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Credit derivatives premium as a new Japan premium.

Article Excerpt
JEL codes: G10, G15, G21

Keywords: credit derivative, Japan premium, Japanese bank.

AT THE HEIGHT of the Japanese banking crisis of 1997-98, a popular indicator of weakness was the so-called Japan premium, that is, the premium in the interest rate charged to Japanese banks in the interbank market. The internationally active Japanese banks had to pay a premium in borrowing US dollars and, to a much lesser extent, Japanese yen, from western banks. The Japan premium was considered to reflect western banks' skepticism on opaque accounting and supervision. The Japan premium disappeared after the second capital injection to major banks in March 1999. (1)

By the end of 2001, the vulnerability of Japanese banks became obvious due to low earnings, newly emerged nonperforming loans, and deflation. The core capital (tier I capital) was depleted and was supplemented only by deferred tax credit which has no liquidation value. However, it was noted by banking experts and researchers that the Japan premium did not reappear. It was a puzzle why the premium was not demanded this time.

The focus of this Letter is to explain why the Japan premium apparently disappeared and to report on an alternative indicator for Japanese bank vulnerability that would replace the...

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