PremiumThe Reserve Bank of India (RBI) on Thursday issued an advisory to banks and other financial institutions, asking them to be prepared for the year-end transition from the London Interbank Offered Rate (Libor).
The global transition from Libor became necessary after it was discovered that banks were manipulating the rate in 2007-08 that sparked an investigation by Britain’s Financial Services Authority (FSA). Libor rates over tenors are calculated as averages of rates polled by major banks and used for pricing debt instruments and derivatives like currency swaps and interest rate swaps.
India’s exposure to borrowings linked to the benchmark is estimated to be around $331 billion, Mint reported in January.
“With the objective of orderly, safe and sound Libor transition and considering customer protection, reputational and litigation risks involved, banks and financial institutions are encouraged to cease, and also encourage their customers to cease, entering into new financial contracts that reference Libor as a benchmark and instead use any widely accepted alternative reference rate (ARR), as soon as practicable and in any case by 31 December," said the advisory, published by the central bank on its website.
Secured overnight financing rate (SOFR), one such alternative reference rate, is based on transactions in the US Treasury repo market and is being widely used as a substitute for Libor in dollar-denominated loans and derivatives across the world.
The central bank on Thursday urged banks and other financial institutions to incorporate robust fallback clauses, preferably well before the cessation date, in all financial contracts that reference Libor where the maturity is after the announced cessation date of the benchmark. It added that banks should also ensure that new contracts entered into before 31 December that reference Libor but mature after the cessation date include fallback clauses.
“Banks are also encouraged to cease using the Mumbai Interbank Forward Outright Rate (Mifor), published by the Financial Benchmarks India Pvt Ltd (FBIL) and which references the Libor, as soon as practicable and in any event by 31 December," the advisory said.
Prior to this, in August 2020, RBI had issued a ‘Dear CEO’ letter to all commercial banks sensitizing them about the need to be prepared for the Libor cessation. Then, in November, governor Shaktikanta Das said that Indian Banks’ Association has been working with market participants to facilitate the transition.
On Thursday, RBI said banks must undertake a comprehensive review of all direct and indirect Libor exposures and put in place a framework to mitigate risks on account of transitional issues.
“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," it said.
Meanwhile, large Indian banks are already testing the waters with dollar transactions on the SOFR and preparing for the transition from Libor. State Bank of India (SBI) and ICICI Bank have executed a couple of transactions, Mint reported in January.
The Financial Conduct Authority (FCA) in the United Kingdom (UK) announced on 5 March that Libor will either cease to be provided by any administrator or no longer be a representative rate.
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