New money-market regulations are pushing up a benchmark interest rate
DURING the financial crisis of 2008, LIBOR was a gauge of fear. The London inter-bank offered rate—at which banks are willing to lend to one another—leapt. (Even then it may have been too reassuring: banks have since been fined billions, and traders jailed, for rigging it.)
Lately it has been climbing again: on August 22nd three-month dollar LIBOR rose above 0.82%. That is no cause for panic, but it is a seven-year high and 0.2 percentage points more than in June. What’s going on?
Increases in LIBOR, a benchmark used to set rates for trillions of dollars’ worth of loans, usually reflect either strains on banks or expected rises in central banks’ policy rates. Although the Federal Reserve has been toying with tightening, this time LIBOR’s ascent has another explanation, traceable to the turmoil of 2008. A change by the Securities and Exchange Commission (SEC) in the regulation of American money-market funds has made borrowing pricier, especially for foreign banks.
Before the crisis investors in money-market funds—which lend for short periods to banks, other companies and the government—had become accustomed to treating their accounts like bank deposits, putting money in and taking it out at will. That changed the day after Lehman Brothers went bust, when the Reserve Primary Fund “broke the buck”, declaring that investors could no longer redeem shares for the customary $1 apiece. A run on funds ensued; to halt the chaos, the Treasury was forced to guarantee them.
The SEC’s new rule, which takes effect on October 14th, obliges “prime” funds (buyers of banks’ and companies’ paper, as well as public debt) serving institutional investors to let their net asset values vary, rather than fix them at $1 a share. To prevent runs, they may also limit and charge for redemptions if less than 30% of their assets can be liquidated inside a week.
This has made prime funds much less attractive, causing a “change in the landscape of the wholesale funds market”, says Steve Kang, an interest-rate strategist at Citigroup. Between October 2015 and July 2016 all prime funds’ assets declined by more than $550 billion, to $1.2 trillion, according to the SEC; “government” funds that invest in Treasuries and the like have swollen by a similar amount, to $1.6 trillion (see chart). Prime funds have also pushed their liquidity ratios well above the 30% threshold as the October deadline approaches; they are loth to lend for as long as three months.
Steven Zeng of Deutsche Bank notes that in the past couple of months the average maturity of large funds’ assets has declined from more than 20 days to less than 13.
For foreign banks, which account for more than $800 billion of prime funds’ $938 billion of bank securities, this is depleting an important source of dollars. (American banks rely more on deposits.)
Borrowing has become pricier, which LIBOR echoes. They seem to be filling the gap: for example, cash-rich companies are thought to be lending via “separately managed accounts” rather than prime funds. Banks have other alternatives, but borrowing using exchange-rate swaps, explains Mr Kang, is more expensive; central-bank swap lines are dearer still, and because they are primarily regarded as emergency facilities, banks are reluctant to tap them.
The pain will vary from bank to bank. American lenders with lots of LIBOR-linked mortgages may even gain. Some foreign banks may also recoup higher borrowing costs: their floating interest-rate commercial loans outweigh those at fixed rates. But many borrowers will pay a price. The aftershocks of 2008 rumble on.