5.2The ‘parallel’ markets

The parallel markets are also markets for short-term money. They therefore share

many of the characteristics of the traditional, discount, market. Deals are done for

very large sums at very small rates of prot. Most of the participants, banks and

discount houses, are common to both the traditional and parallel markets. In this

section we shall provide a brief description of each of the markets and follow that

with a discussion of the signicance of the parallel markets as a group.

5.2.1The interbank market

As its name suggests, the interbank market is a market through which banks lend to

each other. Like the discount market this provides individual banks with an outlet

for surplus funds and a source of borrowing when their reserves are low. It is a

wholesale market. Deals are usually measured in £ms. The market developed in the

1960s, involving rstly overseas banks, and later merchant banks and discount houses.

Now it is used by all types of banks and it is not uncommon for NDTIs as well to

lend surplus funds through this market.

The loans are normally for very short periods, from overnight to fourteen days,

though some lending for three, six months and one year occurs. Naturally, given

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Chapter 5 • The money markets

the degree of overlap, there is some connection between interbank interest rates and

rates in the traditional market. If banks are short of liquidity they will lend less to

both markets and rates will rise; if the Bank of England readily provides funds to the

discount market, houses will offer less attractive terms to other banks which will

deposit instead with the parallel markets, causing rates there to fall. However, inter-

bank rates are generally slightly higher and certainly more volatile than rates in the

traditional market. Loans are unsecured and there is no lender of last resort. Also,

the range of participants is much wider than in the traditional market. Lesser banks

will expect to pay slightly more for funds than the major retail banks. In periods of

great shortage of liquidity, the needs of banks which do not have sufcient funds

with the traditional market have driven overnight rates to more than 100 per cent.

Interestingly, operating in the opposite direction, the oversubscription of several

new share issues in the 1980s and 1990s saw seven-day rates dip. While they were

completing the administration of the sale, issuing houses deposited subscribers’ money

in the interbank market. The rate of interest paid on interbank loans is known as

London InterBank Offer Rate or LIBOR. It is an important point of reference to banks

because it is probably the best indication to them of the cost of raising immediate

marginal funds. Numerous bank interest rates are therefore tied to LIBOR, particularly

to the rate for three-month deposits.

Unlike other instruments ‘traded’ in the money markets, interbank deposits are

not negotiable. They cannot be bought and sold between third parties. A lending

bank which wishes to retrieve its funds simply withdraws the deposit from the bank

to which it was lent. In this case, therefore, the distinction between primary and

secondary markets is irrelevant.