In addition to credit risk, Japanes

In addition to credit risk, Japanese banks are also exposed to interest rate risk arising from
their holdings of Japanese government bonds. As is well known, Japanese government debt is
enormous, and is increasing. Almost all recent studies conclude that the Japanese fiscal policy
If the market comes to share the wide spread conclusion among researchers that the
Japanese fiscal policy is unsustainable, the Japanese government will face difficulty in
refinancing bonds, and the interest rates will go up. More than two thirds of the outstanding
Japanese government bonds are held by Japanese financial institutions. Holdings of
government bonds and regional bonds by Japanese banks amount to 142 trillion yen (as of
March 2010). The Bank of Japan’s Financial System Report in March 2010 estimates that if
interest rates were to increase by 1%, the banking sector would face a capital loss of 4.7
trillion yen. This corresponds to 11.7% of Tier I capital for the accounting year ending in
March 2010 or approximately double the industry’s pre-tax earnings for the same period