The risks in Japan’s financial system

The sovereign debt crisis originating in Greece has spread rapidly to other
European nations, and is also jeopardizing the soundness of European financial
institutions which hold large amounts of public debt. In Europe, many banks,
including major banks, are experiencing funding difficulties, and a return of the
financial crisis of fall 2008 is feared. In the U.S., many banks which have not fully
extricated themselves from the aftermath of the financial crisis are also suffering
difficulties. In comparison to these problems in European and U.S. financial systems,
the Japanese financial system appears stable. Japanese financial institutions were
not much exposed to the toxic securitized products that triggered the recent financial
crisis, and the amount of their non-performing loans has not increased. As I will
discuss below, however, the official figures for non-performing loans do not reflect
the actual situation, and that large sums in non-performing loans have come to be
hidden since the financial crisis. Moreover, the fact that Japan’s financial institutions
hold enormous amounts of Japanese government bonds implies dangerously high
interest rate risk. Japan should come up with effective measures to contain the credit
risk and interest rate risk facing its financial system.