Cashing out

Bond-buying helps Japan's banks more than economy

The Bank of Japan's bond-buying is proving to be more of a blessing for the country's lenders than for the deflation-stricken economy. The central bank's spending spree has allowed lenders to offload 12 per cent of their holdings of government debt this year.

Swapping some of the banks' ¥142 trillion ($1.43 trillion) of government bonds for newly minted cash is the prudent thing to do. When the BOJ's money-printing ends and the 10-year bond yield rises from its current level of 0.7 per cent, banks are at risk of suffering large mark-to-market losses on their portfolios. Government bond holdings have fallen this year to 16 per cent of banks' total assets, down from 18 per cent.

If Prime Minister Shinzo Abe is to succeed in ending deflation, banks mustn't stop at shrinking their exposure to the government; they must also lend more. However, given that Japanese companies' own cash hoards are at a five-year high, credit growth is more likely to be a crawl than a gallop.

Deposits in the Japanese banking system have risen by ¥16 trillion this year. Yet, lending has risen by just 6 trillion, or 1.5 per cent. Excluding offshore loans, which are growing quickly as Japanese lenders replace the lending by retreating European banks, domestic credit growth is even more tepid. While awaiting a pickup in loan volumes and margins, Japanese lenders are also looking for acquisitions overseas.

Offloading bonds in Japan's turbo-charged debt market has been lucrative for the banks. Mitsubishi UFJ, Sumitomo Mitsui and Mizuho reported a 63 per cent year-on-year increase in their combined earnings between April and June. In the same period, the three lenders pared their government bond holdings to 3 times their Tier 1 capital, from 4 times, Fitch Ratings says.

The flipside of the lenders' bond sales is that the BOJ must keep buying them by the truckload, lest yields surge and choke loan demand altogether. Faster domestic credit growth will kick in, but only after reforms in product, energy and labour markets. Monetary magic can create cash from thin air. It can't conjure up credit as easily.