People at a regional bank who handle ALM and risk management come into contact with derivatives as protection against changes in interest rates and exchange rates affecting deposits, loans and securities. People in charge of clients deal with them when the bank provides derivatives to corporate clients.

The scope of regional financial institutions and the risks they face

In Financial Services Agency (FSA) documents, first-tier regional banks and second-tier regional banks together are called regional banks, and the group that also includes shinkin banks and credit cooperatives is called regional financial institutions1. At the end of March 2026 there were 97 regional banks, and 397 shinkin banks and credit cooperatives combined2. The examples and materials below are mainly about regional banks.

When the way interest rates are set or the maturities of assets and liabilities do not match, a bank can lose money when interest rates move. This is called interest rate risk. When interest rates move, how far deposit and lending rates follow market rates can affect financial institutions' earnings and balance sheets. Closer attention is therefore needed to risk management that looks at deposits, loans, securities and other assets and liabilities together (ALM)3. As a real-world example, one regional bank invests funds raised through deposits and other sources in loans and securities, which makes it sensitive to interest rate changes. It trades derivatives as part of its ALM4.

Regional financial institutions that hold foreign bonds also bear currency risk, because the yen value of those bonds moves with exchange rates. The difference between hedging, which limits losses, and speculation, which seeks profit, is covered in Hedging, Speculation and Arbitrage.

Adjusting rate mismatches with interest rate swaps

A bank that funds fixed-rate loans with deposits whose rates change can limit the squeeze on its interest margin by entering into an interest rate swap in which it pays a fixed rate and receives a floating rate. The difference shows when deposit rates rise.

Consider a hypothetical example in which Bank A funds a 5-year, 10 billion yen loan at a 2.0% fixed rate with deposits. The deposit rate is reset each year to the level of that year's benchmark rate. Bank A enters into a 5-year interest rate swap with a notional amount of 10 billion yen, paying a 1.5% fixed rate and receiving the benchmark rate. Interest is paid once a year.

DepositorDepositsBank ASwap partySwapInterest1.5% fixedBenchmark rate
Figure 1Bank A's deposit interest payments and swap payments
Figure description

This figure shows the direction of the yearly interest payments. The interest received on the loan is left out.

Benchmark rate for the year Interest on the loan (million yen) Interest on deposits (million yen) Margin without the swap (million yen) Net amount received on the swap (million yen; negative means paid) Margin with the swap (million yen)
0.5% 200 50 150 −100 50
1.5% 200 150 50 0 50
2.5% 200 250 −50 100 50

When the benchmark rate rises, the swap receipts make up for the higher deposit interest. When it falls, the swap payments take back the savings on deposit interest. Either way the margin is 50 million yen a year. Without the swap, a rise to 2.5% would have meant a loss, and a fall to 0.5% a larger margin.

The regional bank mentioned above uses interest rate swaps entered into as part of its ALM to hedge the interest rate risk of its loans and bonds5.

There are also ways to narrow the rate mismatch without derivatives. The Bank of Japan's Financial System Report of April 2026 says that some regional financial institutions switch fixed-rate loans to loans linked to market rates when the fixed-rate loans mature6. On the securities side, holdings of longer-dated bonds are falling, and interest rate risk tends to decline7.

The example set the deposit rate equal to the benchmark rate, but actual deposit rates do not necessarily behave that way. Many financial institutions raised their ordinary deposit rates after the policy rate increase of December 2025, but those rates remain below the uncollateralized overnight call rate over the same period8. The part of deposits that have no fixed repricing dates and can be withdrawn at any time but in practice stay with the bank for a long time is called core deposits. How core deposits are defined changes the calculated amount of interest rate risk greatly9.

According to a Bank of Japan paper from June 2021, the share of new yen interest rate swaps cleared through a central counterparty rose from 60–70% in 2014 to around 90% from 2017 onward. The share rose especially sharply in the Bank of Japan's category of regional banks and others, which also includes shinkin banks. The Bank of Japan attributes this to the clearing mandate imposed on trades by financial institutions with OTC derivatives outstanding of 1 trillion yen or more from December 2014, and 300 billion yen or more from December 201510.

Hedging the currency risk of foreign bonds

The currency risk of the principal of a foreign bond can be hedged with FX forwards, FX swaps and similar transactions, but this involves a hedging cost equal to the interest rate gap between the two currencies. This is because the forward rate is set to offset the interest rate gap between the two currencies, and when dollar rates are higher than yen rates, the yen is stronger at the forward rate than at today's rate11. A Bank of Japan paper refers to observations that Japanese life insurers use FX swaps and similar transactions to hedge the currency risk of their foreign-currency bonds12.

