What Drove the 6-Month Vilibor During the Late-2000’S Economic Crisis?

WHAT DROVE THE 6-MONTH VILIBOR DURING THE LATE-2000’S ECONOMIC CRISIS? Sigitas Šiaudinis Lietuvos bankas Gedimino pr. 6 LT-01103 Vilnius E-mail: [email protected] The paper* investigates the drivers of the litas interbank reference rate Vilibor and its spread to Euribor in the second half of the 2000s. The investigation focuses on 6-month indices. The interest rates on loans to Lithuanian corporations and households are largely linked to the 6-month Vilibor or Euribor, depending on the currency of denomination. The rise in the Vilibor significantly higher than Euribor imposed additional interest burden on the borrowers in litas during the prolonged period of stress in 2007-09. This contributed to an increase in the share of euro-denominated loans to predominance and fuelled discussions on the reasonability of the quote-based Vilibor reference rate under a currency peg to the euro. The paper offers some evidence that the 6-month Vilibor – as a reference rate for S. Šiaudinis during the Late-2000’s Economic What Drove the 6-month Vilibor Crisis? the bulk of litas retail loans – was determined by the factors beyond a mere equilibration of the litas 5 money market. Our analysis supports the view that, during the aforementioned period of stress and subsequent moderation, the domestic banking sector as a whole steered the 6-month Vilibor and its spread to Euribor to link litas lending rates to retail deposit rates, while also managing bank exposure to the euro. Keywords: Vilibor; Euribor; the litas; interbank market; interest rate spread; exposure to the euro. Introduction In autumn 2008 through summer 2009 the Lithuanian public observed and expressed its discontent with a dramatic growth in the domestic interbank reference rate Vilibor (Vilnius Interbank Offered Rate) and its spread to Euribor. This followed after a prolonged period (2005-07) of negligible spreads across the litas yield curve. Litas-denominated loans contributed to around a half of the banks’ portfolio of loans to the real economy at the end of 2007** and were predominantly granted at floating rates linked to Vilibor – mostly with a 6-month term. Most of the borrowers in litas – particularly households and non-financial corporations – had borne the interest rate risk and suffered an increased interest burden, or refinanced their loans in euros in 2008-09. The opinion that Vilibor*** was significantly above its fair level during the period of elevated stress in 2008-09 was widespread in domestic media. Commercial banks were blamed for market manipulation, and the central bank of the Republic of Lithuania – Lie- *The author thanks Akvilë Barei- tuvos bankas (Bank of Lithuania) – was criticized for the lack of effective prevention. Maèiulis kaitë, Algirdas Neciunskas, Vyte- nis Paþemys, Tomas Ramanaus- from the ISM University in Vilnius expressed the prevailing opinion, arguing that commercial kas, and Simonas Vilûnas for banks in Lithuania had been able to offer the arbitrary low or high reference rates depending their insightful comments, and Antanas Bumblauskis and Edita of their objectives in different periods, such as the credit boom in 2005-08 and the sub- Jurgaitienë for their assistance in sequent credit crunch (Èerkauskas 2009). Such judgment was based on the following the research. The paper has also benefited from helpful discus- assumptions: there were no material flows into the litas interbank market with the ma- sions with an anonymous re- feree. Any errors or omissions are turities of over 1 month; the Vilibor panel was comprised of a few banks which were the responsibility of the author. able to silently coordinate their quotes to reach a desirable level of the reference rate for **See statistics on loans to re- sidential non-financial corpora- the bulk of their loans. Some market commentators, however, indicated the market tions and households on the factors which justified Vilibor’s elevation. Skyrius from Baltic investment bank “Gild ban- website of Lietuvos bankas at http://www.lb.lt kers” referred to the competitive litas retail deposit market as a determinant of the ***In this paper the term “Vili- longer-term Vilibor rates in periods when the respective segment of the interbank market bor” refers to the 6-month Vili- bor unless specified otherwise. did not work effectively (Èerkauskas 2009). Kudaras (2009) observed that the litas Sigitas Šiaudinis is a Doctor of Social Sciences, Head of the Monetary Policy Operations Division, Depart- ment of Market Operations, Lietuvos bankas. Fields of study: monetary policy implementation, design of monetary policy instruments, money market functioning. 