Banks need to “step up the pace” to move away from the Libor interest rate by Dec. 31 or prepare for regulatory consequences, Federal Reserve vice chairman for oversight Randal Quarles said on Tuesday.
As of January 1, banks will no longer be allowed to extend new loans using the London Interbank Offered Rate, or Libor, which is being phased out globally after a rate-rigging scandal years ago . Existing contracts may continue to reference Libor until mid-2023.
Speaking at a sector conference, Quarles said the Fed was ready to use its “full panoply of supervisory tools” on banks that do not shy away from Libor. .
This includes actions beyond a simple stern letter. He said the Fed could issue official opinions on “matters needing attention” to banks or perhaps issue an enforcement action for a bank that is “blatantly” sticking to Libor.
âWe will approach this problem very vigorously and with the full range of tools available to supervisors,â Quarles warned.
The abandonment of Libor has gone slowly, with banks continuing to provide commercial loans using the soon-to-be-disappeared interest rate instead of using alternative rates. According to the Fed’s estimates, less than 1% of variable-rate business loans from large banks were using rates other than Libor by mid-year.
âTo be ready for the end of the year, lenders will need to step up the pace, and our examiners expect supervised institutions to step up their use of alternative rates,â Quarles said.
Asked about the consequences of a last-minute transition, Quarles said borrowers might see the “big dislocations” one can expect when “everyone tries to walk through a door at the same time.”
But he predicted a significant pick-up in non-Libor lending throughout October as banks scramble to prepare their customers for the change. He also said approval of a forward-looking “SOFR” rate this summer should boost non-Libor lending, as some borrowers have expressed a desire to know in advance what rate they will pay.
The lack of a SOFR forward option has long been a criticism among some banks about the guaranteed overnight funding rate, the benchmark that a US group of market players called by the Federal Reserve set in 2017 replacing Libor. But its emergence has given banks and borrowers a “much more convenient” option for lending, Quarles said.
In recent interviews, bankers and consultants said the industry was preparing for a âmultiple rateâ environment, in which banks could use SOFR along with other alternative rates. Options include Ameribor, an American Financial Exchange benchmark that is preferred by some regional banks because it is tied to their actual borrowing costs, and a more recent Bloomberg benchmark called BSBY. At least two other tariffs are in progress.
Banking regulators have expressed openness to non-SOFR rates in their communications to banks, and Quarles reiterated this in his remarks. A bank can choose any rate it “determines to be appropriate for its funding model and the needs of its customers” as long as it does the extra work necessary to satisfy regulators in their decision-making, said Quarles.
âIf market players use a rate other than SOFR, they must ensure that they understand how the chosen reference rate is constructed, that they are aware of the weaknesses associated with this rate and, above all, that they use strong fallback layouts, âQuarles said.
A handful of banks have said “they may want more time to assess potential alternative rates,” Quarles said, but that’s not possible.
“The time is running out and the banks won’t find the Libor available after the end of the year, no matter how unhappy they may be with their options to replace it,” he said.