Bank of Japan Warns AI Market Correction and Shadow Bank Lending Threaten Banking System

The Bank of Japan warned in its semi-annual report on Friday that a market correction in the AI sector and growing generative AI cybersecurity threats could spill over into Japan's banking system. Japanese domestic banks have steadily increased their lending to foreign non-bank financial institutions, including private credit providers and private equity funds that act as major funders for AI hyperscalers. The central bank noted that if expectations for AI investment profitability decline, portfolio adjustments within the foreign shadow banking sector could amplify market shocks and hit Japanese equities, where domestic banks hold direct market exposure. While the BOJ stated it did not see major financial imbalances, it called for close attention to stock and property prices across Japan's three major metropolitan areas following last month's interest rate hike to a 31-year high of 1.25%. "If expectations regarding the profitability of AI-related investment were to decline, shocks could be amplified, mainly through portfolio adjustments in the foreign NBFI sector, and the effects could spill over to Japan." — Bank of Japan