Hara-Kiri Swap

Currency Carry Trade

What is a Hara-Kiri exchange

A hara-kiri swap is an interest rate or currency swap with no profit potential for the initiator. The term became popular in the 1980s when Japanese banks and brokers offered very attractive rates to get deals from predominantly foreign companies. In Japan, hara-kiri is a form of slow ritual suicide. Swaps have been nicknamed hara-kiri because not making profits on this type of transaction was considered financial suicide.

Break the Hara-Kiri exchange

Hara-kiri swaps offer no intrinsic advantage to the parties that offer them, but there are extrinsic advantages to consider. Offering an attractive swap to a large company can encourage them to do business with your bank. This could open up opportunities for profit elsewhere, including buying new issues, loans, bank charges, insurance policies, and the list goes on. The danger for the bidder is that sophisticated investors will take advantage of the hara-kiri swap without providing profitable deals elsewhere.

How Hara-Kiri exchanges work

Hara-kiri swaps work like other currency or interest rate swaps. The difference is that with a hara-kiri swap, the rate offered by the initiator is more attractive than what is available on the market. For example, the swap issuer may offer the other party higher interest payments than those offered by other banks, or they may offer a more attractive exchange rate on currencies. Such actions reduce the bank’s profit margin, making it less likely that it will or will directly benefit from the transaction.

These swaps are traded over the counter (OTC) and, in this case, are often directly marketed by a bank or a brokerage to potential customers. With OTC transactions, the parties can negotiate the terms they wish to swap. In this way, the initiator could set maximum and minimum rates that they will pay / receive, essentially guaranteeing that the other party will exit even (worst case) or in advance (best case) on the swap. With fluctuating exchange rates and interest rates and potentially large sums of money involved in these typically institutional transactions, if markets go the wrong way, this could lead to large losses or a potential for missed profit for the bank or broker.

Hara-kiri swaps were the most popular in Japanese yen swaps. Their popularity declined as Japanese banks expanded in Europe and therefore no longer needed to try to entice foreign companies to do business in Japan. In addition, the Japanese stock market began to collapse in the early 1990s, straining banks and the economy.

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