What Is the Reykjavik Interbank Offered Rate (REIBOR)?
The Reykjavik Interbank Offered Rate (REIBOR) is the formal interbank market reference rate used to set rates for short-term loans at Icelandic commercial and savings banks. It is a weighted average of market rates offered by banks to each other for short-term funding. It is similar to other benchmark rates, such as the secured overnight financing rate (SOFR). Icelandic banks and lenders use REIBOR (plus a spread) as the basis for setting the rate on loans they make to nonbank borrowers. The REIBOR is relatively new as it only formally began operating in 1998.
- REIBOR is a benchmark reference rate based on short-term interest rates offered between Icelandic banks, and it is used to set other interest rates in Iceland.
- REIBOR is calculated and published by Iceland's Central Bank and is similar to other benchmark rates, such as SOFR.
- The REIBOR market and its relationship to global credit markets were factors in the severe financial crisis that Iceland experienced beginning in 2008.
The Central Bank of Iceland regulates the REIBOR market and the interbank foreign exchange market. Iceland's four major banks negotiate loans for short-term funds in the Icelandic currency, the krona, with each other under rules set by the Central Bank of Iceland.
Market making banks can make bids to the interbank market that extend overnight, one week, two weeks, three months, six months, nine months, and one year. In December 2019, the Central Bank of Iceland stated its intention to stop publishing 9- and 12-month REIBOR rates after July 1, 2020. No interbank loans have been made on those terms since 2008. 90% of volume in the interbank market since 1998 is for loan terms of one week or less. Banks must still submit quotes for loans from overnight to six months. They can offer quotes for 9- and 12-month loans if they make any, but the Central Bank will not list those rates.
Banks in Iceland submit their quotes for rates on short-term deposits and loans to the Central Bank. The Central Bank then averages these quoted rates for various terms to calculate the REIBOR reference rate, which it lists on a daily basis.
Disadvantages of REIBOR
Iceland is a small country, so REIBOR is generally only used in that country to establish rates. REIBOR is usually somewhat higher than other major interbank rates used in global markets. That creates a carry trade as foreigners seek a higher return on their short-term funds. Higher interest rates also contributed to economic instability in Iceland.
During the early years of the 21st century, Iceland's financial sector ballooned in a massive credit bubble fueled by easy access to international credit markets. Iceland's banks grew to nine times the size of the country's Gross Domestic Product (GDP). There were large inflows of deposits from Britain and the Netherlands seeking the relatively high return on REIBOR-based deposit accounts. Iceland became overly dependent on other countries' economies staying afloat and those countries' residents and businesses paying off their debt.
As the global bubble burst and world credit markets came to a halt, Iceland experienced a severe financial crisis of its own from 2008-2011. The REIBOR rate soared between 2003 and 2008. For the average Icelander, rate hikes caused mortgage rates to skyrocket, hitting a rate of 18% in October of 2008, the highest level in Europe.
Iceland was on the brink of bankruptcy when the International Monetary Fund (IMF) intervened with a bailout plan. It took the better part of a decade for the economy to come back to its previous levels.