RBI to banks: Phase out Libor soon, move to alternative reference rates

However, lenders say they're not sure which alternative will be more reliable

With the end near for the London Interbank Offered Rate (Libor), the Reserve Bank of India (RBI) on Thursday told banks and other financial institutions to stop using the benchmark as soon as possible and mandatorily by December 31 and move to any Alternative Reference Rates (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, which is being phased out by this year’s end.  

Libor had to be scrapped after a rate fixing scandal was unearthed a few years back. In August 2020, the RBI had advised banks to move away from Libor. Almost all banks that deal in foreign exchange by now are ready with the transition to ARR, but they have not yet decided which one will be the most reliable ARR.  

Bankers say it is unlikely that Indian banks will take a lead on this issue. Instead, they will follow the international practices that evolve.  

“While certain US dollar Libor settings will continue to be published till June 30, 2023, the extension of the timeline for cessation is primarily aimed at ensuring roll-off of USD Libor-linked legacy contracts, and not to encourage continued reliance on Libor,” said the RBI in an advisory to banks. 

Any Libor contract after December should be done only for hedging against other remaining Libor-linked contracts, the RBI said. 

“Banks and financial institutions are urged to incorporate robust fallback clauses in all financial contracts that reference Libor and the maturity of which is after the announced cessation date of the Libor settings,” it said. 

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. 

MIFOR publisher Financial Benchmarks India (FBIL) has started publishing daily adjusted MIFOR rates from June 15, and modified MIFOR rates from June 30, “which can be used for legacy contracts and fresh contracts respectively,” the RBI said. Again, usage of MIFOR after December 31 should be limited to hedging and managing interest risks.  

Banks and financial institutions will have to undertake a comprehensive review of all direct and indirect Libor exposures and put in place a framework to mitigate risks arising from such exposures on account of transitional issues, including valuation and contractual clauses, the RBI said, adding the banks must also put in place the necessary infrastructure to be able to offer products referencing the ARR. 

“The Reserve Bank will continue to monitor the evolving global and domestic situation with regard to the transition away from Libor and proactively take steps, as necessary, to mitigate associated risks in order to ensure a smooth transition,” the central bank said.