6-month interest rates implied by the litas-euro forwards were very similar to those of Vilibor. Since the litas-euro forward market was considerably more active than the interbank market at longer-term maturities*, Kudaras came to a conclusion that such co- movement of rates testified to Vilibor’s reasonability. Explaining the later fall in the Vilibor spread in the second half of 2009, the analysts referred to the developments in the banks’ exposure to the euro, while the macroeconomic situation had not improved accordingly (Jakeliûnas 2010; Matuliauskas 2010; Truk- ðinas 2010). They assumed that litas-denominated assets of banks considerably exceeded their litas liabilities in the final stage of the credit boom (2007), since the intensified litas- denominated lending had probably been largely financed in euros by the parent banks. The jump in Vilibor-Euribor spread was interpreted as a struggle of banks to balance their Pinigai ir bankininkystë euro assets and liabilities when the recent crisis (2008-09) occurred. By raising the spreads between the litas and the euro rates for retail deposits and loans, banks encouraged their clients to save more in litas and refinance litas-denominated loans in euros. By this approach, banks reduced Vilibor and the litas retail interest rates relative to the euro rates after balanced or long exposure to the euro had been achieved (second half of 2009). Separately, Lithuanian Government transfers of the EU funds and revenues from Eurobond issues to the economy through domestic banks were treated as a significant contributor to Pinigø studijos 2010/2 banks’ excess reserves and a promoter of Vilibor decrease from summer 2009. The decisions 6 of Lietuvos bankas to suspend the outlying bank from the Vilibor panel (1st quarter of 2009) and to publish individual quotes by the contributing banks (since July 2009) were seen as minor factors affecting further development of Vilibor (Matuliauskas 2010). It is notable, however, that there still has been a lack of publications with comprehensive analysis of the functioning of the litas interbank market and the recent development of Vilibor. The abovementioned assumptions appeared in local media in the forms of comments and interviews. At the same time, international observers mainly focused on the sovereign and devaluation risks and considered the development of Vilibor as a reflection of those risks and tighter external liquidity conditions which raised competition among domestic banks for retail deposits (IMF 2009). This paper attempts to identify the underlying determinants of the Vilibor-Euribor spread development and to assess the argumentation of market commentators. In this paper, a period from January 2006 to July 2010 is reviewed covering the last years of credit boom (2006-08), the financial turmoil of 2007, the intensified crisis in autumn 2008-summer 2009, tension easing in the second half of 2009, and stabilization in mid-2010. The cut- off date for the data of this paper is 31 July 2010. The paper is structured in five parts. Section 1 compares the formal definition of Vilibor with those of the other Baltic money market’s reference rates, Libor and Euribor. In this paper, the term “Baltic(s)” refers to Estonia, Latvia, and Lithuania. Section 2 offers a periodization scheme for Vilibor spread and sovereign short- and long-term risk premium development in the second half of the 2000s. The influence of Government transfers *See Interbank Market and Fo- reign Exchange Market Statistics and the measures of Lietuvos bankas are also discussed here. Section 3 analyzes the on the website of Lietuvos bankas at http://www.lb.lt structure of the litas interbank lending market and compares its role in the interest rate **We refer the term “domestic pass-through with that of the euro area interbank market. Section 4 investigates the banking sector” to the commercial banks established in Lithua- relationship between Vilibor and retail interest rates on deposits and loans, and discusses nia, including foreign banks’ the formation of Vilibor from the perspective of the domestic banking sector’s** exposure branches and subsidiaries, while the central bank is not included. to the euro. And final Section 5 concludes. Using the aggregate data of the banking sector’s balance sheet we refer to the available statistics on the other monetary fi- 1. Definitions of Vilibor and other selected money market reference rates: nancial institutions published by similarities and differences Lietuvos bankas, which also in- clude credit unions. The latter, The Baltic central banks established the domestic money markets’ reference rates in however, made up a negligible share of the banking sector’s the second half of the 1990s to develop local financial markets. Eesti Pank (2007) – Bank balance sheet (Lietuvos bankas 2010b: 69). of Estonia – introduced Talibor (Tallinn Interbank Offered Rate) at the beginning of 1996; ***See: Eesti Pank (2007); Bank Latvijas Banka – Bank of Latvia – launched Rigibor (Riga Interbank Offered Rate) in De- of Latvia (2001); Lietuvos bankas (2005, 2010c). cember 1997; Lietuvos bankas introduced Vilibor since the beginning of 1999***. In contrast, the well-known international analogues Libor and Euribor, as well as the majority of other European money market rate indices have been determined and calculated by the respective associations of market participants, while the central banks have played a supportive role in some cases.

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