TOKYO -- The Bank of Japan's unprecedented buying of exchange-traded funds leave the central bank increasingly vulnerable to a stock market downturn when it comes.
The BOJ held a staggering 20.3 trillion yen ($182 billion) worth of Japanese-equity ETFs as of Sept. 30, up 4.4 trillion yen from six months earlier, data released Tuesday shows. That figure is 2.5 times the bank's capital of 8.1 trillion yen and could top 3 times by the end of the fiscal year next March.
This growth reflects both the volume of the bank's buying and an ongoing stock market rally. The BOJ has been buying ETFs as a tool for achieving its 2% inflation target, and in July 2016 raised the pace of purchases to 6 trillion yen a year from 3.3 trillion yen. No end to the program appears in sight.
With the stock market trending upward over the last five years, the market value of the BOJ's ETF portfolio has stayed above the book price. Unrealized gains reached a record-high 4.2 trillion yen at the end of September. But the risks associated with this shopping spree are ever increasing.
Under its accounting rules, if the market value of the BOJ's ETF holdings falls short of the book value, the bank sets aside the amount of the decline as a reserve. This would undercut the bank's capital even if ETFs are not sold off.
That risk cannot be ignored. In recent weeks the BOJ has been grabbing large amounts of ETFs with share prices at high levels, pushing up the average purchase price. Estimates show that the market level where the central bank's paper gains would turn to losses lies at around 16,000 for the Nikkei Stock Average, compared with the index's current level of around 22,500. The longer the central bank continues buying, the higher this break-even point will rise.
With Japan's inflation rate remaining below 1%, the BOJ shows little inclination to rethink its ETF purchases. But at its monetary policy meeting in October, a board member did call for examining the program's effectiveness and side effects "from every angle." The bank is indeed starting to pay attention to the long-term consequences of its unconventional purchases, including how they distort share prices.
The BOJ's finances could come under pressure during a future tightening cycle. Concerns are also growing about negative spreads, where interest payments to commercial banks on their deposits at the central bank exceed the interest income on government bonds. In the six months ended in September, the BOJ booked 227.9 billion yen of 597.2 billion yen in interest income as a reserve.
The BOJ's capital ratio stands at 8.12%, near the lower end of the 8-12% range indicating strong financial health. A weakening capital base at the central bank "could have an adverse impact on currency stability," warns Takahide Kiuchi, a former BOJ board member who notably dissented with aspects of the bank's monetary easing under Gov. Haruhiko Kuroda.