Special Funds-Supplying Operations (Japan)

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.

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).

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).