Special Funds-Supplying Operations (Japan)

Purpose

The operations aimed to ensure financial stability in Japanese financial markets and facilitate corporate financing through expanded money market operations.

Key Terms

Introduction Date

November 21, 2008
Operational Date

January 8, 2009
Termination Date

March 31, 2010
Legal Authority

Article 33/37/38, Bank of Japan Act 1997
Size of the Fund

Unlimited
Aggregate Loans

~¥38 trillion (~$370 billion)
Covered Maturities

Residual maturity between 1 month and 3 months
Loan Rate

Avg. of target uncollateralized overnight call rate; fixed rate of 0.1%

Following the collapse of Lehman Brothers in September 2008, the global commercial paper (CP) market began to tighten as interest rates rose and investors sought more-liquid money market securities. The Bank of Japan (BOJ) introduced several measures in late 2008 to make liquidity available to nonfinancial corporations that were strapped for cash. In December 2008, the BOJ implemented special funds-supplying operations in order to provide unlimited liquidity to banks and other financial institutions so they could continue to fund nonfinancial corporations. The BOJ would provide one- to three-month loans against an equal value of eligible corporate debt at a rate equal to the target uncollateralized overnight call rate, which was consistently 0.1% throughout the operation’s lifetime. The short-term credit market gradually improved over the next year amidst consistent usage of the special operations. Approximately ¥38 trillion in loans were provided before the special operations ceased in March 2010. The special operations are viewed as relatively successful, as they contributed to shrinking CP spreads during the first few months of implementation and promoted new issuances of CP and other corporate debt.

In 2008, Lehman Brothers’ bankruptcy disrupted short-term funding for nonfinancial companies, particularly through the commercial paper (CP) market. As CP markets tightened and investors turned to safer assets, investor demand for CP fell and interest rates on money market securities rose. The Bank of Japan (BOJ) introduced three facilities to promote liquidity in the commercial paper market. First, the BOJ enhanced its repo operations to cover a wider range of eligible collateral, including CP. The BOJ then introduced two new operations in December 2008: (1) special funds-supplying operations (the special operations), meant to facilitate short-term corporate financing, and (2) a measure to conduct outright purchases of CP, in which the BOJ would purchase three-month CP and asset-backed CP (ABCP), aimed at shifting credit risk from financial institutions to the BOJ.

The special operations became active on January 8, 2009, with an initial expiration date of March 31, 2009. Under the special operations, the BOJ could auction loans to financial institutions, providing an unlimited amount of liquidity. Loan amounts were equal to the value of corporate debt instruments by participating counterparties. Under the terms and conditions, collateral that the BOJ deemed eligible included corporate debt, CP, and other bills or deeds for companies, with a residual maturity of between one month and three months. When loan payments were due at maturity, counterparties had to repay the principal loan amount, in addition to a fee equal to the average of the target uncollateralized overnight call rate, determined monthly by the BOJ Monetary Policy Board.

The BOJ extended the measure three times: once until September 30, again until December 31, and lastly until March 31, 2010. The special operations were also amended to provide loans only up to three months and to not include ABCP as eligible collateral. Throughout 2009 and into early 2010, the BOJ loaned an aggregate amount of approximately ¥38 trillion to counterparties against eligible collateral under the special operations.

Key Design Decisions

Purpose of MLP 1

Under the special operations’ terms and conditions, the purposes of the operation were to “facilitate corporate financing” by conducting money market operations and to ensure stability in financial markets (Special Operations 2009). Another aim was to put downward pressure on short-term lending rates in Japan (OECD 2009).

During the BOJ’s Monetary Policy Meeting in November 2008, members of the Policy Board stated that strained financial markets and the deteriorating funding environment had played a significant role in decreased issuances and widening spreads on CP and corporate bonds since September (BOJ Minutes, November 2008). Because the funding environment for nonfinancial corporations was “less accommodative,” members suggested implementing a measure to provide liquidity to support them (BOJ Minutes, November 2008). Such measures, BOJ Board members said, should include altering the types of corporate debt eligible as collateral against BOJ loans and should expand existing funds-supplying operations collateralized by that debt.

The special operations were launched under Article 33/37/38, Bank of Japan Act 1997.

