB+ local gov.bonds	10	10	10	11	8	6	18	19	23	16	13	12	…	…	…	…	…	…
		Corporate bond	3	2	1	5	5	8	5	4	2	6	5	11	…	…	…	…	…	…
		Equities	5	6	6	3	2	1	2	2	2	2	1	0	…	…	…	…	…	…
		Others (incl. foreign)	4	4	3	3	2	5	5	5	6	3	3	4	…	…	…	…	…	…
	Loans		59	59	56	66	73	58	53	53	45	65	70	49	…	…	…	…	…	…
Liabilities			0						0
	Customer deposit		67	64	56	87	91	91	75	72	63	88	91	93	…	…	…	…	…	…
	Money market 4/		13	15	19	2	1	0	9	10	14	3	2	0	…	…	…	…	…	…
	Loans and bonds		3	3	4	1	1	0	6	6	9	2	1	0	…	…	…	…	…	…
Net asset
	Shareholder’s equity 5/		4.2	4.1	3.9	4.3	3.9	5.3	4.5	4.4	4.1	4.6	4.2	5.1	…	…	…	…	…	…
Total assets in trillions of yen			918	804	427	206	61	114	970	841	455	243	63	129	…	…	…	…	…	…
	share in the sample		100	88	47	22	7	12	100	87	47	25	7	13	…	…	…	…	…	…

Sources: Japanese authorities, Japanese Bankers Association, CEIC, IMF staff calculations.

^{^1/}Aggregated with the unconsolidated basis data. City + regional bank columns include trust bank data

^{^2/}Capital defined as net asset on the balance sheet.

Table 8.

Japan FSAP—Soundness of Banking Sector and Selected Balance Sheet Components, 2001–2011

			2001 March						2011 March						2011 September
			All	City + region	City	Tier 1 retion	Tier 2 region	Shinkin	All	City + region	City	Tier 1 retion	Tier 2 region	Shinkin	All	City + region	City	Tier 1 retion	Tier 2 region	Shinkin
			(In percent, unless otherwise mentioned)
*Capital adequacy*
	Total capital ratio ^1/		10.5	11.1	11.6	10.1	8.1	10.5	14.1	14.9	17.5	12.0	10.3	14.0	N/A	15.4	18.2	12.4	10.6	N/A
	Tier 1 ratio ^1/^2/		…	7.0	6.7	7.5	6.4	…	…	11.5	12.9	9.8	8.0	…	…	12.0	13.6	10.3	8.3	…
	NPL net of provisions/capital ^1/		41	34	14	10	4	7	16	12	4	5	2	4	N/A	12	4	5	2	N/A
*Asset quality*
	NPL ratio ^1/		6.7	6.3	8.7	7.0	8.2	9.6	2.9	2.4	1.8	3.1	3.7	6.0	N/A	2.4	1.9	3.1	3.9	N/A
*Earnings and profitability*
	ROA		0.0	−0.1	0.0	0.0	−0.9	0.1	0.3	0.3	0.4	0.2	0.1	0.2	0.3	0.3	0.4	0.3	0.2	N/A
	ROE		−0.8	−1.2	0.9	−0.6	−25.5	1.7	6.3	6.9	8.8	4.6	2.6	3.0	6.7	7.3	8.4	5.8	5.0	N/A
	Interest rate margin		1.8	1.7	1.5	2.1	2.4	2.5	1.6	1.5	1.3	1.7	1.9	2.1	1.5	1.5	1.2	1.6	1.8	N/A
	NII/gross income		73	71	61	84	91	90	73	70	61	82	86	89	72	69	59	82	85	N/A
	Trading income/total income		…	15	17	8	5	…	…	9	11	5	7	…	…	…	…	…	…	N/A
	Noninterest expenses/gross income		59	57	50	66	74	73	65	63	58	68	75	76	65	63	58	69	76	N/A
	Personnel cost/operating cost		50	47	42	53	55	61	48	45	39	50	52	59	…	…	…	…	…	N/A
*Liquidity*
	Liquid assets/total assets		13	14	14	13	13	7	21	23	27	17	15	9	22	24	27	17	16	N/A
	Liquid assets/short-term liabilities		44	45	47	40	51	34	48	50	59	35	38	29	50	52	61	36	41	N/A
	Customer loans/deposits		71	64	52	84	90	121	69	61	57	63	75	126	70	62	59	64	75	N/A
*Other*
	Capital/total assets ^2/		4.6	4.7	4.2	5.2	4.4	4.6	4.7	4.7	4.4	5.1	4.4	4.6	4.7	4.7	4.4	5.1	4.4	N/A
	RWA/total assets		44	42	36	51	54	44	33	32	25	43	43	33	N/A	31	24	41	42	N/A
	Equity exposures/Capital ^2/		105	121	153	58	44	11	42	48	56	34	28	10	38	43	52	30	25	N/A
	Gross derivative asset/capital		35	41	62	0	0	0	53	61	97	5	2	0	60	70	110	6	2	N/A
	Gross derivative liability/capital		33	39	57	2	2	0	49	57	89	5	2	0	54	63	100	5	2	N/A
*Selected components of balance sheet, in percent of total assets 1/*
Assets
	Cash		4	5	6	4	3	1	5	5	6	4	4	1	…	…	…	…	…	…
	Money market 4/		4	2	2	4	4	17	5	3	4	1	2	21	…	…	…	…	…	…
	Securities		22	22	21	22	17	19	30	31	33	27	23	27	…	…	…	…	…	…
		JGB+ local gov.bonds	10	10	10	11	8	6	18	19	23	16	13	12	…	…	…	…	…	…
		Corporate bond	3	2	1	5	5	8	5	4	2	6	5	11	…	…	…	…	…	…
		Equities	5	6	6	3	2	1	2	2	2	2	1	0	…	…	…	…	…	…
		Others (incl. foreign)	4	4	3	3	2	5	5	5	6	3	3	4	…	…	…	…	…	…
	Loans		59	59	56	66	73	58	53	53	45	65	70	49	…	…	…	…	…	…
Liabilities			0						0
	Customer deposit		67	64	56	87	91	91	75	72	63	88	91	93	…	…	…	…	…	…
	Money market 4/		13	15	19	2	1	0	9	10	14	3	2	0	…	…	…	…	…	…
	Loans and bonds		3	3	4	1	1	0	6	6	9	2	1	0	…	…	…	…	…	…
Net asset
	Shareholder’s equity 5/		4.2	4.1	3.9	4.3	3.9	5.3	4.5	4.4	4.1	4.6	4.2	5.1	…	…	…	…	…	…
Total assets in trillions of yen			918	804	427	206	61	114	970	841	455	243	63	129	…	…	…	…	…	…
	share in the sample		100	88	47	22	7	12	100	87	47	25	7	13	…	…	…	…	…	…

