TOKYO (Reuters) - A largely overlooked scheme created by the Bank of Japan to mitigate the drawbacks of its massive stimulus programme may become the central bank’s new weapon to stimulate the economy, sources familiar with its thinking says. The key takeaways from a policy review last month were steps to tiptoe away from a radical monetary experiment that has sought, but failed, to fire up inflation through decades of heavy money printing. Drawing less attention was the creation of a new “interest scheme to promote lending,” a highly technical programme aimed at compensating banks for the hit from negative interest rates. Offsetting the negative rate charge, the scheme will pay banks varying rates for taking up cash from the BOJ, depending on the purpose of the loans they make. The key aim was to convince markets that with tools available to deal with the side-effects, the BOJ can take rates deeper into minus territory to combat economic shocks. But the scheme also gives the BOJ discretion over which sectors to divert money to, making it a potentially useful tool to assist initiatives such as green investment, say four sources familiar with its thinking. The move underscores how the BOJ, left with a dearth of monetary tools, is veering closer to fiscal policy to spur growth in an economy hit by the COVID-19 pandemic. “This scheme has the potential to become the BOJ’s new tool,” said one of the sources. “It can be used to incentivise or promote lending for certain growth areas.” While the BOJ does not plan to deploy such new targeted lending anytime soon, it is an idea being brain-stormed as a future possibility, the sources say. “The BOJ can choose timely themes like green, and pay higher interest to lenders,” another source said. The plan also highlights how the BOJ’s policy is geared toward aligning with government goals, even if Prime Minister Yoshihide Suga’s administration isn’t directly guiding the central bank. Nodding to Suga’s policy priorities, deputy governor Masazumi Wakatabe has said the BOJ must “scrutinise and debate” ways to promote a green and digitalised Japan. “With the scheme, the BOJ probably wanted to appeal to the government that it’s doing its part to support the economy,” said former BOJ board member Takahide Kiuchi. (Click here tmsnrt.rs/3a3ju1N and here tmsnrt.rs/3wEmknB for interactive graphics on the central bank"s total lending and the country"s core consumer prices) (Graphic: Japan"s bank lending spikes as COVID-hit firms hoard cash, ) (Graphic: Inflation remains distant from BOJ"s 2% target, ) The European Central Bank also pays banks to tap its cash coffers to cushion the blow from negative rates. What makes the BOJ’s scheme unique is the three-layered structure where loans qualifying as “high priority” receive higher interest. If the BOJ deepens negative rates, the interest reward rises in tandem. It was an idea the BOJ had been studying internally for years amid criticism over its negative rate policy, sources say. The BOJ now uses the scheme only for COVID-19 relief. But it can add new type of loans even before deepening negative rates. The tool may allow the BOJ to more efficiently pump money to areas in need, and respond to future government pressure for stronger action to protect the economy. By approaching the realm of fiscal policy, however, the BOJ risks undermining its independence from political interference. Markets are also suspicious the scheme would allow the BOJ to more easily cut rates, or help meet its elusive inflation target. “It’s better than nothing but not enough to boost lending,” said Satoru Kado, an analyst at Mitsubishi UFJ Research and Consulting. “Bank profits won’t improve unless short-term rates rise more. That’s something the BOJ has not addressed and probably won’t be able to do so in the foreseeable future.”