Auction or Standing Facility 1

Program Duration 1

Eligible Institutions 1

Eligible counterparties were already counterparties in the BOJ’s open market operations. They included banks and other financial institutions, financial instrument firms, securities finance companies, and tanshi (broker) companies. The financial institutions and banks that could be eligible as a counterparty under the special operations were those listed under Article 37 of the Bank of Japan Act 1997, with some exclusions as defined in the terms and conditions (Special Operations 2009).^FFinancial institutions are defined in Article 37, Paragraph 1 of the Bank of Japan Act, Act No. 89, 1997. Eligible financial instrument firms, securities finance companies, and tanshi companies are defined in Article 10, Paragraph 1, Clauses 2-4. Eligible instruments are defined in Article 28, Paragraph 1 of the Financial Instruments and Exchange Act, Act No. 25, 1948. The program excluded bridge banks. (Principle Terms and Conditions for Outright Purchases of CP 2009).

Also, the BOJ decided to add to the list of its counterparties the Development Bank of Japan, which had been privatized in October 2008 but retained access to government funds and a mandate to support the government crisis response, with a focus on funding large and medium-sized nonfinancial corporations. The Development Bank began outright purchases of CP in December, at the request of the government. The BOJ also added the bank to its list of open market counterparties and, specifically, to its CP repo program (Bank of Japan, January 27, 2008).

Haircuts 1

The prices of eligible collateral were calculated using the formula set forth by the BOJ, p. Different margins for each eligible collateral were dependent upon its residual maturity. Additionally, the margins could be adjusted when necessary to ensure consistency in the margin table as a whole in light of creditworthiness and marketability of the collateral (Guidelines on Eligible Collateral 2000).

Loan Terms 1

Interest Rate 1

Eligible Collateral or Assets 1

Initially, the measure allowed the BOJ to purchase a range of corporate debt, which included different types of CP (Special Operations 2009).

However, the BOJ excluded specifically accepting asset-backed commercial paper, and then, excluded CP issued by real estate investment corporations, at the same time announcing that it would begin to accept real estate investment corporation securities as collateral in the CP repo program (BOJ Amendment, January 2009).

Participation Limit 1

According to an analysis by Hirose and Ohyama, the special operations significantly contributed to reducing CP issue rates during the first four months of operation (Hirose and Ohyama 2010). While CP rate spreads in Japan were increasing in late 2008, the coordination of implementing the outright purchase measure and special operations helped decrease CP rate spreads in January and February of 2009. However, the study finds that only the special operations, not the outright purchase measure or repo operations, contributed to decreased rates in March, April, and May (Hirose and Ohyama 2010).

One cause of this may have been that the special operations were viewed as the least expensive of the three CP measures taken by the BOJ due to their low fixed rate—the BOJ maintained a 0.1% rate throughout the special operations’ lifetime. The low cost, in addition to an improving CP market in Japan, may have provided institutions the ability to submit better collateral against these loans. The BOJ believed that outside of extending the special operation’s lifetime, any other amendments to the operation might have had a negative impact on financial markets by increasing volatility (Mizuno 2009). According to one speech, it was the BOJ’s view that the special operations had greatly contributed to changing interest rates on CP. Moreover, if institutions chose to rely more on the special operations rather than other monetary measures, it would disrupt the market greatly and damage financing operations once the special operations expired (Mizuno 2009).

Key Program Documents

Principal Terms and Conditions for the Special Funds-Supplying Operations to Facilitate Corporate Financing (Bank of Japan — 12/19/2008)

Principal terms of the special funds-supplying operations included providing selected counterparties unlimited loans in the form of auctions, but only up to the value of posted collateral. Loans initially had a duration of between one and three months and were to be repaid with a rate equal to the uncollateralized overnight call rate.

Guidelines on Eligible Collateral (Bank of Japan)

The Bank of Japan Policy Board prescribes a set of guidelines that the Bank of Japan follows to conduct monetary and currency operations, where collateral is accepted only if creditworthy and marketable.
Minutes of the Monetary Policy Meeting on November 20 and 21, 2008 (Bank of Japan – 12/25/2008)

The Bank of Japan Policy Board introduced the special funds-supplying operations as a response to strained credit markets that aimed to facilitate corporate financing.
Minutes of the Monetary Policy Meeting on December 18 and 19, 2008 (Bank of Japan – 01/27/2008)

The Bank of Japan Policy Board introduced the principal terms and conditions of the special funds-supplying operations.
Minutes of the Monetary Policy Meeting on January 21 and January 22, 2009 (Bank of Japan – 02/24/2009)

