Magazine article American Banker

Once Burned, U.S. Banks Said to Be Better Shielded from Sharp Rise in Yen

Magazine article American Banker

Once Burned, U.S. Banks Said to Be Better Shielded from Sharp Rise in Yen

Article excerpt

U.S. banks are expected to avoid sharp losses despite the past year's startling rise of the Japanese yen against the dollar.

Bankers and analysts attribute the good news to caution by the banks after disastrous trading results in last year's third quarter, when markets were roiled by Russia's default on its bonds and problems in other emerging-market countries.

As part of their ordinary business, big banks and securities firms seek to take advantage of differences in interest rates from one country to another. Japan has been a favorite venue for such business, because the yield on 10-year government bonds is only 1.7%, compared with 6% on similar U.S. securities. These deals are called carry trades.

An investor could earn a high return by selling yen for dollars and investing the dollars in the higher-yielding U.S. securities. And an investor, such as a bank, easily could borrow yen at the lower rate and invest it in the United States at the higher rate.

But it is a gamble. The wild card is the exchange rate. If the dollar/yen rate remains unchanged, the investor ends up with the higher return. But if the yen were to move sharply higher in relation to the U.S. currency, the losses could be severe, because the dollar would buy far fewer yen.

And the dollar has plunged versus the yen, by 9% since mid-August and 28% over the past 14 months.

The scenario could have been devastating for the world's trading banks, but currency specialists say that many saw the problems coming and unwound many of their arbitrage positions. As a result, the rise of the Japanese yen is unlikely to cause much fallout among banks with international trading operations, observers say.

It was not only the early unwinding of arbitrage positions that kept banks from being badly wounded, but also conservatism after last year's third-quarter debacle, when banks lost millions on emerging-market securities. …

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