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About The LIBOR


Recently, the RBI stated that some banks and financial institutions were yet to facilitate an absolute transition away from the London Interbank Offered Rate (LIBOR) benchmark.


GS III: Indian Economy

Dimensions of the Article:

  1. About LIBOR
  2. Controversies Surrounding LIBOR
  3. Alternative to LIBOR: Secured Overnight Financing Rate (SOFR)
  4. Response to the Regime Change from LIBOR


  • LIBOR, or the London Interbank Offered Rate, is a widely used benchmark interest rate.
  • LIBOR is a global benchmark interest rate that combines individual rates at which banks opine they may borrow from each other (for a particular period of time) at the London interbank market.
Applications and Significance:
  • Benchmark for financial instruments:
  • Used as a reference rate for settling trades in various financial instruments, including futures, options, swaps, and other derivatives.
  • Applied in over-the-counter markets and on exchanges globally.
Impact on consumer lending:
  • Serves as a benchmark rate for consumer lending products, such as mortgages, credit cards, student loans, and more.
  • Determines the interest rates offered to consumers by financial institutions.
Indicator of financial system health:
  • Provides insights into the stability and liquidity of the financial system.
  • Helps assess the potential direction of central bank policy rates.

Controversies Surrounding LIBOR:

Integrity and Reporting Accuracy:

  • Banks were relied upon to provide honest reporting of their borrowing rates.
  • This system neglected the potential conflict of interest that banks might have had in manipulating the rates for their own benefit.

Concealment of Disadvantages:

  • As LIBOR rates were publicly disclosed, banks had little incentive to disclose any difficulties they faced in obtaining funds.
  • During the 2008 financial crisis, some banks artificially lowered their rate submissions, concealing the true extent of their financial distress.

Barclays’ Misconduct and Penalties:

  • In 2012, Barclays admitted to misconduct related to LIBOR manipulation.
  • The bank agreed to pay $160 million in penalties to the U.S. Department of Justice as a result.
  • Discrepancies in Borrowing Costs:
  • The Wall Street Journal reported in May 2008 that some panelists paid significantly lower borrowing costs than other market measures indicated.
  • This suggested a potential discrepancy between reported LIBOR rates and the actual costs of borrowing.

Profit-Motivated Rate Alteration:

  • There were instances of banks adjusting their rate submissions based on the derivative positions of their trading units to enhance their profitability.
  • This manipulation could result in inaccurate and misleading LIBOR rates.

Alternative to LIBOR: Secured Overnight Financing Rate (SOFR)

  • In 2017, the U.S. Federal Reserve introduced the Secured Overnight Financing Rate (SOFR) as a preferred alternative to LIBOR.
  • India also adopted the use of SOFR, along with the Modified Mumbai Interbank Forward Outright Rate (MMIFOR), to replace the existing MIFOR for new transactions.
Features of SOFR:
  • Based on observable repo rates: SOFR is derived from repo transactions, which involve borrowing cash overnight collateralized by U.S. Treasury securities.
  • Transaction-based rate: It is determined by actual market transactions, making it a more reliable and transparent benchmark.
  • Reduces reliance on expert judgment: Unlike LIBOR, SOFR eliminates the need for expert judgment in rate-setting, reducing the potential for market manipulation.
Advantages of SOFR:
  • Reduced manipulation risk: By using actual transaction data, SOFR is designed to be less susceptible to manipulation compared to LIBOR.
  • Increased transparency: SOFR is based on observable market rates, promoting transparency and enhancing market confidence.
  • Reflective of collateralized borrowing costs: As a secured rate, SOFR captures the cost of borrowing cash collateralized by U.S. Treasury securities accurately.

Response to the Regime Change from LIBOR:

Assessment of LIBOR Exposures:

  • The Reserve Bank of India (RBI) instructed banks to evaluate their exposures to LIBOR in loan contracts, Foreign Currency Non-Resident Accounts (FCNR-B) deposits, and derivatives.
  • This assessment aimed to understand the extent of reliance on LIBOR and facilitate the transition to alternative reference rates.

Adoption of Alternative Reference Rates:

  • The RBI directed banks to prepare for the adoption of alternative reference rates, such as SOFR and MMIFOR, to replace LIBOR.
  • Contracts entered into after December 31, 2021, were required to use the new reference rates instead of LIBOR.

Inclusion of Fallback Clauses:

  • Contracts entered into before the specified date were advised to include fallback clauses.
  • These clauses would outline revised considerations and terms in case LIBOR is no longer published, ensuring transparency and consistency in contractual agreements.

Regulatory Guidance and Support:

  • The RBI provided guidance and support to banks throughout the transition period.
  • This assistance aimed to facilitate a smooth and orderly shift away from LIBOR to alternative reference rates.
  • The response to the regime change involved a proactive approach by the RBI, emphasizing the assessment of exposures, adoption of alternative rates, and the inclusion of fallback clauses to ensure a seamless transition away from LIBOR.

-Source: The Hindu

March 2024