Consider a hypothetical example in which Bank B buys USD 100 million of US Treasuries yielding 4% a year for 15.0 billion yen at 150 yen per dollar. It hedges them with an FX forward to sell USD 100 million in one year at 147 yen per dollar. The principal comes back as 14.7 billion yen whatever the exchange rate, and the difference of 0.3 billion yen from the 15.0 billion yen purchase price is the hedging cost. A currency hedge prevents losses from a stronger yen at the price of giving up gains from a weaker yen.

If the hedge is rolled over every year, the hedging cost changes with the interest rate gap at the time. The interest on Bank B's bonds is USD 4 million a year, which is 0.6 billion yen a year at 150 yen per dollar. The dollar price of the bonds does not change, and the rate is 150 yen per dollar on each rollover date too.

One-year forward rate at rollover Hedging cost (billion yen) Interest on the bonds (billion yen) Net (billion yen)
147 yen 0.3 0.6 0.3
144 yen 0.6 0.6 0
141 yen 0.9 0.6 −0.3

If dollar rates rise well above yen rates and the forward rate moves to 141 yen, further toward a stronger yen, the hedging cost exceeds the interest and the net result is a loss of 0.3 billion yen a year.

Japanese financial institutions, including regional banks, rely on the market for much of their foreign-currency funding13. Among the foreign bonds bought in the past low-rate environment are some whose funding costs now exceed their yields, because foreign-currency funding rates have risen sharply since 202214.

As a real-world example from a regional financial institution, the regional bank mentioned above uses cross-currency swaps, FX swaps and similar transactions for currency risk15.

Providing derivatives to corporate clients

Regional banks trade OTC derivatives with their corporate clients and also with other financial institutions such as major banks and foreign banks16. Consider a hypothetical example in which Company C, which must pay USD 1 million for imports in three months, enters into an FX forward with its bank, Bank D (a regional bank), to buy USD 1 million at 150 yen per dollar. On the same day, Bank D enters into an FX forward with Bank E, a major dealer, to buy USD 1 million at 150 yen per dollar. Bank D offsets every forward with the client by an opposite forward. Both forwards have the same rate, and fees are ignored.

Company CClientBank DRegional bankBank EDealer150mn yenUSD 1 million150mn yenUSD 1 million
Figure 2How a regional bank offsets a client's FX forward with an opposite forward
Figure description

This figure shows the direction of the exchange in three months. Bank D pays the yen it receives from Company C to Bank E, and passes the dollars it receives from Bank E to Company C.

Rate in three months (yen per dollar) Bank D's gain or loss on the forward with Company C (million yen) Bank D's gain or loss on the forward with Bank E (million yen) Bank D's total (million yen)
160 yen −10 10 0
150 yen 0 0 0
140 yen 10 −10 0

If the yen weakens to 160 yen, Bank D sells dollars worth 160 million yen to Company C for 150 million yen, losing 10 million yen on the forward with Company C. It can buy the same dollars from Bank E for 150 million yen, gaining the same amount, so its total is zero. Without the forward with Bank E, Bank D would lose 10 million yen if the yen weakened and gain 10 million yen if the yen strengthened to 140 yen.

Risks of structured loans held as investments

Structured loans take the form of loans but embed derivatives and are backed by securities20. The structured loans discussed here are assets that regional banks hold as investments, a separate topic from providing derivatives to clients in the previous section. Structured loans are, in substance, investments in securities. According to the FSA, at the end of September 2025 more than 80% of regional banks held structured loans, with a balance of about 11 trillion yen and unrealized losses of about 0.4 trillion yen. Structured loans have a complex risk structure, for example because they embed derivatives and use special purpose companies (SPCs) and similar vehicles to turn securities into loans21.

In risk management, the points to watch are that their risk characteristics are hard to grasp, that they involve additional transaction costs, and that low liquidity can hinder the response in times of stress. On disclosure, the point to watch is that because they are reported as loans in the accounts, outside stakeholders find it hard to see what they really are21. Examples where the measurement of interest rate, liquidity, swap counterparty and nonlinear option risks was insufficient are also listed as cases of concern22.

Supervision of interest rate risk in the banking book

The banking book is the category that covers transactions other than trading (specified transactions)23. The decline in the economic value of the banking book under interest rate shocks (ΔEVE) shows how much the value of the banking book, measured from its assets and liabilities, falls when interest rates are assumed to move by a set amount. For a domestic-standard bank (a bank that uses the domestic standard for its capital adequacy ratio), a ΔEVE above 20% of its capital makes it subject to further analysis24.

Consider a hypothetical example in which a domestic-standard bank has capital of 100 billion yen. If its ΔEVE is 25 billion yen, the ratio is 25%, above 20%. If its ΔEVE is 15 billion yen, the ratio is 15%, which does not exceed the threshold.

