Small and mid-sized banks now have an electronic marketplace to lend and borrow short-term funds. Launched in December, the American Financial Exchange will focus on serving the overnight and 30-day borrowing needs of 1,740 community and regional banks in the U.S. This represents institutions that manage between $500 million and $125 billion in assets in a total market of nearly $5 trillion.
AFX is the latest brainchild of Richard Sandor, chairman and CEO of Chicago-based Environmental Financial Products and a driving force behind the development of futures based on interest rates and carbon emissions. CBOE Holdings will host the exchange and Sandor will serve as chairman and CEO.
Currently, small and medium-sized banks arrange their overnight and short-term loans by telephone, according to Sandor. AFX was designed to bring the exchange model of standardization, transparency and a rules-based process to interbank lending while helping to reduce transaction costs through an electronic market.
Beyond adding more transparency and competition into the market, Sandor hopes to introduce a new interest rate benchmark, the American Interbank Offering Rate, or Ameribor. “London has Libor, Europe has Euribor, even China has Chibor, yet there is no interest rate benchmark in the U.S.,” he said.
As the rate will be set based on the outcome of a weekly auction for a 30-day loan, Sandor said that AFX sidesteps the problems with manipulation suffered by the London rate. “We hope that we can get people to have a high degree of confidence because it is competitively determined as opposed to being set by some consensus based on no transactions,” he said.
Small banks’ funding costs don’t always track Libor and other better-known interest rate benchmarks, according to Sandor, who argues that Ameribor will help them eliminate this basis risk. “That’s the real economic driver here,” he explained.
Once auction volume grows beyond $100 million, Sandor predicted that Ameribor will be a reliable measure of actual rates in the market. “I think when we get from $100-500 million traded in each auction we’ll be confident that the rate is effective of the funding costs,” he said.
