The Japanese Foreign Exchange Market
Author: Asahiko Isobe

From the Foreword to the first issue: “Among the responsibilities of the International Monetary Fund, as set forth in the Articles of Agreement, is the obligation to fact as a center for the collection and exchange of information on monetary and financial problems,’ and thereby to facilitate ‘the preparation of studies designed to assist members in developing policies which further the purposes of the Fund.’ The publications of the Fund are one way in which this responsibility is discharged. “Through the publication of Staff Papers, the Fund is making available some of the work of members of its staff. The Fund believes that these papers will be found helpful by government officials, by professional economists, and by others concerned with monetary and financial problems. Much of what is now presented is quite provisional. On some international monetary problems, final and definitive views are scarcely to be expected in the near future, and several alternative, or even conflicting, approaches may profitably be explored. The views presented in these papers are not, therefore, to be interpreted as necessarily indicating the position of the Executive Board or of the officials of the Fund.”


From the Foreword to the first issue: “Among the responsibilities of the International Monetary Fund, as set forth in the Articles of Agreement, is the obligation to fact as a center for the collection and exchange of information on monetary and financial problems,’ and thereby to facilitate ‘the preparation of studies designed to assist members in developing policies which further the purposes of the Fund.’ The publications of the Fund are one way in which this responsibility is discharged. “Through the publication of Staff Papers, the Fund is making available some of the work of members of its staff. The Fund believes that these papers will be found helpful by government officials, by professional economists, and by others concerned with monetary and financial problems. Much of what is now presented is quite provisional. On some international monetary problems, final and definitive views are scarcely to be expected in the near future, and several alternative, or even conflicting, approaches may profitably be explored. The views presented in these papers are not, therefore, to be interpreted as necessarily indicating the position of the Executive Board or of the officials of the Fund.”

Japan is among the world’s leading trading countries; in 1965, its exports accounted for 5.2 per cent (f.o.b.) and its imports for 4.7 per cent (c.i.f.) of the world totals. Its even more outstanding role in the world capital market has also been recognized of late, as Japan has gradually changed from a net importer to a net exporter of capital.

Most of the transactions—current and capital—between residents of Japan and of other countries are settled by conversion of Japanese yen into foreign currencies, or vice versa, in Japan’s well-organized foreign exchange markets, not in markets abroad. Although the importance of the yen in the world monetary framework as a recognized convertible currency is likely to increase, supply and demand for Japanese yen abroad are rather limited at present. Particularly since World War II, the Japanese yen has been used less widely in international transactions than before, and instruments for foreign payments and receipts are customarily expressed in terms of foreign currencies such as the U.S. dollar or the pound sterling.

The purpose of this article is to explain briefly the structure and the working of Japan’s domestic foreign exchange markets, so far known only to limited numbers of exchange operators at home and abroad. An understanding of these markets is worthwhile because they now exhibit a typical example of foreign exchange markets in non-reserve-currency countries, which include most of the countries of the world.

Section I below describes the main participants and the principles which govern the behavior of these participants in customer and interbank exchange markets. The differences in the mechanism of these two markets are also studied. Section II outlines the official framework that regulates the upper and lower limits on foreign exchange rates, together with the way in which the banks, in practice, fix the rates that they quote daily to their customers. It also explains the function of interoffice rates of large trading firms, rates which are not within the official framework but which are those at which daily foreign transactions are actually effected. Section III deals with the foreign exchange operations of the Bank of Japan, the nation’s central bank, including the purpose of these operations, and the effects of its activities, particularly after the April 1963 reform that widened their scope. Section IV discusses some problems incidental to the fast-growing foreign exchange markets such as those in Japan, and presents some suggestions for their solution.

Markets for Japanese yen in foreign countries operate on only a very limited basis; they are not dealt with in this article.

I. Organization and Mechanism of the Markets

Japan’s foreign exchange markets may be grouped into three closely related categories:

Customer markets, which are virtually nation wide in the sense that participants of these markets are located in every part of Japan, but which constitute essentially a single market in the sense that almost uniform exchange rates are applied, thanks to the advanced telecommunication network maintained among branches of commercial banks throughout the country.

Interbank markets in the three largest cities—Tokyo, Osaka, and Nagoya—where most large commercial banks have their head offices.

Policy-oriented market operations between the Bank of Japan and commercial banks.

This section and the following one describe the functioning of the first two markets. Foreign exchange transactions between the Bank of Japan and commercial banks are treated in Section III.

Dealers in the first two markets customarily engage in both spot exchange transactions and forward exchange transactions with firm exchange rates but with undetermined delivery terms (usually not exceeding six months). In the interbank markets, swap transactions involving both spot and forward exchange transactions of the same amount are also usual. The U.S. dollar is by far the currency most often traded, but transactions in the pound sterling are fairly substantial.1 Trading in other prescribed foreign currencies is also permitted and takes place to a limited extent every day.

Customer markets

Japanese manufacturing firms usually have no direct contact with the foreign exchange markets. The limitation of their role as direct foreign exchange buyers or sellers stems mainly from the long-standing Japanese tradition that manufacturing firms can best achieve industrial efficiency and high quality if they concentrate their attention on production. Usually they turn the distribution of their products over to specialized trading firms, which deal in almost all categories of goods from agricultural products to oil tankers. These trading firms not only distribute the products domestically, but also make export contracts with importers abroad, take care of shipments, and undertake all foreign exchange transactions with banks on behalf of the manufacturing firms. The trading firms are also importers of most categories of goods for domestic consumption.

Recently, some big manufacturing firms have begun limited buying or selling of foreign exchange related to their exports or imports, dealing directly with banks. On occasions, also, manufacturing firms come into the foreign exchange market as large-scale sellers of foreign exchange, when they receive loans from abroad in foreign currencies. Nevertheless, it remains one of the peculiarities of the Japanese trade system that a limited number of large trading firms, including the widely known Mitsubishi Shojo Co. Ltd., Mitsui & Co. Ltd., Marubeni Iida Co. Ltd., and C. Itoh Co. Ltd., are the leading participants in the customer markets. Since the operations of other participants in these markets are less important both in quantity and variety of transactions, the following discussion will be centered on the operations of these trading firms.

