Sri Lanka dollar risk rates shoot up as banks chase US currency

Mar 24, 2008 (LBO) – Premiums above benchmark rates for dollar loans in Sri Lanka’s interbank markets have rocketed as a global credit crunch made the US currency dearer and local demand was boosted by an active swap market, bankers said. . “Banks were borrowing in the interbank market at around 15 basis points above the London Interbank Offered Rate (LIBOR), a few weeks ago, but now the rates are above 100 basis points,” says Dudeepa Ratwatte, head of global markets at Commercial Bank of Ceylon.

“After the sub-prime bubble burst local banks are also having to pay high rates to borrow dollars from abroad, and everyone wants to be liquid.”

Skittish Perceptions

Sri Lanka’s interbank dollar market is not very active and there are no ready quotes in the market unlike the rupee interbank market.

Since the sub-prime bubble burst last July, risk premiums have shot up internationally and lenders have been unwilling to lend long term due to uncertainties about the credit worthiness of the borrowers.

But uncertainties intensified this year after bigger losses were revealed by banks who were earlier claiming to have weathered the crisis.

This showed that the problem was deeper than previously thought and that some were either hiding or were not fully aware of the real value of securities – especially US originated mortgage securities backed by sub-prime or risky borrowers – that are no longer traded freely.

The collapse of Wall Street giant Bear Stearns and rumours that were circulating about other banks from time to time has made already jittery lenders even more skittish.

This has created a global preference for dollar liquidity which is making it difficult for Sri Lankan banks to borrow from foreign markets.

Swap Opportunity

“Banks want to be liquid in dollars,” says Rukshan Dias, head of global markets at Standard Chartered in Sri Lanka.

“There is also demand for dollars in the swap market.”

A dealer who sells dollars in the spot market and buys forward through a swap contract can now generate rupees at rates around 12 to 13 percent. But short term Treasury yields are about 500 basis points higher, giving a clear arbitrage opportunity for banks.

But to start a swap contract a bank needs dollars to sell in the spot market.

“Even if you borrow at 150 or 200 basis points above LIBOR it is still profitable,” says Dias.

“So borrowers are willing to pay high rates.”

The benchmark LIBOR rates have fallen since the Fed Reserve started to cut rates last August. Last week the Fed cut its target rate by 75 basis points to 2.25 percent. But in London, LIBOR rates are now about 50 basis points higher than the US rate.

The spread between interbank and treasury rates in the UK rose above 175 basis points last week, reports said, compared to just 10 basis points before the sub-prime bubble burst.

Offshore Banking

In Sri Lanka banks run foreign currency banking units and lend to customers both in the island and abroad, especially the Maldives. Meanwhile, high rupee rates are increasing the demand for dollar loans in the country from customers qualified to borrow in dollars.

Deposits are raised mostly through non-resident foreign currency units (NRFC) of Sri Lankans working abroad as well as qualified resident depositors.

The high demand for foreign exchange loans is also pushing up rates offered by banks for dollar deposits. Bank that used to offer rates above 25 basis points above Libor are now offering as much as 150 basis points in some cases, bankers said.

Risk premiums for sovereign debt in Sri Lanka have also risen amidst the global turmoil.

Sri Lanka got commitments for 150 million dollars for a syndicated loan with a call option at one year earlier this month priced at around 259 basis points without fees.

Two years ago Sri Lanka was raising one and two year dollars through bonds at 130 to 150 basis points above benchmark rates.