The Bank of Japan could become unprofitable as interest rates rise and the deposits it holds become far more expensive.
“It’s quite possible that the BOJ will run in the red,” said Hideo Kumano, executive chief economist at Dai-Ichi Life Research Institute.
Analysts add that the independence of the institution could be threatened if it becomes a money-losing entity.
The BOJ is now in a race to cut the size of its bond holdings so it can reduce its deposit obligations and the risk that comes with them, they note.
Japan’s central bank has a ¥750 trillion ($4.7 trillion) balance sheet. Much of its holdings are funded with interest-bearing deposits from private financial institutions.
These currently total about ¥470 trillion — about $3 trillion — and the rate on them is about 0.1%.
Given that the BOJ is looking to raise its short-term interest rate, the interest payments will likely swell. If the central bank raises the rate to 1%, it must pay nearly ¥5 trillion of interest annually. The total ordinary profits of Japanese banks nationwide was about ¥4.1 trillion in fiscal 2022.
As interest rates rise, the central bank will have to pay more on deposits, resulting in a mismatch between what it pays out and how much it receives on bonds it holds.
At some point, it could start to lose money.
Takahide Kiuchi, executive economist at Nomura Research Institute, estimates in a report published in January that the BOJ would be running in the red if it raises its benchmark rate to 0.6%.
Most BOJ profits are paid to the government, and since the Bank of Japan Act — which gave the central bank more independence — was passed in 1998, the BOJ has never run a full-year deficit.
In fiscal 2023, the government received a record ¥2.17 trillion from the central bank. That is almost 2% of the government’s total budget.
“The government would lose the revenue and it would cause huge damage,” Kumano said in discussing the consequences of a rapid increase in interest rates.
Whether the BOJ actually loses money will depend on the pace of the rate increases and the pace at which the balance sheet is trimmed, he added.
Central bank independence could be threatened if profits become losses as it could face political attacks, according to analysts.
“If the government starts saying that running a deficit is bad, the freedom of policy making would be restrained,” Kumano, a former BOJ official, said.
The U.S. Federal Reserve has already had to deal with this problem. It booked an operating loss of $114.3 billion last year as rates rose rapidly in the United States and the institution had to pay more in interest on deposits.
The U.S. Fed has downplayed the possibility that losses would hinder it in carrying out its mission.
Even if “the Fed’s net income turns negative temporarily, the Fed would still be able to meet all its responsibilities,” it wrote in a July 2022 note.
Last September, BOJ Gov. Kazuo Ueda offered some assurances about the ability of the central bank to do its job in the event of losses being incurred.
“A central bank’s ability to conduct monetary policy is not impaired by a temporary decrease in its profits and capital,” he noted.
“Central banks are unique in terms of their profit structure and their function as issuers of banknotes. Central banks have aspects that cannot be captured through analogies with private financial institutions or business corporations,” Ueda added.
The BOJ is already set to trim the size of its balance sheet. It is planning to cut the purchase of government bonds, which results in a net reduction in the amount of debt owned as bonds already on the books hit maturity.
Reducing bond purchases is in line with its efforts to allow long-term rates to be guided more by the market. The net reduction in bonds owned could also help stabilize the yen, which is currently trading at 38-year lows.
Analysts said that the need to reduce its exposure to interest-rate risk might also compel the central bank to cut its purchases of government bonds.
The BOJ currently buys about ¥6 trillion of bonds each month. It said after its June meeting that it would present a plan to reduce that amount after its July meeting.
Lack of clarity on the reduction in bond purchases has been cited by some analysts as one reason for the yen hitting recent lows, as it suggests uncertainty about the BOJ’s commitment to tightening monetary policy.
