Banks' refusal to lend cash keeps LIBOR rates high.
Posted on October 27th 2008
Three month LIBOR at the time of writing this column is at 6.11% which is over 160
basis points above BBR. Whilst overnight LIBOR is easing since the announcement
of the raft of historic measures regarding the banking sector, it is the longer
term rates that most lenders base their pricing on.
One of the key targets for Gordon Brown’s rescue plan is to bring LIBOR down to
more manageable and sustainable levels; this in theory should be a bi-product of
increased liquidity in the banking system. However, the banks are still incredibly
nervous about lending to each other and therefore are hoarding cash rather than
lending it. Gordon Brown’s attempts at recapitalising the banking sector are no
doubt bold and decisive and his ideas are being copied around the globe but it will
take several weeks for the flow of money to reach the markets. Many believed that
we would see a speedy reduction in LIBOR but the reality is that the flow of money
into the banking system is yet to happen. Confidence in the markets has reached
a level that no longer respond to words.
Given the sheer scale of the measures announced it is to be expected that the legal
work and the sign off processes will take several weeks to pass through the various
institutions. When the money actually starts to flow banks should be more confident
in each others ability to repay their debts and rather than hoarding cash they will
start to lend again. In theory this should result in the longer term LIBOR spreads
coming down to more manageable levels. Ideally you would expect to see 3 month LIBOR
at approximately 20-25 basis points above BBR but it is yet to be seen whether this
kind of level can be reached in the current financial climate.
As and when the markets start to stabilise we should expect mortgage lenders to
be in a position to price their products in a more competitive way. What we won’t
see is a return to 2007 volume levels, this would be fool hardy and unnecessary.
Lenders appetite for mortgage volumes will be closely linked to their ability to
raise retail deposits. It will be several years before large scale lenders have
confidence to place such a large reliance on capital markets. Lloyds TSB have already
gone on record to say that HBoS’ business will have to change fundamentally and
what they meant is substantially less reliance on securitisations and more focus
on raising deposits in a more traditional manner. HBoS has had a 20%+ market share
for many years so their reduced appetite will have a significant impact on the mortgage
market and it is unclear whether others will take up the slack. My expectations
for annual mortgage volumes over the next 3 years is that £250bn gross lending and
£50bn net lending will be a more realistic than the heady volumes of 2007.
