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Bank Funding and LIBOR

I previously posted this on fool.co.uk and thought it may be of interest. Or not of course.

or there's more than one way to skin a cat

There's been a lot of comment on here (and elsewhere) about bank funding, LIBOR and the BoE recently and I thought I'd add my £0.01 'orth.

Banks fund themselves short term in several ways and at the moment there is a lot of concentration on LIBOR rates.

LIBOR is an average measure of unsecured interbank financing rates over different time periods (a day, a week, a month &c.). Banks don't trust each other right now so they are demanding more to lend unsecured to each other and thus LIBOR is rising.

Another source of bank funding is the repo market. For the unitiated, a repo (repurchase agreement) is where a bank agrees to sell a bond to another bank and agrees to buy it back at an preagreed price after a certain period of time - maybe after a day, a week or a month for example.

In effect it is a form of secured borrowing. You hang on to my bond for the night (or whatever) and I'll use your cash. We swap back at the end of the contract.

If the BoE exchanges CDOs or MBSs or other small bowls of Alphabetti Spaghetti for Gilts then those Gilts can be used in repo deals thus circumventing the need to borrow unsecured in the interbank money markets (from which LIBOR is calculated). This enables the banks to lend to each other with a degree of security provided by the collateral of the Gilt.

Any downward pressure this would exert on LIBOR would be indirect as the banks in the most trouble (and thus likely to pay the highest rates in the interbank money markets) will be able to finance themselves using repos instead.

I'm not trying to make a point as to whether the BoE intervention is a good or a bad thing, just trying to point out its most obvious impact on bank funding.

http://boards.fool.co.uk/Message.asp?mid=11039133

Comments

  • nelly_2
    nelly_2 Posts: 17,863 Forumite
    10,000 Posts Combo Breaker
    Generali wrote: »
    Banks don't trust each other right now

    So banks have become like us......they dont like banks

    Now theres some jolly fantastic irony eh.

    I fell out of my loft hatch today and have probably the sorest knee in britain
  • jamescredmond
    jamescredmond Posts: 1,061 Forumite
    I hope you're allright, nelly.
    miladdo
  • nelly_2
    nelly_2 Posts: 17,863 Forumite
    10,000 Posts Combo Breaker
    I hope you're allright, nelly.

    Im quite phylosofical about pain

    It like having the in-laws over for dinner it turns up it isnt pleasant but at least you know it'll end.


    What I dont get is how banks are posting record profits but sulking about the money they dont have!

    What gives?
  • ManAtHome
    ManAtHome Posts: 8,512 Forumite
    Part of the Furniture Combo Breaker
    Generali wrote: »
    and agrees to buy it back at an preagreed price after a certain period of time - maybe after a day, a week or a month for example.
    And at the end of the term, if you're "too big/important to fail and can't/won't buy it back"... that'll be a problem for the next government then.
  • Generali
    Generali Posts: 36,411 Forumite
    10,000 Posts Combo Breaker
    ManAtHome wrote: »
    And at the end of the term, if you're "too big/important to fail and can't/won't buy it back"... that'll be a problem for the next government then.

    Not really. That's the point of a repo, it's secured lending so if the bank with the money can't repay then the bank with the Gilt sells that instead.
  • EdInvestor
    EdInvestor Posts: 15,749 Forumite
    Trying to keep it simple...;)
  • brit1234
    brit1234 Posts: 5,385 Forumite
    EdInvestor wrote: »
    Libor down to 5.8% last week following BoE liquidity

    Libor always goes down after these type of interventions and then creeps back up again. It has been doing this since September, also don't forget interest rates have been cut as well.
    :exclamatiScams - Shared Equity, Shared Ownership, Newbuy, Firstbuy and Help to Buy.

    Save our Savers
  • Generali
    Generali Posts: 36,411 Forumite
    10,000 Posts Combo Breaker
    EdInvestor wrote: »

    Hmm. 0.8% above the base rate. That's not what I'd consider a low or even a normal spread. A 'normal' spread would be less than 0.2% above the Bank of England Bank Rate I reckon.
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