Sources: Japanese authorities, Japanese Bankers Association, CEIC, IMF staff calculations.

^{^1/}Aggregated with the unconsolidated basis data. City + regional bank columns include trust bank data

^{^2/}Capital defined as net asset on the balance sheet.

9. Internationally active banks are preparing for Basel III implementation. The Basel III capital framework will be put in place for internationally active banks from 2013 on, following the medium-term schedule set by the FSA.² The FSAP team estimates that applying immediately and in full the Basel III capital definition for the major banks, while keeping the Basel II definition of risk weighted assets (RWA), would reduce their core Tier 1 and Tier 1 capital ratios by about 2 percentage points and total capital adequacy ratios (CARs) by 6 percentage points. In addition, the three mega financial groups estimate that more prudent risk weights (in line with Basel III phase-in as of September 2011) would reduce Tier 1 capital ratios by about an additional 1 percentage point. However, as noted, these financial groups have recently been issuing equity capital, reducing dividend payments, and accumulating retained earnings. Therefore, as of September 2011, they benefit from a solid capital basis of about 14¾ percent CAR, 11⅓ Tier 1 ratio, and 9⅓ core Tier 1 ratio (on a Basel III basis).

10. At the same time, Japanese banks face growing challenges (Tables 7–8, Figures 3–4). Japanese banks’ profitability has improved since the 2003 FSAP, but remains consistently below international norms. Net interest margins (NIM) have been exceptionally weak given the low interest rate domestic environment. This is encouraging banks to increasingly diversify or take on greater risk exposures, including overseas or, for regional banks, through increased JGB portfolio durations. While bank asset quality improved substantially during the past decade, it has recently shown signs of deterioration, and nonperforming loan (NPL) levels may be underestimated due to measures to support SMEs.

11. Insurance companies meet their solvency requirements, but these do not reflect a full economic valuation of their assets and liabilities (Figure 5). Both life and nonlife insurers showed strong regulatory solvency margins under the requirements prior to FY2011. The new solvency requirements that took effect in FY2011 (e.g., as a result of additional risk recognition and new risk calibration) are estimated to have reduced solvency margins by about 20–30 percent, although keeping them still well above the regulatory minimum. Importantly, however, the new requirements still do not incorporate full economic valuation. The profitability of the insurance sector has risen only marginally in recent years, but is expected to improve gradually.

12. Although substantial reforms were made to Japan’s public pensions in 2004, significant challenges to the viability of the system remain. Key elements of the 2004 reforms, such as macroeconomic indexation of benefits, have yet to be implemented. Also, although some additional changes with regard to indexation are currently under consideration, they do not include what are perhaps the most significant items—raising the retirement age beyond age 65, and harmonizing the system across sectors. The private pension system in Japan has also been evolving and growing, but it still remains small compared to the public pension system.

13. Major Japanese securities firms appear adequately capitalized and have strong liquidity buffers compared to their foreign peers. The largest securities companies have Tier 1 capital ratios of 16–24 percent. The sector has been hit hard by global market turbulence since 2007 and core profitability has contracted sharply, reducing equity and raising leverage above comparators. Declining turnovers in equity and bond markets have cut commission income, and net losses were recorded in 2008, 2009, and 2011. Continued pressures on profitability could further push some smaller firms to exit, though the traditional nature of Japanese security firms’ business limits the risks of disorderly exits.

Sources: Bankscope, company reports and IMF staff calculation.

