Bank of Japan is making losses on its balance sheet – so what?

Sometimes when I am reading some story or analysis about the economy I sense a sort of glazing over effect – I just read the words as they appear on the paper and it is not until after I have read the entirety that I sort of have to pinch myself and realise that this is an attempt at serious journalism. The realisation that I have just read the most extraordinary nonsense that one could devise to present to readers then sinks in. I then wonder how a journalist could be so stupid as to actually construct and article in that way and seek so-called ‘expert’ commentary from an array of highly paid economists and bankers to support the nonsense. Who are they trying to fool? Well almost everyone is the answer. Why does this sort of journalism continue other than the lurid headlines sell products and that is what journalism has really become? I don’t accept that all these characters are part of a massive conspiracy to deceive the rest of us. Obviously, some of the players know clearly that they are manipulating the truth to advance their own agendas – like when bank economists continually claim interest rates have to rise (which they know will just boost the profits of the companies they work for). But the better way of thinking about this mass deception is that we have all been captured by the fictional world created by economists, who themselves are mostly trapped by the Groupthink that is impressed on them during their university days. Whatever the explanation, it still amazes me how stupid we all are for accepting this nonsense as serious commentary.

I had this feeling when I read this recent article (July 2, 2024) in the Japan Times newspaper – The Bank of Japan’s $3 trillion problem – written by one of their staff writers.

The premise of the article is this:

1. The Bank of Japan has a lot of government debt that on a mark-to-market basis is losing value because interest rates are rising.

2. The Bank is also going to pay more in interest payments on banks reserves which are accounts that the commercial banks are required to hold with the central bank to facilitate the payments system.

3. At some point, the Bank “could become unprofitable as interest rates rise and the deposits it holds become far more expensive.”

4. Then “the independence of the institution could be threatened if it becomes a money-losing entity.”

5. “The BOJ is now in a race to cut the size of its bond holdings so it can reduce its deposit obligations and the risk that comes with them, they note.”

6. “Japan’s central bank has a ¥750 trillion ($4.7 trillion) balance sheet. Much of its holdings are funded with interest-bearing deposits from private financial institutions.”

That should be enough to suggest the journalist has it all ar#@ about.

Take point 6 first.

The latest (as at June 30, 2024) – Bank of Japan Accounts – show that the Bank’s total assets sum to 753,670,969,498 thousand yen.

Of that total, 588,496,940,054 thousand yen are accounted for by the Bank’s holdings of Japanese government securities – which it has bought through its various quantitative easing and yield-curve-control programs.

That is, 78.1 per cent of its total assets are in that form.

On the liability side, we note that ‘Current deposits’ amount to 551,771,445,604 thousand yen or 73.2 per cent of the total liabilities (which of-course together with the Bank’s capital equal total assets as an accounting convention).

You might then wonder what these deposits comprise.

The Bank of Japan provides this information – What are current account deposits at the Bank? Are interest rates applied to the deposits? – to educate the public.

We learn that:

The Bank accepts deposits from financial institutions to their current accounts they hold at the Bank. These deposits are referred to as current account deposits at the Bank or BOJ account deposits.

They can be used for the following purposes:

(1) Payment instrument for transactions among financial institutions, the Bank, and the government;
(2) Cash reserves for financial institutions to pay individuals and firms; and
(3) Reserves of financial institutions subject to the reserve requirement system.

If you are wondering about these accounts then this information will help – Who holds accounts at the Bank?.

And if you want to learn about the support interest rates that the Bank of Japan pays on these Current deposit accounts then this page will help – What is the Complementary Deposit Facility?.

Essentially, the Bank of Japan pays the interest rate:

… to financial institutions’ excess reserves (current account balances and special reserve account balances at the Bank in excess of required reserves held by financial institutions subject to the reserve requirement system).

The support rate was first paid during the GFC, when the commercial banks started building up large quantities of excess reserves in the accounts they are required to keep at the central bank.

At that point, the Bank of Japan paid a positive interest rate on excess reserves.

As I have explained in the past, if there are excess reserves in the cash system and no support rate is paid, the commercial banks will try to rid themselves of the excess in the overnight market – basically lending to banks with a shortage of reserves.

Competition will drive the overnight rate down to zero and if the central bank’s monetary policy target rate is non-zero, then such a process will force it to lose control of its policy target.