Operations of trading firms as customers

In almost every city throughout Japan there are large and small trading firms, some of them branches of large trading companies in Tokyo or Osaka. These firms handle the exportable specialties of the local industry and imports for local consumption. When they have export bills receivable in foreign currencies from their partner importers abroad, for instance, they bring them to the nearby bank for conversion into yen; when they have import bills payable to the exporters abroad, they appear at the banks as buyers of specified foreign exchange in exchange for yen. When they have concluded future export or import contracts with their partners abroad, they get into touch with their nearby banks or the local branches of Tokyo or Osaka commercial banks, to arrange forward exchange transactions. Most of the large trading firms, however, have their head offices in Tokyo or Osaka and concentrate their export and import business in the specialized sections of these head offices. For this reason, and also because Tokyo and Osaka have large-scale interbank markets, the operations of customer markets are largest in Tokyo and next largest in Osaka. In smaller cities, local banks or local branches of big banks rarely issue their own daily exchange rate quotations. Instead they follow those which are established in Tokyo and Osaka markets and teletyped daily to them.

Not all the export and import bills or their future contracts concluded by trading firms are immediately brought into the customer markets. Under the present foreign exchange regulations, most large trading firms are allowed to retain for prescribed periods of time, usually 20 days, their foreign exchange receipts in the form of foreign currency deposit accounts with authorized banks, which they can use to offset (“marry”) their demand for spot foreign exchange for current transactions.2 For instance, an import payment falling due within one or two weeks can be met out of export proceeds in foreign exchange which mature today, the offset being effected on the due date in the foreign exchange accounts in the books of the trading firm concerned. Foreign exchange transactions, either spot or forward, that are offset (or “married”) within the accounts of a single firm naturally do not appear as supply and demand in the markets.

Again, future export and import contracts which are outside the surrender requirements and often remain “unmarried” within the framework of the foreign exchange accounts of the firm will not necessarily lead to supply or demand of forward exchange in the markets. Even though, in general, trading firms are keenly sensitive to exchange risks, some may occasionally hold uncovered positions when they anticipate favorable future movements of spot rates. A firm is completely free to leave its risks uncovered, depending on its own traditional policy in the light of its judgment as to its future needs for foreign exchange and the future trends of exchange rates, both at home and abroad.

Large trading firms usually have their own experienced foreign exchange operators. These operators play an important role in deciding how much foreign exchange, both spot and forward, to sell to or buy from a particular bank at a particular rate of exchange in the course of a business day. They also give advice used in the firm’s decision, usually made by one of the directors in charge of export and import trade, on the exchange rates (interoffice rates, see Section II) to be applied to the firm’s export and import trade on a particular date, the amount of export or import contracts to be left uncovered, and so on.

Operations of foreign exchange banks

The Ministry of Finance classifies the commercial banks into Class A and Class B according to the scope of the foreign exchange business that they are authorized to conduct. Class A banks may engage in all normal foreign exchange business; Class B banks are permitted only to serve as intermediaries in transactions between customers and Class A banks, and are usually prohibited from entering into correspondent arrangements with banks abroad. At present, 12 Japanese banks and 15 foreign banks with offices in Japan have been approved as Class A banks, and about 50 Japanese banks, mostly local ones, as Class B banks.

Commercial banks authorized by the Ministry of Finance to deal in foreign exchange can freely quote every morning (once a day) the rates of foreign exchange at which they will sell and buy foreign exchange, within limits set by the official framework and a “gentlemen’s agreement” among themselves, and subject to consideration of their own exchange position mentioned below. A rate, called the “basic interbank rate,” is usually calculated daily by one of the authorized Class A banks in charge during that particular month. This rate is teletyped to all the other authorized banks before the opening of the next business day. It provides the basis on which banks quote rates for their customers.

Interbank markets

Interbank foreign exchange markets in Japan are concentrated in Tokyo, Osaka, and Nagoya, where the head offices of the large commercial banks are located. The amounts traded in the three markets vary a great deal. Tokyo accounts for almost 70 per cent of the total and Osaka for most of the remaining 30 per cent; only minor amounts are traded in Nagoya. Despite the highly advanced teletype network in Japan, these three do not function as one uniform market. The main reason for this separation is that in each market foreign exchange brokers3 operate efficiently enough to match demand and supply. Most of the foreign exchange trading among commercial banks is done through these brokers, although there is direct trading on a limited scale between banks themselves. In the long run, however, it may be expected that Japan will have a single uniform interbank market centered in Tokyo.

Foreign exchange brokers are not allowed to hold foreign exchange themselves. They help to match demand for and supply of foreign exchange by telephoning to the commercial banks that are their customers. From the buying bank they receive a brokerage fee of ¥ 0.03 per U.S. dollar or ¥ 0.06 per pound sterling.4 Each morning at nine o’clock, when the commercial banks open for business, the brokers are ready to fill out lists of offers and demands from their customer banks. They may get an amount of spot exchange offered by Bank A at a particular rate of exchange. In the course of the business day, Bank B may or may not make a demand for the same amount at the same rate of exchange. If it does, the deal is contracted and confirmed between the two banks, and the payment of the equivalent yen from Bank B to Bank A will be made through the Bank of Japan’s Banking Department, where banks keep their checking accounts. The brokers are expected to notify the Banking Department through the Bank’s Foreign Department as soon as each contract has been concluded. If demand for the amount of exchange offered does not develop at the exchange rate offered, first the rate and, second the amount, will be adjusted until usually both sides are satisfied.

