BoJ’s equity ETF purchases may be diluted by stock lending

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Despite slowing down purchases due to consumer price inflation rising above 3%, the BoJ continues to use ETFs as a tool in its monetary policy. Most recently, it purchased ¥70 billion ($470 millionn) of ETFs following a stock market drop triggered by a spike in US Treasury yields.

However, research conducted by Koji Takahashi from the Bank for International Settlements and two other academics suggests that the benefits of this policy may be diluted by stock lending by the ETFs in which BoJ invested. Their study indicates that BoJ’s purchases increase demand for individual stocks within ETFs, potentially leading to equity overvaluation or liquidity shortages. This might encourage hedge funds and others to borrow stock to short these overvalued equities.

The researchers argue that BoJ’s purchases have led to an increase in lendable stocks, as the ETFs it has invested in could lend their holdings to short sellers to generate extra revenue. This could lower stock lending fees, making shorting more appealing, which could counteract the upward momentum initiated by BoJ’s initial purchases.

The study found a significant relationship between the amount of BoJ’s ETF purchases and lendable shares. Over time, the BoJ’s accumulated purchases have lowered lending fees in the stock lending market and weakened the effects of its purchases on stock returns, thereby diminishing the policy effect of the ETF purchase programme. This effect was significant for “special” stocks and equities with limited availability in the stock lending market, where dilution was as high as 30%.

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