Never Go Full-Kuroda: NIRP Plus QE Will Be Contractionary Disaster In Japan, CS Warns

In late January, when Haruhiko Kuroda took Japan into NIRP, he made it official.

He was full-everything. Full-Krugman. Full-Keynes. Full-post-crisis-central-banker-retard.

In fact, with the BoJ monetizing the entirety of JGB gross issuance as well as buying up more than half of all Japanese ETFs and now plunging headlong into the NIRP twilight zone, one might be tempted to say that Kuroda has transcended comparison to become the standard for monetary policy insanity.

The message to DM central bank chiefs is clear: You’re either “full-Kuroda” or you’re not trying hard enough.

But as we’ve seen, the confluence of easy money policies are beginning to have unintended consequences. For instance, it’s hard to pass on NIRP to depositors without damaging client relationships so banks may paradoxically raise mortgage rates to preserve margins, the exact opposite of what central banks intend.

And then there’s the NIRP consumption paradox, which we outlined on Monday: if households believe that negative rates are likely to crimp their long-term wealth accumulation, they may well stop spending in the present and save more. Again, the exact opposite of what central bankers intend.

In the same vein, Credit Suisse is out with a new piece that explains why simultaneously pursuing NIRP and QE is likely to be contractionary rather than expansionary for the real economy in Japan.

In its entirety, the note is an interesting study on the interaction between BoJ policy evolution and private bank profitability, but the overall point is quite simple: pursuing QE and NIRP at the same time will almost certainly prove to be contractionary for the Japanese.

Here’s how the chain reaction works.

Obviously, as the term spread narrows, bank margins are pinched. NIM at Japanese banks has plunged over the past decade and the correlation between that decline at the flattening 2s10s spread is noticeably strong:

As CS goes on to note, “flattening of the JGB yield curve has also affected the duration of bank liabilities.”

In short, as the spread between term deposits and demand deposits narrowed, it made no sense for depositors to keep their money tied up for longer. So what did they do? Well, they just shifted to demand deposits:

Of course that’s bad news for banks because it increases liquidity risk.

Demand deposits are due.. well.. on demand and so, to the extent you were offsetting some of your maturity mismatch (which is inevitable in fractional reserve banking, but which must nonetheless be managed) with term deposits, the shift forces you to change the composition of your assets. Or, as Credit Suisse puts it:

This means that banks now face greater liquidity risk on the liabilities side of their balance sheets and must therefore invest in more liquid assets. Banks thus have a strong incentive to hold (highly liquid) JGBs while finding it harder to lend at relatively high interest rates to relatively high-risk businesses that are in need of funds. This is likely to have been another factor behind tightening of interest spreads. Of course, the fact that banks have grown more reluctant to lend is also an important problem in its own right.

You can probably start to see where this is going.

The flattening yield curve (the result of QE) had already put enormous amounts of pressure on bank margins. Because, as Credit Suisse puts it, “retail deposit rates exhibit greater downward rigidity than loan rates,” NIRP only pinches those margins further. That is, as the BoJ moves further into NIRP, the only thing moving lower for banks is what they can charge on loans. There’s no passing the cost on to depositors. In a rare moment of sellside conciseness, Credit Suisse puts it thus:

The bottom-line is that the BoJ's simultaneous pursuit of the NIRP and the QE (quantitative easing) or aggressive long-term JGB buying, which is likely to lead to further flattening of the JGB yield curve, would make private banks increasingly less confident in their future earnings and therefore weaken their capacity to make loans over the medium run. As the term spread has narrowed by roughly 10bps since the BoJ announced the introduction of the NIRP, there appears to have been some 0.4% of contractionary impact on bank loans in the pipeline.


Unfortunately private banks are implicitly being asked to bear the burden of negative interest rates, with various policymakers having indicated that they do not want to see negative rates imposed on retail depositors. Banks have responded by lowering term deposit rates so that they are now on a rough par with ordinary deposit rates at only just above zero, which is likely to catalyze a shift out of term deposits into ordinary deposits that will saddle banks with greater liquidity risk on the liabilities side of the balance sheet. This mechanism is ultimately likely to impede financial intermediation, thereby having a contractionary impact on credit.

"Unfortunate", indeed. 

What this means is that Kuroda has now managed to ease and expand his way into a contractionary tightening. And by the way, it's not only the NPL problem that plagues European banks. There are also very real concerns about the effects NIRP will have on profitability. There's every reason to believe that the same dynamic described above will apply there as well. 

The lesson: you never, ever go full-Kuroda.

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