The collapse of Silicon Valley Bank is due to many reasons. However, this is primarily due to the bond portfolio, the value of which has fallen sharply against the backdrop of rising interest rates. Not surprisingly, analysts and investors are trying to identify companies that may have similar problems in other countries. Unexpected conclusions were drawn regarding Japan. Local investment institutions have accumulated huge stocks of domestic and foreign bonds with long maturities.
The value of these bonds has already plummeted after the sell-off and repricing that occurs when rates rise: the risk associated with the duration. The volume of long-term foreign bonds among “other financial corporations”, which includes insurance companies, investment firms and pension funds, stood at $1.5 trillion in June, about $293 billion less than at the end of 2021.
The Japanese investment company Norinchukin Bank is the holder of such bonds. The company was the largest buyer of secured loan obligations. The value of the bond portfolio fell due to rising rates from 36 trillion yen ($293 billion) in March last year to 28 trillion yen in December. Savings bank Japan Post Bank, almost a third of which is owned by the Japanese government, is also exposed to risks. Foreign securities accounted for 35% of the firm’s total assets, compared to almost zero in 2007.
The clients of these companies are likely to be more reserved than those of SVB. In the case of Silicon Valley, the run was initiated by panicked venture capitalists. Japan Post Bank has many individual depositors across the country who have opened approximately 120 million accounts. Norinchukin Bank’s clients, mostly agricultural cooperatives, also appear to be less likely to flee than those in the tech sector.
Under pressure
However, the risk is associated with fluctuations in exchange rates. As Brad Setser of the Council on Foreign Relations think-tank noted, higher US interest rates have greatly increased the cost of hedging foreign exchange risks for both investors and the companies and governments they buy bonds from. Japanese investors sold $165bn more foreign long-term bonds than they bought last year, the largest liquidation in history. Rising rates have forced bond issuers around the world to pay more on loans. And the outflow of reliable buyers only exacerbates the problems.
Huge amounts of foreign financial assets are just one component of the risk. Interest rates in Japan are at the lowest level by world standards since the early 1990s, after the land and stock bubble burst in the country. Thirty years of relative economic stagnation, as well as intermittent deflation, contributed to extremely low bond yields, forcing financial institutions to buy longer-term, higher yield yen-denominated bonds. Because of this, the amount of damage that even a slight tightening of monetary policy can cause increases.
At the same time, it is less and less clear whether Japan will really be able to keep rates low. In January, consumer price inflation reached 4.3%; salaries in large companies look set to grow at the fastest rate in decades. A one percentage point rate hike would cut the value of yen-denominated bank bonds by more than 9 trillion yen. The unrealized losses of large banks would be about 10% of their capital. Losses in sinking banks, types of credit unions, would be even greater – about 30%.
Last year, the Bank of Japan published the results of the analysis, according to which the losses will be compensated by changes in the value of liabilities. Typically, the interest rates banks offer to savers rise much more slowly than the rates they charge on new loans, which eases the pressure. In the case of regional banks, these two forces almost cancel each other out. But in its calculations, the Central Bank proceeds from the assumption of the loyalty of depositors. The value of bank portfolios is likely to fall due to higher rates, while depositors have not had to undergo a loyalty test recently.
The Bank of Japan says it will not raise rates. However, recent inflationary pressures and rising prices in the rest of the world mean that this position is becoming increasingly difficult to maintain. The very possibility of an increase is already weighing on the volume of foreign bonds, as investors get rid of assets. And as Japanese institutions shift from buyers to sellers, corporate and government bond issuers around the world are losing once-reliable customers just when they are most needed.
Prepared by Profinance.ru by materials editions of The Economist
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