This week the Economist highlights some of the concerns and risks to the financial system as Libor – the London Interbank Offered Rate – comes to a 'planned demise' in 2021.
The 'world's most important number' is used in trillions of transactions; around $260 trillion-worth of loans and derivatives are based on the rate. And there are concerns over how the transfer to a different benchmark will be managed. The Economist notes two risks in particular.
One is that the transfer from Libor to a different benchmark interest rate – whether that will be SOFR, Sonia, Tonar, Ameribor or another proposed reference rate – could cause market instability. It says: “That shift could have big effects, such as a sudden jump to higher interest rates for borrowers.” The answer, according to the newspaper, is for loans and derivatives contracts to include 'fallback' clauses that set out clearly what must happen when Libor ceases to be.
The other risk relates to the new reference rates that will replace Libor. The Economist says these could “cause banks' assets and liabilities to become disconnected” and this could lead to banks' own borrowing costs rising even if their income from loans is falling. This mismatch could be dangerous for banks.
The Economist concludes: “Neither of these dangers can be wished away. Finding a rate that is both immune to manipulation and an accurate reflection of banks' borrowing costs is hard. And replacing a number that has become embedded in the financial system risks instability.”
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