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The Impacts Of The Bank Of Japan’s Policy Reversal On Banks and Insurers

Japan’s central bank, the Bank of Japan had embarked on a policy of negative interest rates in late January this year. But last week, the central bank revealed a major change in its monetary policy stance when it announced its aim to guide 10 year Japanese government bonds (JGB) to a zero percent yield.

Prior to the announcement, 10 year Japanese government bond yields had remained mostly in negative territory for much of 2016. When the Bank of Japan announced its policy change, yields rose the next day to as a high as a positive 0.005%.

Let’s take a look at the impacts that this change in policy could have on financial institutions – banks and insurers – in Singapore.

Impact on banks

Negative interest rates in Japan have pushed Japanese banks’ profits lower. It remains to be seen if the Bank of Japan’s change in monetary policy would help reverse the current global phenomenon of low interest rates.

But it should be noted that the US Federal Reserve had signalled that an increase in interest rates is likely by the end of 2016 in its recent policy meeting, even though it chose to keep interest rates in the US unchanged ultimately.

My colleague David Kuo had recently stated that a rise in global interest rates could be a boon for banks in Singapore. He wrote:

“Singapore banks that include DBS Group (SGX: D05), UOB (SGX: U11) and OCBC (SGX: O39) make the bulk of their money from the difference in the interest rates that they charge borrowers and the deposit rate that they pay to savers.

When interest rates are low, the margin between borrowing and lending can be wafer-thin. But as interest rates rise, so too does the Net Interest Margin. So, some of the main beneficiaries of a US rate rise could be our local lenders.”

Let’s turn our attention now to insurance companies. In Singapore’s stock market, there are a handful of insurers. One of the largest would be Great Eastern Holding Limited (SGX: G07), which manages over S$60 billion in assets and has 4.7 million policy holders.

Impact on insurers

In general, insurance companies take in your insurance premiums today and promise to pay you back a certain sum years later – the sums and timeframes involved depend on the type of policy products taken up.

Some products sold by insurance companies would come with a guaranteed return component. It would thus make the life of insurers much easier if low-risk assets such as sovereign bonds have positive instead of negative yields. Due to regulations, insurers are not allowed to simply invest all their assets into risky assets even if doing so can boost their returns.

Moreover, Singapore insurers have to ensure that the cash flows from their assets are higher than the cash outflows from their liabilities. A higher interest rate environment would be helpful to match asset and liability cash flows.

A Foolish Conclusion

Financial institutions are affected by changes in the macro economic environment and the decisions of major central banks. These are largely outside the control of financial institutions but investors should still keep a lookout for such developments.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Ong Kai Kiat owns shares in DBS Group.