Small size
Quite often Guyanese lament the small size of their economy, but just for one time, they might be glad that their country is small. The population is small. That, along with relatively low wages, contributes to a small market size. Economic output is also small despite an abundance of natural resources, and an ability to export a number of products. Despite its importance to the national economy, exports, as part of global supply, are also small. The smallness of its economy leaves it at the margins of the global economic system. While much of what happens around the world can impact Guyana favourably or unfavourably, whether it likes it or not, Guyana does not always have to be involved in all the markets in the world. Even if it did, with its current size, the penetration would hardly ever be deep considering that Guyana is a low middle-income country with very little resources to throw around. Guyana is not wrapped up in the global capital markets where various types of security could be bought and sold. It also means that Guyana is too small to be interested in the loans that are based on the London Interbank Offered Rate (LIBOR). From that view point, the scandal that currently surrounds LIBOR has limited implications for Guyana.
Price-fixing
In week three of July 2012, the Lucas Stock Index (LSI) rose 0.39 per cent. The slight increase came from a 7.69 per cent increase in the stocks of Citizens Bank Inc (CBI) and a slight rise in the share price of Banks DIH (DIH). The index got no help from Demerara Bank Limited (DBL), Demerara Tobacco Company (DTC), and Guyana Bank for Trade and Industry (GBTI) whose stock prices remained unchanged. As a result, the LSI remains above the yield of the 364-day Treasury Bills by about 14 percentage points.
LIBOR is a household name among banks, but some of the banks that help determine the LIBOR have been accused of price-fixing. LIBOR refers to the interest rate that banks charge each other to borrow money for short periods, ranging from one day to one year. Banks tend to be subject to reserve and liquidity requirements. The situation varies for each country, but most local regulators must impose rules for liquidity requirements that are generally consistent with the recommendations of the Basel Committee on Banking Supervision. In Guyana’s case, the liquidity levels that banks were required to maintain last year was 25 per cent of the deposits in chequing accounts and 20 per cent of deposits in the time and savings accounts. Anytime a bank’s ratio fell below that level or was at risk of doing so, it would have faced a liquidity crisis and risked being penalized for a deficiency in liquid assets. This possibility arises when a bank is able to do good business and does not want to lose that business. As a consequence liquidity levels for each bank could vary daily and, to avoid the penalty, local financial institutions borrow money from each other overnight when necessary. According to the Bank of Guyana, there were 111 trades in the interbank market in Guyana last year to protect against liquidity deficiencies. The interbank rate of interest was 4.4 per cent in 2011.
Royalty
It is under similar circumstances that LIBOR comes into play in the international market. The LIBOR is like the interbank rate in Guyana, except that it is the rate of interest that banks charge each other for borrowing money for short periods of time, one day to one year, across borders. The LIBOR is like royalty in financial circles. The rate is set by the British Bankers Association (BBA), and banks, especially in major industrialized economies, rise and fall on the daily pronouncements of the rate-setting panels that generate the numbers. The LIBOR is fixed in the currencies of nine countries and the currency of the European Union. The nine countries are Australia, Canada, Denmark, Japan, New Zealand, Sweden, the United Kingdom and the United States of America. The banks in these and other countries use LIBOR to price a number of financial products that carry variable rates of interest. As such, when LIBOR rises, interest rates on many products rise. When it falls, interest rates fall.
No direct impact
Both consumer and commercial financial products are affected by the LIBOR. Typical consumer loans that are affected by the LIBOR include auto loans, residential mortgages and credit cards rates. The interest rates on commercial paper and many small business loans are based also on the LIBOR. An estimated 45 per cent of prime rate loans and about 80 per cent of subprime loans are based on the LIBOR. Despite the appearance of LIBOR rates on the home page of its website, a well-placed source at the Bank of Guyana confirmed that LIBOR has no direct impact on the pricing of financial products in Guyana. Guyanese banks do not borrow money using LIBOR facilities and this was confirmed by a representative of one commercial bank speaking for his institution.
Measure of health
Of interest to Guyanese is the price-fixing of which banks are accused in the LIBOR scandal. It raises questions about the reliability of the LIBOR as a measure of financial risk and hence, the reliability of the global financial system to fairly allocate money. It raises questions also about the integrity of those who control some of the powerful banks across the globe that could influence the interest rate on securities that commercial banks in Guyana might invest. Based on some reports, the price-fixing that regulators are examining might have occurred around the time that the recent global financial crisis started. The role that LIBOR plays in the assessment of risk in the global is a crucial one. The movement in the LIBOR is seen as a measure of the health of a financial institution. A low and gradually rising LIBOR suggests that the banks that borrow at such low rates are healthy. Banks that borrow at higher LIBOR were likely to be seen as experiencing difficulties and could face uncertain reactions from depositors. That the LIBOR between 2006 and 2008 is in question once again raises doubts about the true soundness of some financial institutions, and the value of their underlying assets.
A blessing
Through the unethical act of fixing interest rates LIBOR has moved from the sublime to the ridiculous. Indeed, the LIBOR is based on subjective views of bankers and is not tested against any verifiable data base. Financial institutions are often thought of as honest entities that play by the rules. The LIBOR scandal tells us that that might not always be the case. The price-fixing might have helped some consumers and hurt others. It might have helped some investors, especially those with insider information, and hurt others who were depending on the market to guide their decisions. Investigators make that claim about Barclay’s Bank which was fined nearly US$400 million for its role in the scandal. No one knows for sure what the cost will be when the investigations are over.
Fortunately, Guyana does not have to worry. It does not depend on LIBOR and Guyanese do not have to care just yet about the negative impact of the scandal. For once, Guyana’s small size that keeps it out of the LIBOR market might be deemed a blessing.
