Can NYFR really replace LIBOR?
Well. For the recently initiated, NYFR (just a day old) is New York Funding Rate while LIBOR (22 year old) is London Inter bank Offer Rate.
LIBOR is the rate of interest at which banks borrow funds from each other, in marketable size, in the London Inter Bank Market. It is basically designed as a benchmark rate that would be applied to Eurodollar funds. By definition Eurodollar is US dollar denominated deposits at foreign banks out side US or foreign branches of American banks. By locating outside of the United States, Eurodollars escape regulation by the Federal Reserve Board.
Since the Eurodollar market is relatively free of regulation, banks in the Eurodollar market can operate on narrower margins than banks in the United States. Due to this reason mainly, the Eurodollar market has expanded largely as a means of avoiding the regulatory controls and costs involved in dollar denominated financial intermediation.
Originally Eurodollar deposits were held almost exclusively in Europe; hence the name Eurodollars. These deposits are still mostly held in Europe, but they are also held in such countries as Hong Kong, Japan, Singapore, Bahamas, Canada, etc. Regardless of where they are held, such deposits are referred to as Eurodollars (Actually in the cold war period, USSR started accumulating US dollar funds; fearing proscription or blockage of funds in the account if held in the United States it strategically moved its funds to France and particularly to French banks)
LIBOR is compiled by British Banks’ Association in conjunction with Reuters and released to the market shortly after 11 AM London time daily. BBA asks 16 banks to report the borrowing rates offered to them and it takes the middle eight of these and reports the average.
There has been a lot of controversy in recent months over the accuracy of LIBOR. Wall Street Journal study claimed that even some big US banks might have been underreporting LIBOR rates as not to reveal how desperate for cash they were due to the current global credit crunch in general and to fund their uncovered losses in particular.
The recent questions on the accuracy of LIBOR might have arisen only because of the present turbulent times in financial markets. Some researches have shown a dramatic imbalance between the funding patterns of US and European banks might have fuelled the tensions in money markets. For their increasing dollar funding requirements, the European banks have been depending on US banks.
Bank for International Settlements opined some banks might have understated their borrowing costs to avoid being perceived as lacking creditworthiness. Banks, reluctant to lend to one another because of fears they would need the money themselves, pushed up the LIBOR rate and lifted the cost for inter bank borrowing.
Due to this some market participants have called for an alternative US dollar benchmark rate to the London Interbank Offer Rate.
ICAP, a bond broker based in the United Kingdom launched the New York Funding Rate - NYFR - on 11th June 2008 – a measure of the average interest rate at which banks lend to one another.
For the NYFR, ICAP polls at least 16 banks for perceived market borrowing costs. The bottom and top 25 per cent of these rates are tossed and the ICAP reports the average of the remaining rates. The process is anonymous and the NYFR is released at 9.30 AM New York time daily.
ICAP further explains that selected banks, on an anonymous basis, will be asked to submit a representative rate for where an institution would be likely to obtain funding in the market, rather than report of their own costs that morning.
Now, let us come back to our original question: Can NYFR really replace LIBOR? To answer this question squarely let us compare and contrast NYFR and LIBOR.
British Banks’ Association compiles LIBOR whereas NYFR is compiled by ICAP – a bond broker.
BBA relies on identified 16 banks and these reporting banks are required to furnish rates offered to them. Whereas ICAP polls at least 16 banks for their perceived market borrowing costs.
BBA releases the LIBOR at around 11 AM London time and whereas ICAP releases NYFR at 9.30 AM New York time.
While the above may be on comparable basis, there is one major contrast between these two rates.
LIBOR is mainly designed and maintained for Eurodollar funds, which are not applied regulatory controls and costs whereas NYFR by virtue of its origin takes into account such regulatory controls and costs.
The questions of accuracy, which are raised against LIBOR, can be raised at any time against NYFR also because NYFR is anonymously polled and published by ICAP – a broker (possible conflict of interests?).
Even the ‘less than’ favourable time zone difference makes LIBOR acceptable in far off Asian markets with little inconvenience. Definitely it would be very difficult (if not impossible) for NYFR to claim that status. With ever increasing newfound wealth in Asian markets, it may not be advisable to overlook their comfort and convenience levels.
This being so, LIBOR can be accepted as the only benchmark rate on Eurodollar funds with a global outlook and requirement. NYFR can be viewed as just yet another rate for dollar funds for a regional requirement.
Of course, the BBA has to look into and clean all the inaccuracies and ensure the LIBOR remains robust benchmark forever. BBA would need the right pricing structure to overcome the stigma problems.
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