The portfolio rebalancing channel – achieved through large-scale purchases of assets – is one of the major transmission channels envisaged by a central bank under the zero or effective lower bound (Joyce et al. 2012). To realise this channel, the Bank of Japan (BOJ) launched quantitative qualitative monetary easing (QQE) in April 2013 by the large-scale purchase of Japanese Government Bonds (JGBs) with the maturity extended to the maximum 40 years. In September 2016, the BOJ shifted the official guideline for market operations from the monetary base (hence the amount of JGB purchases) to the 10-year yield (with a negative interest rate of -0.1%). At the same time, the BOJ emphasised a continuation of an annual pace of JGB purchases of about ¥80 trillion – suggesting its high evaluation of this channel. This column will assess whether the portfolio rebalancing channel has been effective in Japan by focusing on the three entities – financial institutions, firms, and households, separately (Shirai 2017a).
The portfolio rebalancing channel raises aggregate demand, and hence inflation, by encouraging investors to change the composition of their portfolios, thereby lowering funding costs and raising various asset prices directly. Some studies support that the portfolio rebalancing channel had been effective in the US, the UK or the Eurozone (e.g. Albertazzi et al. 2016, Gagnon et al. 2012, Joyce et al. 2015, Jouvanceau 2016).
To promote portfolio rebalancing, the BOJ not only expanded its degree of monetary accommodation substantially (as evidenced by the ratio of the BOJ’s assets to GDP having exceeded 90%), but has also purchased risk assets directly such as exchange-traded funds and real estate investment trusts. Therefore, the BOJ has envisaged that portfolio rebalancing of financial institutions would take place forcefully, from safe assets (i.e. JGBs) to risk assets (such as bank loans, M&A, outbound foreign direct investment, and other domestic and foreign securities investment). Together with the banking sector’s provision of innovative financial services, households’ portfolios would be rebalanced from safe assets (such as bank deposits and cash) to risk assets (such as residential investment, investment in equity investments and investment trusts, etc.). Firms would be encouraged to shift from holding bank deposits and cash to expanding business fixed investment, M&A domestically and overseas, R&D, outbound foreign direct investment (FDI), and so on. In other words, the unprecedented massive monetary easing is aimed at energising Japan’s economy by promoting ‘healthy’ risk-taking behaviour among financial institutions, households, and firms, which has been lacking since the collapse of the equity and real estate bubbles in the early 1990s.
The bank loans to deposit ratio declined rather than increased
is unique among advanced economies in terms of the abundance of deposits relative to the size of the financial industry. For example, deposits and currency held by Japanese banks accounted for 45% of the total liabilities of all financial intermediaries (covering depository corporations, pension funds and insurance firms, and other financial institutions) in June 2016. The ratio is greater than that of the Eurozone (34%) and the US (16%) according to the BOJ estimate using the flow of funds data (BOJ 2016).
Focusing on depository corporations in Japan, bank deposits have substantially exceeded bank loans. The limited demand for credit relative to abundant bank deposits is a structural phenomenon, as evidenced by the persistently low bank loans to deposit ratios. The ratio dropped from 66% in 2000 to 53% in 2016 (Figure 1). This reflects that the pace of an increase in bank deposits has been faster than the pace of increase in bank loans. The gap between loans and deposits is mainly filled by JGB holdings. This suggests that abundant capital has not been utilised efficiently for productive purposes in the private sector. Long-standing limited demand for credit reflects not only the actual rapid pace of aging and its declining population, but also the outlook for the shrinking markets of goods and services.
Figure 1 Loans, deposits, and loans: Deposit ratio of depository corporations, (billion yen, %)
Source: Flow of Funds, Bank of Japan.
Since 2013, Abenomics and QQE have enabled stagnant loan growth to turn positive and the year-on-year loan growth has since remained at around 2%–3%. As for the corporate loan growth, more than 50% of the growth has been allocated to the real estate sector. Growth of households’ mortgage loans showed a moderate pick up. Growing bank lending to the real estate sector has been related to loans to real estate investment trusts, construction activities (partly related to the 2020 Tokyo Olympic Games), as well as loans to housing for rent (mainly driven by tax-saving purposes as a result of the tighter inheritance taxation). Nevertheless, loan growth remains too moderate to offset a decline in the interest rate margins. Deposit growth, rather than slowing, grew even faster than bank loans as explained below; thus, the already low loan-deposit ratio dropped even further – contrary to the phenomenon expected under the portfolio rebalancing channel.
Figure 2 indicates that the ratio of loans to total financial assets has declined over the past four years. The decline in the ratio of debt securities’ holdings (largely comprised of the JGBs) – mainly as a result of selling the JGBs to the BOJ – was replaced by an increase in deposits (largely comprised of the current account balances at the BOJ). The ratio of foreign investment did not show a rising trend over the same period. This reveals that the portfolio rebalancing channel has not been strong to the extent expected by the BOJ although it has been successful in lowering lending rates.
Figure 2 Asset composition of depository corporations (% of total financial assets)
Source: Flow of Funds, Bank of Japan.
Household’s excessive reliance on bank deposits remain unchanged
households, they traditionally prefer banks deposits. Deposits and currency accounted for around 50% of households’ total financial assets from 2000 to 2016 (Figure 3). Such large-scale holdings of deposits are quite remarkable given that the deposit interest rate is about 0%. The household sector has remained a substantial net creditor as households’ deposits (about ¥940 trillion currently) have significantly exceeded their loans (about ¥310 trillion) for a long time. Since their deposits grew faster than their loans, the deposits to loans ratio rose moderately over the period since the adoption of the QQE – contrary to the phenomenon expected under the portfolio rebalancing channel.
