Dollar Funding Costs Decrease as BOJ Expands Support Scheme for Japanese Banks – Reuters

By Hideyuki Sano and Yoshiko Mori

TOKYO – Funding costs in dollars for Japanese banks have seen a significant decrease following the Bank of Japan’s recent decision to bolster its support for these institutions. This move has emerged as a somewhat overlooked triumph amidst the central bank’s broader stimulus efforts, which have been met with mixed reactions.

Last Friday, the Bank of Japan announced that it would double the size of one of its dollar lending programs, increasing it to $24 billion from the previous $12 billion. This lending facility, active since April 2012, allows for the borrowing of dollars for a period of one year, with the possibility of rollover for up to four years.

The surprise decision led to a decline in the dollar/yen basis swap spreads, which represent the premium that Japanese banks incur when borrowing dollars. Hiroko Iwaki, a senior fixed income strategist at Mizuho Securities, noted that while the central bank’s actions contributed to the narrowing of the spreads, they would not completely eliminate the pressure associated with dollar funding. Iwaki anticipates that the spreads will remain at relatively high levels.

The one-year dollar/yen basis swap spread, which indicates the cost of exchanging yen for dollars over a year, fell to approximately 70 basis points from around 77 basis points before the Bank’s decision. Similar reductions were noted for shorter maturities as well. Over recent months, the one-year spread has been expanding from a low of about 50 basis points earlier in the year and around 15 basis points in early 2014, largely due to an increased demand for dollars from Japanese banks.

Japanese banks have been actively acquiring dollar-denominated assets, such as U.S. Treasuries, mortgage bonds, corporate bonds, and project finance opportunities, as they have sought to move away from negative-yielding Japanese government bonds. Despite many banks being hesitant to tap into the Bank of Japan’s lending scheme due to the perceived stigma, the central bank’s actions have provided some reassurance that it stands ready to assist with dollar funding requirements.

The reduction in spreads was also influenced by the Bank of Japan not opting for a deeper cut in interest rates, which some market participants had been apprehensive about. Many investors were concerned that a move toward more negative rates could diminish the attractiveness of domestic bonds and drive Japanese investors to acquire foreign assets, subsequently increasing their dollar funding needs.

For many Japanese investors, borrowing in dollars for international investments is preferred over selling yen for dollars to avoid exposure to currency fluctuations.