^{^1/}Over non-interest operating income

	Return on average assets	Share of trading income ^1/	Equity/Total assets	Tier 1 ratio	Liquid asset/ST funding
	2010 (Mar 2011 for Japan), in percent
Nomura	−0.3	37	5.7	16.4	192
Daiwa	−0.3	29	5.5	24.4	209
Goldman	1.0	61	8.5	16.0	190
JP Morgan	0.8	20	8.3	12.1	52
Morgan Stanley	0.7	56	8.1	15.5	177
Merril Lynch	0.6	46	8.1	…	137
	2006-09 average, in percent
Nomura	−1.0	24	6.6	…	308
Daiwa	0.1	34	6.9	…	306
Goldman	1.0	75	6.3		145
JP Morgan	0.8	11	8.1	9.8	57
Morgan Stanley	0.3	52	5.2	…	99
Merril Lynch	−0.5	−14	4.5	…	81

Sources: Bankscope, company reports and IMF staff calculation.

^{^1/}Over non-interest operating income

	Return on average assets	Share of trading income ^1/	Equity/Total assets	Tier 1 ratio	Liquid asset/ST funding
	2010 (Mar 2011 for Japan), in percent
Nomura	−0.3	37	5.7	16.4	192
Daiwa	−0.3	29	5.5	24.4	209
Goldman	1.0	61	8.5	16.0	190
JP Morgan	0.8	20	8.3	12.1	52
Morgan Stanley	0.7	56	8.1	15.5	177
Merril Lynch	0.6	46	8.1	…	137
	2006-09 average, in percent
Nomura	−1.0	24	6.6	…	308
Daiwa	0.1	34	6.9	…	306
Goldman	1.0	75	6.3		145
JP Morgan	0.8	11	8.1	9.8	57
Morgan Stanley	0.3	52	5.2	…	99
Merril Lynch	−0.5	−14	4.5	…	81

Sources: Bankscope, company reports and IMF staff calculation.

^{^1/}Over non-interest operating income

B. Key Risk Factors

14. JGB market exposures represent one of the central macrofinancial risk factors (Figure 6). This risk reflects the possible impact on public debt sustainability of changes in yields and related effects on investor confidence; the increased role of the private financial sector in covering government borrowing needs; the prospect that ongoing demographic shifts will reduce private saving; and growing household interest in investing abroad.³ Interest rate risk sensitivity is especially prevalent in regional banks and insurance companies (JGBs representing about 70 percent of life insurers’ securities holdings and 90 percent of insurance cooperatives’ securities holdings). ⁴ In addition, the main public pension scheme, as well as Japan Post and Norinchukin bank, also have large JGB exposures (Box 1).

15. There are multiple sources of credit risk in the banking system (Table 8). Historically, domestic corporate loans have been the largest source of credit costs, a risk exacerbated by large and concentrated exposures to a few companies or industries for major banks, or to local industries for regional banks. In addition, SME-related credit costs could rise further if growth slows down or if SMEs that benefited from relaxed regulatory requirements for restructured loans fail to recover once these support measures are removed. Other credit risk exposures, such as those reflecting an acceleration of overseas expansion that may strain underwriting and risk management standards, or mortgage-related exposures (Figure 7), appear modest but require close monitoring.

16. Equity market risk exposures have declined but remain important (Figure 6, Table 8). City banks’ equity holdings still represent around half their capital, but Basel III implementation should incentivize them to further reduce such exposures. Regional banks’ equity holdings are smaller but still around 30 percent of capital. Nonlife insurers’ equity holdings have decreased to about 20 percent of assets at present, but are twice the level observed in other advanced countries. In the life sector, equity holdings represent only 5½ percent of total assets.

17. Japanese financial institutions are presently well positioned to deal with potential foreign exchange (FX) market volatility. The U.S. dollar is the most important currency for yen FX transactions (¾ of total). The net FX positions of Japanese banks are small, limiting potential valuation losses. In addition, Japanese financial institutions actively manage FX liquidity risks by using local repos, interbank loans and certificates of deposit, or cross-currency funding using FX swaps to obtain foreign exchange (mostly U.S. dollar). The cost of some of these funding sources (especially swaps) has been unstable in recent months, and in response, banks have lengthened the term of FX swaps and issued U.S. dollar bonds. Securities firms will also need to manage carefully their day-to-day liquidity due to their reliance on market funding, in particular in FX swaps markets.

C. Resilience—Stress Tests

18. The FSAP stress tests were conducted in close collaboration with the BOJ and FSA, building on their existing practices (Tables 9–11). The top-down bank stress tests were based on the framework used by the BOJ in its Financial System Report (FSR), and bottom-up tests with common assumptions were conducted for major banks and insurers.⁵ All calculations were performed by the BOJ (top-down for the banking sector), or by participating banks and insurance companies (bottom-up), based on assumptions and parameters agreed with the FSAP team. The baseline scenario reflects World Economic Outlook projection as of September 2011.⁶ Three adverse scenarios capturing the key macrofinancial risks were applied to both the banking and insurance sectors:

A global double-dip including a significant slowdown in China (mild, with a one standard deviation shock to real GDP growth; and severe, with a two standard deviations shock);
A protracted growth slowdown over the medium-to-long-term with further deflationary pressures; and
A global double-dip mild scenario combined with a 100 bps parallel shift of the yield curve (representing a moderate market yield shock in line with Japan’s experience in the past 15 years).

Table 9.

