Financial Crises and Risk Premiums in International Interbank Markets

In this paper, we analyze how the risk premiums in the Tokyo international interbank markets went through under the financial crisis. First, we briefly look back upon the financial situations under Japan's financial crisis at the end of the 1990s and under the global financial crisis that occurred from the summer of 2007 to 2009. We then examine what happened to the risk premiums in the two crises. We use the interest rates of TIBOR and LIBOR for our analysis. In normal times since the two markets are almost completely integrated, the TIBOR is almost interlocked with the LIBOR regardless of their currency denomination. On the contrary, in the time of the financial crisis, there was a significant gap observed between them. However, the type of gaps that occurred depended largely upon the type of crisis. At the end of the 1990s, the TIBOR surpassed the LIBOR regardless of their currency denomination. On the other hand, under the global financial crisis at the end of the 2000s, the TIBOR fell below the LIBOR in the dollar denomination, but the former still overran the latter in the dollar denomination. The different correlation between the TIBOR and the LIBOR in the yen and the dollar is not explained only by the difference in relative credit risks among financial institutions in the two markets. The regression results show that liquidity risk in addition to credit risk is useful in explaining this apparently paradoxical phenomenon. They also show that the central banks' supply of US dollar liquidity was effective in the global financial crisis. Under increased global liquidity risk, there was an absolute liquidity shortage of US dollar in each market in the global financial crisis. The supply of US dollar liquidity by central banks was a policy measure to alleviate the liquidity shortage in such international financial markets.