UK LIBOR / OIS spread lower but still high
Simon Ward
Post a Comment
Three-month sterling LIBOR fixed today at 4.42%, down from 5.56% before the Bank rate cut and 6.28% as recently as 10 October.
LIBOR can be decomposed into the expected level of Bank rate – measured by the overnight indexed swap (OIS) rate – and the credit risk / liquidity premium banks need to pay to attract term funding.
Of the 186 bp decline in three-month LIBOR since 10 October, 163 bp reflects lower expectations of Bank rate with just 23 bp due to a narrowing of the bank premium, measured by the LIBOR / OIS spread – see chart. The spread is 190 bp today, down from a recent peak of over 230 bp but well above the 75-85 bp level prevailing before Lehman’s failure in September.
With banks’ lending rates mostly linked to either LIBOR or Bank rate, recent falls will bring significant relief to existing borrowers.
However, the high LIBOR / OIS spread suggests banks still face major difficulty raising funds to finance new lending. To the extent that banks are financing loans linked to Bank rate with borrowing linked to LIBOR, it also frustrates their efforts to widen net interest margins – necessary to rebuild capital in order to support additional lending.
The large fall in LIBOR is welcome but the LIBOR / OIS spread also needs to decline significantly to justify hopes that financial and economic risks are diminishing.
View Printer Friendly Version
Email Article to Friend
Reader Comments