Industry Rakes in Over 1 Trillion Yen Amid Government and Bank of Japan Turmoil

The Bank of Japan’s cash flow turns to deficit, and its balance sheet deteriorates.

As interest rate hikes continue, another issue arises: the deterioration of the Bank of Japan’s balance sheet. Looking at the Bank’s financial statements, as of March 2024, the balance of government bonds held is 590 trillion yen, with an average yield of 0.289%.

If the Bank pays 0.5% interest on 500 trillion yen in excess reserves, the interest expense on these excess reserves would exceed the income generated from government bonds, resulting in a “negative spread.” If this negative spread persists, the Bank’s cash flow could fall into deficit.

Additionally, the government bonds held already have over 9 trillion yen in unrealized losses. Is there any rationale for incurring such risks to pay substantial interest on excess reserves?

 

 

The Federal Reserve faces negative equity and the payment of interest on reserve deposits is not unique to the Bank of Japan.

Now, I would like to shift to explaining from the Bank of Japan’s perspective. First, the policy of paying interest on reserve deposits can be considered an irregular monetary policy for central banks. However, in recent years, central banks in Europe and the United States have pursued monetary tightening, during which the Federal Reserve (FRB) and the European Central Bank (ECB) have also been paying interest on reserve deposits. This is not a unique policy to the Bank of Japan.

As a result, the balance sheets of central banks in Europe and the U.S. have significantly deteriorated. For example, the FRB, which implemented substantial interest rate hikes, experienced a negative spread in 2022. The situation has not improved, and by the first half of 2023, it fell into negative equity, with liabilities exceeding assets. The FRB’s financial results for 2023 show a staggering deficit of $114.3 billion (about 16 trillion yen), the largest in its history.

The Bank of Japan takes the stance that there is “no problem”. Is the deterioration of central bank balance sheets “temporary”?

Regarding the deterioration of the FRB’s balance sheet, opinions within the United States are divided. The prevailing view seems to be that “since the U.S. can issue the dollar as a reserve currency, it will be fine in the long run.” However, since 2023, payments of profits to the U.S. government have stopped, leading to growing concerns as time passes (it’s somewhat abrupt, but I suspect this situation is related to the surge in gold prices).

Naturally, the Bank of Japan also maintains that there is “no problem.” In a research paper published in December 2023 titled “Central Bank Finances and the Operation of Monetary Policy,” it states that “in a scenario where monetary policy shifts toward tightening and the balance sheet contracts, there may temporarily be a deficit; however, in such cases, it is generally expected that profits will eventually recover.”