What Is the Bank Bill Swap Rate (BBSW)?
I'm here to explain the Bank Bill Swap Rate, or BBSW, which is a short-term interest rate that acts as a benchmark for pricing Australian dollar derivatives and securities, especially floating rate bonds. You should know it's an independent reference rate used widely in the fixed income market.
Key Takeaways
Let me break down the essentials for you: the BBSW is that short-term benchmark for Australian dollar instruments, and fixed income investors rely on it to price floating rate bonds and similar securities. Remember, there's always a risk premium added to it to cover the extra risk compared to risk-free rates like government bonds.
What Does the BBSW Tell You?
When you look at the BBSW, it's telling you the midpoint rate for bank-eligible securities, essentially the rate at which banks lend to each other in Australia. It's calculated as an average of bank bill rates for different maturities, and it's crucial for pricing those floating rate bonds and other securities.
How Is the BBSW Calculated?
The Australian Securities Exchange (ASX) handles the calculation and publication of the BBSW, which is Australia's version of the LIBOR, used similarly as a reference rate for institutions. For context, LIBOR comes from daily estimates by major banks and sets the base for global loan interest rates. Keep in mind that the Intercontinental Exchange is phasing out LIBOR: one-week and two-month USD LIBOR ends after December 31, 2021, and the rest after June 30, 2023.
In practice, you might see a floating rate quoted as 100 basis points over BBSW, just like over LIBOR elsewhere. The BBSW averages those bank bill rates, but it's not tightly linked to mortgage or retail lending indexes, so its influence there is mostly indirect through overall interest rate levels.
Risk Premium
You need to factor in the risk premium added to the BBSW to compensate for the securities' risk versus the risk-free rate, which is usually based on government bonds—like U.S. Treasuries in America. This premium is often small, say five to ten basis points, but it ballooned to over 300 during the 2008 financial crisis and afterward.
Prime Banks and Prime Bank Eligible Securities
Prime banks are a select group of approved institutions, including Australia's four biggest banks, reviewed yearly by the ASX.
Membership Requirements
- Being an authorized deposit-taking institution (ADI) as defined by the Australian Prudential Regulation Authority (APRA)
- Satisfying a credit rating benchmark, specifically Standard & Poor’s short-term rating of A1+ and long-term rating for the senior unsecured debt of at least AA
- Having securities eligible for use by the Reserve Bank of Australia (RBA) in open market operations and standing liquidity facilities
Example of the Bank Bill Swap Rate (BBSW)
Suppose bank bill rates were 4% for the first half of the year and then jumped to 5% for the second half; the average would be 4.5%, and with a 15 basis point risk premium, the BBSW comes out to 4.65%. In reality, it's the midpoint of multiple rates, but this gives you the idea.
The Difference Between SIBOR and BBSW
The Singapore Interbank Offered Rate (SIBOR) is the benchmark for lending in Singapore dollars within Asia, covering terms from overnight to a year. It's akin to LIBOR in the UK, while BBSW is the Australian counterpart, all serving as reference rates for interbank lending in their regions.
Limitations of Using the BBSW
Like any benchmark, the BBSW might not accurately capture the full credit risk in the market. Benchmarks like this didn't foresee the 2008 crisis or the recession, so the risk premium can lag and fail to reflect total market risk.
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