Japanese Banks' Unbearable Lightness
That's the first departure. The other novelty is that additional easing at this juncture may be more about preempting risks to lenders' balance sheets than fighting deflation. How bank shareholders respond will be as important a metric for the program's success as the reaction of the yen and the bond market.
After the policy board's Thursday meeting, the BOJ is widely anticipated to start offering funds to banks at negative interest rates. The move, it's hoped, will boost lenders' profit margins on commercial advances and dissuade them from parking money as idle reserves with the monetary authority. Considering it's struggled to achieve its objective by imposing a punishment -- negative interest rates on new reserves -- perhaps a reward for boosting credit in the economy will work.
This well-heralded monetary easing will be different from the big bazookas of BOJ Governor Haruhiko Kuroda's tenure so far: The adoption of a larger-than-expected bond-buying program in April 2013, a sudden expansion of the purchases in October 2014, and the foray into negative rates on reserves announced in January. All three were bold moves that surprised investors. This time, the market is dictating Kuroda to be adventurous.
Chalk it up to the stick of negative rates on some excess reserves. That could erode financial institutions' profitability and balance-sheet strength if the impact isn't mitigated by the carrot of paying lenders to borrow from the central bank. To see why, flash back to 2012, the year before Kuroda took charge. Back then, observers including the International Monetary Fund used to routinely highlight the risk from Japanese banks' bloated inventory of their government's bonds. A sudden jump in yields, it was argued, could cause massive mark-to-market losses, potentially undermining the nation's banking system in the same way the sovereign debt crisis had destabilized Europe's.
Those concerns ebbed for a while as Kuroda began buying bonds from banks, relieving them of the risk.
But of late, the fears have returned because of duration risk, a measure of how much bond prices are likely to change when interest rates move. With the BOJ dabbling in negative interest rates, JGB yields have gotten compressed to a maximum of 0.4 percent, and that's at a maturity of 40 years. It's as though Japanese financial institutions are sitting on a tightly wound spring. Even a small increase in the yield -- a little uncoiling -- could send the whole edifice flying, a risk Janus Capital's Bill Gross cites as an example of ``global monetary lunacy.''
So while Japanese banks' JGB load is nominally less onerous, that lightness could still become unbearable thanks to the yield curve.
Shareholders are nervous. Investors have lost between 16 and 23 percent in the four largest Japanese banks so far this year, versus a less than 11 percent drop in the benchmark Topix index. Mitsubishi UFJ Financial Group saw its shares slump more than 4 percent in Tokyo on Tuesday after Kyodo news agency reported that the country's biggest lender by market value will forecast a smaller profit for the financial year ending March 2017. Options on the bank's American depository receipts are indicating the stock could rise or fall by more than 6 percent around its next results announcement in May.
Come Thursday, Kuroda must show banks a way to extricate themselves from the risk of hugging the sovereign's debt too tightly. Of course, paying lenders to borrow doesn't necessarily mean they'll rush to finance new factories, stores and equipment. Japan's ageing society doesn't exactly promise great returns on new corporate investment. That's something the governor can't fix, at least not without the reforms promised by Prime Minister Shinzo Abe.
So forget the much-vaunted 2 percent inflation campaign, the original motivation behind Japan's unprecedented monetary easing. Kuroda's immediate goal must be to stop storing up seeds of trouble in Japan's financial system.
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