From UPSC perspective, the following things are important :
Prelims level: London Interbank Offered Rate (LIBOR)
Mains level: Read the attached story
Central Idea: The RBI has issued an advisory to banks and other RBI-regulated entities regarding the transition away from London Interbank Offered Rate (LIBOR) July 1.
What is London Interbank Offered Rate (LIBOR)?
| Explanation | |
| Definition | LIBOR is a benchmark interest rate used in financial transactions such as loans, derivatives, and bonds.
It is the interest rate at which banks can borrow funds from other banks in the London interbank market. It serves as a benchmark rate for various financial transactions worldwide. |
| Calculation Method | LIBOR rates are calculated based on submissions from a panel of major banks in London.
These banks estimate their borrowing costs for various currencies and tenors. The submissions are used to calculate an average rate, which is published daily by the Intercontinental Exchange (ICE), the administrator of LIBOR. |
| Currencies and Tenors | LIBOR is calculated for different currencies and tenors ranging from overnight to one year.
The currencies include USD, EUR, GBP, JPY, CHF, and others. The tenors represent the time periods for which the rates are quoted. |
| Importance | It has been widely used since the 1980s as a benchmark for financial contracts worth trillions of dollars globally.
It serves as a reference rate for various loans, derivatives, and other financial instruments. |
Why is RBI moving away from LIBOR?
Like many other countries, has been working towards transitioning away from LIBOR. The primary reasons for this transition include:
- Manipulation risks: Following the global financial crisis in 2008, there were concerns about the reliability and potential manipulation of LIBOR.
- Discontinuation of LIBOR: The regulatory authority in the UK that oversees LIBOR, announced in 2017 that it will no longer compel banks to submit the necessary data to calculate LIBOR after the end of 2021.
- Adoption of alternative Reference Rates: Various countries, including India, have identified and adopted alternative reference rates that are more reliable and based on actual market transactions. Ex RBI introduced the Secured Overnight Financing Rate (SOFR).
- Alignment with International Standards: Many countries have already initiated the shift to alternative reference rates, necessitating India’s alignment to maintain consistency and harmonization in international financial markets.
- Risk Mitigation: RBI’s move aims to mitigate the potential risks associated with an unreliable or manipulated benchmark rate.
Related terminologiesMumbai Interbank Forward Outright Rate (MIFOR): MIFOR is a benchmark rate used in Indian financial markets. It represents the forward premium or discount on the USD-INR exchange rate based on the LIBOR rate. Fallbacks: They are provisions inserted into contracts to establish alternative reference rates if the original benchmark rate (such as LIBOR) becomes unavailable or unreliable. |
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