An interest rate that banks around the world use as a benchmark for short-term borrowing will be phased out and eventually replaced by June 2023, the Federal Reserve announced Monday.
The Fed was joined by regulators in the U.K. in announcing the plans for the London Interbank Offered Rate, commonly referred to as Libor.
According to the announcement, banks should stop writing contracts using LIBOR by the end of 2021, after which the rate no longer will be published.
Contracts using LIBOR should wrap up by June 30, 2023, the directive said.
“Today’s plan ensures that the transition away from LIBOR will be orderly and fair for everyone – market participants, businesses, and consumers,” Fed Governor Randal Quarles, who serves as the central bank’s vice chair for supervision, said in a statement.
Libor is calculated from an average of banks that participate in overnight lending to each other. The rate is critical for short-term funding that financial institutions use for their operations, but has seen controversy over the years, particularly the role it played in the 2008 financial crisis.
In addition to helping escalate the crisis through higher rates that made it harder for firms to survive, Libor was at the middle of another scandal in 2012. Several banks, including some of the largest in the world, were found to have been manipulating Libor rates for profit.
The Fed has been warning banks to start preparing for a transition away from Libor to what is called the Secured Overnight Financing Rate, or SOFR. Instead of relying on bank quotes, SOFR will use rates that investors offer for bank securities such as loans and assets backed by bonds.
“These announcements represent critical steps in the effort to facilitate an orderly winddown of USD LIBOR,” said New York Fed President John Williams, who has been a SOFR advocate and one of the biggest voices in urging banks to prepare for the transition. “They propose a clear picture of the future, to help support transition planning over the next year and beyond.”
SOFR transactions will take place under the New York Fed’s auspices in its bond repurchase market.