What is the bank bill swap rate (BBSW)?

One of the key terms for Australian fixed income investors is the Bank Bill Swap Rate, or more commonly referred to as BBSW. While BBSW has many uses, for fixed income investors its main relevance is as a benchmark upon which we can evaluate floating rate bonds or investments.

BBSW is simply the short term swap rate.



Using a very simple example which ignores bank sector risk, if interest rates were 4.25% and were expected to rise by 50 basis points (0.50%) in 6 months and then remain unchanged, the one year swap rate would be the average over the year i.e. 4.25% for 6 months plus 4.75% for six months = average 4.50%. The one year swap rate would be 4.50%.

Generally the risk assigned to the banking sector is small (say 5bps to 15bps), however, in the midst of the global financial crisis, the US equivalent of BBSW, US$ LIBOR saw bank risk premiums in excess of 400bp.

Officially, BBSW is a compilation and average of market rates supplied by domestic banks in regard to the specific maturities of bank bills. In other words, it is the rate at which banks will lend to each other (via bank bills). It is calculated for various maturities, compiled by Australian Financial Markets Association (AFMA) and is published at approximately 10.08am AEST on an approved information vendor’s service (i.e. Thomson Reuters Screen BBSW page). The purpose of BBSW is to provide independent and transparent reference rates for the pricing and revaluation of Australian dollar derivatives and securities.

The 90 day BBSW is often referred to as the reference rate for market interest rates and, in particular, is used as a benchmark interest rate for floating rate bonds and other floating rate financial instruments such as hybrids.

Typically, there is a strong correlation between changes in the cash rate and the impact on BBSW, as demonstrated in the Figure 1 below. It must be noted, however, that other factors, in addition to changes in the official cash rate, impact the market rates charged by banks and other financial institutions.

Figure 1