Deep diveScenarios used to calculate ΔEVE, and the threshold for international-standard banks

For a domestic-standard bank, ΔEVE is the largest of the values calculated under three scenarios named in the supervisory guidelines (an upward parallel shift, a downward parallel shift and a steepening). For an international-standard bank, the test is whether the maximum ΔEVE exceeds 15% of its Tier 1 capital24.

Because an interest rate swap in which the bank pays a fixed rate gains value when rates rise25, it tends to reduce ΔEVE for a bank whose ΔEVE grows when rates are assumed to rise by a set amount. Exceeding this threshold does not mean a bank is regarded as taking excessive risk, and it does not automatically lead to a demand for improvement26.

According to the Bank of Japan's Financial System Report of April 2026, for financial institutions' banking books as a whole, combining loans and securities on the asset side with deposits on the liability side, yen interest rate risk is low relative to capital. The risk on the asset side and the liability side is also roughly balanced27.

As of September 2023, regional banks that take large risks in securities investment are selected and monitored closely. A useful example is the practice of monitoring the ratio of interest rate risk in the banking book and ΔEVE by currency and by scenario and analyzing the drivers28. In its July 2026 report, the FSA says it monitored the market risk of regional financial institutions' securities investment through the early warning system framework, inspections and other means29. The overall structure of the supervisory guidelines is covered in Supervisory Guidelines of the Financial Services Agency.

Notes

  1. Financial Services Agency, "地域銀行 有価証券運用モニタリングレポート" (Report on the monitoring of securities investment by regional banks) (in Japanese), September 2023, page 1 (page 3 of the PDF), footnote 5. ↩

  2. Financial Services Agency, "預金取扱等金融機関モニタリング・分析レポート" (Monitoring and analysis report on deposit-taking institutions) (in Japanese), July 2026, page 41 (page 43 of the PDF), note 2 to chart IV-3-3 and footnote 43 ("協同組織金融機関" (cooperative financial institutions) means shinkin banks and credit cooperatives). ↩

  3. The same document, page 11 (page 13 of the PDF), second paragraph of section II.4 "小括" (Summary). ↩

  4. The Bank of Iwate, "ディスクロージャー誌2026【統合報告書 資料編】" (Disclosure 2026, integrated report data section) (in Japanese), page 7 (page 8 of the PDF), notes to the consolidated financial statements, "金融商品関係" (Financial instruments), item (1) "金融商品に対する取組方針" (Policy on financial instruments). ↩

  5. The same document, page 7 (page 8 of the PDF), the last two paragraphs of item (2) "金融商品の内容及びそのリスク" (Nature and risks of financial instruments) under "金融商品関係". ↩

  6. Bank of Japan, "金融システムレポート" (Financial System Report) (in Japanese), April 2026, footnote 16 on page 45 (page 50 of the PDF). English version: "Financial System Report (April 2026)", footnote 17 on page 47 (page 52 of the PDF). ↩

  7. Bank of Japan, "金融システムレポート" (Financial System Report) (in Japanese), April 2026, page 37 (page 42 of the PDF), main text under "金利リスク" (Interest rate risk) in section IV.2, and chart IV-2-1. English version: "B. Market risk associated with securities investment," "Interest rate risk" and Chart IV-2-1 on page 39 (page 44 of the PDF). ↩

  8. Bank of Japan, "金融システムレポート" (Financial System Report) (in Japanese), April 2026, page 10 (page 15 of the PDF), main text under "短期金融市場" (Short-term money markets) in section II.2, and page 68 (page 73 of the PDF), main text of section VI.1(2) "金利上昇と金融機関の基礎的収益力" (Rising interest rates and the core profitability of financial institutions). English version: "Short-term money markets" on page 10 (page 15 of the PDF), and "2. Rising interest rates and banks' core profitability" on page 71 (page 76 of the PDF). ↩

  9. Financial Services Agency, "中小・地域金融機関向けの総合的な監督指針" (Comprehensive Guidelines for Supervision of Small and Medium-Sized and Regional Financial Institutions) (in Japanese), October 2026, II-2-5-2(2)② (pages 47–48). ↩

  10. Bank of Japan Financial Markets Department, "店頭デリバティブ取引データからみた円金利スワップ市場" (The yen interest rate swap market seen through OTC derivatives trade data) (Bank of Japan Review 2021-J-7) (in Japanese), June 2021, the box "清算集中比率" (Central clearing ratio) on page 6, and note 2 to chart 4 on page 3 (scope of the category). English version: "The Japanese Yen Interest Rate Swap Market Observed from OTC Derivative Transaction Data" (Bank of Japan Review 2021-E-3, September 2021), "Centrally cleared transactions" in the box on page 6, and note 2 to chart 4 on page 3. ↩

