ST : How the rates here are determined

May 13, 2010

How the rates here are determined

IN MANY countries, central banks determine interest rates with the aim of delivering low and stable inflation, and in some cases to deflate developing asset bubbles.

But Singapore is different. Due to the country's small size and high degree of openness, the Monetary Authority of Singapore (MAS) has found the exchange rate to be a more effective tool for controlling inflation.

But this means the MAS must give up control of the interest rate as it cannot control both at the same time. This leaves local banks to set interest rates.

There are two widely used benchmark or reference interest rates here: the Singapore Interbank Offered Rate, or Sibor, and the Swap Offer Rate, or SOR.

Both are fixed by the Association of Banks in Singapore (ABS) every day, with input from a selected panel of banks.

Sibor is the rate at which banks are willing to lend to one another. It is used as a reference rate not just in Singapore but also in Asia, and can be thought of as the Asian version of the London Interbank Offered Rate (Libor) or the Euro Interbank Offered Rate (Euribor).

SOR, on the other hand, represents the average cost of funds that banks in Singapore use for commercial lending. It also takes into account the exchange rate of the Singapore dollar against the United States dollar and so tends to be more volatile than Sibor, according to the MAS' MoneySense website.

The Sibor and SOR are influenced by market forces, particularly two key factors.

One is changes in US interest rates, which Singapore rates track. Historically, Singapore rates have run consistently lower than those in the US.

The second factor affecting interest rates here is the amount of liquidity in the banking system: Excess liquidity tends to push down short-term interest rates.

Finally, each bank also sets its own internal prime rate or board rate, which is the lowest rate at which it is willing to lend money to its best customers. Many other interest rates that a bank uses - including its deposit rates and loan rates - are based on this rate.

Banks arrive at their own prime rate after taking into account its cost of funds, operating expenses, credit risks and desired return for shareholders, according to the ABS.