By Stanley White
TOKYO (Reuters) - The Bank of Japan warned commercial banks on Friday not to become complacent over lending standards and loan-loss provisions as its quantitative easing drives borrowing costs lower.
The BOJ welcomed an increase in commercial lending since the launch of its unprecedented monetary easing last year as a sign that its policies are helping distance the economy from deflation, according to its semi-annual report on the financial system.
The central bank also warned that credit costs and loan-loss provisions are at the lowest since the 1980s bubble economy, so banks should take extra care when evaluating borrowers and hedging against any potential losses.
"There's a possibility credit costs appear small because long-term rates have been low for a long time," the BOJ said in the report.
"As banks expand their support of ventures and revitalised firms, credit costs and loan-loss provisions could rise."
On the whole, the BOJ saw no problems with stability in the financial system, according to its report.
Bank lending rose 2.2 percent year-on-year in the first half of fiscal 2014, faster than a 2.0 percent annual gain in the second half of fiscal 2013 and a 1.6 percent annual increase in the first half of fiscal 2013, the BOJ said.
The BOJ launched qualitative and quantitative easing in April last year, when it pledged to double base money via aggressive government debt and asset purchases to achieve 2 percent inflation in roughly two years.
CLEAR RESULTS
One aim of the BOJ's monetary policy is to lower the amount of government debt that commercial banks hold, which gives them more funds to simulate the economy by lending to businesses.
This aspect of the BOJ's monetary policy has produced clear results. Since March last year, holdings of government debt on bank balance sheets have fallen 39.3 trillion yen ($368.9 billion) (229.13 billion pound), while domestic lending has risen 13.1 trillion yen, the report said.
Banks, however, have not sold all their government debt and are still exposed to interest-rate risk should yields rise.
A 1-percentage-point increase in Japanese interest rates would result in 2.6 trillion yen in unrealised losses on government debt held by major Japanese banks, the BOJ's report said.
For regional banks, the unrealised losses would total 3.0 trillion yen, the central bank added.
The figures are based on data at the end of June this year.
(Reporting by Stanley White; Editing by Chris Gallagher and Richard Borsuk)