Hoosier Banker 37 Post-LIBOR Landscape A new era in business loans DIRECTORS / SENIOR MANAGEMENT As of 2022, no new financial contracts can be issued using the LIBOR interest rate benchmark. That means borrowers can choose from several alternative benchmarks for loans and debt securities, which could lower your cost of capital. Bankers have been preparing for the pivot from LIBOR for years. Choosing an alternative to LIBOR is about meeting your customers’ needs while adhering to market conventions. With more choice, bankers are able to meet all the different constituent counterparties’ requirements. And that is good for business. Below are some frequently asked questions about the move away from LIBOR, and what it means for lenders and borrowers. Why is LIBOR going away? In 2012, the British Bankers Association discovered that several large international traders were manipulating LIBOR to boost their profits. It was relatively easy, because the rate was calculated by averaging rates that participating bankers submitted every day – on an honor system. Because few transactions underpinned LIBOR, the people responsible for determining this benchmark tended to use their own judgment in setting it. That was not the only challenge. On top of that, LIBOR was easy to game. LIBOR was reformed in 2012 and 2013, but as problems continued, regulators announced that the index would be phased out in 2021. What are the replacements for LIBOR? There are different benchmarks available for loans that are far more transparent, stable and reflective of your actual cost of funds – with benefits that you can pass on to your customers. There are risk-free rates, which are underpinned by U.S. Treasury bonds, and there are credit-sensitive rates. There is also the Federal Funds Rate that is the rate set by the Federal Open Market Committee. Credit-sensitive rates mirror banks’ true cost of funding, providing an accurate reflection of the interest rate environment for lenders and borrowers. Regional banks are on the record as preferring a credit-sensitive rate for certain types of lending. As policymakers were considering alternatives to LIBOR, 10 regional banks wrote to the Federal Deposit Insurance Corp. stating that a rate secured by Treasury bonds is appropriate for institutions with complex hedging strategies, but “ill-suited for smaller Main Street lenders and community banks with less complex balance sheets.”1 Why do we need so many benchmarks? Actually, choice is a good thing. There are lots of different kinds of loans, and different benchmarks would allow them to be priced more accurately. It’s like the stock market, which has the Dow Jones and S&P 500 Indexes to track the biggest stocks, the Nasdaq to gauge performance in dynamic small company and tech stocks, and even indexes that track specific sectors and country markets. How do I know which rate to use? A benchmark based on unsecured, multilateral lending activity might better represent your cost of funds, whether it is in the deposit market, the cash market or issuing sub-debt, and can pass that benefit on to your customer. It is important to choose a benchmark that is transparent, based on real transactions, not subject to manipulation and IOSCO-compliant. IOSCO, which stands for the International Organization of Securities Commission, Richard L. Sandor, Ph.D. Chair and CEO American Financial Exchange RSandor@theafex.com Continued on page 38.
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