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No one thought it would be easy to retire Libor[1], the global interest-rate benchmark that was the center of a manipulation scandal. But recent money-market volatility could make the process tougher.

Regulators want to replace Libor, the daily London interbank offered rate, by the end of 2021[2]. That means officials and industry executives have about two years to smooth a path for adopting a successor. In September, their chosen overnight replacement rate briefly spiked to 5.25%, far above its usual range.

The Federal Reserve eventually stepped in to stabilize interest rates. But if the future brings more money-market volatility, it could further complicate the move away from Libor. Officials have their hands full already with the roughly $200 trillion of financial contracts tied to the benchmark, including adjustable-rate mortgages, floating-rate bonds, and preferred shares.

One place where the changeover is particularly consequential is the $1.2 trillion market for leveraged loans, sometimes known as bank loans. Interest rates on loans adjust regularly (usually every three months), so they have declined as the Fed has lowered borrowing costs. The Invesco Senior Loan[3] exchange-traded fund is up 3.6% so far this year, lagging far behind the 17% year-to-date gain in the S&P 500[4].

The problem for regulators is that bank loans are usually set at a spread over Libor—3 percentage points higher, for example.

That raises questions about the potential for trouble in the loan market. To understand why, it helps to understand what Libor is, why regulators want to retire it, and what they want to use instead.

Libor is the rate that global banks pay to borrow cash from one another overseas. The banks don’t put up any...

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