Can the BoJ reduce collateral damage?

For a man who had got used to generating reams of positive headlines in his early days as BoJ Governor, Haruhiko Kuroda’s recent meetings have fallen flat. The surprise introduction of negative rates at the start of the year received distinctly mixed reviews, while last week’s failure to do little more than announce a small increase in purchases of ETFs proved distinctly underwhelming.

Of course, Kuroda’s inability to continue to surprise, within the current monetary policy framework at least, reflects his increasingly limited room for manoeuvre. The shock-and-awe of his early days all centred on large-scale asset purchases, first committing to double the monetary base within two years and then doubling down on that via a further big increase in purchases of (mainly) JGBs. But the problem with buying essentially one asset, and committing to do so on an open-ended basis, is that you can quickly run out of sufficient quantities of that asset to purchase. And while that’s not yet the case for the BoJ, it might soon be.

Cumluative net buying of JGBs since QQE launch*

Cumulative net buying of JGBs since QQE launch*Japan Post Bank also includes other financial institutions for small businesses 
Source: BoJ, Japan Post, GPIF and Daiwa Capital Markets Europe Ltd. 

Kuroda, of course, repeatedly argues that this is not the case. And at the end of July, the BoJ’s JGB holdings accounted for about one third of the market, leaving more than ¥500bn in the market. But convincing JGBs holders to continue to sell will become increasingly challenging. To date, roughly one third of the JGBs the BoJ has bought have come from public sector institutions, namely the GPIF and Japan Post. But the GPIF portfolio rebalancing has essentially been completed. And the share of Japan Post’s assets held in JGBs has fallen significantly. At the same time, despite the latest fiscal stimulus package, there is no sign that the MoF will increase issuance markedly. So for the BoJ to be able to maintain its current pace of purchases much beyond next year, it will need to increasingly convince the private sector to sell its holdings. Admittedly, domestic banks have to date been significant net sellers. But while they still remain large holders, they will not maintain the same pace of sales indefinitely, not least because they require JGBs as collateral in their day-to-day operations with the BoJ. Of the ¥76tn of collateral pledged in July, almost half was in JGBs. Free that up, and the banks (may) become more willing to hold fewer JGBs.

Collateral posted at the BoJ

Collateral accepted by the BoJSource: BoJ and Daiwa Capital Markets Europe Ltd. 

One way to do that would be to allow the banks to use the already extremely large deposits they have with the central bank as collateral, rather than JGBs themselves. And, indeed, the other announcement last week, that the BoJ will double the amount of US dollar funds available to banks, will allow them to do exactly that. The BoJ established a new facility whereby it will lend JGBs to banks against their current account balances with the BoJ and then use those as collateral for its US dollar fund operations. Extend the ability to use current account balances as collateral to borrow JGBs under its existing main securities lending facility to then allow those JGBs to be used in the BoJ’s day-to-day operations (or even more simply allow banks to use their current account balances as collateral) and the banks will have less incentive to hold JGBs themselves and more incentive to sell them to the BoJ, particularly at a time when JGBs are providing a negative yield and current account balances (on average) are still paying a positive return. And while the numbers involved may not be particularly large (¥30tn of JGBs pledged as collateral), the BoJ’s forthcoming comprehensive assessment of the effects of negative rates and asset purchases may conclude that every little helps. So, while we don’t expect the review to deliver any marked shift in the BoJ’s overall strategy, there are still things it can do to ensure that the current policy can be maintained for as long as possible.

Banks’ current account balances at the BoJ

Banks’ current account balances at the BoJSource: BoJ and Daiwa Capital Markets Europe Ltd.

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