In interbank markets, banks dispose of their surplus or obtain extra foreign exchange by trading with each other through the exchange brokers, before they turn to the Bank of Japan as the last resort. The supply of foreign exchange to the market consists chiefly of the surplus foreign exchange funds received or to be received in the future as export bills from customers, short-term capital such as Euro-dollar deposits transferred or to be transferred to the domestic markets from London and other European branches of Japanese commercial banks, long-term capital such as loans to private corporations, the foreign exchange equivalent of the proceeds from bond issues abroad, and royalties received from abroad. The demand consists of the extra foreign exchange needed to cover import bills and to be sold to customers, short-term capital outflows such as Euro-dollar deposits withdrawn to London and other markets in Europe, and long-term capital outflows such as loans extended by Japanese corporations to their subsidiaries abroad. So far, exchange transactions related to trade and other current account items have dominated the interbank markets, except that a few volatile movements of short-term capital have had a somewhat disturbing effect on the market.

In interbank transactions, in addition to spot and forward transactions, swap transactions take place through brokers between banks which are short of spot foreign exchange but have ample forward foreign exchange and those which find themselves in a reverse position. For instance, spot selling by Bank A and buying by Bank B, and forward buying by Bank A and selling by Bank B, usually with the same future delivery date, of the same amount of foreign exchange, are all contracted at the same time. Swap contracts can be concluded between any banks, but they take place most often between banks having demands for foreign exchange with different delivery dates—as, for instance, between Japanese commercial banks and Japanese branches of foreign banks.5 There are no official limits to the period of forward exchange transactions, including those related to swap transactions, but ordinarily contracts are not entered into for periods longer than six months. These forward contracts either specify delivery at a date one month later or, more commonly, mention no precise delivery date.6

As the operations of trading firms in the customer markets are affected to a large extent by their present and future foreign exchange positions, so the operations of banks in interbank markets are also closely related to and affected by similar considerations, as well as by the aim of maximizing the profit obtainable through such operations.

When, at the end of a business day, a Class A or Class B foreign exchange bank has a surplus of foreign exchange assets over foreign exchange liabilities, in spot and forward transactions combined, it is said to be in a net “overbought position,” and in the reverse case, in a net “oversold position.” Although commercial banks are encouraged eventually to make their positions even as far as possible by matching exchange assets and liabilities, in order to minimize the foreign exchange risks associated with uncovered positions, they find it difficult always to keep their positions completely even. Commercial banks, therefore, in consultation with the Bank of Japan’s Foreign Department, agree to certain limits (subject to change from time to time) within which temporary net positions, either overbought or oversold, will be regarded as frictional and marginal. When either overbought or oversold positions exceed these limits, the banks are encouraged to adjust their positions by selling surplus foreign exchange or by buying needed amounts in the interbank markets.

Within the limits described above, the banks may sometimes need to operate in interbank markets primarily to meet their own financial needs. In such an event, the exchange risk to which they may be exposed within the above-mentioned limits may have only a secondary importance for them. For instance, they may need to procure a certain amount of forward exchange in order to meet a demand, put forward by a trading firm, to make a payment abroad on a certain future date. Or they may need to sell foreign exchange in forward markets in order to cope with an expected large demand for yen as a result of a long-term loan from abroad received and presented to them for conversion by an industrial firm. In either case, they will want to give their customers the best service possible in covering their exchange requirements quickly and at an exchange rate favorable to them. Under these circumstances, banks would probably accept an uncovered position in their own accounts up to the full limit fixed as maximum. These adjusting operations of foreign exchange banks have an important influence from time to time on the daily interbank rates.

Through the interbank markets, besides the foreign exchange incidental to the current transactions of trading firms or other customers and to the long-term loans extended or received by private corporations, there also pass short-term transactions. These include such short-term foreign currencies as Euro-dollars which commercial banks accept, through their European branches, mainly in London, as deposits from customers or correspondent banks in Europe; they also include extremely small amounts of volatile (hot) money from abroad. Whether Euro-dollars are accepted and used abroad for loans and other short-term credit purposes, are kept on the bank’s books uncovered, or are transferred and converted into Japanese yen in domestic interbank markets, depends completely on the policy of individual banks. Their decision in turn depends on the interest rate differentials between the Japanese and foreign money markets, and also on the total needs for liquidity in yen in the domestic markets. When yen are tight in these markets, the banks tend to transfer some of these short-term funds to their head offices in Japan, and sell them in the interbank markets in order to add to their own domestic yen liquidity. This may tighten the liquidity position of other banks, and set off a chain reaction of further transfer and selling of Euro-dollars. The foreign currencies thus brought unexpectedly into the domestic interbank markets for sale may have a somewhat disturbing effect on the rate of exchange, or, more importantly, on the money supply, although so far the amount of such disturbing short-term capital flows has not been as large as the volume of foreign exchange transactions arising from ordinary trade transactions.

The Foreign Department of the Bank of Japan always keeps a close watch on the moves in the interbank market. Specialized operators of the Bank are notified by the brokers of all the contracts that have been concluded, and of all the exchange rates agreed upon between commercial banks. The Bank of Japan is ready to come into the market whenever the exchange rates tend to move abnormally. When it is clear, as it would be in the circumstances described in the preceding paragraph, that the inflow and conversion into yen of short-term capital from abroad would not only have a disturbing effect on exchange rates, but might also offset the effectiveness of the Bank of Japan’s monetary policies in the domestic yen markets, the Foreign Department, in cooperation with the Banking Department of the Bank, may try to persuade commercial banks to refrain from bringing short-term capital into Japan merely to finance yen requirements. (See Section III below.)

