Japan: Special Funds-Supplying Operations

Through the SFSO, the Bank of Japan (BoJ) provided loans at favorable terms to financial institutions to encourage business lending (BoJ 2021f). The program was designed to “encourage financial institutions to actively facilitate financing of their client firms despite their own severe business conditions” (BoJ 2020g). This, in turn, would “alleviate the anxiety of business managers whose firms were experiencing a deterioration in financial positions” (BoJ 2020g, 14).

The SFSO was one measure in the BoJ’s three-part strategy to contain the economic fallout of the COVID-19 pandemic, which included:

• Implementing the “Special Program to Support Financing in Response to the Novel Coronavirus (COVID-19).”
• Significantly increasing amounts of outright purchases of commercial paper and corporate bonds.
• The creation of SFSO.
• Providing ample funds in yen and foreign currencies without setting upper limits, mainly through purchases of Japanese government bonds and the U.S. dollar funds-supplying operation through which the BoJ offered counterparties USD-denominated loans.
• Actively purchasing exchange-traded funds and Japanese real estate investment trust instruments (BoJ 2021j, 3-6).

The BoJ also deferred by one year the full implementation of the finalized Basel III standards and encouraged banks to use their capital and liquidity buffers.^FThe oversight body of the Basel Committee on Banking Supervision, a Bank for International Settlements group that sets bank regulations standards, agreed to delay the implementation of Basel III standards because its members wanted banks and supervisors to “commit their full resources to respond to the impact of Covid-19” (Bank for International Settlements 2020). The Financial Services Agency of Japan and the BoJ jointly eased leverage coverage requirements (Kuroda 2020b).

The BoJ made several changes to the SFSO as the program progressed. Figure 1 provides an overview of those changes, which are discussed in further detail elsewhere in this case study.

The BoJ activated a version of the SFSO during the Global Financial Crisis (GFC).^FSee Buchholtz 2020, a YPFS case study documenting and evaluating the GFC SFSO program. The main differences between the earlier and later SFSO include (Buchholtz 2020):

• The COVID-19 SFSO charged a 0% loan interest rate, whereas the GFC SFSO provided loans at a rate equal to the average target uncollateralized overnight call rate, which was 0.1% throughout the facility’s life.
• By paying a positive interest rate on financial institutions’ current account balances proportionate to their SFSO lending, the COVID-19 SFSO effectively paid financial institutions to participate; the GFC SFSO did not include this benefit.
• The COVID-19 SFSO loans were available at maturities of up to a year, whereas the GFC SFSO provided one- to three-month loans.
• The BoJ held operations once a month for most of the operation of the COVID-19 SFSO, whereas the central bank eventually held operations once a week for the GFC SFSO.

Article 33 allows the BoJ to make loans against a wide variety of collateral, including negotiable instruments, Japanese government securities, or in the form of electronically recorded monetary claims (Bank of Japan Act 1997).^FJapanese policymakers use the “electronically recorded” description in various policy documents because the country’s financial system has been transitioning from physical certificates to electronic transactions since the late 2000s (Japan Securities Depository Center 2009). Officials call this process “dematerialization,” a word that is now often used to describe certain assets, such as dematerialized commercial paper (BoJ 2000).

The biannual reports must detail the currency and monetary policy measures the BoJ takes, such as interest rate moves and reserve requirement ratio changes (Bank of Japan Act 1997; BoJ 2021b).

The BoJ’s Operations Department administered the SFSO (BoJ 2021f). The central bank did not appear to use a third party to help implement the SFSO.

By encouraging lending via the SFSO, the BoJ said, the program would provide a “sense of security” to both market participants and the Japanese public (Kuroda 2020a, 4).

BoJ officials initially positioned the SFSO as a corporate financing facility (BoJ 2020g) but removed the word “corporate” from the facility’s title in April 2020 as it attempted to reach smaller businesses (BoJ 2020i, 16–17). In May 2020, a member of the BoJ’s Policy Board said it was imperative that the BoJ clarify that the program’s targets were "wide-ranging, from large firms to sole proprietors" (BoJ 2020h, 5). BoJ policymakers said that by supporting the country’s financial institutions, the facility also supported firms and households (BoJ 2021j).

