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

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.