The Bank of Japan Policy Board passed a vote to amend the eligible collateral under the special funds-supplying operations.
Minutes of the Monetary Policy Meeting on February 18 and February 19, 2009 (Bank of Japan – 03/24/2009)

The Bank of Japan Policy Board passed a vote to extend the special funds-supplying operations from March 31, 2009, until September 30, 2009.
Principal Terms and Conditions for the Special Funds-Supplying Operations to Facilitate Corporate Financing (Bank of Japan – 12/19/2008)

Principal terms of the special funds-supplying operations included providing selected counterparties unlimited loans in the form of auctions, but only up to the value of posted collateral. Loans initially had a duration of between one and three months and were to be repaid with a rate equal to the uncollateralized overnight call rate.

Article 37 of the Bank of Japan Act 1997

Article 37 of the Bank of Japan Act 1997 states that the Bank may provide financial institutions uncollateralized loans and when the institutions “unexpectedly experience a temporary shortage of funds necessary for payment due to accidental causes . . .”

Statement on Monetary Policy (Bank of Japan – 11/21/2008)

The Bank of Japan announced that it would create a special funds-supplying operation to provide unlimited loans for liquidity purposes to eligible financial institutions and banks in Japan.

Bank of Japan may reportedly double lending program (MarketWatch – 03/11/2010)

News story mentioning that the special operations lending facility will be expiring on March 31, 2010, while an expansion of the new fixed-rate funds-supplying operation is being considered by the Bank of Japan.
BOJ meets as economy in worst slump since 1970s (MarketWatch – 02/16/2009)

News story discussing an upcoming BOJ Policy Board meeting where the BOJ wanted to seek “extraordinary” measures to assist credit-tight companies and alleviate financing conditions across Japanese markets. The Japanese media states that the demand has been strong for the loans.

Government, Business and Markets after the Lehman Shock: A Review of Aid to the Business Sector in Japan (Komine 2009)

This paper summarizes the effects of Lehman Brothers’ bankruptcy and other economic events in the United States on Japan’s economy and marketplace. The author reflects on the increase in state intervention to maintain financial stability and the advantages or disadvantages that using state intervention has on the market.

The Conduct of Monetary Policy in Japan and Abroad: Excerpts of a Speech at a Meeting with Business Leaders in Okayama (Bank of Japan – 08/2009)

In a speech, the Bank of Japan Governor said that the Bank decided to extend the outright purchases on commercial paper because although the commercial paper market has been recovering greatly, financial firms hoped the operation would still be in use to “facilitate corporate financing,” in case of any imminent debt downgrades or credit slides.
Financial Markets Report – Developments in the First Half of 2009 (Bank of Japan – 08/31/2009)

An analysis by the Bank of Japan found that CP operations have contributed to a decrease in issuance rates, but that effects on CP rated a-1 were greater than CP rated a-1+ or lower.
Identifying the Effect of the Bank of Japan’s Liquidity Facilities: The Case of Commercial Paper Operations during the Financial Turmoil (Bank of Japan – 10/2010)

This paper studies the effects of the Bank of Japan’s three commercial paper operations it implemented between October 2008 and May 2009. It found that outright purchases of commercial paper had visible effects at the onset of its implementation, but subsided as the commercial paper market recovered.

Special Funds-Supplying Operations: Japan Context

GDP

(SAAR, Nominal GDP in LCU converted to USD)

$4,680.1 billion in 2007

$5,321.2 billion in 2008

Source: Bloomberg

GDP per capita

(SAAR, Nominal GDP in LCU converted to USD)

$35,275 in 2007

$39,339 in 2008

Source: Bloomberg

Sovereign credit rating (5-year senior debt)

As of Q4, 2007:

Fitch: AA-

Moody’s: A1

S&P: AA

As of Q4, 2008:

Fitch: AA-

Moody’s: Aa3

S&P: AA

Source: Bloomberg

Size of banking system

$6,980.8 in total assets in 2007

$8,301.60 in total assets in 2008

Source: Bloomberg

Size of banking system as a percentage of GDP

149.2% in 2007

156.0% in 2008

Source: Bloomberg

Size of banking system as a percentage of financial system

Banking system assets equal to 50.2% of financial system in 2007

Banking system assets equal to 52.1% of financial system in 2008

Source: World Bank Global Financial Development Database

5-bank concentration of banking system

50.2% of total banking assets in 2007

58.6% of total banking assets in [year of announcement]

