What’s happening to Australian bank’s trust with each other?

September 18th, 2008

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One of our readers asked in Chained together, for better for worse,

Could you please find out what happened with the interbank lending spread lately? I heard of reports that the overnight LIBOR rate has spiked 100% just 2 days ago. How would this affect the funding cost of banks in Australia? Do you think banks would increase their mortgage/credit rate again after putting them down recently?

In Australia, banks’ lack of trust for each other has risen to almost the same level as in March 2008, just before the bailout of Bear Stearns. One good measure of the level of distrust is the difference between 3-month bank-bill rate and the overnight indexed swap rate. Today, the difference stood at 0.7783%.

Let us take a look at the 1-month and 3-month bank bill rate over the past year:

Australian 1-month & 3-month bank bill rate

As you can see, the bank bill rate was at the highest in March 2008. It remained relatively high until August, when there is a sharp drop. It dropped because the market was anticipating a cut in interest rate by the RBA, which finally happened. Then in the final few days, there is a sharp rise, thanks to the collapse of Lehman Brothers and the bailout of AIG (see Test for credit default swaps (CDS) begins…).

What does this imply for Australian mortgage/credit rate? Well, if banks are already not willing to lower their mortgage rate (see Why are Australian banks not willing to lower mortgage rates?), then this will make them even less willing to do so. That’s why the RBA is busy pumping billions of dollars of liquidity into the financial system.

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