Chillin' out till it needs to be funded
The LIBOR in muddy waters gave banks a brief respite from setting inter bank rates and as European Banks try to think up ways to increase their rate of return in the new ‘over’capitalised regime, they were first shorn of their ring of comfort seemingly by the fact that they would all be heavily reliant on short term gilts less than one year in maturity while increasing credit quality.
These banks feel UK Gilts and other such are more compliant with the Basel’s stringent requirements for Tier I Capital and as they stock up they become increasingly vulnerable to losing on a sudden drop in the pricing of these bonds in the current tentative polity
Outside the banking business, PE firms like Patron are setting up big London property buying units to bet on increased returns. In Fixed Income, banks were able to apply their minds to a new derivative for hedging not trading.
The simple workaround for that for banks incl Lloyds and UBS was to set up a new overnight rate to facilitate derivatives . The rate called Repurchase Overnight Index average or RONIA is unlike LIBOR as it is not based on a survey of agreeing bankers but in real trades of maturity less than one year secured by collateral provided by the five banks, HSBC, Barclays Capital, Nomura, Lloyds and UBS, the rate coming out to barely over the current yields on UK gilts when hedging the UK gilts for example at 4 -5 bp i.e. 48 bp on a 44 bp Gilt yield according to the FT
The Gilt hedges start trading on April 17 and banks aver they will bring down their funding costs. The derivatives according to the banks, will be overseen by the Wholesale Markets Brokers’ association.