Difference in function between the customer and the interbank markets

From the viewpoint of market mechanism, a fundamental difference exists between the customer and the interbank markets. The former, in the process of meeting the demand for and the supply of foreign exchange, does not create exchange rates; the latter does. An increase in supply of foreign exchange in the customer market does not necessarily lead to an immediate fall in the rates quoted to customers, nor does an increase of demand lead to a rise. Equally, a decrease in supply does not necessarily lead to a rise, or a decrease in demand lead to a fall. These changes in the supply of and demand for foreign exchange in the customer markets will affect customer rates only if the foreign exchange positions of the banks are affected by these changes and if the banks proceed to buy from or sell to the interbank markets in order to adjust them, thus raising or decreasing the interbank rates. Rates charged to the banks’ customers will be affected only if, and after, interbank rates are affected. Whether they are so affected, of course, will depend, for example, on whether the banks acquiring additional foreign exchange were previously well supplied or even overbought, so that they have to sell on the interbank market, or were previously ill supplied or oversold, when they would not need to use that market.

The foreign exchange operations of commercial banks, based on their positions from time to time, exert an influence that is not negligible upon the determination of rates in the customer markets. The spot rates that they quote to customers should always fall within the institutional limit set by the official framework and the “gentlemen’s agreement” among foreign exchange banks regarding customer rates and are calculated on the basis of “basic interbank rates” (see below) communicated to each commercial bank by the opening of the day’s business. Subject to the limit mentioned, the banks take into account their exchange positions in different categories (e.g., overbought or oversold in total, on spot only, or on forward only) as well as the present trend of interbank exchange rates. For instance, if a bank’s forward position shows a big oversold balance, it would raise its spot buying rates for customers in order to attract more foreign exchange bills which it could buy so as to move toward an even position, over all, through an increase in its spot overbought position.

Again, under certain circumstances, the profit or loss accruing from buying and selling foreign exchange in the markets amounts to a big percentage in the total profit or loss of the bank concerned. These profit and loss considerations are also important in deciding the foreign exchange rates. In other conditions, as mentioned above, banks may operate in foreign exchange in order to increase or decrease their yen liquidity. In these conditions, banks are tempted to make their buying or selling exchange rate quotations as attractive as possible to their customers, in order to adjust their exchange holdings. The occasions on which the “gentlemen’s agreement” is broken, however, are few, and arise mainly where the relationship of banks to a particular trading or manufacturing firm is very close.

The effect, noticed above, of short-term capital movements (e.g., of Euro-dollars) on the banks’ foreign exchange positions appears only in the interbank markets, not in the customer markets. However, a movement of Euro-dollar funds to or from the interbank markets may influence the rates in the customer markets by offsetting increased buying or selling of foreign exchange by trading firms in the latter markets.

Therefore, the interbank markets can be regarded as markets where various factors play important roles in determining the “basic rates” used by the banks to construct the rates they quote to their customers. The interbank rates do not necessarily reflect the export and import trade situation of the nation; they are products of all the different movements of foreign exchange—trade bills, short-term capital, and long-term capital, which flow in and out of the nation’s economy day by day. Rates quoted to customers, therefore, may be affected by various factors outside the markets in which the customers deal.

II. Structure of the Exchange Rates

The structure of foreign exchange rates in Japan, around which all the activities of customers as well as of banks have developed, has been based on virtually complete liberalization within the framework of the present IMF system. The exchange rates with foreign currencies other than the U.S. dollar are computed on the basis of the U.S. dollar rates,7 since transactions in Japanese foreign exchange markets are predominantly in dollars. In this article, therefore, only exchange rates with the U.S. dollar will be considered.

Interbank rates and their upper and lower limits

The par value agreed with the IMF is ¥ 360.00=US$1. Before April 22, 1963, the Bank of Japan intervened only at rates 0.5 per cent above or below the par value (i.e., at ¥ 361.80 and at ¥ 358.20), allowing interbank rates to fluctuate between these limits. Since that date, however, the Bank of Japan has been automatically selling to and buying from the commercial banks any amount of foreign exchange at rates 0.75 per cent above or below the par value, i.e., ¥ 362.70 and ¥ 357.30, respectively, thereby fixing these rates as the limits within which the interbank rates can fluctuate freely. In addition, from that time, the Bank may intervene at rates within this wider range whenever it deems such action necessary. The widening of the range from 0.5 per cent to 0.75 per cent in either direction from the par value represented an important step toward the further liberalization of the foreign exchange market in Japan. It was expected to make the foreign exchange market a more adequate mechanism than before for bringing about adjustments in export and import trade, and to furnish the Bank of Japan with more effective tools for bringing about adjustments in foreign exchange reserves and in foreign exchange rates. Widening the possible differential between spot and forward rates was also expected to cause the differential between interest rates in Japan and abroad to be fully reflected in the forward premiums in the foreign exchange markets.8

There is no limitation on the forward rates. However, a “gentlemen’s agreement” between the banks specifies that the spread between the forward selling and the forward buying rates of the same delivery date should not be less than the spread of the spot rates. Forward contracts rarely extend beyond six months, and most rates are fixed on monthly, half-monthly, or ten-day delivery terms.9

Banks’ rates for customers

At present, there are no legal restrictions on the exchange rates which banks may quote to customers. Theoretically, banks could quote any rates whatever, according to their foreign exchange positions or expected future rates in the markets at home and abroad. However, since the Bank of Japan is always ready to sell and buy foreign exchange at the upper or lower limits of the interbank rates, banks are not de facto justified in quoting exchange rates for customers significantly outside these limits. By agreement, rates for customers are calculated by adding or subtracting the bank’s profit to or from the daily interbank rate. This profit is fixed by agreement at ¥ 0.50 per U.S. dollar on each transaction, so that the gross profit that the bank obtains from buying one dollar and then selling it is ¥ 1. This automatically fixes the upper and lower limits for the customer rates of ¥ 363.20 (selling) and ¥ 356.80 (buying).