Japan FSAP—Stress Test Matrix (STeM) for the Banking Sector: Solvency Risk

^{^1/}The narrow banking system includes city, trust, regional (tier 1 and 2), foreign, bridge and internet banks, Shinkin bank and credit cooperatives. The broader system additionally includes J-Post and Norinchukin bank.

^{^2/}The relative size of the bottom-up sample are measured by the size of their banking entities in each financial group (overlapping with top-down sample). However, the actual assets covered by bottom-up exercises are larger as financial group consolidation includes exposures held by nonbank entities in a group (including securities firms and consumer finance companies). Assets (RWA) of three mega banks covered in top-down amount to 88 (96) percent of the bottom-up data for the three mega financial groups.

Table 9.

Japan FSAP—Stress Test Matrix (STeM) for the Banking Sector: Solvency Risk

Domain	Assumptions
Domain	Bottom-Up by Banks	Top-Down by the BOJ
Institutions included	Three mega-banks (Mizuho financial group, Mitsubishi UFJ financial group, Sumitomo Mitsui financial group).	All major and regional banks (111), 16 internationally active banks (56 percent), 95 domestically-active banks (44. percent). 11 major banks (63 percent); 63 tier 1 regional banks (30 percent), 37 tier 2 regional banks (7 percent). Share in system by assets in parentheses.
Market share	53 percent of commercial banks 41 percent of the narrow system and 34 percent of the broad system by assets. ^1/^2/	Almost 100 percent of commercial banks 77 percent of the narrow system and 64 percent of the broad system by assets. ^1/
Data and baseline date	Banks internal data as of September 2011 Financial group consolidated, including nonbank subsidiaries.	Bank-by-bank public data and BOJ’s internal data as of September 2011 Bank consolidated, excluding nonbank subsidiaries of a financial group.
Methodology	Banks’ internal models.	BOJ’s internal model (built on those used for FSR) modified to include additional exposures.
Stress test horizon	Two years (March 2013 and 2014).	Five years up to March 2017 (two years for global double-dip +100 bps market yield surge scenario and instantaneous for sensitivity test).
Shocks	Scenario analysis (all are macro scenarios, stressing asset prices and macroeconomic variables, same as the insurance sector scenarios) Baseline: September 2011 WEO, real GDP growth rate for the first two years is 4.2 ppt. Global double-dip (mild/severe): For the first two years, two-year cumulative GDP growth rate shock of 1 standard deviation (−4½ ppts) for mild scenario and two standard deviation (−9 ppts) for severe scenario based on 1980–2010 data. Differentiated yield shocks on major European sovereigns. Protracted slowdown: Real GDP deviating from baseline by 6¾ ppt over five years (about worst 10 percentile shock based on five year cumulative growth rate between 1980 and 2010). Global double-dip with surge in market yield: 100 bps (parallel shift) shock (historical record shock since late 1990s) on market yields is added to global double dip mild scenario.
Shocks		Sensitivity Analysis (Single factor) Market yield surge: instantaneous impact of a larger shock.
Risks/factors assessed	Credit risk from domestic corporate and retail (housing and consumer loans), and overseas loan exposures. Market risks with domestic securities (equity, bonds, incl. own sovereign bonds) in trading, and AFS accounts (excluding HTM (6 percent of total exposures)). Market risks with overseas securities in trading, and AFS accounts (excl. HTM (6 percent of total exposures)). Exchange rate.	Credit risk with domestic corporate and housing, and overseas loans. Market risks with domestic securities (equity, bonds, incl. own sovereign bonds) in trading, AFS, and HTM accounts.
Calibration of risk parameters	Domestic/overseas credit risk is estimated based on internal rating transition model (linked to macroeconomic variables). Point in time probability default (PD) and loss-given default (LGD) are calculated to estimate expected loss and unexpected loss for credit risk. Equity risk is estimated based on individual stock basis. Interest risk is estimated using Basis Point Value and interest rate scenario by region/countries.	Domestic corporate credit cost is estimated based on rating (regulatory loan classification categories) transition model of (linked to GDP) Quantile regression model (with 90 percentile estimates) is used for estimation to capture tail-end sensitivity. Credit cost from housing loan. PD is projected based on empirical relationship between PD and debt service (linked to disposable income projection). LGD = max loan-to-value ratio (reduced to account for property price declines)-100, 0). Once a loan becomes default, 100 percent provisions are set aside for covering LGD. Overseas loan credit cost is estimated by linking credit cost ratio to global GDP growth rate.
Bank Behavior	Constant exposures and no management actions (change in RWA in line with PD and LGD changes of existing portfolio). Assuming fixed dividend amount (across scenarios in line with recent dividend policy of each bank.	Constant RWA and funding. Latest actual data for dividend payout ratio and tax rate (bank by bank). Interest rate passes through upon maturity following bank’s historical patterns except for global double-dip + market yield surge scenario, where following is assumed: 100 percent for term deposit, 74 (68) percent for time deposit, 23 (17) percent for loans of major (regional) banks.
Assessment criteria - Hurdle rate	Basel III ratios including conservation buffer but excluding SIFI charges. Core Tier 1 (Tier 1) requirement without conservation buffer will increase from 3.5 (4.5) percent in 2011 to 4.5 (6) percent in 2017. Conservation buffer will be added by 0.625 every year starting in 2016 for a total of 2.5 by 2019.	For internationally active banks: same as bottom-up. For domestically-active banks. Basel II total capital ratio of 4 percent (current regulation).
− Capital definition	Basel III capital definitions estimated by banks as per gradual phase in and out schedule following draft national regulation (February 2012).	Basel III capital definition estimated by BOJ for all banks for impact analysis (Figure 9, 10, 12, and 13). Gradual phase in following draft national regulation (February 2012). Basel II capital definition for domestically-active banks when judging pass/fail (Figure 11).
− RWA	September 2011 RWAs incorporates Basel 2.5 and Basel III factors are gradually phased in following draft national regulation (February 2012).	Basel II (actual as of September 2011) RWA.
Reporting format to the FSAP team	Aggregate data.	Aggregate for the total sector and by groups (major, Tier 1 regional, and Tier 2 regional). Distribution of capital ratios by number and by share in the sector/subgroups by assets.

