Short-Term Rate Benchmarks: The Post-LIBOR Regime

Abstract

LIBOR, the predominant family of global short-term rate benchmarks for the past 40 years, ceases to exist in June 2023. Given the low volumes of interbank loans on which LIBOR had been based, the revelations that LIBOR had been manipulated, and the risks that countless LIBOR-dependent financial instruments without fallback rates would be cast into limbo, regulators over the last decade pushed to replace LIBOR with risk-free overnight rate benchmarks. In the United States, the new benchmark, SOFR, is an overnight rate based on U.S. Treasury repo transactions; use of term rates and derivatives on term rates is limited; and use of credit-sensitive term rates is discouraged. This paper recounts the rise and fall of LIBOR; reviews the academic literature on the efficiency benefits of benchmarks, the LIBOR scandal, and the pros and cons of risk-free vs. credit-sensitive rate benchmarks; and calls for further academic work on the current policy of entrenching a single-benchmark SOFR regime relative to the alternative of encouraging a two- or multi-benchmark regime of SOFR and one or more credit-sensitive term rates.

Keywords: Rate Benchmarks, LIBOR, SOFR, Euribor, risk-free rates, credit-sensitive rates, overnight rates, term rates, in advance, in arrears, Ameribor, BSBY, AXI, bank loans, interest rate derivatives

JEL Classification: G12, G13, G18, G21