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Negative Interest Rates under the Quantitative Monetary Easing Policy in Japan: The Mechanism of Negative Yen Funding Costs in the FX Swap Market

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  • Shinichi Nishioka

    (Bank of Japan)

  • Naohiko Baba

    (Bank of Japan)

Abstract

This paper aims to reconsider the mechanism of the negative yen funding costs for foreign banks in the foreign exchange (FX) swap market, almost constantly observed since the adoption of the quantitative monetary easing policy in March 2001. Our main findings are as follows. First, if the no-arbitrage conditions for both domestic and foreign banks' foreign currency funding costs between the foreign currency market and the FX swap market hold, then the yen funding costs for foreign banks in the FX swap market can be written as the sum of (i) the yen risk- free interest rate, (ii) the credit risk premium for foreign banks, and (iii) the difference in the credit-risk premium for domestic banks between the yen and the U.S. dollar markets. Second, the recent negative yen funding costs for foreign banks result from the fact that the credit-risk premium for domestic banks is higher in the U.S. dollar market than in the yen market. Third, the difference in credit-risk premium between the yen and the U.S. dollar markets has existed at least since the beginning of the 1990s. As the yen risk-free interest rate has declined under the quantitative monetary easing policy, however, the difference in credit-risk premium has become marked, yielding the negative funding costs. Finally, the yen funding costs are expected to return to zero percent if foreign banks could invest in the risk-free Bank of Japan's current account balances without limits. In reality, however, the yen funding costs have remained below zero percent since foreign banks face credit lines, which limit the holdings of the current account balances.

Suggested Citation

  • Shinichi Nishioka & Naohiko Baba, 2004. "Negative Interest Rates under the Quantitative Monetary Easing Policy in Japan: The Mechanism of Negative Yen Funding Costs in the FX Swap Market," Bank of Japan Working Paper Series 04-E-8, Bank of Japan.
  • Handle: RePEc:boj:bojwps:04-e-8
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    References listed on IDEAS

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    1. Kei-ichiro Inaba & Sayako Konno & Noritaka Fukunaga & Tokiko Shimizu, 2001. "The Structure of and Recent Developments in the Short-term Yen Money Markets: Arbitrage relationship between the uncollateralized call market, the Euroyen market and the dollar/yen swap market," Bank of Japan Review Series Market Review E-series, 2, Bank of Japan.
    2. Shinichi Nishioka & Naohiko Baba, 2004. "Credit Risk Taking by Japanese Investors: Is Skewness Risk Priced in Japanese Corporate Bond Market?," Bank of Japan Working Paper Series 04-E-7, Bank of Japan.
    3. Tetsuro Hanajiri, 1999. "Three Japan Premiums in Autumn 1997 and Autumn 1998 -- Why did premiums differ between markets? --," Bank of Japan Working Paper Series Financial Markets Departm, Bank of Japan.
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    Cited by:

    1. Shinada, Naoki, 2005. "Actual factors to determine cross-currency basis swaps: An empirical study on US dollar/Japanese yen basis swap rates from the late 1990s," MPRA Paper 16425, University Library of Munich, Germany.
    2. Naohiko Baba & Yasuaki Amatatsu, 2008. "Price discovery from cross-currency and FX swaps: a structural analysis," BIS Working Papers 264, Bank for International Settlements.
    3. Baba, Naohiko & Packer, Frank, 2009. "Interpreting deviations from covered interest parity during the financial market turmoil of 2007-08," Journal of Banking & Finance, Elsevier, vol. 33(11), pages 1953-1962, November.
    4. Shinichi Nishioka & Naohiko Baba, 2004. "Credit Risk Taking by Japanese Investors: Is Skewness Risk Priced in Japanese Corporate Bond Market?," Bank of Japan Working Paper Series 04-E-7, Bank of Japan.
    5. Yasuaki Amatatsu & Naohiko Baba, 2007. "Price Discovery from Cross-Currency and FX Swaps: A Structural Analysis," Bank of Japan Working Paper Series 07-E-12, Bank of Japan.

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