Japanese banks borrow in yen and purchase spot dollars from their Western counterparties. Therefore the Western banks are left holding the yen for the time of the loan (three months in this case).

The major point is here. In an FX transaction in this case purchasing Yen the purchased currency may have to be kept overnight in a Yen denominated account. The FX is by definition not euro Yen therefore these accounts have to be in a bank Japan. A few of these will be Japanese banks.

A nostro account is one that a bank embraces with a foreign bank. (In this case London banks embrace Nostro accounts with Japanese Banks in Tokyo for example.) Nostro accounts are generally in the currency of the foreign country. Presume an American bank called Bank A buys Euros from a European bank 'Bank B'. These Euros can't leave Europe. They will be forwarded to a European bank say Bank of Europe to be kept in a Deposit account for the use of Bank A. This would be a nostro account of Bank A. Bank A will have alike nostro accounts in Australia, Japan, and so on to trade Dollar against Yen or Australian dollar.

This permits for easy cash management because the currency does not need to be converted. Incidentally nostro is imitative from the Latin term 'ours'.

The Western banks may not be willing to hold the Yen in their nostro accounts because this requires them to hold capital against the yen for regulatory purposes.

Japanese banks being further risky, risk managers may as well be against holding too much in a Nostro account in Japan. Note that banks control in an environment where others have credit lines against each other. The Headquarters mayn't want a currency desk to have exposure to Japanese Banks beyond a certain limit. This may perhaps force Western banks to dump the excess Yens at a negative interest rate.

By not holding the yen the Western banks might potentially lose significant sums if the bank where the Nostro account is held defaults. For this reason they may favour to dump the yen deposits and earn negative yield for the reason that they can be more than compensated with their earnings from the spot-forward trade.

Going by exchange market conventions the fixed payments for fixed payer swaps are:

• 100 × .0506 × 1 = USD 5.06 million per year

• 100 × .0506 × 1 = Euro 5.06 million per year

Fixed payments for the fixed receiver exchanges are:

• 100 × .0510 × 0.5 = JPY 2.55 million per 6 months

• 100 × .0510 × 0.5 = GBP 2.55 million per 6 months