Table 9.

Japan FSAP—Stress Test Matrix (STeM) for the Banking Sector: Solvency Risk

Domain	Assumptions
Domain	Bottom-Up by Banks	Top-Down by the BOJ
Institutions included	Three mega-banks (Mizuho financial group, Mitsubishi UFJ financial group, Sumitomo Mitsui financial group).	All major and regional banks (111), 16 internationally active banks (56 percent), 95 domestically-active banks (44. percent). 11 major banks (63 percent); 63 tier 1 regional banks (30 percent), 37 tier 2 regional banks (7 percent). Share in system by assets in parentheses.
Market share	53 percent of commercial banks 41 percent of the narrow system and 34 percent of the broad system by assets. ^1/^2/	Almost 100 percent of commercial banks 77 percent of the narrow system and 64 percent of the broad system by assets. ^1/
Data and baseline date	Banks internal data as of September 2011 Financial group consolidated, including nonbank subsidiaries.	Bank-by-bank public data and BOJ’s internal data as of September 2011 Bank consolidated, excluding nonbank subsidiaries of a financial group.
Methodology	Banks’ internal models.	BOJ’s internal model (built on those used for FSR) modified to include additional exposures.
Stress test horizon	Two years (March 2013 and 2014).	Five years up to March 2017 (two years for global double-dip +100 bps market yield surge scenario and instantaneous for sensitivity test).
Shocks	Scenario analysis (all are macro scenarios, stressing asset prices and macroeconomic variables, same as the insurance sector scenarios) Baseline: September 2011 WEO, real GDP growth rate for the first two years is 4.2 ppt. Global double-dip (mild/severe): For the first two years, two-year cumulative GDP growth rate shock of 1 standard deviation (−4½ ppts) for mild scenario and two standard deviation (−9 ppts) for severe scenario based on 1980–2010 data. Differentiated yield shocks on major European sovereigns. Protracted slowdown: Real GDP deviating from baseline by 6¾ ppt over five years (about worst 10 percentile shock based on five year cumulative growth rate between 1980 and 2010). Global double-dip with surge in market yield: 100 bps (parallel shift) shock (historical record shock since late 1990s) on market yields is added to global double dip mild scenario.
Shocks		Sensitivity Analysis (Single factor) Market yield surge: instantaneous impact of a larger shock.
Risks/factors assessed	Credit risk from domestic corporate and retail (housing and consumer loans), and overseas loan exposures. Market risks with domestic securities (equity, bonds, incl. own sovereign bonds) in trading, and AFS accounts (excluding HTM (6 percent of total exposures)). Market risks with overseas securities in trading, and AFS accounts (excl. HTM (6 percent of total exposures)). Exchange rate.	Credit risk with domestic corporate and housing, and overseas loans. Market risks with domestic securities (equity, bonds, incl. own sovereign bonds) in trading, AFS, and HTM accounts.
Calibration of risk parameters	Domestic/overseas credit risk is estimated based on internal rating transition model (linked to macroeconomic variables). Point in time probability default (PD) and loss-given default (LGD) are calculated to estimate expected loss and unexpected loss for credit risk. Equity risk is estimated based on individual stock basis. Interest risk is estimated using Basis Point Value and interest rate scenario by region/countries.	Domestic corporate credit cost is estimated based on rating (regulatory loan classification categories) transition model of (linked to GDP) Quantile regression model (with 90 percentile estimates) is used for estimation to capture tail-end sensitivity. Credit cost from housing loan. PD is projected based on empirical relationship between PD and debt service (linked to disposable income projection). LGD = max loan-to-value ratio (reduced to account for property price declines)-100, 0). Once a loan becomes default, 100 percent provisions are set aside for covering LGD. Overseas loan credit cost is estimated by linking credit cost ratio to global GDP growth rate.
Bank Behavior	Constant exposures and no management actions (change in RWA in line with PD and LGD changes of existing portfolio). Assuming fixed dividend amount (across scenarios in line with recent dividend policy of each bank.	Constant RWA and funding. Latest actual data for dividend payout ratio and tax rate (bank by bank). Interest rate passes through upon maturity following bank’s historical patterns except for global double-dip + market yield surge scenario, where following is assumed: 100 percent for term deposit, 74 (68) percent for time deposit, 23 (17) percent for loans of major (regional) banks.
Assessment criteria - Hurdle rate	Basel III ratios including conservation buffer but excluding SIFI charges. Core Tier 1 (Tier 1) requirement without conservation buffer will increase from 3.5 (4.5) percent in 2011 to 4.5 (6) percent in 2017. Conservation buffer will be added by 0.625 every year starting in 2016 for a total of 2.5 by 2019.	For internationally active banks: same as bottom-up. For domestically-active banks. Basel II total capital ratio of 4 percent (current regulation).
− Capital definition	Basel III capital definitions estimated by banks as per gradual phase in and out schedule following draft national regulation (February 2012).	Basel III capital definition estimated by BOJ for all banks for impact analysis (Figure 9, 10, 12, and 13). Gradual phase in following draft national regulation (February 2012). Basel II capital definition for domestically-active banks when judging pass/fail (Figure 11).
− RWA	September 2011 RWAs incorporates Basel 2.5 and Basel III factors are gradually phased in following draft national regulation (February 2012).	Basel II (actual as of September 2011) RWA.
Reporting format to the FSAP team	Aggregate data.	Aggregate for the total sector and by groups (major, Tier 1 regional, and Tier 2 regional). Distribution of capital ratios by number and by share in the sector/subgroups by assets.

