Bank of England Base Rate vs LIBOR

rbulph

Can someone explain to me what the relevance of the Bank of England Base Rate is? I used to understand that it was the rate at which the Bank of England would lend to banks. But if LIBOR (the interbank rate) is now significantly higher than the Base Rate, why do any banks borrow from other banks? Why don't they just borrow from the Bank of England, causing the interbank market to dry up? Alternatively, if the Bank of England is not willing to lend to banks at its Base Rate, what is the significance of its Base Rate? I'm puzzled.

purch

The Base Rate is the rate used by the Bank of England for it's official operations in the Sterling Money Markets

Firstly these are normal open market activities. Short term repo's are done at Base rate, while longer term repo's etc are put out to tender.

Secondly the rate is used to renumerate the reserve asset balances held with the Bank that meet the balance required by the reserve asset targets. If Banks and other institutions that are required to keep a reserve asset balance with the Bank meet the average amounts required they receive the current base rate.

Finally it is also used by the Bank for their Standing Facilities, both for deposits and collateralised lending. Banks and other eligible institutions can use these facilities on demand subject to 100 basis point penalty on ordinary business days, and a 25 basis point penalty on reserve days (last day in the reserve period)


I remember in the 'olden days' seeing the guys in top hats and tails walking around the City, these were the messengers from the Discount Houses and Banks taking various forms of paper to the Bank to discount. Nowadays of course it is all done electronically, and the Discount Houses are no more, but essentially it is the same system.

if the Bank of England is not willing to lend to banks at its Base Rate

Normal open market activities are done by the Bank to smooth the overnight market and to keep that rate within a range around the Base Rate. They are not done at the behest of the market, but by the Bank itself.

If a Bank needs to use the standing facilities they have to pay 100 basis points over Base for the funds.

rbulph

Thanks very much.

purch wrote: »

If a Bank needs to use the standing facilities they have to pay 100 basis points over Base for the funds.

So in theory, LIBOR should never exceed the Base Rate + 1%? Apart from that, it seems to me that the extent to which the BoE setting the Base Rate is likely to affect the economy is really quite limited. Surely repo rates, reserve asset rates and overnight rates are a bit far removed from and not significant enough to greatly affect the rates that businesses and consumers pay to borrow money?

purch

So in theory, LIBOR should never exceed the Base Rate + 1%?

The Bank in theory has the objective of keeping Overnight rates within a narrow range of it's current Base Rate, and out to the next monetary policy commitee meeting, so their operations focus on that period which could affect LIBOR from O/N out to 1 month maximum. Their desired outcome is a flat curve from whatever today's date is, to the next MPC meeting.

The Bank of England Base Rate is very 'over-hyped' by the media, and we are seeing currently how little affect it can sometimes have on the rates the general public, and wider economy can be subject to.

In times of stress on the economy, like we are witnessing now and also at other times such as the 1992 ERM 'fiasco' the Bank of England has little chance of directing money market rates with any real success.

rbulph

purch wrote: »

The Bank of England Base Rate is very 'over-hyped' by the media

Yes, if you take that on board, it does all seem to make a bit more sense, thanks.

jamesd

Also worth noting that LIBOR is gathered by phoning around a selection of banks and asking them what rate they offer. It's not a real market rate where large numbers of bank to bank lending transactions are done (though lots of other transactions depend on it).

At the moment bank to bank lending seems to be done at rates well above LIBOR, if it's done at all.

Not all banks have access to the Bank of England lending facilities. Writing in various newspapers suggests that smaller mortgage lenders are one example.

purch

Also worth noting that LIBOR is gathered by phoning around a selection of banks

That is correct. LIBOR is a word (acronym) that has entered the lexicon, and is on everybody's list of buzz words (much like Base Rate) without many people really understanding what it means

LIBOR's are set for fixed periods in many currencies daily. They are set from the average of the rates indicated to the BBA by various Banks. I think the list of Banks asked changes frequently (or at least it did)

I recall on many occasions answering the phone on the Trading floor, and being asked for our LIBOR's, and I can recall frequently being told our LIBOR's and that they were either higher or lower (by a 32nd or so) than we were actually trading in the market :eek:

Not all banks have access to the Bank of England lending facilities

Also correct. Most overseas Banks in the U.K. cannot access these facilities on a daily basis, and not all U.K. institutions can either.


P.S. I once asked the Bundesbank if I could access their emergency overnight lending facilities.....and I think they let me have the money just for the cheek of asking. I was definately the first non Domestic German Bank to do so, and probably the last......but that's a different story

ianmr65

Looks like they are getting ready to ditch libor(s), in any case.

http://www.reuters.com/article/rbssFinancialServicesAndRealEstateNews/idUSL2215807020080422

"Loan syndicators are close to implementing alternatives to screen-based Libor rates, a move that could herald a sharp jump in the cost of borrowing as banks try to pass their increased funding costs on to clients, senior bankers said on Tuesday."

purch

Thanks...I hadn't seen that article.

Although I must say that I found this article slightly more upsetting :eek:

http://www.reuters.com/article/newsOne/idUSN2319603620080423

earlgrey_3

purch wrote: »

Although I must say that I found this article slightly more upsetting :eek: [/URL]

Hmm, very worrying. I suppose that's always the danger when you carry your valuables around with you.

pzyktzle

hey purch, if you are still around i would be very interested in your story on why you were the last non-german bank to get funds from their central bank? was this simply due to the introduction of the euro? many thanks.