Before the wider range came into effect in April 1963, the upper and lower limits of customer rates were ¥ 361.80 (selling) and ¥ 358.20 (buying), the same as those for interbank rates. The difference between the selling and buying rates, representing the bank’s expected profit, now ¥ 1 per U.S. dollar, used to be ¥ 1.40 per dollar.10 So the actual ranges within which these rates could fluctuate were rather limited, ¥ 361.80-¥ 359.60 for selling rates and ¥ 360.40-¥ 358.20 for buying rates. These ranges, amounting to ¥ 2.20 in each instance, were only 0.6 per cent of the par value ¥ 360.00, less than one half of the present 1.50 per cent of the margin above and below the par value. For this reason the reform in April 1963 was considered to be of basic importance for the development of Japan’s foreign exchange system.

The whole structure of the foreign exchange rates is shown in Diagram 1.

Diagram 1
Diagram 1

Structure of Japanese Foreign Exchange Rates

(In Japanese yen per U.S. dollar)

Citation: IMF Staff Papers 1966, 002; 10.5089/9781451947236.024.A004

1 Margin fixed by “gentlemen’s agreement” between the commercial banks.2 Margin fixed by the Bank of Japan.

How daily customer rates are determined

Within the foreign exchange rate structure described above, daily customer rates in the Tokyo customer markets are determined in the following way.

Each day large amounts of foreign exchange are bought and sold in the interbank markets at different rates. The foreign exchange brokers record every transaction that has taken place through themselves. One of the large commercial banks authorized as Class A foreign exchange banks is designated each month as monitor in rotation. The monitor bank calculates the “basic interbank rate,” from which individual banks construct all the customer rates, and immediately notifies its fellow banks what the rate is.

Foreign exchange brokers report to the monitor bank all the transactions they handle during the course of a business day. No names of individual banks are cited. When details of all the transactions in the Tokyo market during the day have been collected, the monitor bank calculates the “basic interbank rate” by averaging the rates at which they were effected. It communicates the rate thus calculated to all its fellow banks before the opening of the next business day, usually before 8 o’clock. The other banks thus notified will establish their own rates for customers by adding to or deducting from the basic rate not more than ¥ 0.5 and will quote these rates to customers when business begins at 9 o’clock. While the difference between the rates quoted and the basic rate may not exceed ¥ 0.5, in accordance with the agreement mentioned above, it can be less, depending upon the bank’s own policy as regards its foreign exchange positions. Exchange rates other than telegraphic transfer selling and buying rates—e.g., rates for buying and selling sight bills—are established and quoted also in accordance with other agreements among the banks. The forward rates quoted depend on the position of the bank both in yen and forward exchange, and on the bank’s expectations of future trends of rates at home and abroad.

Banks in Osaka and Nagoya, if they wished, could establish their own customer rates with their own interbank rates as the basis, but they usually use the Tokyo basic rate, teletyped from the head office of the monitor bank in Tokyo. Therefore, although transactions take place in separate markets, rates tend to be uniform in these three markets. The “basic interbank rate” is communicated also to the Bank of Japan’s Foreign Department, which relies on it as an important index of the trends in the market.

Interoffice rates of trading firms

Foreign exchange rates not governed by the foregoing arrangements are quoted daily by trading firms for their own internal purposes; these are called interoffice rates. They are applied to the buying and selling of foreign exchange between the accounting section and the export and import trade section within the same firm. Exporters and importers in the trade section negotiate with their customers abroad on the basis of the rates thus quoted by the accounting section of their firm, not of those quoted by banks. The latter rates are adjusted in order to promote or discourage export contracts or import contracts according to the firm’s business programs and its foreign exchange position at a particular time, or for other reasons. Therefore, the influence of the daily fluctuations of the banks’ foreign exchange rates on the export and import trade of trading firms depends to some extent on the responsiveness of the interoffice rates determined in the firms. Sometimes these are fixed at levels far more attractive than the banks’ rates, in the expectation that the loss which will accrue from such transactions will be more than offset by an increase in profits due to increased trade from abroad. Foreign exchange operations in large trading firms thus play an important role in Japan’s foreign exchange markets.

III. Bank of Japan’s Role in the Foreign Exchange Market

The bank’s transactions with authorized foreign exchange banks

The Bank of Japan acts as the banks’ last resort in foreign exchange markets as it does in the yen markets.

Commercial banks can buy from or sell to the Bank of Japan any foreign exchange automatically when the interbank exchange rates reach the upper and lower limits of ¥ 362.70 and ¥ 357.30. However, since April 22, 1963 the Bank of Japan has been authorized to operate in the foreign exchange market, in agreement with the Ministry of Finance, at any time, even when the interbank rates are between the two limits. Such operations are called “with MOF transactions,” because the Bank of Japan operates in the interbank markets with foreign exchange held in the name of the Minister of Finance in the Foreign Exchange Special Account with the Bank of Japan. The Bank of Japan’s transactions in the interbank markets are always reflected in the foreign exchange reserves of Japan. At present, the Bank does not engage in any forward exchange transactions, but it is authorized to do so at any time that the circumstances may require.

The Bank of Japan does not usually disclose the details of its market operations because it wishes to furnish as little basis as possible for speculative activity on the part of commercial banks. It is possible, however, at least to guess at the purposes of its intervention in the market, as can be done for other central banks. Among the most important may be operations of the following types:

(1) In order to safeguard confidence in the yen both at home and abroad in the face of speculative attack, the Bank of Japan is always prepared to counterattack through its foreign exchange operations in the domestic interbank markets, where large-scale conversion between yen and foreign currencies takes place.

(2) The Bank may come into the market with the direct intention of adjusting the spot rates, and thus possibly the spread between spot and forward rates, thereby exerting an influence on the profitability of commercial banks’ import or export of foreign short-term capital at times when such capital movements might threaten to offset the Bank’s monetary policies in the domestic financial markets.

(3) The Bank may act to avert abrupt changes in exchange rates caused by the outflow or inflow of volatile short-term money to and from abroad, thus passively helping the market to maintain an exchange rate that correctly reflects the underlying trade situation of the nation.

(4) The Bank; may act positively to create a market situation where rates are attractive enough to promote exports and to discourage imports, or vice versa.

