TOKYO – In its decades-long effort to prod financiers to loosen up and lend more to defeat deflation, the Bank of Japan (BOJ) is trying a new tack: incentivizing them with bonuses.
Talk about a language that bankers can understand, even in aging, hyper-conservative Japan. Early indications are that the plan is working, incentivizing BOJ Governor Haruhiko Kuroda to expand the strategy.
Risk-averse Japan doesn’t do shock-and-awe. It’s been four-and-a-half years since the BOJ surprised markets in the slightest. That was in early 2016, when the BOJ began an experiment with negative interest rates that is still backfiring on the financial sector.
The idea was simple. The deeper borrowing costs drop into the red, the greater the amount of liquidity pouring into banks. The initial policy announcement didn’t slam markets at first. In the years since, though, it became clear negative rates hurt bank profits and actually reduced confidence to lend.
The real bread and butter for banks is working the spread between short- and longer-dated securities. Banks borrow cheaply using, say, three-year debt and lend at a higher rate for seven, 10 or 20 years.
When pretty much all rates are below zero, what’s the point? So banks shovel their cash into government bonds. That helps no one.
Hence the BOJ’s bonus scheme, whereby it’s effectively paying banks to extend credit. Especially those in rural areas hurting long before Covid-19 showed up.
The last decade has seen an accelerating mass migration to Tokyo and Osaka, where the biggest and healthiest companies tend to be clustered. This hollowing-out dynamic reduced growth in dozens of Japanese prefectures, hitting tax revenues. They also reduced profits at Japan’s roughly 100 regional lenders.
Many of these institutions, some 100 years old or more, are the place where BOJ largess goes to die.
To catalyze lending, the BOJ is offering banks a sweetener: an extra 10 basis points, or 0.1%, for banks lending money. As a result, banks are stepping up to do just that. So far banks have received about US$250 billion through the BOJ initiative.
That amount is comparable to the number of bank deposits on which the BOJ imposes negative rates.
As of the end of July, total lending by banks and large credit unions jumped 6.3% versus a year earlier, achieving a record $5.4 trillion. That’s the fastest pace since at least 2001.
And it’s broad-based. Lending among the largest banks jumped 7.8% in July. Regional banks ramped up lending by 5.1%. For that latter category that is really something and this is the biggest increase since 1991.
It’s “one of the most effective policy moves the BOJ has made in recent years,” says economist Takehiro Noguchi of Mizuho Research.
There’s talk in BOJ circles of expanding the program to increase its monetary firepower. And the enterprise offers a timely roadmap for government officials as coronavirus fallout slams Japan Inc.
With the economy contracting at a 27.8% annualized rate – and 7.8%, quarter-on-quarter – in Q2, and Covid-19 cases on the rise, the next four months heading into 2021 are likely to be a gloom-a-thon.
The roughly $2.2 trillion of stimulus Prime Minister Shinzo Abe’s government is throwing at traumatized businesses and households has already proven unequal to the problem.
One issue with all this spending, equivalent to 40% of gross domestic product, is a lack of focus. It does little to pump cash into small businesses or at-risk households. Large companies, the main beneficiaries, have not given workers a decent raise in a decade.
The odds of them fattening wages amid the pandemic are nil.
The priority must be directing more cash to households. In recent months, Abe sent 100,000 yen ($942) to consumers who filed for the payments. The process, though, is slow and bureaucratic. And the fact the financial assistance is a one-off has more households saving the money than deploying it.
Enter the BOJ, the one institution with the wherewithal and nimbleness to fill the void. The paying-bankers-bonuses program is a good start. Yet Kuroda’s team should double the incentive to lend, say to 20 basis points – or even more.
The BOJ could also support regional banks by recalibrating government bond purchases to aid in their lending strategies. The BOJ could increase purchases in certain parts of the debt maturity mix and throttle back on others to create wider spreads between certain securities.
The BOJ could buy up debt issued not only by regional lenders but also by municipal governments. Pulling mountains of debt onto the BOJ’s balance sheet would give the 46 prefectures outside Tokyo greater fiscal space to invest in job creation. And greater latitude to implement their own cash-handout schemes.
There’s also scope for the BOJ to get radical. Kuroda could seek a mandate from lawmakers to arrange a quid pro quo with large companies: he’ll buy debt from companies pledging not to lay off workers. And to buy even bigger blocks of debt from CEOs willing to raise wages.
The BOJ could join forces with the Ministry of Finance to get more cash into households with real incentives that it be spent. Some economic advisors to parliament are floating the idea of the BOJ actually issuing the equivalent of debit cards.
It could give households 100,000 yen to spend and only replenish the amount after it is used up.
It’s especially important to target younger Japanese. As Kuroda’s predecessor, Masaaki Shirakawa, warned him, Japan’s rapidly-aging population – the world’s oldest, by nation – is a barrier to ending deflationary pressures once and for all. The basic logic is folks in their 20s and 30s buy more homes, cars, motorbikes, furniture and electronics than the septuagenarian set.
New approach needed
The trouble is, the BOJ continues to think conventional monetary levels are the key to ending what Kuroda called the “deflationary mindset.” It unleashed history’s biggest monetary onslaught, firing its “bazooka” all around Japan’s financial system. Yet inflation is flat at best and a long way from the BOJ’s 2% target.
Covid-19 won’t help. Japan tops the list of places likely to “remain subdued as economic activity remains constrained by social distancing, labor market uncertainty and poor consumer sentiment,” says economist Nicholas Mapa of Dutch bank ING.
Kenji Okamura, vice-finance minister for international affairs, says “the government and the Bank of Japan will keep a close watch on underlying market and economic trends and tackle [them] as needed.”
But how? Since little has worked since Kuroda grabbed the reins in 2013, it’s high time he thought even further out of the proverbial box.
Japan has long since moved past the “helicopter money” phase of monetary stimulus. And while Kuroda claims Tokyo isn’t employing the Modern Monetary Theory, or MMT, of buying aggressive bond purchases indefinitely, Japan basically pioneered the scheme as it corners the government bond market and stocks via exchange-traded funds.
The next logical step is creating mechanisms for buying distressed assets around the nation: giant and little-utilized white-elephant stadiums and conference facilities, cavernous international airports with quiet arrivals halls, failing real-estate projects, sparsely used golf courses, defunct amusement parks, you name it.
The BOJ’s balance sheet has already surpassed Japan’s $5 trillion economy. Why stop now?
The BOJ needs a big assist from Abe’s government. Since 2012, he’s been previewing epochal steps to cut bureaucracy, incentivize innovation, loosen labor markets, raise productivity, empower women and internationalize corporate governance.
The absence of bold supply-side retooling has created a staring contest between CEOs and the government. The CEOs are waiting for the deregulatory Big Bang. Abe and Kuroda believed – mistakenly – that aggressive BOJ stimulus and a weaker yen would be enough to shock the system.
The BOJ needs to tread carefully, of course. Even before taking any of these extraordinary steps, analysts including Stephen Schwartz of Fitch Ratings are raising red flags about “longer-term risks” to the BOJ’s “balance sheet, particularly the purchase of ETFs and fluctuations in underlying equity prices.”
Even so, the BOJ is proving with its paying-bonus gamble that experimentation can increase its firepower, and improve its aim. If Japan needs anything, it’s more potent weapons against a malaise two decades in the making.