Unrealised losses on Japanese government bonds (JGBs) reached ¥7.05 trillion by late 2025, forcing major Japanese banks including Mitsubishi UFJ Financial Group (NYSE: MUFG), Sumitomo Mitsui Financial Group (NYSE: SMFG), and Mizuho Financial Group (NYSE: MFG) to record substantial markdowns as rising global yields eroded bond portfolio values, triggering capital strain and prompting reassessments of domestic lending capacity amid persistent Bank of Japan yield curve control adjustments.
The Bottom Line
- JGB losses exceeded 12% of Tier 1 capital for Japan’s three largest banks, pressuring CET1 ratios below regulatory comfort zones.
- The sell-off reflects shifting global rate expectations, with 10-year JGB yields rising to 1.8% from -0.1% in early 2024, narrowing the U.S.-Japan yield spread and testing BoJ policy credibility.
- Bank stock valuations declined 8-11% YoY as investors priced in prolonged margin compression and reduced sovereign bond holdings as collateral for interbank lending.
How Rising Global Yields Undermined Japan’s Bond Fortress
The ¥7.05 trillion in unrealised JGB losses, reported by Japan’s Financial Services Agency in its December 2025 stability review, represents a 40% increase from ¥5.03 trillion a year earlier and marks the highest level since the BoJ introduced negative interest rates in 2016. This surge coincided with a sharp backup in global sovereign yields, driven by persistent U.S. Inflation above 3% and renewed hawkish signaling from the Federal Reserve, which pushed 10-year Treasury yields to 4.7% by Q4 2025. As foreign investors demanded higher compensation for holding Japanese debt amid currency hedging costs, the Bank of Japan’s yield curve control (YCC) policy came under strain, culminating in the July 2025 decision to allow the 10-year JGB yield to trade flexibly up to 1.0%, a move that accelerated portfolio devaluation for banks holding long-duration JGBs as core liquidity assets.
According to BoJ flow-of-funds data, Japanese banks increased JGB purchases by ¥12 trillion in 2024 as part of yield-seeking behavior under negative rates, extending average portfolio duration to 7.3 years. When yields rose, mark-to-market losses mounted rapidly. Mitsubishi UFJ disclosed in its FY2025 earnings that its JGB portfolio suffered ¥2.1 trillion in unrealised losses, Sumitomo Mitsui reported ¥1.9 trillion, and Mizuho ¥1.8 trillion—figures that, when combined, represent over 85% of the sector’s total exposure. These losses were not realized but reduced available-for-sale (AFS) reserves, directly impacting regulatory capital calculations under Basel III.
Capital Pressure and the Domino Effect on Domestic Lending
The erosion of AFS reserves triggered a measurable decline in CET1 ratios. Mitsubishi UFJ’s CET1 fell to 9.8% at end-2025 from 11.2% a year prior, Sumitomo Mitsui to 9.5%, and Mizuho to 9.2—levels approaching the 8.0% minimum plus 2.5% capital conservation buffer under Japanese implementation of Basel III. While no bank breached regulatory thresholds, the proximity prompted internal stress testing and curtailed balance sheet expansion. Loan growth at the three megabanks slowed to 1.8% YoY in FY2025, down from 4.1% in 2024, with corporate lending particularly weak in sectors sensitive to financing costs such as real estate and equipment manufacturing.
This retrenchment has macroeconomic implications. Japan’s private fixed investment grew just 0.5% in 2025, according to Cabinet Office data, the weakest pace since 2020, as businesses faced tighter credit conditions despite record cash holdings. Meanwhile, consumer lending remained resilient, supported by wage growth above 2% and strong demand for mortgages, but even here, banks reported tightening underwriting standards. As one Tokyo-based credit analyst noted,
The JGB markdowns aren’t just an accounting issue—they’re reshaping how banks allocate capital. When your safest asset loses value, you don’t double down; you pull back.
Market Reaction and Competitive Realignment
Bank stocks reflected the growing concern. Mitsubishi UFJ’s share price declined 9.3% over the 12 months to April 2024, Sumitomo Mitsui fell 10.1%, and Mizuho dropped 8.7%, underperforming the TOXBNK Index’s 3.2% decline. In contrast, regional banks with lower JGB exposure—such as Resona Holdings (NYSE: RFN) and Shizuoka Bank (TSE: 8355)—saw smaller declines of 3-5%, as their loan-to-deposit ratios remained higher and reliance on sovereign bonds for liquidity was less pronounced. Foreign investors, particularly European and U.S. Asset managers, reduced overweight positions in Japanese bank stocks, citing “duration risk without compensatory yield,” according to a Q1 2026 survey by State Street Global Advisors.
The sell-off likewise influenced cross-border capital flows. Foreign ownership of JGBs fell to 11.2% of total outstanding in December 2025 from 14.8% a year earlier, per Japan Ministry of Finance data, as global funds shifted toward higher-yielding U.S. And European debt. This outflow placed indirect pressure on the yen, which weakened to 152 per dollar by March 2026, boosting import costs and contributing to core inflation rising to 2.4%—above the BoJ’s 2% target for the tenth consecutive month. In response, the BoJ ended YCC in March 2026, allowing the 10-year yield to reach 1.8% by April, a move that stabilized bank bond valuations but raised concerns about fiscal sustainability, given Japan’s debt-to-GDP ratio of 260%.
The Path Forward: Duration Management and Yield Curve Normalization
Banks are now actively shortening JGB portfolio duration. Mitsubishi UFJ announced in its FY2025 report a ¥3 trillion reduction in holdings of bonds maturing beyond 10 years, reinvesting proceeds into short-term Treasury bills and floating-rate notes. Sumitomo Mitsui disclosed a similar shift, targeting a portfolio duration of 5.0 years by end-2026. These actions have begun to stabilize unrealised losses, which the FSA estimated declined to ¥6.2 trillion by Q1 2026 as yields plateaued.
Analysts remain cautious.
Japanese banks have bought time, but not solved the structural mismatch between long-duration liabilities and volatile global yields. Until the BoJ credibly anchors expectations, balance sheet volatility will persist.
warned a former BoJ policy advisor now at Nomura Institute. The path forward hinges on the central bank’s ability to communicate a clear exit from ultra-loose policy without triggering a yen crash or fiscal panic—a balance that will determine whether JGB markdowns remain a temporary headwind or evolve into a structural constraint on Japan’s financial intermediation.
*Disclaimer: The information provided in this article is for educational and informational purposes only and does not constitute financial advice.*
