Why are Japanese banks swapping interest rates?

Japan’s banks are paying record premiums to exchange interest rates calculated in Tokyo for ones set in London as a slumping economy exacerbates concerns about the capacity of the nation’s companies to meet their obligations.

Banks paid as much as 49 basis points this week on top of the Tokyo Interbank Offered Rate, or Tibor, to receive the London Interbank Offered Rate, or Libor, for ten years. That’s the largest gap since at least May 1999, and exceeds levels following the banking crisis of the late 1990s when the so-called Japan premium forced domestic lenders to pay higher borrowing costs than their overseas counterparts.

The record spread “is driven by corporate credit risks,” said Tokuyoshi Takano, manager of the financial derivatives section at Mitsui Sumitomo Insurance in Tokyo. “Even if the credit problem doesn’t get solved, you can take a profit of 40 basis points over ten years.”

Six-month Tibor is little changed this year amid renewed demand for loans from companies, after falling about 14 basis points in the two weeks following its peak on 16 December at 0.92615 percent. The rate stood at 0.76692 percent on 4 March, from 0.78692 at the end of last year, according to the Japanese Bankers Association. A basis point is 0.01 percentage point.

Libor has declined to 0.79750 percent from 1.04375 percent, its recent high set on 9 December. Tibor, similar to Libor, is used as a benchmark to set corporate borrowing costs.

“Banks can lock in profits from the Tibor-Libor spread,” said Reiko Tokukatsu, a bond strategist in Tokyo at JPMorgan. “Risk takers should receive Tibor and pay Libor.”

Lending by Japan’s banks slowed for the first time in four months in January after the Bank of Japan said it would buy short-term bonds from companies and a global recession sapped demand for credit.

With Japanese banks opting to utilise the interest rates calculated in London, will the nation’s credit issue be resolved?