Phasing Out of LIBOR

 

Relevance

• GS 3: Effects of liberalization on the economy.

 

Context

• RBI has told the banks and other financial institutions to stop using LIBOR (London Interbank Offered Rate) benchmark as soon as possible and mandatorily by December 31.

 

Key points

• In 2012, the most widely used global financial benchmark, the LIBOR, was found to have been manipulated by individuals at various financial institutions, creating shock waves in the financial system.
• It made scrapping of LIBOR imperative.
• In August 2020, the RBI had advised banks to move away from Libor by December 2021.
• Any Libor contract after December should be done only for hedging against other remaining Libor-linked contracts.
• Almost all banks that deal in foreign exchange are ready with the transition to ARR (Alternative Reference Rates), but they have not yet decided which one will be the most reliable ARR.
• Secured Overnight Financing Rate (SOFR) and Sterling Overnight Interbank Average Rate (SONIA) are the two popular alternatives, but are nowhere near as popular internationally as Libor.
• With the demise of Libor, the popular Indian benchmark Mumbai Interbank Forward Outright Rate (MIFOR), which uses Libor as a benchmark, has to be scrapped too.
• The Clearing Corporation of India Ltd provides guaranteed settlement for IRS (Interest Rate Swap) contracts that reference the MIFOR.
• So, the clearing and settlement arrangements also need to be modified to provide for the alternate benchmark.

 

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What is LIBOR?

• It is the interest rate at which banks borrow and lend from each other in London.
• In India, exposures to LIBOR arise from loan contracts like ECBs (External Commercial Borrowings) linked to LIBOR, FCNR (B) (Foreign Currency Non-Resident Bank) deposits with floating rates of interest linked to LIBOR and derivatives linked to LIBOR.

 

Also Read: Retrospective Taxation: The Taxation Law (Amendment) Bill, 2021