TOKYO -- About half of dollar funding provided to global central banks by the U.S. Federal Reserve in response to pandemic-triggered liquidity concerns have gone to Japan, where banks are hungry for the greenback due to their expanding operations abroad.
Outstanding cross-currency swaps stood at $447 billion as of Thursday, according to the Federal Reserve Bank of New York. The Bank of Japan was the biggest taker on the list by far with $222 billion, about 50% more than the second-ranked European Central Bank at $145 billion. The difference was even more pronounced compared with others on the list, like the Bank of England at $23.1 billion.
The Fed has greatly expanded its liquidity swap programs, in which the U.S. central bank accepts other currencies in exchange for dollars, since March, when the coronavirus' spread in the U.S. fueled global concerns over dollar supply. It is now offering dollar swaps with an 84-day maturity to the BOJ, ECB and other major central banks, and has increased the frequency of seven-day operations as well.
Central banks then lend these dollars to private-sector lenders. The BOJ's heavy participation in dollar swaps "show there is a much stronger demand for dollars among Japan's banks than among their foreign counterparts," said Izuru Kato at Totan Research.
The BOJ conducted a liquidity pumping operation on Tuesday, offering thee-month dollar funding. Banks snapped up about $16 billion, just over half the amount from the previous operation in March, which is now approaching maturity.
"The demand for dollars is not as high as it once was, but concerns over the dollar supply persists," said Ayaka Nakamura at the Daiwa Institute of Research.
Japan's international credit balance, which represents lending and securities investment made overseas by Japanese banks, came to $4.6 trillion at the end of 2019, according to data from the Bank for International Settlements analyzed by the Daiwa Institute. This was 30% higher than the U.K., which had the next-highest balance.
Following the 2008 global financial crisis, the majority of the Fed's liquidity swaps went to the ECB, with the BOJ accounting for just about 20%.
But Japanese banks are now aggressively lending and investing around the world, due to a shrinking market and ultralow rates at home, even as European banks cut back their operations in light of the pandemic.
"Honestly, I don't know what we would have done without the BOJ's dollar injection," said a source at one regional Japanese bank. Many regional banks have offered syndicated loans with megabank partners or invested into bonds overseas. A shortage of dollars would have forced them to make major cutbacks to these efforts, which have become a critical source of revenue.
Meanwhile, the Fed has ramped up its supply of the dollar to ensure foreign players do not dump U.S. government bonds to secure the currency, since this could drive interest rates up and squeeze the American economy. But the injections are a temporary measure, and do not address greater concerns regarding Japanese banks' access to the dollar.
"The extreme demand among Japanese banks could become a political problem with the U.S.," said an official at the Japan Financial Services Agency. The Fed could cut back on its swaps now that the U.S. financial market is settling down from the coronavirus. Japanese banks will have a difficult time finding an alternative source for the $220 billion it gained access to through the swaps via the BOJ.
"This experience has highlighted how reliant Japanese banks are on central banks for dollars in an emergency," said Kentaro Koyama at Deutsche Securities.