It is hardly possible to generalize about the rates at which the central bank would intervene in the market. In operations of type (1) above, however, it is safe to assume that the Bank may often intervene at rates slightly within the theoretical maximum spread, in order to keep speculators uncertain about its exact tactics while carrying out its intention to safeguard the nation’s currency. Operations of the other three types may take place at any exchange rate.

Policy regarding net foreign exchange positions

Reference has been made above to the intervention of the Bank of Japan in the foreign exchange market in defense of its domestic monetary policy. In December 1965, the Bank made an important change in its exchange policy, this time mainly to normalize the market. It decided to discount export usance bills designated in U.S. dollars11 held by commercial banks, so as to eliminate their net overbought positions, created through buying these export bills from their customers. Previously commercial banks had been able to obtain yen credits for holding these export usance bills until maturity by borrowing from the Bank, using these bills as collateral. When they did so, the bills, which were of course foreign exchange assets, remained in their possession, leaving their overbought positions unchanged.

With the recent gradual expansion of Japanese exports on a usance basis, the net overbought positions created in this way could easily have piled up so as to constitute an exchange risk for the commercial banks. After the Bank began to discount usance bills, the net overbought positions of commercial banks decreased by the amount of bills discounted. By eliminating undue pressure from overbought positions, these discounts facilitated the Bank’s efforts to cope directly with the accumulation of net oversold positions (see above) created by the conversion of volatile short-term foreign money into yen.

Experience of the past three years

In the light of the above general review, Japan’s experience for the past three years can be re-evaluated. The development of interbank exchange rates in this period and the effect and purpose of the Bank’s interventions after April 1963 are described briefly below (for the pertinent statistics see Tables 1, 2, and 3 in Appendix I).

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Market changes since April 1963

To summarize, several changes have taken place since the April 1963 reform. The volume of spot transactions in interbank markets increased gradually after April 1963, partly because the Bank of Japan intervened frequently in the markets, and partly because the widening of the range of fluctuations encouraged more active market participation by others. Spot transactions were 2.5 times larger during January-April 1964 (US$775 million) than during the corresponding period in 1963 (US$311 million).

In addition, forward transactions increased after April 1963. Since the Bank has not yet used its authority to intervene in the forward markets, the increase can be attributed only to an increased tendency on the part both of banks and of trading firms to cover their positions by forward transactions. Forward transactions during January-April 1964 (US$393 million) exceeded those of the corresponding period of the previous year (US$318 million) by 23 per cent. Since May 1964, forward transactions have also continued to increase gradually.

Since the range of fluctuation was widened, the interbank rates have not reached the new upper or lower limits as frequently as they reached the old limits, largely because the Bank has intervened from time to time before the rate reached the limits. Although inflows and outflows of short-term capital have been observed sometimes in large amounts, the rate has fluctuated less abruptly than it did before April 1963, again because of the intervention by the Bank.

For some time after the April 1963 reform, changing trends in the balance of trade seemed to be reflected more fully than before in the movements of rates in the exchange markets. However, sizable outflows of capital, both short-term and long-term, which started early in 1965, distorted the whole picture again, and the recent trend of the exchange rates seems largely to reflect these capital movements.

IV. Future Problems for Wider Foreign Exchange Markets

The postwar reformation of Japan’s foreign exchange markets described above has been sufficiently rapid to support the reorientation and reconstruction of the Japanese economy which has taken place, particularly, during the past fifteen years. (A condensed review of 15 years’ progress is given in Appendix II.) There is still room for further adjustment, however, before the market mechanism operates with adequate efficiency and stability. Among the problems to be dealt with are these:

  • (1) Japanese experience is that the fluctuation of exchange rates within a fixed range seems to have only a limited role in helping to bring about any needed adjustment of export and import transactions. This leads to a question whether wide fluctuations of official exchange rates should be institutionally permitted. It may be doubted whether even the largest short-term fluctuation of exchange rates which can take place in the present institutional framework—1.5 per cent of the par value—will be large enough often to offset changes in the prices of export and import commodities.

  • (2) Even if we assume that the fluctuations of exchange rates within the present institutional framework can help to bring about any needed adjustment of trade, its effectiveness may again be disturbed in Japan by the existence of interoffice rates.

    Whether trading firms respond to changes in banks’ customer rates within the range of 0.75 per cent above and below the par value depends largely on factors external to the exchange market. The most important of these factors is the inflexibility of the interoffice rates which trading firms apply in the final stage of export and import contract making. The interoffice rates are rates fixed artificially, the relation to banks’ customer rates being varied according to the foreign exchange position of the trading firm at a particular time, or to the firm’s programed foreign exchange operations. They sometimes do not give any special stimulus to exports even though incentives for export contract making are most needed by the Japanese economy; nor any special discouragement to imports even though imports should be checked from the national point of view.13

  • (3) Another problem is related to the institutional framework peculiar to Japan’s financial system. Large trading firms which have rapidly increasing needs for credit rely for their financing largely on domestic yen credit extended by particular commercial banks. These commercial banks are usually authorized foreign exchange banks, which are always under pressure to expand the scale of their operations in foreign exchange, in competition with other banks. They generally try to persuade trading firms to deal with them exclusively for all the foreign exchange which these firms have to sell or need to buy. The trading firms are easily tempted to let such banks handle their export and import bills on an exclusive basis, in order to maintain close relations and thus ensure the continuous availability of yen credit from these banks. Under such circumstances, there is the possibility that these firms will be given special exchange rates a little less favorable than the customer rates in the market. It would be difficult to eliminate such inflexible or artificial customer rates because links between particular industries and particular banks are fixed by tradition, and participants tend to regard their continuance as essential.

