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BOJ in 'hidden' rescue of banks overextended in foreign markets

Analysts say behind the BOJ's move is a brewing crisis - Japanese banks face a classic funding 'squeeze' as they have made loans in a currency (US$) that is not part of their natural (yen) deposit base.


THE Bank of Japan (BOJ) has embarked on what amounts to a disguised rescue operation for Japanese banks that have risked overextending themselves in foreign-currency lending to borrowers in Asia and elsewhere in attempting to drum up loan business outside of Japan, where demand has been stagnant.

When the BOJ announced earlier this month that it intends to double the size of its dollar-lending programme to Japanese firms overseas - via banks - the link between that and warnings which the central bank had been sounding for some time about the surge in banks' overseas lending went largely unnoticed.

The BOJ itself seemed anxious not to draw attention to the link. It described the decision to double the size of its US Dollar Lending Arrangement from US$12 billion to US$24 billion simply as being designed to help boost economic growth by "supporting Japanese firms' overseas activities through financial institutions".

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Another feature of the BOJ's "hidden" rescue was a move to allow banks to borrow Japanese Government Bonds (JGBs) from the central bank, so that they can use these to obtain potentially much larger amounts of US dollars in the market.

Behind all this is a brewing crisis in which Japanese banks face a classic funding "squeeze" as they have made loans in a currency (US dollars) that is not part of their natural (yen) deposit base, analysts say. They now need to be assured of an amply supple of borrowed dollars in order to fund that lending.

"Japanese financial institutions are struggling to procure US dollar funding," said Tokyo head of market research at JPMorgan Chase Bank Tohru Sasaki in comments made available to The Business Times.

The first warnings that all was not well came earlier this year when the BOJ voiced concerns in a report that banks were exposing themselves to what is known as "currency mismatch" and also to "maturity mismatch" by lending long-term in dollars obtained through yen-dollar swaps or through short-term dollar borrowing.

As reported in BT in April, the BOJ stepped up its vigilance over what it feared were currency risks that Japanese banks night be courting by piling into overseas lending in and beyond the Asia region.

Banks responded to a long period of low, zero and (now) negative interest rates in Japan by looking to overseas loan markets in Asia, North America, Europe and elsewhere - to the point where their overseas lending now exceeds that of British, European and US banks, the BOJ said.

Between 30 and 40 per cent of total assets at Japan's big three megabanks (Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group, and Mizuho Financial Group) are now represented by overseas loans, made by overseas branches or in foreign currency loans from Japan.

The increase in recent years has been "dramatic", say sources close to the BOJ. By far, the majority of these loans are from the megabanks, although Japan's myriad regional banks have also been shifting focus to overseas borrowers in a stagnant Japanese economy, where loan demand is sluggish.

Foreign-currency loans by the three megabanks have more than doubled from around 30 trillion yen in 2010 to above 70 trillion yen (S$925 billion) by 2016, according to the BOJ. Regional bank foreign-currency loans have meanwhile more than tripled to around three trillion yen.

The problem is that the biggest proportion of loans made by Japanese banks (mainly to Japanese and other corporate borrowers overseas) are denominated in dollars or euro as very few overseas borrowers want to borrow yen, which is seen as a volatile currency.

Compared to the 70 trillion yen or so total size of Japanese banks' overseas exposure, the doubling of the BOJ's dollar-lending programme to US$24 billion (or some 2.5 trillion yen equivalent) appears quite puny, but already it appears to be having a positive effect on the market.

While the additional US$12 billion being offered now by the BOJ "represents only a small fraction of what they actually need, swap spreads (have) narrowed somewhat" already, noted JPMorgan's Mr Sasaki, a former BOJ official. "The move will help stabilise the market and support banks' earnings," he said.

Another feature of the hidden rescue plan, noted Mr Sasaki, is that the BOJ has "also created a new facility under which it lends Japanese Government Bonds (JGBs) to private-sector financial institutions against their current account balances with the BOJ".

While this appears to be a technical move, it means in fact that Japanese banks can use part of the massive 260 trillion yen they hold in reserves at the central bank to obtain JGBs, which they can then use as security to obtain much larger amounts of dollar funding than the US$24 billion figure suggests.

A risk that Japanese banks face as a result of their overseas lending binge is the threat of dollar funding costs rising further as the US Federal Reserve seeks to normalise its monetary policy.

"Foreign-currency funding costs are on a rising trend," the BOJ has noted. Therefore, "careful attention should be paid to the liquidity situation in the foreign-currency funding market", it said.

The Japanese central bank cannot act as a "lender of last resort", sources close to the BOJ said, adding that it is up to banks to protect themselves by boosting foreign-currency deposits "or by other means". However, the BOJ's latest moves may signal that it is taking on a lender-of-last-resort role, analysts say.