BOJ to slice almost $672 billion off balance sheet to decrease liquidity in economy

TOKYO – The Bank of Japan (BOJ) made a significant step towards shrinking its massive balance sheet in the week of Jan 20, while market watchers were fixated on the biggest interest rate increase from the central bank in 18 years. 

The BOJ decided on Jan 24 to offer no new lending from July under its fund-provisioning programme to stimulate bank lending. The programme’s outstanding loans stood at ¥77 trillion (S$672 billion) as at Jan 20, accounting for around 10.4 per cent of the central bank’s overall balance sheet, according to BOJ data.   

The phasing out of the loan programme underscores BOJ governor Kazuo Ueda’s determination to slowly but steadily proceed with the normalisation of policy after more than a decade of radical monetary easing. 

All the outstanding loans are now set to expire in early 2028. January also marks the final month for the purchase of commercial paper and corporate bonds, a move first flagged in March 2024. That is another 6.5 trillion yen that will disappear from the balance sheet by January 2028. 

Together with last year’s decision to cut the purchase of government bonds, the central bank has now secured ways to trim its enormous balance sheet by more than 15 per cent it proceeds with quantitative tightening. 

“Although it got little attention, ending the funding programme is a big decision,” Mr Kentaro Koyama, chief Japan economist at Deutsche Securities, said earlier this week.  

The need to undergo quantitative tightening is not unique to the BOJ. Many of the bank’s global peers have already been trimming balance sheets that became bloated during the pandemic as priorities changed from supporting the economy to battling inflation. But the relative scale of the BOJ’s holdings, at 126 per cent against the size of the economy, towers above that of the Federal Reserve or the European Central Bank at closer to 30 per cent of gross domestic product.

Still, the Fed’s experience points to potential risks ahead for the BOJ as it tries to reduce its balance sheet without spooking markets. 

The Fed started tightening in 2022, but in June 2024, policymakers were forced to slow the pace of unwinding, amid growing concerns over the asset run-off roiling short-term funding markets. 

After the stand-pat decision on Jan 29, Fed chair Jerome Powell reiterated the Fed’s readiness to adjust the details of its balance sheet reduction approach if needed to ensure the smooth transition of monetary policy in the light of economic and financial developments.

Mr Powell has sliced about 24 per cent off the Fed’s balance sheet since it hit its peak in April 2022, according to Bloomberg data. 

Mr Koyama, a former BOJ official, says the scrapping of the loan programme will reduce demand for government bonds used as collateral, a factor that might push up yields. The move will nudge the banking sector to search for alternative stable funding sources and may also exert upward pressure on short-term interest rates due to a decrease in the monetary base, he wrote in a report.

All outstanding loans from the lending programme are expected to be wiped off the BOJ’s books by March 2028. The central bank’s balance sheet stood at ¥740 trillion, according to the latest data.

In the BOJ’s portfolio, long-term government bonds account for about 79 per cent, while the share of exchange-traded funds calculated at book value is 5 per cent, according to central bank data. 

The BOJ’s first major quantitative tightening step took place in July 2024 when it decided to slash bond buying by ¥400 billion every quarter. The bank estimated the move would shrink its bond holdings by about 7 per cent or 8 per cent through the first three month of 2026.  

The lending programme dates back to October 2012 when former governor opted to provide long-term funds to banks. At the time, Mr Shirakawa stressed it was an “unlimited” programme, moving shortly after the European Central Bank’s decision to buy an unlimited amount of government bonds during the European debt crisis. 

Back then, the BOJ initiative was viewed by many investors as an effort to escape criticism that it was not embarking on more ambitious monetary stimulus.  

After multiple tweaks in the program over the years, the duration of the loan offering was cut to one year from four years last March, when the central bank decided to call time on the massive monetary easing programme introduced by Mr Shirakawa’s successor, Mr Haruhiko Kuroda. BLOOMBERG