Japan-overnight call rates surged above the BOJ's 0.75 percent ceiling this week as Huge advance in Yen occurred.
Foreign fund demand keeps Japan call market tight (the EuroYen short term money Capital is in London)
Friday, March 02, 2007 1:08:48 AM (GMT-06:00)
Provided by: Reuters News
By Chikako Mogi
TOKYO, March 2 (Reuters) - Periodic surges in Japan's overnight call rate caused by strong foreign demand for cash will likely persist as foreign banks take advantage of arbitrage chances that more cautious Japanese banks are shying away from.
For now Japanese banks have shown little interest in pursuing arbitrage strategies in money markets as the Bank of Japan is seen slow to lift interest rates further after last week's increase to a decade-high 0.5 percent.
Discrepancies between overnight rates in Japan and those in the euroyen market, where short-term yen funds trade in London, have allowed some more aggressive foreign banks to make money on the difference, but by doing so they make Japan's call market more volatile.
The occasional overshoots in call rates due to the foreign bank funding needs, when they come at the end of the month or on other regular fund shortage days, have been and will continue to be a distraction for the BOJ's market operations, traders say.
"If they have ample funds and see funding costs as cheap comparable to returns on their assets, then there is nothing wrong with what they are doing," said a treasury official at a big Japanese bank. "It makes perfect business sense."
Some of the banks with deep access in both the euroyen and Japanese call markets can profit by doing what's called "short funding," whereby they lend yen funds in the euroyen market where overnight rates tend to be higher. Then the next day in Japan, they cover those short positions by borrowing in the call market.
The profit comes from the difference between Japan's relatively low overnight rates and those in the euroyen market. Late last year, that difference was chronically around 20 basis points, widening at one point to about 40 basis points.
This week, overnight call rates surged above the BOJ's 0.75 percent ceiling for interbank lending rates because some European banks, which failed to raise enough overnight yen cash in the euroyen market, tapped funds in Japan's overnight call market.
Currency moves also affect swings in overnight call rates, though experts were cautious about linking it to the carry trade because funds are used for various purposes beyond such trade, in which investors fund in low-yielding currencies like the yen to buy higher-yielding currencies and assets.
PROBLEM WITH JAPANESE BANKS
Japan's overnight call market will not be so vulnerable to unpredictable swings in foreign demand for funds if more Japanese banks offer funds to foreign banks on any jump in rates.
Japanese banks have recently returned to financial health after struggling for years under the weight of bad loans, and "mega" banks have yet to put their houses in order after a string of mergers.
"Japanese banks don't have the mentality of taking risks and raising profits from market dealings," said Masayuki Ebira, director of money markets at Barclays Capital.
Analysts said such structural hurdles as sectionalism within Japanese banks may be preventing interactions between money and currency sections or networking between a bank's domestic and overseas bureaus, making cross-border arbitrage inefficient.
"We realise there is profit opportunity in these arbitrage dealings, but our risk management guidelines and credit line limits don't allow us to offer funds in the overnight call market at the high rate and huge amount demanded by foreign banks," said a money market dealer at a big Japanese bank.
Profiting from such money market arbitrage involves ample funds, which Japanese banks can't set aside as they don't have departments specialising in such money dealings that require global cooperation from an institution, bankers said.
Other factors that stand in the way of easing upward pressure on call rates include an inactive repo market, which puts more pressure on banks to seek funds in the overnight call market.
The BOJ is now studying how to revitalise the repo market.
Ebira said foreign banks also need to be more risk-sensitive.
"They are simply lending at a spread over their funding without scrutinising how much cost they are paying," he said.
What is typical about these foreign fundings is that they are large in size and are actively done by European, not U.S. banks.
"Compared to U.S. banks, European banks seem to be more lax about expanding balance sheets and not too strict about cost-effectiveness when they aggressively chase after any profit opportunities," a monetary official said.
Why these European banks need so many yen has puzzled dealers and experts, except that yen assets held by foreigners have grown over the past few years and currency swaps also seem to play a role.
Funding needs vary depending on positions held by their clients, such as hedge funds, whose purpose may be to secure cash liquidity to cover sudden losses, some experts said.
Average outstanding volume of call money trades by foreign banks was 7.2 trillion yen ($61 billion) in January, the highest since the BOJ's monthly data going back to January 1975.
The yen slumped in January this year, leading some to relate the data to the carry trade, But others say foreign banks may have been raising funds to buy Japanese stocks and bonds.
In January, foreigners bought a net 2.3 trillion yen of yen bonds, the largest since May, and Tokyo shares rose nearly 1 percent.
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