The numbers game…

Setting it right makes a come-back
I think it is fair to say that UK plc is facing tough times right now. The economy is still in trouble internationally, and the Bank of England is struggling to set rates that will keep inflation low. What many people do not know, however, is that finance companies do not set their rates based on the Bank of England’s base rate. The figure that they use is the rate by which banks lend money to each other, known as LIBOR – and this has important implications when it comes to the provision of finance.

LIBOR stands for the ‘London Interbank Offered Rate’ and is the main setter of interest in the London wholesale money market. Unlike base rate, which is set directly by the Bank of England, LIBOR rates are set by the demand and supply of money as banks lend to each other to balance their books on a daily basis. It is used to price all kinds of financial instruments such as loans and floating-rate mortgages as well as asset finance and leasing. Managed by the British Banking Association and the news agency Reuters, LIBOR dates back to the early 1980s – and is a sort of poll-of-polls of bank interest rates from the top 15 financial institutions in the City of London.
At the time of writing, the Bank of England’s base rate is 5 per cent. If the market behaves within normal parameters and the Bank of England does not change the base rate over the next three months – which is what is expected – then by historical standards, LIBOR would trade at, or around, 5.15 per cent. This is because the three-month LIBOR rate normally trades at a small premium of around 0.15 per cent over where the market thinks the Bank of England base rate will be in three months’ time. But these are not normal times, and the three-month LIBOR rate is currently around 5.9 per cent. The gap between the base rate and LIBOR rate has become much larger by historical standards, since the credit crunch began in August 2007.
At a simplistic level the reason for this is that banks are nervous about the financial security of other banks – Bradford and Bingley being the latest to declare problems – and as such are pricing this potential risk into the cost of borrowing. The effects of this are now clearly feeding through into other finance markets such as consumer credit, which offered mortgage rates rising substantially relative to the base rate and many products disappearing from the market all together.
The situation is lightly different in the business finance sector – we are anecdotally aware of banks increasing the cost of borrowing for some of our vending operator partners and also amending terms. Lessors, too, are having to increase some rates but in relative terms, when credit becomes tight, leasing becomes more popular; primarily because the finance is in the main secured on the value of that asset. For businesses, especially ones that are facing a credit squeeze or cash gap, the additional benefits of leasing depreciating technology assets become even more important – fixing and inflation-proofing payments and then spreading them over the useful working life of the asset, matching cost to benefit, are of great value. So whilst the credit crunch makes life harder for all of us, it is not without its opportunities.
Kevin Reed is National Sales Manager – Vending, Siemens Financial Services.