Can the CD interest rate reflect the money market?

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Hi, guys! How have you been? Today, I am bringing the issue as hot as this summer. These days, we often hear about ‘the Certificate of Deposit (CD)’ interest rates. The Fair Trade Commission (FTC) is investigating whether the CD interest rate was manipulated or not. Concerned voices say that such manipulation would be regarded as Korean version of Libor Scandal. Responding to the issue, the Financial Services Commission (FSC) and other financial authorities are trying to improve the current method to calculate the short-term interest rate indicator including the CD interest rate.

Actually, the CD rate has played an important role in the money market as one of the major short-term interest rate indicators. It is shown from the fact that the CD interest rate indexed loan amounts to 30% of total loans in Korea. This figure represents that the CD interest rate has been often used as the benchmarking rate. Moreover, the CD interest rate has been the floating rate index for most of the interest rate swap transactions.

So, by now you all recognize that the CD interest rate has had its significance as one of the most frequently used indicators. Then, what’s the problem? The problem is that the CD interest rate is not effective enough to reflect conditions in the money market. Throughout the year, the CD interest rate has been rarely changing along with the downward pressure on its transactions. Accordingly, the CD interest rate has lost its representativeness as a major index rate.

The following graph indicates the down-size of marketable CD since 2008. Marketable CD is traded by the financial companies, and it is used to calculate the CD interest rate.

The Korean government has made an effort to set a benchmarking interest rate that would be more reflective of the market condition and hence replace the CD interest rate. In this regard, the Cost of Fund Index (COFIX) was designed in 2010. This rate represents the actual cost of funds raised by banks including CDs, bonds, etc. The plan to further improve the short-term interest rate indicator was announced by the government bodies including the Ministry of Strategy and Finance (MoSF), the FSC and the Bank of Korea (BOK).

I hope you don’t feel so lost after reading my blog post, since the short-term interest rate is one of the most difficult issues for the public to understand. Actually it is not an easy area to be dealt with even by the professionals. So, joint task force team composed of the FSC, the MoSF, the BOK, the FSS, the Korea Institute of Finance and the Korea Capital Market Institute is working on it with academic professors. Considering the importance of the short-term interest rate in the financial market and industry, this issue should be thoroughly dealt with. I believe the government would bring up some proper measures.

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