Japan to include COVID-19 scenarios in next bank stress tests

October 6, 2020.

The and the country’s Financial Services Agency said Tuesday that their next simultaneous stress test of the nation’s five largest banks will include scenarios related to the COVID-19 pandemic.

Financial Group, Sumitomo Mitsui Financial Group, Mizuho Financial Group, Sumitomo Mitsui Trust Holdings and Norinchukin Bank will all take part in the test.

The BOJ and FSA, which oversee the test, only began using a “common scenario” when conducting the test, which is typical in most Western countries, in October 2019. Previously, each financial institution came up with its own scenario when conducting stress tests, and the FSA examined the results, according to a 2019 Reuters report, but in December the regulators gave out their first common scenarios to banks.

The “common scenario” in the bank's first round of simultaneous stress tests actually compared two scenarios: a baseline scenario that presented little disruption to business as usual, and a tail-event scenario when stress was expected to occur. Because the scenario was formulated last year, it did not take into account potential effects of the coronavirus.

The baseline scenario for the first simultaneous stress test was developed based on the economic situation from October to November 2019 and on the average outlook of multiple research institutions and markets. The tail event scenario hypothetically assumed that the overseas economy would slow down as much as it did in 2008, and the supply-demand gap in Japan would deteriorate to the same level as during the shock from the Lehman Bros. bankruptcy, along with the depreciation and the decline in domestic and foreign interest rates. 

The banks received feedback on the test, which was not released publicly, in July. 

The next round of tests will be updated to take the global pandemic into account as Japan's banks continue to face low interest rates.

Simultaneous stress tests have been more common in western countries, and they, too, have been looking to update their tests to contend with the fallout of the pandemic. In June, the U.S. Board released the results of a 2020 stress test as well as additional sensitivity analyses the Fed conducted because of the coronavirus pandemic. The results showed that large U.S. banks would face heavy losses from the pandemic but remain well-capitalized under harsh economic scenarios. 

The Fed recently unveiled details of a second stress test for 2020 for 34 of the country’s largest banks. The unusual second stress test in a single year will help assess whether banks will still be able to lend to customers and businesses under economic conditions that could be created by the pandemic.

— Additional reporting by Zack Fishman