Ensure complete transition away from Libor: RBI tells banks/FIs
- May 13, 2023
- Posted by: OptimizeIAS Team
- Category: DPN Topics
Ensure complete transition away from Libor: RBI tells banks/FIs
Subject: Economy
Section: Monetary Policy
Context:
- The Reserve Bank of India has asked banks financial institutions to ensure that new transactions undertaken by them or their customers do not rely on or are priced using the US$ LIBOR (London Interbank Offered Rate) or the Mumbai Interbank Forward Outright Rate (MIFOR).
- The aforementioned key message to banks and other RBI-regulated entities is part of an advisory emphasising the need to take steps to ensure a complete transition away from LIBOR from July 1.
- The central bank said the Financial Benchmarks India Pvt Ltd (FBIL) will cease to publish MIFOR after June 30.
- Banks/FIs have been advised to take all necessary steps to ensure insertion of fallbacks at the earliest in all remaining legacy financial contracts that reference US$ LIBOR (including transactions that reference MIFOR).
- RBI said banks/FIs are expected to have developed the systems and processes to manage the complete transition away from LIBOR.
Past
The Reserve Bank will continue to monitor the efforts of banks/FIs for ensuring a smooth transition from LIBOR. The central bank had issued an advisory on ‘Roadmap for LIBOR Transition’ in July 2021, where banks/FIs, inter-alia, were encouraged to undertake transactions using widely accepted Alternative Reference Rate (ARR), as soon as practicable and in any case by December 31, 2021, and insert robust fallback clauses in relevant LIBOR-linked financial contracts.
The complete transition from LIBOR is a significant event in the global financial markets, which requires continued attention from all stakeholders to mitigate operational risks and ensure an orderly transition, said the RBI.
Concerns about LIBOR
- The use of LIBOR was called into question following the global financial crisis. Regulatory reviews identified that shifts in the way banks fund their operations meant LIBOR was increasingly calculated based on panel bank judgments as to their borrowing costs, rather than actual transaction data, according to India Exim Bank’s FAQs on LIBOR transition.
- Global regulators desired that interest rate benchmarks be founded upon actual transactions, not expert judgment, in order to be robust and reliable.
- In 2017, the UK Financial Conduct Authority/ FCA announced that the underlying markets, upon which LIBOR is derived were insufficiently active to offer a sustainable interest rate benchmark. It announced it had secured undertakings from panel banks to make LIBOR submission until the end of 2021 but would not expect to compel them to make submissions beyond that date.
- The FCA had announced in March 2021 that all LIBOR settings will either cease to be provided by any administrator or no longer be representative: immediately after December 31, 2021, in the case of all Pound sterling, Euro, Swiss franc and Japanese yen settings, and the 1-week and 2-month US dollar settings; and immediately after June 30, 2023, in the case of the remaining US dollar settings.
LIBOR
- LIBOR is a benchmark interest rate at which major global lend to one another in the international interbank market for short-term loans.
- LIBOR, which stands for London Interbank Offered Rate, serves as a globally accepted key benchmark interest rate that indicates borrowing costs between banks.
- The rate is calculated and published each day by the Intercontinental Exchange (ICE).
- LIBOR is the average interest rate at which major global banks borrow from one another.
- It is based on five currencies including the US dollar, the euro, the British pound, the Japanese yen, and the Swiss franc, and serves seven different maturities—overnight/spot next, one week, and one, two, three, six, and 12 months.
- The combination of five currencies and seven maturities leads to a total of 35 different LIBOR rates calculated and reported each business day.
- The most commonly quoted rate is the three-month U.S. dollar rate, usually referred to as the current LIBOR rate.
Why the transition from Libor?
- The rate isn’t sustainable because of a lack of transactions providing data. Libor became a byword for corruption after traders were caught manipulating the benchmark, leading to about $9 billion in fines and the conviction of several bankers.
- The London Interbank Offered Rate (Libor) transition opens up a sizeable business opportunity for large consulting firms such as PwC, KPMG, EY and Deloitte and also for global IT firms, including leading players in India.
- Regulators globally have asked firms to move away from Libor to other alternate, risk-free rates (RFRs)