The London Interbank Offered Rate (Libor) has more than doubled in 2010, as concerns about European sovereign debt have increased borrowing costs for banks. While the Libor still remains far below rates during the 2008 global economic crisis, many analysts believe that the recent substantial increases in the rate reflect the fragility of the European banking system. The following article from Money Morning has more on this.
LIBOR (London Interbank Offered Rate) – the rate banks pay each other for three-month loans in dollars – yesterday (Tuesday) rose to its highest level since last July.
The rise in borrowing costs is directly attributable to Europe’s debt crisis, which is forcing financial institutions to re-think their peers’ creditworthiness.
The Libor increased to 0.536%, the highest level since July 7, from 0.510% on Monday, the 11th consecutive day it has increased, according to data from the British Bankers’ Association (BBA). German and French bonds surged, pushing 10-year yields to record lows, as investors moved into the safest assets.
“It’s all part of concern about the system, about whether the sovereign-debt crisis will morph into a bigger systematic crisis,” Padhraic Garvey, head of investment-grade strategy at ING Groep NV (NYSE ADR: ING) in Amsterdam told Bloomberg News. “We’re not quite at a point where that’s imminent, but that risk is being priced in.”
While the current Libor – which is seen as an indication of mutual trust between banks – is far below the sky-high level of 4.8% it reached at the height of the financial crisis in 2008, it is still significantly higher than 0.25% in March.
The rate has more than doubled this year as the European debt crisis fueled speculation that the quality of banks’ collateral has been degraded.
The Libor’s jump is hitting European banks hardest, as those banks are being forced to pay more for short-term dollar borrowings than banks in the United States and Asia. Lenders appear to be increasingly nervous about the risks facing European banks as government debt mushrooms in Greece, Spain and other Eurozone countries.
German state-controlled lender WestLB AG told The Wall Street Journal it cost 0.565% to borrow dollars for three months on Monday, up from 0.38% a month earlier. U.S. banks reported lower costs: Bank of America Corp. (NYSE: BAC), reported its three-month dollar Libor stood at 0.48%. J.P. Morgan Chase & Co. (NYSE: JPM) told The Journal it paid 0.47%.
The markets “have already downgraded the European banking system,” George Goncalves, head of U.S. interest-rate strategy in the Americas at Nomura Securities in New York told The Journal.
A rising Libor reflects worries about $2.8 trillion in debt originating in Portugal, Greece, Ireland, Spain and Italy. Efforts to reduce the deficits are almost certain to blunt economic growth and make it tough for companies to repay their loans.
That would expose European banks to higher losses, and increase their borrowing costs.
Concern that more institutions in Europe are facing stress rose after the central bank of Spain decided to bail out regional savings bank CajaSur with $621.75 million (500 million euros), last Saturday. Controlled by the Roman Catholic Church, the 146-year-old lender financed real-estate projects on Spain’s Mediterranean coast.
Four of Spain’s savings banks with more than $165 billion (135 billion euros) in assets announced earlier this week that they plan to merge.
Dollar Libor is posted by a panel of 16 banks every day around lunchtime in London after a daily survey by the BBA. Contributing banks provide estimates on how much it would cost to borrow in 10 currencies for periods ranging from a day to a year.
Libor’s surge is dimming hopes for a sustained global economic recovery because an increase in banks’ borrowing costs can spark higher interest rates for borrowers on mortgages, credit cards and corporate loans.
Current market conditions could continue to push the Libor higher, some analysts predict, as European banks find it tougher to borrow and investors around the world cut back on how much they’re willing to lend to U.S. and European banks.
The benchmark rate could go as high as 1.5% in the next several months, according to Citigroup Inc. (NYSE: C) analyst Neela Gollapudi.
“The banking world is extremely interconnected and still very fragile,” Nikolaus von Bomhard, chief executive of Munich Re AG and president of the Geneva Association, a research group that includes CEOs of major insurers, told The Journal in an interview.
“The confidence that has been built since the Lehman crisis is vanishing to some extent, and the challenges for the banking industry are not yet resolved,” he said.
This article has been republished from Money Morning. You can also view this article at Money Morning, an investment news and analysis site.