Dollar funding costs drop after BOJ doubles up scheme to support Japanese banks

TOKYO (Reuters) - Dollar funding costs for Japanese banks dropped considerably after the Bank of Japan last week enhanced its support for Japanese banks, a little-noticed success in the central bank’s otherwise underwhelming stimulus.

A man runs past the Bank of Japan (BOJ) building in Tokyo, Japan, July 29, 2016. REUTERS/Kim Kyung-Hoon

The Bank of Japan said on Friday it would double the size of one of its dollar lending schemes to $24 billion from the current $12 billion.

The facility was introduced in April 2012 to lend dollars for one year, with a maximum of up to four years after roll-overs.

Friday’s unexpected decision reduced the so-called dollar/yen basis swap spreads, or the premium Japanese banks pay to borrow dollars.

“The BOJ’s measures had a certain impact on the narrowing of the spreads. But this will not alleviate dollar funding pressure completely,” said Hiroko Iwaki, senior fixed income strategist at Mizuho Securities.

“I would expect the spreads to remain at elevated levels.”

The one-year dollar/yen basis swap spread JPYCBS1Y=, or the cost of swapping yen for dollars for a year, dropped to around 70 basis points from around 77 basis points before the BOJ decision.

Spreads for shorter maturities also dropped following the BOJ’s decision.

The one-year spread has been widening for many months from around a low of 50 basis points earlier this year and about 15 basis points in early 2014, due to rising dollar demand from Japanese banks.

Japanese banks have been snatching up dollar-denominated assets, including U.S. Treasuries, mortgage bonds, corporate bonds and project finance, as they turn away from negative-yielding Japanese government bonds.

While many Japanese banks are reluctant to use the BOJ scheme because of the potential stigma of relying on the central bank, the BOJ’s steps did reassure banks that the central bank is ready to help with dollar funding if they need it.

The spreads shrank also because the BOJ did not cut interest rates deeper into negative territory as some participants had feared, traders said.

Many investors had been worried that deeper negative rates would make domestic bonds even less attractive and accelerate Japanese investors’ buying of foreign assets, and so increase their dollar funding needs.

Most Japanese investors prefer to borrow dollars for overseas investments, rather than selling yen for dollars, because they do not want exposure to currency fluctuation risk.

Reporting by Hideyuki Sano and Yoshiko Mori; Editing by Eric Meijer