Wednesday, October 24, 2012

LIBOR converging with CD rates; CD transparency proves useful

It looks increasingly likely that going forward the dollar LIBOR curve will be set based on term deposit rates (discussed here). There simply is not enough term (longer than one week) interbank unsecured lending to determine LIBOR without the risk of potential manipulation (or perception of manipulation).

A term deposit is commonly referred to as a "CD" (certificate of deposit) and most banks publish these rates daily. In effect it is the rate at which banks can borrow from the public for a period of time. The convergence between LIBOR and CD rates is now clearly taking place.


This is good news in terms of transparency because CD rate averages are easily available, leaving little room for manipulation. One can monitor the CD curve over time to see where banks are funding themselves out to 5 years. The chart below shows the CD curve now and a year ago. Rates basically have not changed out to 9 months, but have come in beyond that point. Any funding strains in the banking system will quickly become apparent in this curve.


CD rates also tell us which banks are having a tougher time raising deposits or issuing bonds. As the table below shows, some of the smaller/newer banks, internet banks, or banking firms that don't have enough bank branches (such as CIT, MetLife, or Sallie Mae) will pay more for term deposit funding.

Highest CD rates (Source:
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