Japan's Negative Rate Experiment: The Biggest Losers
Last week the Bank of Japan published detailed estimates of the distribution of Japan's banks' reserves under the new three-tier system. The figures show that this interest rate regime imposes a disproportionately heavy burden on foreign banks and Japan Post Bank. Whether or not this was an intended consequence of the policy remains to be seen, but as Deutsche Bank points out, in a research note issued to clients at the end of last week, it may be advantageous for the BoJ that foreign banks bear the brunt of the policy.
Foreign banks will bear the brunt of negative rates
There are two main reasons why Deutsche believes it may be beneficial that foreign banks bear the brunt of the BoJ's negative rate experiment.
Firstly, foreign banks are likely to have a relatively high propensity to substitute riskier assets for excess liquidity, and especially foreign assets. The negative impact on foreign banks thus raises the likelihood of substantial capital outflows.
Secondly, with foreign banks bearing the brunt of the policy, there is greater scope for cutting rates further into negative territory if deemed necessary.
¥23 trillion is subject to the negative rate policy, around 9% of BoJ reserves held by the total bank system. This share is as high as 17%, and 18% for foreign banks and "other institutions subject to reserve requirements." Foreign banks hold around 10% of total BoJ balances of ¥253 trillion but account for 18% of the total policy bucket of ¥23 trillion. Japan Post accounts for 53% of the total policy rate bucket and 27% of total BoJ balances. So, while the negative interest rate policy will hit foreign banks harder than most domestic lenders, Japan Post will also be disproportionately affected.
Negative rate experiment - Two outliers
There are two main reasons for this anomaly. Firstly, Japan Post and foreign banks have been accumulating reserve balances rapidly in the last few months, and their reserve balances now far exceed the 2015 average, which is the primary determinant of the upper limit on the basic balances that can be held at +0.10%.
A quick reminder of how the BoJ's NIRP works:
The outstanding balance of each financial institution's current account at the bank will be divided into three tiers, each of which will receive a different interest rate.
1) Basic balance - corresponds to the existing balance of each financial institution's current account at the bank calculated as the average outstanding balance during 2015. The interest rate applied on this first tier will be +0.1%.
2) Macro add-on balance - the sum of a) the amount of required reserves, b) the received amount of the BoJ's several lending support programs, and c) the amount of reasonably increased balance in line with the directive of asset purchases program. The rate applied on this second tier will be +0.0%.
3) Policy-rate balance - the outstanding balance of each financial institution's current account at the bank more than the sum of tiers one and two. An interest rate of -0.1% will be applied to this third and final tier.
This three-tier system means that the negative interest rate will only be applied to the unreasonably increased amount of excess reserves, under the progress of the BoJ's asset purchases. Bank's will not be penalized for reasonably increased reserves, which could come as a result of the BoJ's asset purchases as these will fall under the tier two (Macro add-on balance) criteria. Therefore, the share of current accounts that incur a negative interest rate at each financial institution should be subtle.
As Japan Post and foreign banks have been increasing their reserves, most domestic, regional banks' reserves are no higher than the 2015 average and thus continue to earn +0.10%, with the exception again of required reserves.
The second reason why foreign banks and Japan Post are set to be the main losers of this regime is that foreign bank's required reserves (part of the Macro add-on balance) amount to only 0.2% of their total BoJ balances and "other institutions subject to reserve requirements" such as Post Bank only post 3.6% of their balances as a requirement. City and regional banks, on the other hand, have reserve requirements that range from 5% to 10%.
Moreover, foreign banks have not participated in the BoJ's Loan Support Program, and even Post Bank accounts for only 10% of the liquidity created by the Program despite its size. Of the remainder, 60% is held by the city banks, 20% by regional banks and 10% by trust banks. As a result, foreign banks and Japan Post Bank have only few reserves that qualify as 'Macro Add-on' balances.