Japanese banks' exposure to government bonds exceeds Tier 1 capital by four times

But they're still resilient against interest rate risk.

Fitch Ratings says in a new report that Japan's banks are better protected by a higher loss absorption capacity despite a substantial and an increasing exposure to Japanese government bonds (JGBs).

Here's more from Fitch Ratings:

The improvement in capitalisation has been more notable at major banks in particular, reflecting sustained, albeit still modest, internal capital generation. As a result, their capital positions now compare favourably with that of many global peers.

The major banks' exposure to JGBs exceeds their Tier 1 capital by four times on average. Fitch expects such exposure to continue to rise, given the banks' abundant yen liquidity and limited alternative investment options.

In its analysis Fitch concludes that only a severe rise in JGB yields would have a marked impact on the major banks' capital. Despite increased sensitivity to interest rate movements arising from an increased portfolio size and longer duration compared with 2009, the banks are in a healthier position due to their higher capitalisation levels. In most cases, the banks are resilient even under the worst of the potential conditions including the extreme scenario observed for Italian government bonds in 2011.

Key risk-mitigating factors for Japanese banks include strong liquidity positions backed by solid retail funding bases as well as low loans/deposits ratios (approximately 70% on average), and still modest durations on the bond portfolios. Fitch believes the banks are less likely to face funding pressure that would force them to liquidate their bond portfolios and realise valuation losses, even in a scenario of substantially higher bond yields.