Bank of Japan paying banks to lend

In its decades-long effort to prod financiers to loosen up and lend more to defeat deflation, the Bank of Japan (BOJ) is trying a new tack: incentivizing them with bonuses. Talk about a language that bankers can understand, even in aging, hyperconservative Japan. Early indications are that the plan is working, incentivizing BOJ Governor Haruhiko Kuroda to expand the strategy.

Risk-averse Japan doesn't do shock-and-awe. It's been four-and-a-half years since the BOJ surprised markets in the slightest. That was in early 2016, when the BOJ began an experiment with negative interest rates that is still backfiring on the financial sector.

The idea was simple. The deeper borrowing costs drop into the red, the greater the amount of liquidity pouring into banks. The initial policy announcement didn't slam markets at first. In the years since, though, it became clear negative rates hurt bank profits and actually reduced confidence to lend.

The real bread and butter for banks is working the spread between short- and longer-dated securities. Banks borrow cheaply using, say, three-year debt and lend at a higher rate for seven, 10 or 20 years.

When pretty much all rates are below zero, what's the point? So banks shovel their cash into government bonds. That helps no one.

Hence the BOJ's bonus scheme, whereby it's effectively paying banks to extend credit. Especially those in rural areas hurting long before Covid-19 showed up. The last decade has seen an accelerating mass migration to Tokyo and Osaka, where the biggest and healthiest companies tend to be clustered. This hollowing-out dynamic reduced growth in dozens of Japanese prefectures, hitting tax revenues. They also reduced profits at Japan's roughly 100 regional lenders.

Many of these institutions, some 100 years old or more, are the place where BOJ largess goes to die. To catalyze lending, the BOJ is offering banks a sweetener: an extra 10 basis points, or 0.1%, for banks lending money. As a result, banks are stepping up to do just that. So far banks have received about US$250 billion through the BOJ initiative.

That amount is comparable to the number of bank deposits on which the BOJ imposes negative rates.

As of the end of July, total lending by banks and large credit unions jumped 6.3% versus a year earlier, achieving a record $5.4 trillion. That's the fastest pace since at least 2001.

And it's broad-based. Lending among the largest banks jumped 7.8% in July. Regional banks ramped up lending by 5.1%. For that latter category that is really something and this is the biggest increase since 1991.

It's "one of the most effective policy moves the BOJ has made in recent years," says economist Takehiro Noguchi of Mizuho Research.

There's talk in BOJ circles of expanding the program to increase its monetary firepower. And the enterprise offers a timely roadmap for government officials as coronavirus fallout slams Japan Inc.

With the economy contracting at a 27.8% annualized rate and 7.8%, quarter-onquarter in Q2, and Covid-19 cases on the rise, the next four months heading into 2021 are likely to be a gloom-a-thon.

The roughly $2.2tr of stimulus Prime Minister Shinzo Abe's government is throwing at traumatized businesses and households has already proven unequal to the problem.

One issue with all this spending, equivalent to 40% of gross domestic product, is a lack of focus.