Table 10.

Japan FSAP-Stress Test Matrix (STeM) for the Banking Sector: Liquidity Risk

^{^1/}The narrow banking system includes as city, trust, regional (tier 1 and 2), foreign, bridge and internet banks, Shinkin bank and credit cooperatives. The broader system additionally includes J-Post bank and Norinchukin bank.

Table 10.

Japan FSAP-Stress Test Matrix (STeM) for the Banking Sector: Liquidity Risk

Domain	Assumptions
Domain	Bottom-Up by Banks	Top-Down by BOJ
Institutions included	Three mega-banks (Mizuho Corporate Bank, Bank of Tokyo Mitsubishi UFJ, Sumitomo Mitsui Bank).	All major and regional banks (111) 11 major banks (63 percent); 63 tier 1 regional banks (30 percent), 37 tier 2 regional banks (7 percent).
Market share	About 50 percent of top-down sample, (near 40 percent of the narrow system and 30 percent of the broad system) by assets.^1/	77 percent of the narrow system and 62 percent of the broad system by assets.^1/
Data and baseline date	Banks internal, data as of September 2011. Bank consolidated.	BOJ data as of September 2011. Bank consolidated.
Risk factors	US$ funding (withdrawal and market freeze) risk (uniform shock across banks, independent of solvency tests). Focus on access to funding (quantity), rather than funding cost.	¥ funding risk (uniform shock across banks, independent of solvency tests). Focus on access to funding, rather than funding cost.
Test horizon	One week and one month.	Three month.
Methodology	• Cash flow based analysis	Liquidity ratio based analysis. Compute post stress liquid asset ratio when (i) wholesale markets freeze; and (ii) deposit are withdrawn. No haircut is applied for the liquidity value of JGB, which constitutes a large share of liquid asset.
Methodology	Shocks on liability side: withdrawal rates are applied for interbank funding (including commercial paper, certificate of deposits, deposits by banks and central banks), deposits by nonbanks, repos (using United States Treasuries, T-bonds, and government guaranteed agency bonds only), yen-US$ cross-currency funding, and committed credit lines. Mitigating actions to generate cash: banks can raise additional liquidity by selling unencumbered securities (with haircut according Fed requirements), using Fed excess reserve deposits, Fed Discount Window (amount is determined by the value of unremunerated eligible collateral banks hold) etc. US$ funding through FX spot purchases and BOJ's US$ funds supplying operations are excluded from additional funding tools.
Shocks	Stress scenario: withdrawal upon maturity—interbank funding (30 percent), deposit (20 percent), repos (5 percent). No additional cross-currency funding using swaps beyond the amount they already have. 100 percent of committed asset back commercial paper and 5 percent of other committed credit facilities are incorporated as cash outflows. Extreme stress scenario: withdrawal upon maturity—interbank funding (40 percent), deposit (20 percent), repos (5 percent). Cross-currency funding using swaps is reduced by 20 percent upon maturity. 100 percent of committed asset back commercial paper and 5 percent of other committed credit facilities are incorporated as cash outflows.	Market freeze scenario: wholesale funding market completely freezes for three months (Liquid asset ratio with 0 runoff rate for deposits). Deposit withdrawal scenario: in addition to wholesale market freeze, maturing and liquid deposits will be withdrawn by 5 and 10 percent (runoff rate). The withdrawal rate is severer than historical experiences.
Assessment criteria	A bank is considered liquid if it can maintain positive net cash inflow position after taking mitigating actions to generate liquidity.	Liquid asset ratio of 100 percent (analytical, not regulatory, criteria). Liquid asset ratio = (deposits with the BOJ+cash+JGB)/(net market funding matured within three months+runoff of deposits with a renewal time within three months).

Table 10.