Source: World Bank Global Financial Development Database

Foreign involvement in banking system

1% of total banking assets in 2007

1% of total banking assets in 2008

Source: World Bank Global Financial Development Database

Government ownership of banking system

Data not available for 2007/2008

Source: World Bank Global Financial Development Database

Existence of deposit insurance

Data not available for 2007/2008

Source: World bank Deposit Insurance Dataset

Because of the weakening commercial paper market throughout the global economy, Japan’s commercial paper market was hit heavily in late September 2008, following the Lehman Brothers bankruptcy. In response to the spreading financial crisis, the Bank of Japan’s Policy Board issued a number of operations to alleviate the commercial paper (CP) market.

First, the BOJ expanded the conditions for the pre-existing repurchase operations for CP to facilitate short-term money market financing for financial institutions as a response to the credit crunch (CP Repo Operations). The BOJ increased the frequency of the operations from being conducted on a quarterly basis to twice a week, while also increasing the fund supply per operation from ¥300 billion to ¥600 billion (BOJ Markets Report, March 2009). Moreover, the BOJ expanded eligible loan collateral to include dematerialized CP issued by real estate investment corporations and government-guaranteed dematerialized CP (BOJ Amendment, January 2009).

In early November, the BOJ introduced special funds-supplying operations (the special operations) that would provide unlimited liquidity in exchange for an equal amount of commercial paper collateral from financial institutions (Special Operations 2009). The special operations provided a one- to three-month loan at a low fixed loan rate equal to the average uncollateralized overnight call rate. The value of the loan would be equal to the value of collateral posted by the participating counterparty. Collateral that was eligible to be posted against a loan included corporate bonds, dematerialized CP issued by domestic corporations, dematerialized CP issued by foreign corporates with guarantees, bills drawn by companies, commercial paper (excluding ABCP and, later, CP issued by real estate investment corporations), and loans on deeds to companies (Special Operations 2009).

Finally, the BOJ passed a measure to conduct outright purchases of CP from financial institutions, aiming to transfer some of the risk from bank balance sheets onto the BOJ’s own sheet (Outright Purchases of CP 2009). The decrease in risky CP would help institutions avoid credit downgrades, thus allowing them to continue borrowing liquidity in the general credit market in order to meet financing needs. However, the amount of CP the BOJ could buy was limited to ¥3 trillion overall, limited to ¥300 billion per auction date, and limited to ¥100 billion per issuer per auction (Outright Purchases of CP 2009). Moreover, the purchases included an interest rate equal to the overnight call rate plus a penalty rate, making the outright purchases of CP the most expensive of the three CP operations (Outright Purchases of CP 2009).

Taxonomy

Intervention Categories:

Market Support Programs

Countries and Regions:

Japan

Crises:

Global Financial Crisis

Special Funds-Supplying Operations (Japan)

Purpose

Key Terms

Abstract

At a Glance

Key Design Decisions

Purpose of MLP 1

The BOJ introduced special operations to ease capital constraints on financial institutions and improve access to funding for nonfinancial companies.

Auction or Standing Facility 1

Initially, auctions were to be conducted twice a month. The BOJ later increased the frequency to once a week.

Program Duration 1

Initially, the special operations were set to expire on March 31, 2009. The BOJ extended the expiration date of the special operations multiple times.

Eligible Institutions 1

The program could lend to financial institutions that were counterparties of the Bank of Japan.

Haircuts 1

The amount of a loan would be equal to the discounted value of eligible collateral pledged by counterparties.

Loan Terms 1

Initially, the special operations would provide one- to three-month loans. Later, the BOJ amended the operations to provide only three-month loans.

Interest Rate 1

The loans were provided at a low fixed rate, equal to the average of the target uncollateralized overnight call rate.

Eligible Collateral or Assets 1

Collateral eligible to be submitted by counterparties included a range of corporate debt.

Participation Limit 1

The BOJ could provide an unlimited amount of loans to selected counterparties.

Evaluation

References 21

Key Program Documents

Program Summaries 1

Implementation Documents 6

Legal/Regulatory Guidance 1

Press Releases/Announcements 1

Media Stories 2

Key Academic Papers 1

Reports/Assessments 3

Appendices

Taxonomy

Intervention Categories:

Countries and Regions:

Crises:

Notes