QQE contributed to raising households’ equity and investment fund share holdings as a share of total financial assets moderately from around 12% in 2013 to 13%–14% in 2016. However, the ratio did not exceed the maximum (17%) reached in 2007 before the Global Crisis. The household sector remained a net seller of stocks most of the time over the past four years – partly because stock prices rose but achieved only about a half of the historically highest level achieved in the past, and partly because of large fluctuations of the stock prices. Households’ holdings of debt securities accounted for only 1%–2% of total financial assets over the same period partly because a wide range of JGBs and other corporate bonds are available to professional investors as compared with households. Also, the corporate bond market is too small.
Figure 3 Households’ financial assets by type of assets (billion yen)
Source: Flow of Funds, Bank of Japan.
The risk adverse behaviour of Japan’s households is in contrast with that of households in the US and the Eurozone. According to the BOJ’s estimates, deposits and currency accounted for 52% of households’ total financial assets in Japan in September 2016 while they accounted for only 14% in the US in September 2016 and 35% in the Eurozone in June 2016. Equity holdings and investment trusts accounted for 46% in the US and 25% in the Eurozone, while only accounting for 13% in Japan.
Cautious corporate sector with ample deposits and cash
Like households, Japanese firms are known to be highly risk averse, as demonstrated by their large holdings of deposits and currency. The amount of deposits and currency held began to rise from 2011 and rose at an accelerated pace from 2013 owing to an increase in corporate profits. In 2016, the amount of deposits and currency exceeded ¥240 trillion – about one fourth of firms’ total financial assets and about 45% of GDP. The high profitability was attributable to various favourable factors:
- the yen’s substantial depreciation;
- low lending rates;
- a series of corporate tax cuts;
- a sharp decline in commodity prices and imported materials in 2014–2016; and,
- an increase in foreign demand since 2015.
This reflects firms’ choice to accumulate profits in the form of retained earnings rather than allocating them more intensively to expanding business fixed investment, M&A, R&D, foreign portfolio investment, and outbound FDI. While firms increased their non-residential fixed investment over the past four years, the amount of increase was moderate and remained well below cash flows or change in deposits and currency. Since 2013, firms have expanded outbound FDI, but the increase was moderate and foreign assets related to FDI accounted for only half of deposits and currency in 2016. In the US, meanwhile, firms also increased their holdings of deposits due to an increase in profits over time and achieved about US$1 trillion in December 2016. However, the outstanding amount of deposits is relatively small compared with Japan, accounting for only 5% of firms’ total financial assets and 5% of US GDP. In addition, US firms actively engaged in outbound FDI so that the amount of foreign assets related to FDI recorded US$5 trillion, which is about five times as large as deposits. Firms’ non-residential fixed investment exceeded cash flows or change in deposits.
Implications for BOJ’s monetary policy
Given abundant deposits and the public’s preference for bank deposits, Japan’s banking sector has been struggling with its problem of how to utilise abundant deposits given the limited demand for credit. An increase in corporate profits since 2013 has further increased corporate holdings of deposits and currency. Households continue to prefer deposits and cash. These observations suggest that the more drastic, comprehensive structural reforms and growth strategies should be urgently implemented. One related concern growing in Japan is whether the low, stable interest rate environment has discouraged firms from restructuring unviable businesses, and discouraged the government from maintaining the sense of urgency needed to raise potential growth and tax revenue in the long run. Financial institutions may find it difficult to conduct ‘healthy’ financial intermediation because of the difficulty of properly pricing the creditworthiness of borrowers. Given the limited effectiveness of the portfolio rebalancing channel and the little prospect of achieving 2% inflation stably any time soon, the BOJ’ challenge is whether it makes sense to continue with the current policy for many more years.
The continuation of the current policy for longer will likely to make it more difficult for the BOJ to take steps toward normalisation of monetary policy for two reasons. First, as the current monetary policy has distorted the financial and capital markets deeply and to an unprecedented level, there is growing anxiety in Japan about what would happen to these markets if the BOJ’s current policy is continued for many more years. The declined functioning of the JGB market is a concern given its disproportionately large size in the debt securities market and its role of providing a benchmark for pricing corporate and other bonds. Concerns are also raised on the stock market due to the growing presence of the BOJ – with regards to its impacts on reducing the downside risk related to stock prices (as the BOJ’s purchase is viewed to take place when stock prices fall) and on potentially undermining corporate governance (as a result of growing presence as a tacit large investor since no voting rights are exercised).
Second, the adverse impact of normalising monetary easing on the BOJ’s financial statements is expected to become greater. When the BOJ starts normalisation or raising the interest rate on excess reserves related to the current account balances, it is likely to result in net income loss. A continuation of net income loss for several years will wipe out accumulated provisions and then legal reserves, resulting in negative equity. This may become a politically sensitive issue since there is no provision specified under the new Bank of Japan Act – which has been in effect since April 1998 – regarding the case of net income loss. This is in contrast with the old Bank of Japan Act, whose supplementary provisions specified that the government must supplement the BOJ’s losses if legal reserves are not sufficient to cover such losses. The removal of the provisions under the new act is a reflection of the views of major central banks that it is important to maintain the soundness of their balance sheets to retain operational independence. (Shirai 2017b, 2017c).