The Bank of Japan says Japanese banks have enough capital to withstand a stress in which crude oil prices jump, expectations for AI investment profits fall and interest rates rise sharply, all at the same time. The conclusion comes in its October 2026 Financial System Report, released on October 23. The same report names the channels it wants watched: banks' growing links to foreign non-bank financial intermediaries (NBFIs) and valuation losses on yen-denominated bonds at regional and shinkin banks.
The report's overall verdict is that Japan's financial system "has been maintaining stability on the whole", with loan demand rising and no major financial imbalances in current activity. It judges stability to hold under two tests: stress equivalent to the global financial crisis, and the compound shock described above.
What the compound scenario assumes
The harsher test is the report's "rises in foreign interest rates scenario plus". This edition refines how a drop in AI-profit expectations is modelled and assumes the shock is amplified mainly by portfolio adjustments in the NBFI sector. The test covers 105 banks and 247 shinkin banks through the January-March quarter of 2029.
| Variable | Assumption |
|---|---|
| WTI crude oil | Rises temporarily to $180 a barrel, then stays at $140 |
| U.S. federal funds rate | 2 percentage points above baseline for one year, then eases moderately |
| U.S. and Japanese long-term rates | 1.5 percentage points above baseline throughout |
| U.S. BBB corporate bond spreads | Additional 600bps widening versus the April 2026 scenario, from NBFI amplification |
| Foreign GDP, especially Asia | Around 7 percent below baseline at maximum divergence |
| AI-related stocks | Fall sharply, in line with the dot-com collapse |
The BOJ stresses that the scenarios are hypothetical. They are neither its outlook for the economy, asset prices or policy, nor a judgment on likelihood.
Where the stress lands
Capital adequacy ratios at the end of the simulation are lower than in the baseline for all bank types, yet stay above regulatory requirements throughout. The BOJ concludes that the stability of the system as a whole is maintained.
The path to that result matters. Domestic credit costs rise by more than in the global-financial-crisis scenario, because higher oil prices weigh on corporate profits and lower interest rates are not there to ease debt repayment. Credit costs on foreign exposures rise notably in Asia, where AI-related manufacturing is a large share of activity. Impairment of loans to private credit funds and data centers also adds to the increase.
Securities losses differ by bank type. Shinkin banks take a larger hit from yen-denominated bonds because of the longer duration of those holdings. At internationally active banks, foreign bonds contribute more. Valuation gains and losses on securities count toward those banks' regulatory capital, so simultaneous falls in stock and bond prices cut their capital ratios directly.
The foreign-fund link
Bank lending to and investment in foreign NBFIs, which the report says include private funds and hedge funds, has risen from ¥8tn in March 2008 to ¥126tn in June 2026. Foreign investment funds' holdings of Japanese markets rose from ¥111tn to ¥408tn over the same period. The report says this may have left Japan's financial system more susceptible to swings in global markets and in foreign investment funds.
The exposure is concentrated in the big banks. Foreign loans make up over 30 percent of major banks' loan portfolios. Lending to foreign funds is 9 percent of their total overseas lending, and data-center lending is also a limited share. Both have become focus segments because of high interest rate spreads.
The BOJ flags two weak points. Investment-grade ratings are common in fund lending because it is often structured as subscription finance backed by commitments from creditworthy limited partners, but "it is not always easy to obtain a timely understanding of foreign funds' actual investment practices and value". On the funding side, non-traded business development companies in the United States have seen redemption outflows since the start of 2026, tied to worries over the software industry.
Yen bonds and thin buffers
As interest rates have risen, valuation losses on yen-denominated bonds have been increasing, particularly at regional and shinkin banks with large yen bondholdings. Even among banks with relatively low resilience to rate rises, many have cut those holdings and shortened duration, which has limited the growth in losses. Pre-provision net revenue, the measure of core profitability, has continued to improve.
The report adds a longer-term caveat. If loan demand keeps shrinking with the population, banks' profitability and loss-absorbing capacity could decline.
The sharpest tension is in committed credit lines to foreign funds. Utilization has stayed unchanged, but the BOJ warns that rapid drawdowns could occur in a large-scale shock.