Fall in Libor May Overstate Improvement in Interbank Lending Market

An interesting piece in Bloomberg contends that the record low level of Libor, which would say that everything is hunky dory as far as banks lending to each other is concerned, is in fact giving a misleading picture. The spread among rates quoted is close to its highest level for the year, indicating some banks prefer are a bit chary of parting with cash. However, some analysts argue for other interpretations.

From Bloomberg:

The drop in the London interbank offered rate, the benchmark for $360 trillion of financial products, to a record low masks a growing gap between the rates that the biggest banks charge each other for credit.

The difference between the highest and lowest interest rates banks say they pay for three-month dollar-denominated loans is near the widest this year, according to data compiled by the British Bankers’ Association. The spread signals that lenders still lack confidence in each other, even though measures ranging from the so-called Libor-OIS spread to corporate bond sales show credit markets have recovered from the freeze caused by the Sept. 15 collapse of Lehman Brothers Holdings Inc.

“It’s premature to judge that the credit meltdown is fully over,” said Kazuto Uchida, chief economist in Tokyo at Bank of Tokyo Mitsubishi UFJ Ltd., a unit of Japan’s largest bank. “Banks remain wary of extending credit to each other due to strenuous concerns about counterparty risk.”….

“The dispersion of Libor submissions seems to be exceptionally wide,” said Marc Chandler, the global head of currency strategy at Brown Brothers Harriman & Co. in New York. “There is potential for bifurcation of the financial system between banks perceived to be healthier than others.”…

Libor-OIS, which indicates banks’ reluctance to lend, fell to 0.45 percentage point last week, the lowest level since February 2008. Still, futures indicate the measure is about two years away from shrinking to 0.25 percentage point. That’s the level former Fed Chairman Alan Greenspan has said would be considered “normal.”….

“The disparity and the difference is really a signal to the market of who really wants to make some loans and who’s got the ability to make those loans,” said Mark MacQueen, partner and money manager at Austin, Texas-based Sage Advisory Services Ltd., which oversees $7.5 billion. “A lot of banks are just trying to hold on to what they have and not really make loans.”

Rather than signaling that the world’s banks are more willing to lend to each other, some investors and strategists say the decline in Libor has more to do with deposits reducing demand for funds in the interbank market. Deposits at U.S. banks jumped by almost $400 billion in the past six months, according to Jim Vogel, head of bond research at Memphis, Tennessee-based FTN Financial.

“Libor’s decline is not necessarily a sign of improving bank credit or the willingness of banks to lend to each other,” said Vogel, whose firm is one of the 10 biggest underwriters of Fannie Mae, Freddie Mac and other U.S. government agency debt. “It’s a sign of improving bank liquidity as customer deposit growth replaces borrowing in the short-term money markets.”

Originally published in Naked Capitalism and reproduced here with the author’s permission.