Officials also said that the increased use of the SFSO magnified the effects of the BoJ’s various asset purchase programs by increasing financial institutions’ demand for collateral (BoJ 2021j).

The BoJ exceeds this responsibility, releasing balance sheet updates every 10 days (Bank of Japan Act 1997; BoJ 2021b). The BoJ does not report SFSO transaction-level data.

This key design decision does not apply to the SFSO.

Though BoJ officials did not set an explicit overall lending limit for the SFSO, the facility is capped by the pool of available collateral that meets the central bank’s requirements (BoJ 2021f). The BoJ expanded the range of SFSO eligible collateral and eligible counterparties during its April 2020 monetary policy meeting (BoJ 2020i).

Policymakers did limit how much individual counterparties could borrow from the SFSO. This maximum is the sum of an institution’s collateral pledged to the SFSO plus its total amount of loans outstanding to SMEs through (or similar to) certain government programs (BoJ 2021f).^FFor example, the Ministry of Economy, Trade and Industry created a program supporting SME financing by guaranteeing 80% of eligible loans to eligible SMEs (Ministry of Economy, Trade and Industry 2020). See Loan Amounts key design decision for further discussion of the calculation of individual lending limits.

BoJ policymakers added the SME loan portion of the calculation as part of its broader efforts to support smaller enterprises (BoJ 2020h). This was one of several tweaks BoJ officials made to its maximum lending amount policy (see Figure 1). For example, when the central bank first activated the SFSO in early 2020, the BoJ’s calculation included just corporate debt (BoJ 2020a), but it later updated the calculation to include a broader variety of collateral, which expanded the maximum amount certain counterparties could borrow from the SFSO (BoJ 2020i).

The BoJ’s 2020 Market Operations report showed SFSO outstanding loans totaled JPY 64.8 trillion on March 31, 2021, the end of its 2020 fiscal year (BoJ 2021j). The monthly time series data the BoJ releases do not break out SFSO lending individually. Rather, the data include SFSO lending as part of aggregate loans against pooled collateral, which include lending operations conducted prior to the pandemic.^FAn example of a facility grouped with the SFSO in BoJ reporting is the BoJ’s “Funds-Supplying Operations against Pooled Collateral,” which was created in 2006 to facilitate money market operations by substituting the previously paper-based bill-purchasing operations with paperless operations against pooled collateral (BoJ 2006). Another example is the “Funds-Supplying Operation to Support Financial Institutions in Disaster Areas of the 2016 Kumamoto Earthquake” facility, created in 2016 to support financial institutions in areas hit by natural disasters to help meet demand for rebuilding funds (BoJ 2016). These grouped data show rapid growth in these lending programs: The BoJ’s lending in this category surged to JPY 133 trillion in August 2021 from JPY 49 trillion in February 2020, a month before the COVID-19 pandemic began and the SFSO was activated and (see Figure 2).^FSee the Bank of Japan’s Account data.

Source: Bank of Japan Accounts.

When the program launched in March 2020, primarily city banks, trust banks, and money market brokers (called tanshi companies) borrowed through the SFSO (BoJ 2021j). Regional banks and financial credit cooperatives, known as shinkin banks, began using the facility as the BoJ broadened counterparty eligibility in April 2020 (BoJ 2021j). Use of the SFSO by regional banks increased substantially after the BoJ expanded eligible collateral to include private debt, and in particular beneficial interests of a trust in house loans (BoJ 2021j) (see Figure 3).

Source: Bank of Japan.

The BoJ’s balance sheet expanded to JPY 714.6 trillion at the end of March 2021, up from JPY 110.1 trillion a year earlier at the start of the pandemic (BoJ 2021j).

The BoJ has aggressively and innovatively used its balance sheet to conduct unconventional monetary policy and secure financial stability since the late 1990s, when it purchased asset-backed securities and asset-backed commercial paper to ease credit conditions (Shiratsuka 2010). Other major central banks, such as the US Federal Reserve and the European Central Bank, took similar actions nearly a decade later during the GFC (Logan and Bindseil 2019).

SFSO eligibility was initially limited to financial institutions with BoJ accounts that the BoJ deemed creditworthy (BoJ 2020a). The standards by which the BoJ examined and deemed a potential counterparty sufficiently creditworthy are unclear with available documentation.

