According to this site, the current overnight GBP LIBOR is 0.45638%, and the Bank of England base rate is 0.5%.

My understanding is that the overnight LIBOR should always be higher than the base rate, since it's unsecured.

So, why is it lower?


IBOR (Interbank Offered Rate) and OIS (Overnight Index Swap) are two fundamentally different forms of published interest rates. IBOR is calculated as an average of interest rate submissions from a series of panel banks, ignoring upper and lower outliers to improve robustness, and OIS is calculated as a weighted average of executed traded volume in an overnight unsecured cash lending market. Different currencies have different nuances but the principles are generally the same. However, these fundamental differences give rise to a variation known as the IBOR/OIS basis, essentially the spread between the two. The variation has greater variance when you compare longer tenors (1M, 3M, 6M etc.) but, for simplicity, lets restrict this to simply a 1D tenor (or overnight) as per your question.

In the case of 1D the difference between IBOR and OIS is actually negligibly small and stable. IBOR tends to stay above OIS, since by definition it is an 'offered' rate, and not a 'bid' or 'mid' rate but there is no specific reason it cannot be lower.

In this case the main driver, or the dominantly observed variable is the OIS rate since it is derived from actual trading liquidty and data, so the real question you should be asking is why is the OIS rate, or SONIA (Sterling Overnight Index Average) lower than the deposit rate? And from that answer you derive the answer to your question.

The answer to this new question is ultimately due to Quantitative Easing (QE) and the surplus amount of GBP liquidity cash in the system. You may legitimately question why any bank would lend money to another bank at below 0.5% when the ability to deposit funds at the Bank of England (BoE) base rate is a better credit quality and a higher rate? The answer is access and availability. In order to access the 0.5% rate, any bank must have gone through the approval process associated with the BoE and become registered. No doubt this additionally results in some form of regulatory and on going demands. As such I expect that a large number have not done this and in order to access the facilities they deposit cash with UK banks who then deposit with the BoE. The intermediate facilitation fee is made up by the difference by BoE rate minus SONIA rate. When there is more GBP in the system spread around multiple counterparties this effect is greater, hence the reason the SONIA price steadily dropped over the years as more and more QE had an effect.

When liquidity is withdrawn from the system you can expect this to reverse, although it generally processes slowly, and currently I do not believe there are any real plans to withdraw QE at an accelerated pace (although I have no traded Sterling for many years now).

My comments here are supported by the analysis of E Gagnon, D Bowman and M Leahy. in their article “Interest on Excess Reserves as a Monetary Policy Instrument” from the series: International Finance Discussion Papers.

  • $\begingroup$ Thanks very much for your response! I think I may have misunderstood what the base rate was. The Bank of England website states that it is "...the rate of interest we pay on reserves held by commercial banks at the Bank of England", whereas Wikipedia states that it is interest charged on overnight lending. Is Wikipedia incorrect, or are both of these true? $\endgroup$ – Samuel Banks Aug 1 '18 at 22:23
  • $\begingroup$ Semantically there must always be a lender when there is a borrower. However, in my opinion Wikipedia is wrong. Banks do not lend the BoE money. Instead they deposit funds with the central authority. For example you cannot store digital cash funds under your mattress you must have bank account to account for your funds. Similarly banks can't just store digital funds in accounts on its servers, instead it must collectively deposit them in their account with the BoE $\endgroup$ – Attack68 Aug 2 '18 at 7:02
  • $\begingroup$ Still a little confused, is the base rate the interest paid on funds deposited with the BoE, or is it the rate charged on loans to commercial banks? $\endgroup$ – Samuel Banks Aug 2 '18 at 9:30
  • $\begingroup$ The BoE base rate is the interest rate applied (on an overnight basis) to deposits that commercial banks post to their account with the central bank (BoE), which are also called reserves. The BoE does not loan money (unsecured) to commercial banks. To have an account with the BoE, commercial banks must have applied, been approved and fulfil ongoing regulatory obligations. $\endgroup$ – Attack68 Aug 2 '18 at 9:36
  • $\begingroup$ why then EONIA is strictly above ECB depo rate over the years? the excess liquidity point certainly applies to Europe too? $\endgroup$ – Mike Jan 27 '20 at 17:09

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