So to avoid this possibility, the central banks started to offer a competitive return on the excess reserves held by the commercial banks at the central bank.

In Japan, that situation became complicated in January 2016, when the Bank of Japan introduced its Quantitative and Qualitative Monetary Easing (QQE) program which produced a negative interest rate.

The question was how would they deal with the excess reserves that were previously receiving a positive return from the Bank.

The solution the Bank of Japan came up with was to tier the reserve deposits into three tranches:

1. that received a positive support rate payment.

2. that received no interest rate payment.

3. that was penalised with a negative rate applied.

Then in March 2024, as the Bank has sought to push the policy target rate back towards the positive, the policy shifted again and the tiers were abandoned and the excess reserves were paid a positive support rate.

The support rate is currently around 0.1 per cent in line with the recent adjustment in the policy rate that the Bank of Japan announced.

Obviously, if the Bank increases its policy rate in the coming months (as part of its misguided notion of policy normalisation) then the support rate will rise too.

Of course, the Bank of Japan could simply go back to pre-GFC policy and leave the support rate at zero but that is another story.

That information is really necessary so that an understanding of how lame the Japan Times analysis is.

So the proposition (under point 6 above) that these ‘Current deposits’ from the commercial banks are funding the Bank of Japan is an absurdity.

Just reflect for one second (that is all it takes).

The commercial banks have accumulated these excess reserves largely because the Bank of Japan was buying up JGBs in large quantities in the secondary bond markets.

The facilitate these purchases the Bank swaps the bonds for reserves in the commercial banks.

The capacity to make that transaction comes from the fact that the Bank of Japan can always just click a few computer keys to type yen-denominated amounts into the accounts of the commercial banks – ex nihilo.

To suggest that the Current deposits are funding the Bank of Japan is to render the term ‘funding’ meaningless.

In fact, the currency-issuing capacity of the Bank of Japan is what ‘funds’ the excess reserves held at the Bank by the commercial banks (and other financial institutions).

Once you understand that point, then the rest of the propositions advanced in the article become untenable.

The basic argument the journalist presents is that:

Given that the BOJ is looking to raise its short-term interest rate, the interest payments will likely swell. If the central bank raises the rate to 1%, it must pay nearly ¥5 trillion of interest annually. The total ordinary profits of Japanese banks nationwide was about ¥4.1 trillion in fiscal 2022.

As interest rates rise, the central bank will have to pay more on deposits, resulting in a mismatch between what it pays out and how much it receives on bonds it holds.

At some point, it could start to lose money.

The payments on the bonds it holds come from the Ministry of Finance.

You can learn about that from this page – About JGBs.

It tells us that:

As the name implies, JGBs are the bonds issued by the government of Japan, which is responsible for the interest and principal payments. Interest is paid every six months, and the principal payments are secured at maturity.

In turn, the Bank of Japan is a curious body – “It is a juridical person established based on the Bank of Japan Act (hereafter the Act), and is not a government agency or a private corporation” (Source).

Under the Bank of Japan Act, the total capital is 100 million yen of which at least 55 per cent must be provided by the government of Japan.

The rest of the capital is traded on the Tokyo Stock Exchange.

So it is not fully government owned or controlled.

In this respect is is very similar to the central banks in Belgium and Switzerland.

Unlike private companies that issue tradeable shares, the private owners of the Bank of Japan receive no dividends (nor have voting rights).

Some might say that this private ownership tranche makes the Bank of Japan more like a private corporation than a government agency.

But that would be wrong given that the difference between the two types of organisations are to be found in their organisational objectives or mission.

A private corporation must make profit to survive.

The Bank of Japan Act prescribes a number of statutory obligations that the Bank must fulfill which are unrelated to making profits.

The fact that some of its capital is privately owned then is irrelevant.

Now who might the Bank of Japan pay any profits to?

From this document – How are the Bank’s profits distributed? What is the payment to the national treasury? – we learn that:

The Bank’s final profits — that is, all of the Bank’s net income for the relevant term, after subtracting necessary expenses and taxes, and then providing for the amount transferred to the legal reserve and for dividends to contributories — are paid to the government as the nation’s property (Article 53 of the Bank of Japan Act). This is called the payment to the national treasury.

