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Transition from LIBOR

  • Category
    Economy
  • Published
    19th Jul, 2021

The RBI advised banks and financial institutions need to cease entering into new financial contracts that reference LIBOR as a benchmark and instead use any widely accepted alternative reference rate (ARR), as soon as practicable and in any case by December 31, 2021.

Context

The RBI advised banks and financial institutions need to cease entering into new financial contracts that reference LIBOR as a benchmark and instead use any widely accepted alternative reference rate (ARR), as soon as practicable and in any case by December 31, 2021.

About

What is LIBOR?

  • The London Interbank Offered Rate (LIBOR) is a benchmark interest rate at which major global banks lend to one another in the international interbank market for short-term loans.
  • LIBOR serves as a globally accepted key benchmark interest rate that indicates borrowing costs between banks.
  • The rate is calculated and will continue to be published each day by the Intercontinental Exchange (ICE), but due to recent scandals and questions around its validity as a benchmark rate, it is being phased out.
  • According to the Federal Reserve and regulators in the UK, LIBOR will be phased out by June 30, 2023, and will be replaced by the Secured Overnight Financing Rate (SOFR).

What is a reference rate?

  • A reference rate is a benchmark interest rate used to determine other interest rates. For example, LIBOR provides an indication of the average rates at which LIBOR panel banks could obtain wholesale, unsecured funding for set periods in particular currencies. Lenders then use this rate to determine interest rates for a variety debt instruments - such as mortgages and commercial loans - and financial products like derivatives.
  • The need for benchmarks to be based on transparent, arms-length transactions has been reinforced by global regulators, including The Financial Stability Board and the International Organization of Securities Commissions.
  • In response, industry has started to utilize a raft of alternative reference rates, and from the AONIA (Australian Interbank Overnight Cash Rate) to SARON (Swiss Average Rate Overnight) strategies are in place to embrace new benchmark.

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