By Takaya Yamaguchi, Makiko Yamazaki and Paritosh Bansal
TOKYO (Reuters) -Japan's financial&nbsp;regulator&nbsp;has&nbsp;sounded&nbsp;out&nbsp;top&nbsp;domestic&nbsp;banks&nbsp;about&nbsp;China&nbsp;risks&nbsp;and whether they have plans in place if Sino-Western tensions escalate, according to multiple&nbsp;sources&nbsp;with direct knowledge of the matter.&nbsp;
The Financial Services Agency's&nbsp;(FSA)&nbsp;request, which has not been previously reported, is to ensure&nbsp;Japan's megabanks&nbsp;are thinking about&nbsp;the&nbsp;risks&nbsp;and are prepared to respond if the geopolitical situation worsens, including over the issue of Taiwan's political status, said three of the&nbsp;sources.
Japanese megabanks&nbsp;Mitsubishi UFJ Financial Group (MUFG), Sumitomo Mitsui Financial Group (SMFG) and Mizuho Financial Group have a combined $6.5 trillion in assets, according to Refinitiv.
As of end-March, the three&nbsp;banks&nbsp;had total credit exposure of about&nbsp;$64 billion to&nbsp;China, or roughly 1% of their total assets, according to their financial statements. The number does not include all business unit of the&nbsp;banks.
A major risk for&nbsp;Japanese&nbsp;banks&nbsp;would involve U.S. sanctions on&nbsp;China, hobbling their ability to do business there similar to the bans on Russia dealings after the invasion of Ukraine, said one of the&nbsp;sources, who is a financial industry executive.
All the&nbsp;sources&nbsp;requested anonymity because of the sensitivity of the matter.
The FSA, MUFG and Mizuho declined to comment. SMFG said it declined to comment on anything related to dealings with&nbsp;regulators.
The FSA has not given the&nbsp;banks&nbsp;any specific directions for actions they need to take, one of the other&nbsp;sources&nbsp;said, adding the lenders were thinking about&nbsp;various eventualities and the&nbsp;regulator&nbsp;was hoping for their insights and information.
The FSA's request&nbsp;to look into&nbsp;China-related geopolitical risk was made in May, said two other&nbsp;sources. At a meeting last month, one of the&nbsp;banks&nbsp;was asked by the FSA how it is assessing risk related to&nbsp;China&nbsp;operations, one of them said.
The&nbsp;watchdog's move&nbsp;comes as tensions between&nbsp;China&nbsp;and Western allies have increased over the last 18 months amid a series of disputes involving the Russia-Ukraine war, Taiwan's sovereignty, and technology access.&nbsp;&nbsp;&nbsp;
&nbsp;&nbsp;&nbsp;&nbsp;In particular, tensions have risen between the United States and&nbsp;China.
U.S. Secretary of State Antony Blinken met with&nbsp;China's&nbsp;top&nbsp;diplomat Wang Yi on Monday at the start of the second and final day of a rare visit to Beijing aimed at ensuring that the many disagreements do not spiral into conflict.
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&nbsp;&nbsp;&nbsp;&nbsp;Japanese&nbsp;banks, like many multinational companies, find themselves faced with the prospect of being caught in the middle.&nbsp;
Top&nbsp;Japanese financial firms, led by&nbsp;banks, are&nbsp;heavily exposed to&nbsp;China&nbsp;either via their onshore operations in the world's second-largest economy or through their offshore business networks.&nbsp;They also do business in the West. &nbsp;&nbsp;
&nbsp;&nbsp;&nbsp;&nbsp;The&nbsp;regulator's move underscores how far-reaching the impact of a&nbsp;geopolitical crisis,&nbsp;such as one involving Taiwan, would be for the global economy and businesses.
China&nbsp;claims democratically governed Taiwan as its territory and has&nbsp;never renounced the use of force to bring it under its control. Taiwan strongly objects to&nbsp;China's sovereignty claims and&nbsp;says&nbsp;only the island's people can decide their future.&nbsp;&nbsp;&nbsp;&nbsp;China&nbsp;has over the past three years stepped up its pressure to try and force Taiwan to accept Beijing's sovereignty, including staging war games around the island.
&nbsp;&nbsp;&nbsp;&nbsp;Many global businesses worry an escalation of tensions could result in the U.S. imposing sanctions on&nbsp;China, as it did with Russia in the aftermath of the Ukraine war. They are taking steps such as&nbsp;drafting contingency plans&nbsp;and&nbsp;inquiring about&nbsp;manufacturing capacity&nbsp;outside Taiwan.&nbsp;&nbsp;&nbsp; Almost half of the companies surveyed by the American Chamber of Commerce in Taiwan are revising or plan to revise&nbsp;their business continuity plans&nbsp;amid tensions with&nbsp;China, Reuters reported in February.
For&nbsp;Japanese&nbsp;banks&nbsp;with large exposure to the United States, the impact of any Western sanctions against&nbsp;China&nbsp;is likely a greater concern than the fallout&nbsp;of their direct exposure to Taiwan, the financial industry executive said.
Dealing with&nbsp;China&nbsp;sanctions would be extremely complex, the executive added.
(Reporting by Takaya Yamaguchi and Makiko Yamazaki in Tokyo and Paritosh Bansal in New York; Editing by Sumeet Chatterjee and Jamie Freed)

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Japan regulator sounded out top domestic banks about China risks, sources say