Home Business NewsBusiness Wider Libor spreads don’t signal rising bank credit risks

Wider Libor spreads don’t signal rising bank credit risks

13th Apr 18 7:44 am

Moody’s finds

he recent widening in the spread between Libor and overnight indexed swaps (OIS) is unlikely to reflect an increased reluctance among banks to lend to one another due to credit concerns, Moody’s Investors Service said in a report published today.

“We do not believe that an increase in the perception of banks’ credit risks has initially widened the Libor-OIS spread since mid-November last year,” said Colin Ellis, Moody’s Chief Credit Officer EMEA and co-author of the report. “A broader array of indicators points to a very gradual pick-up in credit stress only in recent weeks, coinciding with higher volatility and tighter financial market conditions.”

Other factors may have contributed to the recent spread widening. For instance, banks have increased commercial paper issuance, a substitute for interbank lending, in expectation of rising corporate demand for investing cash holdings in short-term paper following recent changes to US tax laws. At the same time, short-term US government debt issuance has also increased. Both have led to higher short-term market rates, which has eventually fed through to higher interbank rates.

While it is uncertain whether wider spreads will persist or revert to ‘normal’ levels in the coming months, a higher Libor will increase interest payments on floating rate debt and hit borrowers’ cash flows, potentially depressing profitability and spending.

Highly leveraged borrowers funded with these variable rate instruments which already have low interest coverage will be most affected, but most companies, in particular investment grade issuers, can withstand higher rates.

Moody’s views the recent financial markets tightening within the context of stronger global growth and the inevitable normalisation of interest rates in advanced economies. While some companies and households will face higher interest bills as a consequence, US rates have been rising for some time, and have started rising in other countries, too.

“Given that we expect two or three more increases in the Fed’s target rate this year, the increase in the spread to around 60 basis points can be thought of as a modest acceleration of this expected policy tightening,” Mr Ellis added.

“At this point, we do not think the extra increase in effective interest rates is enough to derail the US or global growth outlook. Our central case remains robust and steady GDP growth across most major economies in 2018 and 2019. However, we will continue to monitor the spread and alternative credit and interest rate signals.”

Leave a Comment


Sign up to our daily news alerts

[ms-form id=1]