  • (4) The exchange market in Japan is uncomfortably “thin” (the daily average in 1965 being about US$10 million). It is generally considered that, without the Bank of Japan’s intervention, the movement of even a few million dollars of short-term capital or long-term loans might shift exchange rates to the upper or lower limits within a day or two. An increase in the volume of transactions in the market of foreign exchange related to trade would be necessary in order to help form a normal market situation which would reflect more nearly the country’s balance of trade pattern. Both the authorities and traders in Japan seem to agree on this point. In order to increase the turnover of foreign exchange, besides all other conceivable measures to increase the confidence in the market, it would be necessary to encourage trading firms to use the market more, rather than to “marry” their exports and imports on their accounts.

    A considerable expansion of the volume of transactions in forward markets is also essential to provide an efficient mechanism in which exchange risks can easily be covered, and in which the difference between interest rates at home and abroad is fully reflected. The latter is particularly necessary if the central bank is to operate in both spot and forward markets in order to prevent any disturbances from the movements of hot money. In order to bring about an increase in the volume of forward transactions, it may be necessary to consider some modification in technical practices, notably more use of contracts providing for delivery on fixed future dates.

  • (5) In order to help establish a more flexible market mechanism, the present once-a-day quoting system needs to be reconsidered. The highly advanced telecommunication system between offices of even different banks furnishes a means of adjusting the basic interbank rate from time to time during a business day.

  • (6) Intervention by the Bank of Japan has proved to be successful to avoid abrupt and abnormal changes in the exchange rates. The Bank has been mainly concerned about the possibility that the conversion of any large amount of short-term foreign capital into or out of yen in the interbank markets might cause a disturbing movement of the exchange rate. Ways of making the intervention by the Bank more effective, including intervention in the forward market, as it becomes broader in the future, need to be studied further.

  • (7) At present, some divergences are observed between the foreign exchange rates established in the markets at home and those established in the markets abroad. This means that there is insufficient arbitrage to keep the markets for the yen all over the world continuously linked. The most important step is considered to be to help to enhance the understanding in markets abroad of the mechanism and function of the foreign exchange markets in Japan and of their institutional reliability, so that foreign banks will shift transactions into these markets whenever more advantageous rates are available there.

The yen is again beginning to play an important role in the world monetary system. It should be stressed that there again exists a smoothly operating institutional framework for foreign exchange transactions in Japan, and well-prepared policies to be applied whenever a threat to confidence in the yen appears in the market. While the Japanese foreign exchange markets face several difficult problems, the authorities seem to be making every effort to strengthen the markets on as liberal a basis as possible in the present international monetary framework.


I. Statistics

Table 1.

Japan: Amount of Foreign Exchange Transacted in Interbank Markets, 1963-65

(Expressed in millions of U.S. dollars)

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Source: The International Finance Journal (in Japanese), 1963-65.

Excluding forward side of swaps.

Fluctuation range widened.

Because of rounding, figures do not add to some totals.

Table 2.

Japan: Interbank U.S. Dollar Rates, 1963-65

(In Japanese yen)

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Source: The International Finance Journal (in Japanese), 1963-65.
Table 3.

Japan: Balance of Payments, Foreign Exchange Basis, 1962-651

(In millions of U.S. dollars)

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Source: Bank of Japan, Statistics Department, Economic Statistics Monthly.

Minus sign (—) indicates outflow of foreign exchange.

Because of rounding, figures do not add to all totals.

II. Steps Taken to Liberalize Japanese Foreign Exchange Markets in the Past 15 Years

The advance in the Japanese foreign exchange market, both in liberalization and in technique, was not achieved in a short period of time. Preparations to reconstruct the foreign exchange markets on their prewar basis started early in 1955; the reform in 1963 is considered to have gone some way toward this goal. The following is a condensed history of various steps taken since 1949, when the postwar exchange rate was fixed, in order to facilitate foreign trade through an official channel:

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Les marchés des changes japonais


Le Japon utilise principalement les dollars E.U. pour le règlement de ses échanges extérieurs, tant pour les recettes que pour les paiements. Les transactions de change sont effectuées presque exclusivement sur les marchés des changes japonais, qui comprennent des marchés pour les transactions entre banques, et des marchés clients, situés pour la plupart à Tokyo. Les variations des taux de change sur le marché des changes de Tokyo peuvent maintenant atteindre 0,75 pour cent de part et d’autre de la parité (360 yens pour un dollar E.U.).

Bien que la majeure partie des transactions de change effectuées chaque jour sur le marché relèvent du commerce courant, tant visible qu’invisible, les mouvements de capitaux, en particulier lorsqu’ils sont à court terme, ont parfois été assez considerables pour provoquer des fluctuations inattendues à la fois des taux de change et du volume des transactions. La Banque du Japon s’est inquiétée des répercussions fâcheuses de ces mouvements sur la masse monétaire et a essayé d’empêcher les mouvements de capitaux soudains et néfastes, en persua-dant aux banques commerciales de limiter la position nette de leurs avoirs en devises. En avril 1963, lorsque l’éventail des fluctuations des taux de change a été élargi au-delà de 0,5 pour cent de part et d’autre de la parité, la Banque a commencé à intervenir sur le marchà des changes interbanque de Tokyo, à des taux compris dans les nouvelles limites fixées. Le but essentiel de cette intervention de la Banque sur le marché des changes est d’en assurer le bon fonctionnement et de protéger contre des perturbations soudaines et imprévues le crédit dont jouit le yen sur le marché mondial. La politique suivie par la Banque dans ce domaine s’est, jusqu’à présent, révélée efficace. Néanmoins, le rétablissement rapide du marché des changes aprés la Seconde Guerre mondiale a laissé plusieurs problémes sans solution. Parmi ceux-ci, on peut l’exiguïte du marché à terme et le fait que les sociétés commerciales importantes fixent pour leurs propres transactions des taux de change qui ne sont pas nécessairement conformes à ceux que les banques utilisent avec leurs clients, ce qui porte atteinte à l’influence exercée par ces taux sur les exportations et les importations.