Japan FSAP-Stress Test Matrix (STeM) for the Banking Sector: Liquidity Risk

Domain	Assumptions
Domain	Bottom-Up by Banks	Top-Down by BOJ
Institutions included	Three mega-banks (Mizuho Corporate Bank, Bank of Tokyo Mitsubishi UFJ, Sumitomo Mitsui Bank).	All major and regional banks (111) 11 major banks (63 percent); 63 tier 1 regional banks (30 percent), 37 tier 2 regional banks (7 percent).
Market share	About 50 percent of top-down sample, (near 40 percent of the narrow system and 30 percent of the broad system) by assets.^1/	77 percent of the narrow system and 62 percent of the broad system by assets.^1/
Data and baseline date	Banks internal, data as of September 2011. Bank consolidated.	BOJ data as of September 2011. Bank consolidated.
Risk factors	US$ funding (withdrawal and market freeze) risk (uniform shock across banks, independent of solvency tests). Focus on access to funding (quantity), rather than funding cost.	¥ funding risk (uniform shock across banks, independent of solvency tests). Focus on access to funding, rather than funding cost.
Test horizon	One week and one month.	Three month.
Methodology	• Cash flow based analysis	Liquidity ratio based analysis. Compute post stress liquid asset ratio when (i) wholesale markets freeze; and (ii) deposit are withdrawn. No haircut is applied for the liquidity value of JGB, which constitutes a large share of liquid asset.
Methodology	Shocks on liability side: withdrawal rates are applied for interbank funding (including commercial paper, certificate of deposits, deposits by banks and central banks), deposits by nonbanks, repos (using United States Treasuries, T-bonds, and government guaranteed agency bonds only), yen-US$ cross-currency funding, and committed credit lines. Mitigating actions to generate cash: banks can raise additional liquidity by selling unencumbered securities (with haircut according Fed requirements), using Fed excess reserve deposits, Fed Discount Window (amount is determined by the value of unremunerated eligible collateral banks hold) etc. US$ funding through FX spot purchases and BOJ's US$ funds supplying operations are excluded from additional funding tools.
Shocks	Stress scenario: withdrawal upon maturity—interbank funding (30 percent), deposit (20 percent), repos (5 percent). No additional cross-currency funding using swaps beyond the amount they already have. 100 percent of committed asset back commercial paper and 5 percent of other committed credit facilities are incorporated as cash outflows. Extreme stress scenario: withdrawal upon maturity—interbank funding (40 percent), deposit (20 percent), repos (5 percent). Cross-currency funding using swaps is reduced by 20 percent upon maturity. 100 percent of committed asset back commercial paper and 5 percent of other committed credit facilities are incorporated as cash outflows.	Market freeze scenario: wholesale funding market completely freezes for three months (Liquid asset ratio with 0 runoff rate for deposits). Deposit withdrawal scenario: in addition to wholesale market freeze, maturing and liquid deposits will be withdrawn by 5 and 10 percent (runoff rate). The withdrawal rate is severer than historical experiences.
Assessment criteria	A bank is considered liquid if it can maintain positive net cash inflow position after taking mitigating actions to generate liquidity.	Liquid asset ratio of 100 percent (analytical, not regulatory, criteria). Liquid asset ratio = (deposits with the BOJ+cash+JGB)/(net market funding matured within three months+runoff of deposits with a renewal time within three months).

Table 11.

Japan FSAP—Stress Test Matrix (STeM) for the Insurance Sector

Sources: IMF and FSA.

Table 11.

Japan FSAP—Stress Test Matrix (STeM) for the Insurance Sector

Domain	Bottom-up Stress Test
Domain	Life insurance companies	Nonlife insurance companies
Institutions included	Four major life insurance companies: Meiji Yasuda life insurance, Dai-ichi life insurance, Sumitomo life insurance, and Nippon life insurance.	Five major nonlife insurance companies: Tokio Marine &Nichido Fire Insurance Sompo Japan Insurance, Nipponkoa Insurance, Mitsui Sumitomo Insurance, Aioi Nissay Dowa Insurance.
Market share	43 percent as of FY2010 by life premium.	82 percent as of FY2010 by nonlife premium.
Balance sheet data cutoff date	Data as of end-September 2011 for all analysis, except for life insurer's interest rate sensitivity analysis using March 2010 data.
Methodology	Life insurance internal models.	Nonlife insurance internal models.
Stress test horizon	Two years (one-time, cumulative shock applied).
Shocks	Scenario analysis (same as the bank solvency test, using accounting based valuation) Baseline: September 2011 WEO, real GDP growth rate for the first two years is 4.2 ppt. Global double-dip (mild/severe): For the first two years, two-year cumulative GDP growth rate shock of 1 standard deviation (-4½ppt) for mild and 2 standard deviation (-9 ppts) for severe scenario based on 1980-2010 data. Differentiated yield shocks on major European sovereigns. Protracted slowdown: Real GDP deviating from baseline by 6¾ ppt over five years (about worst 10 percentile shock based on five year cumulative growth rate between 1980 and 2010). Global double-dip with surge in market yield: 100 bps (parallel shift) shock (historical record shock since late 1990s) on market yields is added to global double dip mild scenario. Sensitivity (single factor) analysis Interest rate sensitivity analysis: provided an indication of the potential effects of the stresses if an economic-based valuation was adopted. Shocks correspond to the two-year cumulative change in each scenario.
Shocks	A pandemic event causing a negative deviation of mortality for life insurance sector. The shock on mortality rate is set at 0.13 percent provided by the authorities based on the study by the Ministry of Labor, Health and Welfare.	A moderate reinsurance failure on nonlife insurance (set as 80-90 percent failures). No further catastrophic shock is considered given the nonlife insurance sector faced an actual shock from the Great East Japan Earthquake.
Risks/factors assessed	Market risk: Losses/gains from securities holdings, including JGBs, domestic and foreign equities, and holdings of corporate and local government bonds. Securities investments such as equities, real estate, and fixed income assets in AFS account are subject to shocks in the stress test, but debt securities earmarked for policy reserves and held to maturity (about two-thirds of bond holdings) is not subject to a markdown under the accounting basis. Interest rate risk: Interest rate sensitivity provided an indication of the potential effects of the stresses if an economic-based valuation was adopted including JGBs in HTM account and account earmarked for policy reserves amounting to about 2/3 of JGBs. Pandemic shocks and reinsurance failures: Assess the impact of the pandemic shock and reinsurance failures on solvency margin, various reserves position, and change in net assets.
Reporting basis of results	All results were reported using the accounting basis, except for the results on interest rate sensitivity that provided an indication of the potential impact of an economic-based valuation. Results were reported to FSAP team on an aggregate basis.
Assessment criteria	Although the stress test did not provide solvency ratios, the impact on solvency was assessed using sector (separate for life and nonlife) aggregate solvency margin (including breakdown); and net assets (including unrealized gains and losses).

