'Japan Premium' Continues for TIBOR vs. LIBOR

The expression ‘Japan Premium’ gained popularity following the failure of Hyogo Bank in 1995 and collapse of Yamaichi Securities in 1997.  In 1997, the TIBOR (Tokyo Interbank Rate) overseen by the Japan Bankers’ Association (JBA) the rate at which Japanese banks (mainly city banks) lend to one another, rose to 30-35 bps higher than LIBOR (London Interbank Offered Rate) which is set by the British Bankers’ Association. Since about ¥100trn of Y433trn in bank lending (with more derivative transactions tied to LIBOR/TIBOR) is priced off of Tibor, one has to ask why the ‘premium’ still exists where the financial position of Japan’s banks is no longer an issue. This discrepancy also undermines the efficacy of the BOJ’s new negative interest rate policy.

A 2002 study suggested that the premium was due to declining long-term JGB yields, a flatter yield curve and weaker bank share prices, which all served to raise the risk premium. [1] Some regulators blame the discrepancy on the pedantic nuance, where  London bankers are being asked ‘what they think they have to pay’ as opposed to ‘what they think the prevailing rate is’ in Tokyo. However, some have alleged that TIBOR rate setting involves some collusion.[2]

This premium is all the more surprising given the publicity received from the Yen Libor fixing probe which saw heavy fines for Deutche Bank, UBS and Barclays (among others) for allegations of price fixing between 2005-2009.

One of the main objectives of increasing the ‘excess reserves’ in the BOJ’s ‘current account reserves’ is to ensure that banks follow the central bank’s policy rate. In the case of Japan or the ECB, the rate on  excess deposits becomes a floor for interbank overnight lending where the central bank tries to keep interbank lending close to the lower bound to have an effective interest rate policy. Japan’s excess reserves (the reserves in excess of mandatory reserves and special lending commitments) has averaged ¥178trn over the last 3 months, well above the ¥30trn, or so, we calculate as necessary to maintain bank discipline within the lower bound of -10bps. Still the fact that TIBOR is 18bps above the floor is surprising as I had expected the gap to come down to 10bps, for a TIBOR of close to zero. For reference, Euribor  rates are currently hovering at -18bps compared to the ECB deposit rate of -30bps. While Eonia overnight bank rates have been hovering around -25bps, only 5bps above the ECB deposit facility of -0.30%.

Meanwhile the premium for interbank rates over the 3 mo. Interest swap swap has expanded as banks factor in further cuts to deposit rate in the future.

 


[1] Vicentiu Covrig, Buen Sin Low, Michael Melvin, A Yen is Not a Yen: TIBOR/LIBOR and the Determinants of the Japan Premium

[2] FT March 19, 2014, FT February 16, 2013


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