TOKYO -- Concerns are growing in Japan's financial sector that the Bank of Japan may decide to push interest rates further into negative territory at a two-day policy board meeting that starts Tuesday.
Banks are considering setting a floor of zero on lending rates even if the BOJ decides to cut rates further. That could constrain the central bank in its effort to further ease credit. Lowering rates further would hurt bank profits and could destabilize the financial system.
"It may be extremely tough work to avoid having loan rates fall into negative territory," a lending official at a major bank said. That is a valid concern. Base rates on loans to corporate borrowers may drop below zero if the BOJ lowers its own rates further.
The Tokyo interbank offered rate is usually used as a base rate for loans to big companies.
The outstanding balance of loans based on Tibor is close to 100 trillion yen ($975 billion). For long-term loans of more than one year, banks often charge interest on principal based on three- and six-month Tibor rates.
Since the BOJ introduced the negative rate policy in February, rates on the call money market -- interest rates on short-term loans to brokers --have fallen from 0.1% per year to minus 0.1%, resulting in a drop in the three-month Tibor to 0.06% from 0.17%. If the BOJ takes rates further below zero, the Tibor "could go underwater," a banking official said.
Don't be so negative
If Tibor rates fall into negative territory, banks will have to pay, rather than receive, interest on the money they lend. Banks extend loans to corporate borrowers out of funds collected from depositors, but they are reluctant to cut deposit rates below zero. That would cause a fierce backlash from retail customers.
Banks are thus hoping to persuade corporate borrowers that they cannot set lending rates below zero even if Libor rates fall into negative territory. The London Interbank Offered Rate, which is often used to calculate rates on international loans, is already below zero and some companies have reportedly agreed on zero rates for their loans.
But as major Japanese banks each have extended tens of thousands of Tibor-based loans, negotiations with borrowers over lending rates "could get into a mess," said a senior BOJ official.
Haruhiko Kuroda, the central bank governor, said there is "still ample space" for further cuts in the negative interest rates, though he recognizes the adverse effect on financial institutions.
But if banks and corporate clients agree on zero lending rates, the BOJ's deeper cuts would lose their punch. The BOJ will need to thoroughly analyze the pros and cons of more negative rates before making its next move.