Sources: IMF and FSA.

Table 11.

Japan FSAP—Stress Test Matrix (STeM) for the Insurance Sector

Domain	Bottom-up Stress Test
Domain	Life insurance companies	Nonlife insurance companies
Institutions included	Four major life insurance companies: Meiji Yasuda life insurance, Dai-ichi life insurance, Sumitomo life insurance, and Nippon life insurance.	Five major nonlife insurance companies: Tokio Marine &Nichido Fire Insurance Sompo Japan Insurance, Nipponkoa Insurance, Mitsui Sumitomo Insurance, Aioi Nissay Dowa Insurance.
Market share	43 percent as of FY2010 by life premium.	82 percent as of FY2010 by nonlife premium.
Balance sheet data cutoff date	Data as of end-September 2011 for all analysis, except for life insurer's interest rate sensitivity analysis using March 2010 data.
Methodology	Life insurance internal models.	Nonlife insurance internal models.
Stress test horizon	Two years (one-time, cumulative shock applied).
Shocks	Scenario analysis (same as the bank solvency test, using accounting based valuation) Baseline: September 2011 WEO, real GDP growth rate for the first two years is 4.2 ppt. Global double-dip (mild/severe): For the first two years, two-year cumulative GDP growth rate shock of 1 standard deviation (-4½ppt) for mild and 2 standard deviation (-9 ppts) for severe scenario based on 1980-2010 data. Differentiated yield shocks on major European sovereigns. Protracted slowdown: Real GDP deviating from baseline by 6¾ ppt over five years (about worst 10 percentile shock based on five year cumulative growth rate between 1980 and 2010). Global double-dip with surge in market yield: 100 bps (parallel shift) shock (historical record shock since late 1990s) on market yields is added to global double dip mild scenario. Sensitivity (single factor) analysis Interest rate sensitivity analysis: provided an indication of the potential effects of the stresses if an economic-based valuation was adopted. Shocks correspond to the two-year cumulative change in each scenario.
Shocks	A pandemic event causing a negative deviation of mortality for life insurance sector. The shock on mortality rate is set at 0.13 percent provided by the authorities based on the study by the Ministry of Labor, Health and Welfare.	A moderate reinsurance failure on nonlife insurance (set as 80-90 percent failures). No further catastrophic shock is considered given the nonlife insurance sector faced an actual shock from the Great East Japan Earthquake.
Risks/factors assessed	Market risk: Losses/gains from securities holdings, including JGBs, domestic and foreign equities, and holdings of corporate and local government bonds. Securities investments such as equities, real estate, and fixed income assets in AFS account are subject to shocks in the stress test, but debt securities earmarked for policy reserves and held to maturity (about two-thirds of bond holdings) is not subject to a markdown under the accounting basis. Interest rate risk: Interest rate sensitivity provided an indication of the potential effects of the stresses if an economic-based valuation was adopted including JGBs in HTM account and account earmarked for policy reserves amounting to about 2/3 of JGBs. Pandemic shocks and reinsurance failures: Assess the impact of the pandemic shock and reinsurance failures on solvency margin, various reserves position, and change in net assets.
Reporting basis of results	All results were reported using the accounting basis, except for the results on interest rate sensitivity that provided an indication of the potential impact of an economic-based valuation. Results were reported to FSAP team on an aggregate basis.
Assessment criteria	Although the stress test did not provide solvency ratios, the impact on solvency was assessed using sector (separate for life and nonlife) aggregate solvency margin (including breakdown); and net assets (including unrealized gains and losses).

Sources: IMF and FSA.

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Abstract

I. Background

II. Current State of Financial Stability

A. Financial System—Performance and Soundness

B. Key Risk Factors

C. Resilience—Stress Tests