SONIA vs LIBOR
The Bank of England calculates the LIBOR (London Interbank Offered Rate) and the SONIA (Sterling Overnight Index Average) rates using distinct approaches. The LIBOR rate is derived from actual data provided by a panel of 16 banks. Each bank estimates the interest rate at which it believes it could borrow funds from other banks in the London interbank market. To determine the LIBOR rate, the Bank of England excludes the top and bottom 5% of these figures and calculates the average of the remaining rates. This process helps eliminate extreme values and provides a representative average for interest rates. In contrast, the SONIA rate is based on observed transactions in the overnight sterling wholesale funding market, providing a more direct measure of market activity.
SONIA replaced LIBOR because LIBOR was found to be vulnerable to manipulation and fraud by some banks that submitted false data to influence the rate. LIBOR also became less representative of the underlying market as the volume and liquidity of interbank lending declined after the global financial crisis. The UK Financial Conduct Authority announced in 2017 that it would no longer compel banks to submit data for LIBOR after 2021, which effectively meant the end of LIBOR as a reliable benchmark.
SONIA is calculated by the Bank of England using data from banks that report their transactions in the sterling overnight market. The Bank of England publishes SONIA every London business day by 9am. SONIA is used to value around £30 trillion of assets each year and is referenced in over £90 trillion of new transactions each year.
SONIA and Base Rates Going Up
The SONIA rate, which reflects the average of the interest rates that banks pay to borrow sterling overnight from other financial institutions and other institutional investors, has increased significantly in recent months. The SONIA rate tracks the Bank of England base rate very closely, which means that any change in the base rate affects the SONIA rate almost immediately. The Bank of England has raised the base rate twelve times since November 2022, from 0.25% to 4.5%, in response to rising inflation and strong economic recovery from the pandemic. The Bank of England has signalled that further rate hikes may be needed to keep inflation under control, which could push the SONIA rate higher in the future. The current SONIA rate as of June 14 2023 is 4.4283%, up from 0.10% in March 20204.
Recent Lending
According to the latest data from the Bank of England, UK non-financial businesses (PNFCs and public corporations) borrowed £0.9 billion of bank and building society loans in June 2022, on net, compared to £1.8 billion of repayments in May 2022. This was the first positive net borrowing since March 2021, when businesses borrowed £2.7 billion on net. The annual growth rate of bank lending to PNFCs was -0.4% in June 2022, slightly higher than -0.6% in May 2022 but still well below the peak of 11.8% in June 2020.
The British Business Bank’s Small Business Finance Markets 2022/23 report shows that £35.5 billion of bank lending came from challenger and specialist banks in 2022. This exceeded lending by the major banks during the period, giving challenger and specialist banks a 55% share of the market. The report also finds that gross bank lending to smaller businesses in 2022 was £65.1 billion, a 12.8% increase from 2021, despite a significant drop in the proportion of smaller businesses using external finance – 33% versus 44% in 2021.
Correlation Between Bank Rates and Lending Rates
The amount of money lent by banks to businesses in the UK depends on various factors, such as the demand for credit, the availability of funding, the risk appetite of lenders and borrowers, and the cost of borrowing. The cost of borrowing is influenced by the Bank of England base rate, which is the interest rate that the Bank of England charges to commercial banks that hold money with it. The base rate affects the interest rates that banks charge to businesses and consumers, as well as the interest rates that banks pay to savers and investors. Generally, a higher base rate means higher borrowing costs and lower lending volumes, and vice versa.
However, the relationship between the base rate and bank lending is not straightforward or mechanical. There are other factors that affect the transmission of monetary policy to bank lending, such as the level of competition among banks, the expectations of future interest rates, the availability of alternative sources of finance, and the impact of regulatory and fiscal policies. Moreover, the effect of changes in the base rate may vary depending on the type and size of businesses. For example, small and medium-sized enterprises (SMEs) may be more sensitive to changes in borrowing costs than large businesses, as they have fewer financing options and lower bargaining power. Similarly, businesses that rely on variable-rate loans may be more affected by changes in the base rate than those that use fixed-rate loans.
SONIA and Factoring
The increase in SONIA rate has an effect on the amount of money being financed by factoring firms, as it affects their cost of funding and their profitability. A higher SONIA rate means that factoring firms have to pay more interest when they borrow money from banks or other sources to finance their operations. This may reduce their margins and limit their ability to offer competitive rates to their clients. A higher SONIA rate may also discourage businesses from using factoring as a source of finance, as they may face higher interest charges on their invoices.
However, the effect of SONIA rate increases on factoring may not be uniform or linear. There are other factors that influence the demand and supply of factoring, such as the availability and cost of alternative sources of finance, the credit conditions and expectations in the market, the growth and performance of different sectors and industries, and the regulatory and fiscal policies that affect businesses and factors. Moreover, some factoring firms may use hedging strategies or fixed-rate contracts to mitigate the impact of changes in SONIA rate on their funding costs and revenues.
Therefore, it is difficult to establish a clear and stable correlation between increases in SONIA rate and the amount of money being financed by factoring firms. The correlation may change over time and across different segments of the factoring market. However, it is likely that there is a negative correlation in general, meaning that higher SONIA rates tend to reduce factoring volumes.
In Conclusion
It is difficult to establish a clear and stable correlation between increases in borrowing rates and the amount of money lent by banks and factoring firms to businesses in the UK. The correlation may change over time and across different segments of the business sector. However, it is likely that there is a negative correlation in general, meaning that higher borrowing rates tend to reduce bank lending and invoice finance to businesses, all else being equal.
