Kuroda Negative Rate Bazooka Fizzles on Overnight Lending Freeze

  • Outstanding balance of call market slid to record low
  • Uncertain how deep overnight call rate will sink: MUFJ MS

Japan’s banks have almost stopped lending to one another in the overnight market, threatening to undermine the impact of the central bank’s negative-rates stimulus.

The outstanding balance of the interbank activity plunged 79 percent to a record low of 4.51 trillion yen ($40 billion) on Feb. 25 since Bank of Japan Governor Haruhiko Kuroda on Jan. 29 announced plans to charge interest on some lenders’ reserves at the monetary authority. Bond volatility has soared to a 2 1/2-year high as the evaporation of trading volumes in the call market dislocates funding of a range of debt investments.

While Kuroda wants to lower the starting point of the yield curve to reduce borrowing costs and spur shift of funds into riskier assets, the interbank rate has fallen only about as far as minus 0.01 percent, above the minus 0.1 percent charged on some BOJ reserves. The swings on bond yields will make it harder for financial institutions to determine how much business risks they can take, weighing on lending in a weak economy even as they are penalized for keeping some of their money at the central bank.

QuickTake Negative Interest Rates

“It is still uncertain how deep into the negative the overnight call rates will sink,” said Naomi Muguruma, a senior market economist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo. “It won’t settle until funding flows in the new scheme become clear. That may pressure volatility to stay high for government bonds.”

Policy Shift

The overnight rate was the BOJ’s main policy target until Kuroda switched it to monetary base growth in April 2013. The central bank said the initial amount to which its minus rate would be applied to is about 10 trillion yen of financial institutions’ reserves held at the BOJ.

Reflecting the confusion among traders about the unprecedented negative-rate policy, the one-month premium for one-year interest-rate swaps have surged, according to data compiled by Bloomberg.

“The swaption market is reacting to the heightening volatility because players don’t know where Libor will settle,” said Naoya Oshikubo, a rates strategist at Barclays Plc in Tokyo. “One reason behind this is the fact that unsecured overnight call rates and general collateral repo rates aren’t falling as intended by the BOJ.”

Oshikubo said the overnight call rate could fall to as low as minus 0.05 percent.

‘Conservative Approach’

It will take at least another month until the market finds a level where many dealings are settled, as financial institutions face uncertainty over how the new policy affects monthly fund flows, said Izuru Kato, the president of Totan Research Co. in Tokyo.

“Since past patterns don’t apply under the entirely new structure, financial institutions will take a conservative approach until the financing picture is nailed down,” Kato said. “If the funding estimate proves wrong, banks might lose by prematurely lending in negative rates. People are cautious and staying on the sidelines.”

BOJ board member Takahide Kiuchi said on Thursday that adopting the negative-rate policy might have increased market instability. Ten-year Japanese government bond yields plunged to a record low of minus 0.075 percent on Friday, while 40-year JGB yield slid below 1 percent for the first time the day before. The benchmark 10-year yield was at minus 0.065 percent on Monday.

Not Prepared

Subdued trading in the overnight call market is partly because most banks aren’t prepared with systems dealing with negative rates, said Kenji Sato, a manager at the planning and research department of Central Tanshi Co., a Tokyo-based money-market dealer and broker.

Trust banks and other institutions including Japan Post Bank Co. are likely to constantly face excess reserves subject to the BOJ’s penalty and may need to lend in the call market, while some regional banks seem to have scope for fundraising without being charged, Central Tanshi’s Sato said. What the major banks would do will depend on JGB redemption and fiscal payments such as pension payouts, he said, basing his analysis on central bank data.

“The focus will be how much money these institutions facing negative rates will lend out in the market,” he said.

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