LIBOR(London InterBank Offered Rate); is the average of interest rates at which banks borrow fund globally, average is determined by banks that have significant presence in London market, these banks are members of ICE (Intercontinental Excahnge) LIBOR panel. Every morning before 11 am GMT,IBA (ICE Benchmark Administration) asks its members(11-18 members) ‘at what rate you could borrow the fund’ and after that LIBOR rate is calculated using trimmed mean.
LIBOR rate may no longer be followed after end of 2021, as per Oliver Wyman “a huge amount of work remains to transition the 240 Trillion US Dollar LIBOR market to alternative Risk Free Rates“. This transition will require both the market participants and regulators to take actions to avoid any future disruption in financial industry. As LIBOR is globally recognized base rate for debts, derivatives and pricing loans as a result transition can have significant effect on customer, product, banks, regulators and economy.
However progress towards LIBOR transition has been made but still it needs to be accelerated at required speed to meet the final date. The need for transition is LIBOR is illiquid and can lead to price manipulation, right now focus is in developing alternative risk free rates which has more exposure in liquidity in terms of swaps, options, loans, futures, forwards and bonds.
LIBOR transition also gives banks an opportunity to re-price their large portion of loan book and can identify customer repositioning.To be economically neutral, lending margins would need to increase to reflect the LIBOR vs. RFR spread, plus a premium for the risk of increased funding cost in a crisis – that is, to compensate for the transfer of risk from the borrower to the bank. However it is early to depict that it is the sunset of LIBOR, because there are still many organisations that are opposing the transition to take place they still have faith in LIBOR and believes its going to consume lot of efforts, might also disrupt their existing products and services.
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