In late April 2020, BoJ officials broadened eligibility to include the Development Bank of Japan and member banks of financial cooperative central organizations (BoJ 2020i).^FThe central organizations include the Shinkin Central Bank, the Shinkumi Federation Bank, the Rokinren Bank, and the Norinchukin Bank (BoJ 2020j). These member institutions resemble credit unions in the US and disproportionately lend to SMEs.

Financial cooperative member institutions wanting to tap the SFSO had to work through their cooperative’s parent organizations. The BoJ provided a separate set of rules that the parent organizations had to use to tap SFSO funding for their member institutions. For example, the parent organization had to request, in advance, their member institutions’ collateral offerings (BoJ 2020j).

The BoJ initially held SFSO operations twice a month through August 2020 and scaled them back to once a month from September 2020 onward (BoJ 2021j). The BoJ held operations once a week for the GFC SFSO (Buchholtz 2020).

The BoJ structured the SFSO’s lending terms to encourage counterparties to lend to Japan’s broader business community (BoJ 2021f).

Initially, the SFSO accepted only corporate debt, but after its April 2020 monetary policy meeting, the BoJ broadened the list of eligible collateral to include the following (BoJ 2020i; BoJ 2021f):

• Corporate bonds;
• Dematerialized commercial paper issued by domestic corporations, foreign corporations with guarantees, and real estate investment corporations, in addition to non-electronic commercial paper;
• Asset-backed securities;
• Dematerialized asset-backed commercial paper;
• Bonds issued by real estate investment corporations;
• Bills drawn by companies and real estate investment corporations;
• Electronically recorded monetary claims on companies and on real estate investment corporations;
• Loans on deeds to companies (including those denominated in USD) and to real estate investment corporations; and
• Beneficial interests of a trust in housing loans.

The assets also had to meet standards outlined in the BoJ’s eligible collateral guidelines. The BoJ sets these guidelines to enhance transparency, protect itself from losses, and implement monetary and currency policy (BoJ 2000; BoJ 2009). The guidelines vary by asset type and include maturity limits, creditworthiness standards, limitations on the types of underlying investments, and the structure of the assets themselves (BoJ 2000).^FSee BoJ (2000) for a list of full requirements.

The GFC SFSO also accepted a broad range of corporate debt as collateral (Buchholtz 2020).

This maximum amount for an individual financial institution was calculated by summing (BoJ 2021f):

• The total value of eligible collateral pledged to the SFSO at the time of the loan disbursement;^FMaximum loan amount rules for financial cooperatives were nearly identical to the rules for other financial institutions, with one exception. In calculating the maximum loan figure, cooperatives would use 50% of the face value of eligible private debt. This 50% rule does not apply to COVID-19-related lending outlined in points 2 and 3 of the calculation, just point 1 (BoJ 2020j).
• The amount of loans outstanding to SMEs in response to COVID-19 through credit guarantees by the country’s guarantee corporations or the program to reduce/exempt interest rates; and
• The amount outstanding of SME loans that are equivalent to the funds lent through the previously mentioned government initiatives but that an institution lent out independent of such programs.

At the time the loan was disbursed, this sum could not exceed the unused value of the total pool of eligible collateral pledged by all borrowers to the BoJ (BoJ 2021f). The BoJ initially placed a JPY 100 billion (roughly USD 1 billion) limit on funds that it would offer counterparties against loans made to SMEs on their own (outside of government programs). It later removed this limit to encourage broader lending to SMEs (BoJ 2021j).

The GFC SFSO was similar to the COVID-19 SFSO in that counterparties’ borrowing was limited by the total value of corporate debt collateral available (Buchholtz 2020).

The BoJ uses historical market price fluctuations (actual or estimated) and the asset’s residual maturity to calculate the margin on eligible collateral (BoJ 2000). The BoJ used a similar formula to price collateral for its GFC SFSO (Buchholtz 2020).

Financial institutions paid no interest on loans in the COVID-19 SFSO program. In contrast, the GFC SFSO provided loans at a rate equal to the average target uncollateralized overnight call rate (Buchholtz 2020). Throughout 2020, the short-term prime lending rate adopted by the largest number of city banks, a measure the BoJ uses to track rates, was 1.48%.^FSee Bank of Japan historical prime lending rates data.

