Banks' reluctance to part with cash keeps the heat on Libor
David Oaklcy | Friday, 30 May 2008
FT Syndication Service
LONDON: One of the enigmas of the past few weeks has been why interbank lending rates have stayed so high when conditions elsewhere in financial markets have been improving.
Since the Bear Stearns rescue on March 16, equity and debt markets have revived as fears of further banking failures have receded.
Yet Libor -- London interbank offered rates -- remain elevated, with banks still refusing to lend to each other.
On May 22 last, all three main Libor rates in dollar, euro and sterling remained around 70 basis points above base rates. Before the credit crisis, they traded around 10 basis points above official rates.
Jim Reid, credit strategist at Deutsche Bank, believes higher levels are here to stay this year, in spite of actions from the main central banks, the US Federal Reserve, the European Central Bank and the Bank of England to boost liquidity.
Mr Reid says: "In the new financial climate, banks are slowly changing their mode of operations. They are moving from a world where they would be happy to lend to anybody to one where they are much more careful.
"This is not telling us that the world is about to end, but just a reflection of the changing financial conditions. It is a problem for the rest of the economy as interbank rates are important as a reference to mortgages. But it is now a fact of life that Libor is likely to remain elevated for a while."
Libor remains problematic for reasons that may prove difficult to address. In essence, the big banks need to keep the cash on their books at a certain level . This enables them to dip into the equity and bond markets to raise capital, vital to repair balance sheets that have been savaged by billions of dollars in asset writedowns.
And this is where the problem lies: to raise money in the capital markets they need to find investors ready to buy their paper. These investors instinctively look at cash and liquidity on the balance sheet when making their buying decisions.
As cash has drained away from the banks' books as more companies draw on their credit lines and loans, mandated before the credit crisis struck, there is less money to go around for interbank operations.
Willem Sels, head of credit strategy at Dresdner Kleinwort, says: "Banks have a number of pressures from loans still stuck on their books and the need to show they have liquidity, or cash.
"To raise money in the equity and debt markets, they need to show investors that they are attractive. One of the ways to attract investors is by having liquidity on their balance sheets."
This lack of cash has put pressures on the wider economy, as Libor is used as a reference point for borrowing in the wholesale markets and for mortgages on the high street.
Bankers and analysts, alarmed by the potential problems these elevated rates could cause as companies and individuals have to pay more for loans, are now questioning the validity of Libor as a credible market benchmark. It has put the British Bankers Association (BAA), which sets the Libor rates, under the spotlight in the way it evaluates the index.
One of the big criticisms is the limited number of banks, which submit quotes, that take part in setting the Libor rate, The BBA uses the average overnight rate of 16 banks in London in dollars, euro and sterling.
Another source of controversy is centred around dollar Libor, which is set in London before the US markets open. Only a small proportion of the banks that contribute quotes are domiciled in the US, even though dollar Libor is used to set a large volume of dollar loans and derivatives.
The BBA is due to submit a report on the index to an advisory committee on May 30. This will be used as a basis for discussion about whether it needs to be changed.
But many bankers remain sceptical over whether alternative indices would solve the problem in a financial world that has changed dramatically since August.
Only when the banks have repaired their balance sheets and loans are shifted off their books will there be more cash for interbank lending, they say. This is essential if rates are to fall back to pre-crisis levels.
LONDON: One of the enigmas of the past few weeks has been why interbank lending rates have stayed so high when conditions elsewhere in financial markets have been improving.
Since the Bear Stearns rescue on March 16, equity and debt markets have revived as fears of further banking failures have receded.
Yet Libor -- London interbank offered rates -- remain elevated, with banks still refusing to lend to each other.
On May 22 last, all three main Libor rates in dollar, euro and sterling remained around 70 basis points above base rates. Before the credit crisis, they traded around 10 basis points above official rates.
Jim Reid, credit strategist at Deutsche Bank, believes higher levels are here to stay this year, in spite of actions from the main central banks, the US Federal Reserve, the European Central Bank and the Bank of England to boost liquidity.
Mr Reid says: "In the new financial climate, banks are slowly changing their mode of operations. They are moving from a world where they would be happy to lend to anybody to one where they are much more careful.
"This is not telling us that the world is about to end, but just a reflection of the changing financial conditions. It is a problem for the rest of the economy as interbank rates are important as a reference to mortgages. But it is now a fact of life that Libor is likely to remain elevated for a while."
Libor remains problematic for reasons that may prove difficult to address. In essence, the big banks need to keep the cash on their books at a certain level . This enables them to dip into the equity and bond markets to raise capital, vital to repair balance sheets that have been savaged by billions of dollars in asset writedowns.
And this is where the problem lies: to raise money in the capital markets they need to find investors ready to buy their paper. These investors instinctively look at cash and liquidity on the balance sheet when making their buying decisions.
As cash has drained away from the banks' books as more companies draw on their credit lines and loans, mandated before the credit crisis struck, there is less money to go around for interbank operations.
Willem Sels, head of credit strategy at Dresdner Kleinwort, says: "Banks have a number of pressures from loans still stuck on their books and the need to show they have liquidity, or cash.
"To raise money in the equity and debt markets, they need to show investors that they are attractive. One of the ways to attract investors is by having liquidity on their balance sheets."
This lack of cash has put pressures on the wider economy, as Libor is used as a reference point for borrowing in the wholesale markets and for mortgages on the high street.
Bankers and analysts, alarmed by the potential problems these elevated rates could cause as companies and individuals have to pay more for loans, are now questioning the validity of Libor as a credible market benchmark. It has put the British Bankers Association (BAA), which sets the Libor rates, under the spotlight in the way it evaluates the index.
One of the big criticisms is the limited number of banks, which submit quotes, that take part in setting the Libor rate, The BBA uses the average overnight rate of 16 banks in London in dollars, euro and sterling.
Another source of controversy is centred around dollar Libor, which is set in London before the US markets open. Only a small proportion of the banks that contribute quotes are domiciled in the US, even though dollar Libor is used to set a large volume of dollar loans and derivatives.
The BBA is due to submit a report on the index to an advisory committee on May 30. This will be used as a basis for discussion about whether it needs to be changed.
But many bankers remain sceptical over whether alternative indices would solve the problem in a financial world that has changed dramatically since August.
Only when the banks have repaired their balance sheets and loans are shifted off their books will there be more cash for interbank lending, they say. This is essential if rates are to fall back to pre-crisis levels.