When it comes to accounting conventions, the Fed and the BOJ differ in one major way: unlike the Federal Reserve, the BOJ counts its bond holdings at the purchase price, minus amortization costs. In the old days before NIRP this wasn't an issue because with positive yields, it meant that with time, the value of any central bank bond purchases would accrete through maturity and never lead to a booked loss; however under NIRP, it means that the BOJ is purchasing hundreds of billions in bonds at prices that are so high they guarantee a loss, meaning that by maturity the central banks will face a cumulative loss on the face value of recent bond purchases.
From a purely accounting standpoint, it means that a gap has opened on the BOJ's balance sheet, representing the difference between the book and face value of the central bank's monetizations.
That "gap" is the difference between the 326.7 trillion yen in BOJ bond purchases at face value, and where they are marked on the balance sheet in August, or 335.4 trillion yen. That gap is 42% bigger than before the introduction of negative rates in January, and rapidly rising. At the end of the 2015 fiscal year on March 31, the gap between the two valuations was 6.4 trillion yen and the BOJ wrote down 874 billion yen, according to documents seen by Bloomberg. That was covered by the 1.29 trillion yen in coupon income the bank received that year. However, since the coupon of all current and future purchases are negligible, the BOJ will see limited future current income, and thus will have to resort to other means to plug the balance sheet gap.
“These numbers show the distortions of the BOJ’s current policies,” said Sayuri Kawamura, a senior economist at the Japan Research Institute in Tokyo. “The annual amortization losses are going to increase and consume the BOJ’s profits, and the risk is increasing that the bank’s financial stability will be shaken.”
As Bloomberg adds, "while not an immediate problem because the BOJ’s income can cover the losses, the widening gap raises questions about the sustainability of the central bank’s bond purchases, which Governor Haruhiko Kuroda has said could be expanded."
The BOJ did not have much to say about this troubling decoupling which will eventually require the BOJ to plug the hole: Tadaaki Kumagai, a spokesman for the central bank, said “the BOJ releases half-yearly and yearly accounts,” while declining to comment further.
With the gap between the two valuations even larger now, it “would probably be a pretty safe bet” that the losses the BOJ will book for this fiscal year will increase from 2015, according to Naomi Fink, the chief executive officer of Europacifica Consulting. As Bloomberg puts it, "while when those losses may exceed its income is unknown, with the bank buying more high-price, low-income bonds, that time will probably come soon." Fink said that under some scenarios, this could even happen this fiscal year.
How much losses can the BOJ absorb? The central bank currently has 2.69 trillion yen in a reserve to draw on to pay for bond losses.
“In preparation for an eventual exit from stimulus, the BOJ last year started adding to its reserves to guard against bond losses, but if profits decline, there’s a chance that they won’t be able to continue that,” Japan Research Institute’s Kawamura said. “It’s a pretty dangerous situation now, even before they start to exit."
At the current pace it is virtually assured that the BOJ's reserves will be depleted in the not too distant future. At that point the BOJ will have to approah the government to change legislation, allowing it to short up capital for future losses. How the market will respond to such an unprecedented central bank bailout is unknown.