Los mercados japoneses de divisas


El Japón utiliza principalmente dolares estadounidenses como medio externo de sus ingresos y pagos. El intercambio de divisas se realiza casi exclusivamente en sus mercados cambiarios internos, los cuales consisten en el mercado interbancario y el mercado de clientes independiente, que tienen su centro en Tokio. Actualmente se permite que los tipos de cambio en el mercado cambiario de Tokio fluctúen hasta un límite de un 0,75 por ciento por encima y por debajo del valor par (¥360=US$1,00).

Aunque la mayor parte de las transacciones cambiarias que a diario se efectúan en el mercado son atribuibles al comercio corriente de visibles e invisibles, los movimientos de capital, especialmente los de índole a corto plazo, han sido algunas veces tan grandes que han causado inesperadas fluctuaciones tanto en los tipos de cambio como en el volumen de las transacciones. El Banco del Japón se ha mostrado preocupado ante el impacto perturbador que semejantes movimientos han surtido sobre el medio circulante interno, y ha tratado de frenar los movimientos súbitos desfavorables de capital persuadiendo a los bancos comerciales a que limiten sus respectivas posiciones netas en materia de divisas. En abril de 1963, cuando el margen de las fluctuaciones de los tipos de cambio se amplió màs allà de un 0,5 por ciento por encima y por debajo del valor par, el Banco comenzó a intervenir, a cualquier tipo que cayera dentro de los límites ampliados, en el mercado interbancario de divisas en Tokio. El objeto principal que el Banco se propone respecto al mercado cambiario es lograr su funcionamiento ordenado y resguardar la confianza exterior en el yen contra súbitas e inesperadas perturbaciones. Sus políticas en estos campos han logrado éxito hasta ahora. Sin embargo, la ràpida rehabilitatión del mercado cambiario después de la Segunda Guerra Mundial ha dejado varios problemas sin resolver. Un ejemplo es la poca consistencia del mercado a término. Otro es el hecho de que las grandes empresas comerciales fijan tipos de cambio para sus propias transacciones, los cuales no concuerdan necesariamente con las cotizaciones que los bancos emplean con sus clientes, y de este modo la influencia de los tipos bancarios sobre las exportaciones e importaciones sufre menoscabo.


Mr. Isobe, economist in the Trade and Payments Division, is a graduate of the School of Economics, Hitotsubashi University, Tokyo, and did his graduate studies at Ohio State University. He was formerly a member of the staff of the Bank of Japan’s Foreign Department.


In 1965, transactions in the pound sterling in interbank markets amounted to the equivalent of US$102 million, against US$4,839 million in U.S. currency.


Foreign exchange held “unmarried” beyond the prescribed period must be immediately surrendered to the foreign exchange authorities. At present, persons or companies other than large trading firms and authorized foreign exchange banks are required to surrender any foreign exchange received within 10 days from the date of acquisition.


Most of these brokers are professional brokers also in yen transactions, in which capacity they are usually called “call-money brokers.” At present there are seven such brokers in Tokyo, three in Osaka, and one in Nagoya.


These brokerage rates are determined from time to time by agreements between the commercial banks and these brokers.


This is attributable mainly to the fact that the demands for yen of Japanese branches of foreign banks and those of Japanese foreign exchange banks arise in general at different times because of the different positions held by their clients in the nation’s industrial and commercial structure.


See footnote 9.


For instance, the daily exchange rate for the pound sterling is calculated by multiplying the basic interbank U.S. dollar rate by the prevailing cross rate in representative markets abroad. Daily quotations by commercial banks usually include, besides the U.S. dollar and the pound sterling, Austrian schillings, Belgian francs, Canadian dollars, Danish kroner, deutsche mark, French francs, Italian lire, Netherlands guilders, Norwegian kroner, Portuguese escudos, Swedish kronor, and Swiss francs.


If there is an inflow of short-term capital with repayment due three months hence, the spot rate of exchange of the Japanese yen in terms of the dollar is usually at a premium; if the spot rate for the dollar is in the vicinity of the lower limit of ¥ 357.30, its three-month forward rate will usually be near the upper limit of ¥ 362.70. The differential between the spot and three-month future rate is then ¥ 362.70 minus ¥ 357.30, or ¥ 5.40, equivalent to 6.0 per cent per annum on the basis of the par value. This means that, if other conditions are neutral, and if there are not enough exchange traders who want protection against possible changes in exchange rate policy to have any decisive influence in the market, the maximum differential between interest rates at home and abroad, which can be offset by the exchange-rate differential, is 6.0 per cent. If the range of fluctuation of the spot rate had been kept at 0.5 per cent in either direction, the interest-rate differential would not have been able to exceed 4.0 per cent per annum. The widening of the range therefore affords more room for interest-rate arbitrage of the foreign exchange rates.


For example, future contracts concluded in June are usually made on such terms as “effective in the latter half of November at ¥ 360.30” or “effective in the second 10 days of December at ¥ 362.50.” This means that the buyer and seller of the foreign exchange concerned agree to effect payment and receipt in the first instance on any day between November 16 and 30 at ¥ 360.30 and in the second, between December 11 and 20 at ¥ 362.50.


The main reason why the expected profit from one dollar’s trade was lowered from ¥ 1.40 to ¥ 1.00 by “gentlemen’s agreement” is that, after the widening of the range, banks were expected to operate more freely in the interbank markets, so that there would be more opportunities from time to time for profits from their exchange operations.


The limitation of the designation to the U.S. dollar was due to its dominant role as a means of payment in Japanese foreign trade.


At that time Japan was preparing for its shift to Article VIII status under the Fund Agreement. This took place in April 1964. The reform of April 22, 1963 was supported by business circles as an important step in the preparation for the expected shift to an open economy.


This is not to deny that these interoffice rates may be effective in the desired direction. If a particular trading firm finds it profitable to promote exports at a time when the nation as a whole needs more exports, the interoffice rates which it fixes will usually be in line with the national interest.

IMF Staff papers: Volume 13 No. 2
Author: International Monetary Fund. Research Dept.