SOFR

SOFR

Subject : Economics

Context : State Bank of India (SBI) has executed two inter-bank short term money market deals with pricing linked to SOFR (Secured Overnight Financing Rate).

Concept :

• This follows the U.K.’s Financial Conduct Authority deciding not to compel banks on LIBOR calculation after December.
• SOFR is a replacement for USD LIBOR that may be phased out end-2021.

About SOFR

• The secured overnight financing rate (SOFR) is a benchmark interest rate for dollar-denominated derivatives and loans that is replacing the London interbank offered rate (LIBOR).
• SOFR is based on transactions in the Treasury repurchase market,where investors offer banks overnight loans backed by their bond assets.
• It is seen as preferable to LIBOR since it is based on data from observable transactions rather than on estimated borrowing rates.
• While SOFR is becoming the benchmark rate for dollar-denominated derivatives and loans, other countries have sought their own alternative rates, such as SONIA and EONIA.

LIBOR

• LIBOR is the benchmark interest rate at which major global banks lend to one another.
• LIBOR is administered by the Intercontinental Exchange, which asks major global banks how much they would charge other banks for short-term loans.
• The rate is calculated using the Waterfall Methodology, a standardized, transaction-based, data-driven, layered method.
• LIBOR has been subject to manipulation, scandal, and methodological critique, making it less credible today as a benchmark rate.
• LIBOR is being replaced by the Secured Overnight Financing Rate (SOFR) on June 30, 2023, with phase-out of its use beginning after 2021.