The Bank of Japan wrote down the value of its holdings of government debt by ¥874 billion ($8.5 billion) in the last fiscal year, undercutting the income from its still profitable asset-purchase program.
With yields below zero, the central bank is buying debt at prices higher than the face value. As the bank purchases and holds debt until maturity, it doesn’t value the bonds at market price but takes the markdown gradually so that at maturity the book value equals the principal.
That cost last fiscal year equaled 40 percent of the bank’s interest income from the bonds it owns, according to central bank documents seen by Bloomberg. The reduction in income is poised to worsen as bond prices rise, with the yield of all Japan’s debt falling below 0.1 percent.
That has raised concerns both inside and outside the bank as to the sustainability of the BOJ’s finances and adds to questions about how it will exit from its unprecedented easing policy. Existing reserves are already seen by some as insufficient to cover the eventual normalization of policy, and the rising prices will exacerbate this problem.
“When people realize the limits to the BOJ’s finances, it could possibly create a massive shock,” said Sayuri Kawamura, a senior economist at the Japan Research Institute Ltd. in Tokyo. “The bank has about ¥7 trillion in capital, but that would be eaten up quickly.”
“If the amortization losses from the BOJ’s bond-buying operations become too large, it’s possible that income could go negative,” former Deputy Gov. Kazumasa Iwata said in an interview in April.
The BOJ will buy ¥120 trillion worth of bonds this year, and if it buys ¥100 bonds at ¥103, that would mean a total loss of ¥3.6 trillion, said Iwata, who now heads the Japan Center for Economic Research.
The BOJ aims to increase its holdings of government bonds by about ¥80 trillion a year. Because of redemptions, it actually buys about ¥120 trillion worth of JGBs a year, and held ¥320 trillion in government bonds on June 20.
Then-Federal Reserve Chairman Ben Bernanke played down concerns about central bank balance sheet risk in a landmark 2003 speech in Japan that called for stronger reflation efforts — a presentation still discussed within the BOJ today. The BOJ couldn’t go bankrupt in the way a private bank could, he said.
“One could make an economic case that the balance sheet of the central bank should be of marginal relevance at best to the determination of monetary policy,” Bernanke said in the speech, made years before he enacted unprecedented stimulus as Fed chair. “There are many essentially cost-less ways to fix” it, including assistance from the Ministry of Finance, he said.
The bank’s purchases often occur at a slight premium to the current market price. One current board member raised this issue at the June meeting, saying the bank should review the current policy of its massive scale of JGB purchases, and that “purchasing JGBs at prices deviating from those prevailing in the market eventually will result in losses for the Japanese people.” In its summary, the BOJ doesn’t specify which board member made these comments.
Takahide Kiuchi, a BOJ board member who opposed the October 2014 expansion in bond purchases as well as introduction of the negative rate in January, is concerned. “This isn’t going to become a massive problem right now, but looked at over the long term, this is going to be an extremely big problem,” he told reporters after a speech in Kanazawa last week.
Although the BOJ owns older bonds that have higher interest rates and thus generate more income, income from new debt purchases won’t exceed the cost of the write-downs, cutting the bank’s total income.
In its purchase operations on June 10, the BOJ bought ¥416 billion worth of the No. 342 10-year bond, at an average price of about ¥102.65, according to Makoto Yamashita, chief strategist at Deutsche Securities. The purchase amount is based on the face value of the bond.
The BOJ will earn ¥416 million income annually from the 0.1 percent coupon on these bonds, and will have to write down ¥1.1 billion each year to account for the ¥2.65 by which the purchase price exceeded the principal.