  11. Investment Trusts Association, Japan, "為替ヘッジってなに？‐2" (What is currency hedging? Part 2) (in Japanese), email newsletter No. 183, June 3, 2009, the sections "フォワードレートの決まり方" (How forward rates are set) and "ヘッジコスト" (Hedging cost). ↩

  12. Bank of Japan Financial System and Bank Examination Department, "生命保険会社の国際比較：ビジネスモデルの変化に伴う金融安定上の論点" (Bank of Japan Review 2026-J-7) (in Japanese), May 2026, footnote 18 (page 8). English version: "International Comparison of Life Insurers: Evolving Business Models and Financial Stability Issues" (Bank of Japan Review 2026-E-7). ↩

  13. Financial Services Agency, "地域銀行 有価証券運用モニタリングレポート" (in Japanese), September 2023, page 11 (page 13 of the PDF), section II.2.(4)② "外貨流動性ストレステスト" (Foreign-currency liquidity stress testing). ↩

  14. The same document, page 13 (page 15 of the PDF), section II.2.(5)② "期間損益減少リスクへの備え" (Preparing for the risk of lower period earnings). ↩

  15. The Bank of Iwate, "ディスクロージャー誌2026【統合報告書 資料編】" (in Japanese), page 8 (page 9 of the PDF), "金融商品関係", item (3)② b "為替リスクの管理" (Management of foreign exchange risk). ↩

  16. Financial Services Agency, "店頭デリバティブ取引市場の多面的実態把握に向けた検証" (FSA Analytical Notes) (in Japanese), March 2026, page 6, chart 10 and footnote 13 (scope of "regional banks"). The data cover trades executed from April 1, 2024 to September 30, 2025 and reported to the FSA (page 2). ↩

  17. Financial Services Agency, "中小・地域金融機関向けの総合的な監督指針" (in Japanese), October 2026, II-2-4-2(7)① and ② (page 45). ↩

  18. Financial Services Agency, "中小・地域金融機関向けの総合的な監督指針" (in Japanese), October 2026, II-3-2-1-2(2)①イ, items a to c (pages 85–87). ↩

  19. The same document, II-3-2-1-2(2)①イ, item g (page 87). ↩

  20. Financial Services Agency, "預金取扱等金融機関モニタリング・分析レポート" (in Japanese), July 2026, footnote 42 (page 41, page 43 of the PDF). ↩

  21. Financial Services Agency, "地域銀行における仕組貸出モニタリングレポート（2026）概要" (Summary of the 2026 report on the monitoring of structured loans at regional banks) (in Japanese), March 2026, page 1, "地域銀行の取組状況" (Regional banks' activity) and "モニタリングにおける主な論点等" (Main issues in monitoring). ↩ ↩2

  22. The same document, page 2, the "懸念事例" (Cases of concern) under "入口審査" (Screening at entry). ↩

  23. The same document, II-2-5-2(1)③ (page 47; trading (specified transactions) divisions and non-trading (banking) divisions), and the disclosure points in III-4-9-4-4(1)⑥イ (page 281; "銀行勘定と特定取引勘定を区別すること" (distinguish between the banking book and the trading book)). ↩

  24. Financial Services Agency, "中小・地域金融機関向けの総合的な監督指針" (in Japanese), October 2026, II-2-5-3(2)②イ (pages 50–51). ↩ ↩2

  25. Bank of Japan Financial Markets Department, "店頭デリバティブ取引データからみた円金利スワップ市場" (Bank of Japan Review 2021-J-7) (in Japanese), June 2021, main text on page 3 (a fixed-rate receiver gains when rates fall, and a fixed-rate payer the opposite). English version (Bank of Japan Review 2021-E-3), main text on page 3. ↩

  26. Financial Services Agency, "中小・地域金融機関向けの総合的な監督指針" (in Japanese), October 2026, note 3 to II-2-5-3(2)② (page 51). ↩

  27. Bank of Japan, "金融システムレポート" (Financial System Report) (in Japanese), April 2026, main text on page 38 (page 43 of the PDF) and chart IV-2-3 "銀行勘定の金利リスク" (Interest rate risk in the banking book). English version: "Financial System Report (April 2026)", main text on page 40 (page 45 of the PDF) and Chart IV-2-3 "Interest rate risk in the banking book." ↩

  28. Financial Services Agency, "地域銀行 有価証券運用モニタリングレポート" (in Japanese), September 2023, section I "公表の趣旨" (Purpose of publication) on page 1 (page 3 of the PDF), and the useful examples in (5)① on page 12 (page 14 of the PDF). ↩

  29. Financial Services Agency, "預金取扱等金融機関モニタリング・分析レポート" (in Japanese), July 2026, page 41 (page 43 of the PDF), first paragraph of section IV.3 "地域金融機関のモニタリング" (Monitoring of regional financial institutions). ↩