JGB Yield Curve and Macro-Financial Stability: ow Would a Steeper JGB Yield Curve Affect Bank Profitability? Japan

JGBYieldCurveandMacro-FinancialStability: HowWouldaSteeperJGBYieldCurveAffectBankProfitability? Japan SalihFendoglu SIP/2023/032 IMFSelectedIssuesPapersarepreparedbyIMFstaffasbackgrounddocumentationforperiodicconsultationswithmembercountries.ItisbasedontheinformationavailableatthetimeitwascompletedinMarch2023.ThispaperisalsopublishedseparatelyasIMFCountryReportNo23/128. 2023 MAY ©2023InternationalMonetaryFundSIP/2023/032 IMFSelectedIssuesPaper AsiaandPacificDepartment JGBYieldCurveandMacro-FinancialStability: HowWouldaSteeperJGBYieldCurveAffectBankProfitability? PreparedbySalihFendoglu* AuthorizedfordistributionbyRanilSalgadoMay2023 IMFSelectedIssuesPapersarepreparedbyIMFstaffasbackgrounddocumentationforperiodicconsultationswithmembercountries.ItisbasedontheinformationavailableatthetimeitwascompletedinMarch2023.ThispaperisalsopublishedseparatelyasIMFCountryReportNo23/128. ABSTRACT:Giventhatthereisexceptionallyhighuncertaintyaroundthedomesticinflationoutlook,allowingforgreaterflexibilityinlong-termJapaneseGovernmentBond(JGB)yieldsbytheBankofJapan(BoJ)couldbeconsideredgoingforward.Againstthisbackground,thisstudyempiricallyfindsthatasteeperJGByieldcurvehelpsimprovebanks’profitability,especiallyafterayearlag,andtheoverallimpacthingesonmacroeconomicandfinancialmarketresponses.AsteeperJGByieldcurvecouldalsohavespilloversonglobalyields.Financialsectorpoliciestomitigateshort-termvulnerabilitiesincasetheJGByieldcurvesteepenscouldbeconsidered,includingbyfurtherstrengtheningengagementwithfinancialinstitutionswithrelativelyhighexposuretointerestratemovements,tobetterharnessthebenefitsinthemediumterm. RECOMMENDEDCITATION:Fendoglu,Salih.2023.“JGBYieldCurveandMacro-FinancialStability: HowWouldaSteeperJGBYieldCurveAffectBankProfitability?”IMFSelectedIssuesPaper(SIP/2023/032).Washington,D.C.:InternationalMonetaryFund. JELClassificationNumbers: C58,E52,E43,G21,G28,F32. Keywords: Termstructure,Interestrates,Bankprofitability,Cross-borderspillovers,Japan. Author’sE-MailAddress: sfendoglu@imf.org SELECTEDISSUESPAPERS JGBYieldCurveandMacro-FinancialStability: HowWouldaSteeperJGBYieldCurveAffectBankProfitability? Japan PreparedbySalihFendoglu1 1IwouldliketothanktheJapaneseauthoritiesforprovidinghelpfulcomments.Iwouldalsoliketothank,withoutimplicating,RanilSalgado,PabloLopezMurphy,PurvaKheraandHarukiSeitaniformanyhelpfulsuggestions. March2023 JAPAN SELECTEDISSUES PreparedBySalihFendoglu ApprovedBy AsiaandPacificDepartment CONTENTS JGBYIELDCURVEANDMACRO-FINANCIALSTABILITY:HOWWOULDASTEEPERJGBYIELDCURVEAFFECTBANKPROFITABILITY?2 A.Introduction2 B.DataandCharacterizationofJGBYieldCurve2 C.EmpiricalResults5 D.TakingStockandPolicyImplications8 FIGURE 1.CharacterizationoftheJGBYieldCurve4 APPENDIX I.Tables10References9 JGBYIELDCURVEANDMACRO-FINANCIALSTABILITY:HOWWOULDASTEEPERJGBYIELDCURVEAFFECTBANKPROFITABILITY?1 A.Introduction 1.Themacroeconomiclandscaperecentlyhaschanged,comparedtowhentheBoJstarteditsunconventionalpoliciesadecadeago.Tofightdecade-longdeflationandsupportthefinancialsystem,theBoJhasemployedaseriesofunconventionalmonetarypolicies(UMP)since2013,includingtheYieldCurveControl(YCC)policythatcapsthe10-yearratesat0percentwithinanarrowband(Westelius,2020).Akeychangeinthemacroeconomiclandscapeistheaccelerationininflationin2022.Whileheadlineinflationhasbeenabovethecentralbank’stargetof2percenty/ysinceApril,therecontinuestobeconsiderableuncertaintyaroundtheinflationoutlookgivenstilluncertainspringwagenegotiationsandtheimplicationsofapotentialglobaleconomicslowdown,whichcallsforgreaterpolicyflexibilitygoingforward.Concurrently,continuingmonetarypolicydivergencewithotheradvancedeconomycentralbankshasledtodeteriorationinlong-termJGBmarketfunctioning,promptingtheBoJtowidenthetargetbandfor10-yearJGByieldsinitsMonetaryPolicyMeetinginDecember2022.Dependingondatarealizations,achievingasustainedincreaseinpricesandwagescouldimplyallowingforhigherlong-termyields. 2.Tothisend,thisnoteanalyzeshowchangesintheslopeoftheJGByieldcurvecouldimpactprofitabilityofbanksinJapan.Inparticular,thenotestartswithcharacterizingtheJGByieldcurvewithafewparameters(includingtheslope)usingastate-spacemodel.Itthenutilizesbank-levelfinancialstatementsdataandestimateshowbanks’profitabilityreactstochangesintheslopeoftheyieldcurve,usingafixed-effectspanelestimationbasedonhistoricaldata.Thenoteexaminesotherissues,includinglaggedeffects,heterogeneityacrossbanks,spilloversfromtheJGByieldcurvetotheUSTreasuryyieldcurve(andviceversa),andconcludeswithpolicyimplications. B.DataandCharacterizationofJGBYieldCurve 3.TheJGByieldcurvehasingeneralbeenlowercomparedtoearlierperiods,withthecurveflatteningovertimeandthensteepeningmorerecently(Figure1chart1).Thedatacomprisesofconstant-maturityyieldsofJGBs,withmaturitiesrangingfrom3monthsto30years,startingfromJanuary2000tillOctober2022.2Chart1showsthattheJGByieldcurveasawholeislowercomparedtopreviousperiods,andtheslopeofthecurve(thedifferencebetweenlong-andshort-endofthecurve)flatterovertime,especiallyaftertheBoJ’sUMPs,butincre