However, the BoJ effectively paid financial institutions to use the COVID-19 SFSO program by implementing important changes to the facility’s terms (BoJ 2020i).

First, the BoJ said in April 2020 that it would pay a positive 0.1% interest rate on a portion of a financial institution’s current account balances with the central bank corresponding to the amount of its SFSO loans, at a time when the BoJ’s policy rate was negative 0.1%.

Second, the BoJ agreed to add twice the amount outstanding of borrowing via the SFSO to financial institutions’ “Macro Add-on Balances” (BoJ 2020i, 15–17). Macro Add-on Balances are the portion of financial institutions’ balances with the central bank that carry a zero interest rate, according to the negative interest rate policy that the BoJ introduced in 2016. The BoJ applies negative interest rates to the portion of financial institutions’ balances that it calls the “Policy-Rate Balances” tier. It applies a positive interest rate to the “Basic Balances” tier (BoJ 2021c). The Policy-Rate Balance is the balance in excess of the Basic Balance and Macro Add-on Balance.^FSee (BoJ 2021j, 25–26) for further explanation of the tiering system.

The BoJ increased these incentives in March 2021 with the “Interest Scheme to Promote Lending” (BoJ 2021h, 35–36). Under this new incentive structure, the BoJ applied a positive 0.2% incentive interest rate to money in current account balances that corresponds to SFSO funds against certain money lent outside of government-incentivized programs. The central bank continued to apply a positive 0.1% interest rate to funds provided through the SFSO against other eligible loans and the private debt pledged as collateral (BoJ 2021h).

The BoJ said it would raise incentives when policymakers lower the central bank’s short-term policy interest rate, potentially mitigating “the impact on financial institutions’ profits to a certain degree at the time of rate cuts” (Kuroda 2021, 6–7). The more a bank makes qualifying loans, the more funds in that bank’s current account that will receive a 0.2% interest rate, offsetting the impact of the given negative rate.

The central bank did not charge fees for SFSO loans (BoJ 2021f).

The SFSO’s terms limited maturities to a year (BoJ 2021f), but the central bank in practice used shorter-term maturities, initially three months and later extended to six months (BoJ 2021j). The GFC SFSO, in contrast, provided one- to three-month loans (Buchholtz 2020).

The BoJ required that financial cooperative parent organizations ensure adequate credit risk standards of their member financial institutions that received SFSO funding. BoJ officials reserved the right to suspend loan disbursements to parent organizations if they did not adhere to SFSO rules (BoJ 2020j).

The central bank did not appear to impose restrictions on other SFSO participants. Overall, the BoJ reserved the right to exclude otherwise eligible counterparties from SFSO participation if the central bank deemed the measure prudent (BoJ 2021f).

This key design decision does not apply to the SFSO.

This key design decision does not apply to the SFSO.

BoJ officials planned to stop accepting new applications for loans through the SFSO on March 31, 2022 (BoJ 2021i). Policymakers extended this deadline multiple times since the SFSO’s initial activation (see Figure 1).

During the April 2020 monetary policy meeting, BoJ Governor Haruhiko Kuroda asked BoJ staff to consider measures that would enhance the central bank’s easing policies and support Japanese businesses (BoJ 2020i). Days before an unscheduled Policy Board meeting in which the SFSO’s deadline was extended to March 2021, Governor Kuroda publicly expressed concerns that corporate financing conditions were not adequately accommodative, citing rising commercial paper issuance rates and broad deterioration in financial positions across firm size (Kuroda 2020a; BoJ 2020h). He said that because “the economy [was] in an increasingly severe situation, the stress on the financial system [had] been growing in Japan” and though “tension in financial markets [had] abated somewhat, the markets have remained nervous due to a decline in liquidity” (Kuroda 2020a, 3).

The BoJ in December 2020 extended the SFSO’s deadline six months to September 30, 2021, because Policy Board members predicted that business financing conditions would remain stressed because of the government’s continued COVID-19 mitigation measures (BoJ 2021g). The Policy Board in June 2021 extended the program’s duration another six months to March 31, 2022, because the move would “indicate its direction to financial institutions early and give a sense of security, mainly to firms that received loans from these institutions” (BoJ 2021i, 17; 26).