Developments in the Japanese Money Markets and their Functioning with Excess Reserves

While implementing a variety of unconventional monetary policy measures, the Bank of Japan has provided ample reserves that far exceed the levels of required reserves for most of the past 25 years. This report assesses the impact of the unconventional monetary policy measures on the money markets by looking back on the rate formation and transaction trends in the money markets with such excess reserves. The money markets are expected to function as (1) the starting point of the yield curve and (2) a place to adjust the excess and shortage of funds. With excess reserves, the importance of the latter function is considered to be declining. However, there is a growing importance of ensuring the uncollateralized call market consisting of diverse participants with a certain transaction volume, given the role which the uncollateralized overnight call rate (TONA) has taken as an interest rate benchmark in recent years. The period in which unconventional monetary policy measures were taken can be broadly divided into (1) the quantitative easing period from 2001 to 2006 (the first phase), (2) the period from the introduction of the complementary deposit facility in 2008 to the introduction of the negative interest rate policy in 2016 (the second phase), and (3) the negative interest rate policy period from 2016 to 2024 (the third phase), based on the interest rate on excess reserves. In the first phase, in which the complementary deposit facility did not exist and a zero percent interest rate was applied to excess reserves, trading incentives were lost in the uncollateralized call market, and the functioning of the market declined. In the second phase, the complementary deposit facility was introduced, and trading incentives arose between financial institutions eligible for the facility and those not eligible. Under these circumstances, the functioning of the uncollateralized call market gradually recovered and was maintained in the third phase as well. Meanwhile, the functioning of the GC repo market was also maintained in terms of rate formation and transaction trends. Following the decision to change the monetary policy framework in March 2024 and the termination of the negative interest rate policy, the money markets transitioned smoothly from the world of "negative interest rates" to the one with "positive interest rates." The fact that participants in the uncollateralized call market were diversified, resulting in the expansion of trading networks in the third phase, among other factors, has contributed to the smooth transition. Given the role which TONA has taken as an interest rate benchmark in recent years, in addition to the fact that the Bank set the short-term interest rate as its primary policy tool, it is becoming ever more important that the functioning of the money markets remains robust. The Bank intends to continue to carefully monitor the rate formation and trading trends in the money markets and pay attention to the market functioning.