WASHINGTON – Banking regulators said Friday that financial institutions can choose any reference rate to replace the rate offered by the London Interbank, or Libor, which is set for sunset in 2021.
The statement comes after several small and medium-sized banks joined the Federal Reserve, the Federal Deposit Insurance Corp. earlier this year. and the office of the currency auditor had informed that the preferred Libor replacement of the regulators – the secured overnight rate – was unsuitable for them as they do not have many connections to the repo market. They argued that SOFR would be better suited for larger banks.
Some banks have also raised concerns that SOFR, if economically stressed, could create a “mismatch” between bank assets and liabilities.
The Alternative Reference Rates Committee, a group set up by the Fed, has endorsed SOFR as the best replacement for Libor. But the banking agencies said Friday that the use of SOFR is voluntary.
Federal Reserve Chairman Jerome Powell told Senators in February that he was open to considering a separate alternative benchmark rate that was credit sensitive.
"A bank can use any reference interest rate for its loans that the bank deems appropriate for its financing model and its customer needs," the regulators said in the joint statement.
Regardless of which replacement rate banks choose, they should include fallback language in all loan agreements that take effect when Libor is discontinued to ease the transition from the benchmark rate, the agencies said.
Many small and medium-sized banks have stated that they would prefer to use Ameribor, an index created specifically for small and medium-sized banks by Richard Sandor, a major Chicago retailer. The index is based on transactions in the overnight credit market on the American Financial Exchange, which Sandor also founded.
"The agencies recognize that banks' funding models differ and that when structuring their lending it is appropriate for banks to select appropriate replacement rates for LIBOR that are most appropriate given their particular circumstances," the joint statement said .
Federal Reserve Chairman Jerome Powell told Senators in February that he was open to considering a separate alternative benchmark rate that is credit sensitive as the industry prepares for the Libor transition.
“A number of banks have come forward saying they want to work on a separate rate that would not replace SOFR but would be credit sensitive. So that's what they're doing now and … we're working with them to support this process, ”he said. “We are open to it, but that does not mean that the transition from Libor to SOFR will stop with it. It must go forward. "