Regulators warn banks against using Libor in new contracts

WASHINGTON — Federal regulators urged banks on Monday to stop using the London interbank offered rate, or Libor, in their contacts and to begin transitioning away from the benchmark “as soon as practicable.”

In an interagency statement, the Office of the Comptroller of the Currency, Federal Reserve and Federal Deposit Insurance Corp. said that “[f]ailure to prepare for disruptions to USD LIBOR, including operating with insufficiently robust fallback language, could undermine financial stability and banks’ safety and soundness.”

Monday’s statement coincided with an announcement from the ICE Benchmark Administration — a subsidiary of the Intercontinental Exchange that administers Libor — that it would cease publication of its one-week and two-month Libor settings as planned on Dec. 31, 2021, but would extend the sunset dates of the remaining Libor settings to June 30, 2023. That extension, the Fed said in a separate press release also released Monday, "would allow most legacy USD Libor contracts to mature before Libor experiences disruptions."

Bloomberg News

Libor had been the centerpiece of interest rate risk hedging for decades before a rate manipulation scandal broke in 2012, in which several large contributing banks were found to be routinely manipulating their rate quotes to their own ends. The Federal Reserve Bank of New York convened the Alternative Reference Rate Committee in 2014 to either fix the problems with Libor or identify a better interest rate benchmark. The ARRC settled on the Secured Overnight Financing Rate, or SOFR, in 2017 as its preferred alternative, though some banks say they prefer still other interest rate benchmarks to SOFR.

Regulators said in their statement that it is critical for banks to undertake the Libor transition in earnest or face enhanced supervisory scrutiny.

“Given consumer protection, litigation, and reputation risks, the agencies believe entering into new contracts that use USD LIBOR as a reference rate after December 31, 2021, would create safety and soundness risks and will examine bank practices accordingly,” the regulators' statement said.

“New contracts entered into before December 31, 2021 should either utilize a reference rate other than LIBOR,” the regulators continued, “or have robust fallback language that includes a clearly defined alternative reference rate after LIBOR’s discontinuation.”

The guidance from regulators builds on a recent string of developments surrounding the outgoing financial benchmark. In early November, the OCC, FDIC and Federal Reserve announced that banks could use any reference rate as a replacement to Libor.

The regulators supplied a handful of “limited circumstances” in which banks could continue to enter into new contracts that use LIBOR as a reference rate, such as certain transactions that would hedge potential exposure to Libor as the benchmark winds down.

The FDIC, OCC and Federal Reserve emphasized that their statement “should not be read as announcing that the LIBOR benchmark has ceased, or will cease.”

The Bank Policy Institute — a trade association representing the largest U.S. banks — called the announcement of an extension of most Libor contracts to 2023 "a prudent step that will help facilitate an orderly transition away from LIBOR."