Reuters: US Dollar Report: MONEY MARKETS-As liquidity drops, Libor vulnerable to guesswork

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MONEY MARKETS-As liquidity drops, Libor vulnerable to guesswork Jun 27th 2012, 19:52 By Karen Brettell NEW YORK, June 27 | Wed Jun 27, 2012 3:52pm EDT NEW YORK, June 27 (Reuters) - The rate that banks say they can borrow short-dated funds in the interbank market is vulnerable to a degree of guesswork by banks as liquidity in the short-term funding markets drops, with many institutions less willing, or less able, to borrow short-term funds. The benchmark London interbank offered rate (Libor) plays a vital role in fixed income markets and is the basis for hundreds of trillions of dollars in interest rate swaps, mortgages, corporate, municipal and other debt. Libor has maintained its key role as a benchmark despite numerous regulatory probes relating to manipulation of the rate by market participants before and during the 2007-2009 credit crisis. U.K. bank Barclays said on Wednesday it will pay $453 million to U.S. and British authorities to settle allegations that it manipulated the key rates. Since the crisis the accuracy of the rate has also come under question as banks have radically reduced their reliance on short-term funding, leaving Libor to some degree based on the guesswork of banks over where they could fund in the short-term markets. Libor is calculated by banks reporting the borrowing rate they think is available, rather than from figures based on actual loans. "Interbank lending during London hours is significantly reduced compared to what it was before the crisis," said Ira Jersey, interest rate strategist at Credit Suisse in New York. "It started with banks not wanting to take each others' credit risk because they were worried that the bank would have credit concerns over a three month horizon. Then banks ended up with so much cash and reserves that they didn't need short-term funding. Now, they also might not want to borrow," he said. Fears over bank credit quality came back in force in the second half of 2011, in large part on spreading fears over bank exposures to risky European sovereign debt exposures. This added to the drop in lending in the short-term dollar-based markets, further muddying borrowing rates for the banks that submit to Libor. "In the last year we had the pickup of the European crisis and lot of people reduced their U.S. dollar assets," said Mike Lin, director of U.S. funding at TD Securities in New York. "They started to use more secured funding to fill the gaps of lost funding in unsecured market." The case was especially acute for French banks that scrambled to fund their U.S. operations as U.S. money funds pulled back on extending loans. They have since off-loaded many of their U.S. assets and increased other sources of funding, including bank deposits. Bank funding stress in the late 2011 prompted the European Central Bank to offer cheap, three-year loans in December, which has since helped ease funding stresses in the markets and replaced interbank lending. Libor remains, however, the benchmark for much of the fixed income market. "All of these things are relying on something that has less volume going through it, and as a result is probably a little less meaningful than it was a while ago," Lin said. The British Bankers Association has been reviewing the process of calculating Libor since February. Three-month dollar-based Libor fixed at around 46 basis points on Wednesday, down from its recent high of 58 basis points in January. The rate traded at over 5 percent in 2007. Societe Generale reported the highest rate of the 18 reporting banks on Wednesday at almost 60 basis points, followed by BNP Paribas at 56 basis points and Credit Agricole at just under 55 basis points. HSBC reported the lowest borrowing rate at 26 basis points, followed by Barclays at 33 basis points and Rabobank at 40 basis points. Link this Share this Digg this Email Reprints

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