This follows practice in almost all countries.

Put 1 and 1 together and you get this:

1. The Bank of Japan received payments from the Ministry of Finance on the JGBs it holds.

2. It then might make profits on its holdings, which it returns to … wait … the Ministry of Finance. In the 2023 financial year, “the government received a record ¥2.17 trillion from the central bank. That is almost 2% of the government’s total budget.”

3. It might make a loss on its holdings as the yields on them fall below the support rate it is paying on excess reserves.

4. So what?

The Japan Times article cites some economist as saying if the Bank of Japan ran a loss because of rising interest rates:

The government would lose the revenue and it would cause huge damage … If the government starts saying that running a deficit is bad, the freedom of policy making would be restrained.

There would not be “huge damage”.

The Bank could simply continue to operate with negative capital or it could ask the Ministry of Finance to put more cash in.

Further, under the Bank of Japan Act, the Monetary Policy Board cannot be dictated to by the government.

So it is hard to see how its ‘freedom’ would be restrained any more than it is now.

On September 30, 2023, the governor of the Bank of Japan Ueda Kazuo made a speech to the Autumn Meeting of the Japan Society of Monetary Economics – Central Bank Finances and Monetary Policy Conduct – which really closes the books on this nonsensical journalism.

He explained to the audience the structure of the Bank’s balance sheet and the “profit structure of the central bank”:

The central bank receives interest income on assets, such as the government bonds it purchases. On the other hand, on the liability side, banknotes and current deposits of financial institutions held as required reserves are costless, in the sense that the central bank pays no interest on them. The profits earned from this difference are called “seigniorage,” and the central bank is usually able to generate such profits on a stable basis.

Then, as a result of the various quantitative easing initiatives, “three major changes in the Bank’s balance sheet” arose.

1. “the large increase in purchases of long-term … JGBs”.

2. “risk assets such as exchange traded funds (ETFs), which the Bank began to purchase to encourage a reduction in risk premiums, appeared on the Bank’s balance sheet for the first time”.

3. “in line with the developments on the asset side, there was a substantial rise in current deposits on the liability side, in the form of an increase in financial institutions’ excess reserves.”

And:

In order to control short-term interest rates at the target level in the presence of such large excess reserves, it became necessary to apply interest rates on excess reserves.

This is what I explained above about thwarting the competition for loans in the interbank market.

So now the Bank earned money on its asset holdings but “started to record interest payments as expenses”, the latter being “small compared to the rising income”.

I will consider the rest of this Speech in another post because it is a really clear statement on how the central bank works in conjunction with the commercial banks.

But for now, reflect on these statements from the Governor.

1. When the central bank starts to sell its JGB holdings in the market there is also a “a decline in current deposits on the liability side” – just the reverse of the initial transaction.

2. When interest rates are hiked, “interest expenses will increase, putting downward pressure on the central bank’s profits.”

3. “However, eventually, interest expenses will decline as current deposits decrease.”

4. as interest income “increase as such government bond holdings are successively replaced by higher yielding ones” and “the central bank’s profits will eventually recover”.

5. There is a “major difference between a central bank and private financial institutions or business corporations” such that “a central bank can supply its own means of payment and settlement” – in other words it is the monopoly currency issuer.

6. “it is inappropriate to capture central bank finances through analogies with private financial institutions or business corporations”.

7. “decreases in the central bank’s profits and capital do not immediately impair its ability to conduct policy in an operational sense”.

The final summary:

… central banks can supply their own means of payment and settlement. Therefore, a central bank’s ability to conduct monetary policy is not impaired by a temporary decrease in its profits and capital … This applies not only to monetary policy but also to the basic role of central banks in general, such as maintaining the stability of the financial system, the stable operation role as the government’s bank, and the smooth operation of the payment and settlement system. Central banks are unique in terms of their profit structure and their function as issuers of banknotes … Thus, central banks have aspects that cannot be captured through analogies with private financial institutions or business corporations.

Conclusion

I hope this blog post has taught readers about the way the Bank of Japan operates specifically, and how central banks operate generally.

The mainstream economists who bleat about central banks going broke simply do not comprehend these basic operations, or, if they do they lie about them.

That is enough for today!

(c) Copyright 2024 William Mitchell. All Rights Reserved.