Banks must “pick up the pace” on shifting away from the Libor interest rate by Dec. 31 or prepare for regulatory consequences, Federal Reserve Vice Chair for Supervision Randal Quarles said Tuesday.
Starting Jan. 1, banks will no longer be allowed to make new loans using the London interbank offered rate, or Libor, which is being phased out globally after a rate-rigging scandal years ago. Legacy contracts can continue to refer to Libor until the middle of 2023.
Speaking at an industry conference, Quarles said the Fed is prepared to use its “full panoply of supervisory tools” on banks that fail to move away from Libor.
That includes actions beyond just a stern letter. He said the Fed could issue formal “matters requiring attention” notices to banks or perhaps issue an enforcement action for a bank that is “egregiously” sticking with Libor.
“We will address this very vigorously and with the full range of tools that supervisors have,” Quarles warned.
The transition away from Libor has
“To be ready for year-end, lenders will have to pick up the pace, and our examiners expect to see supervised institutions accelerate their use of alternative rates,” Quarles said.
When asked about the consequences of a last-minute transition, Quarles said borrowers could see the “significant dislocations” that may be expected when “everyone is trying to get through a door at once.”
But he predicted a significant pickup in non-Libor lending throughout October as banks work to prepare their customers for the change. He also said that the approval of a forward-looking “term SOFR” rate this summer should boost non-Libor lending, given that some borrowers have expressed a desire to know up front the rate they will pay.
The lack of a term SOFR option has long been a criticism among some banks about the Secured Overnight Financing Rate, the benchmark that a U.S. group of market participants convened by the Federal Reserve established in 2017 as a Libor replacement. But its emergence has given banks and borrowers a “much more practicable” option for loans, Quarles said.
In recent interviews, bankers and consultants have said the industry is preparing for a “multirate” environment, in which banks may use SOFR along with other alternative rates. Options include Ameribor, a benchmark from the American Financial Exchange that is preferred by some regional banks because it is tied to their actual borrowing costs, and a newer benchmark from Bloomberg called BSBY. At least two other rates are in the works.
Bank regulators have expressed an openness to non-SOFR rates in their communications to banks, and Quarles reiterated that in his remarks. A bank can choose any rate that it “determines to be appropriate for its funding model and customer needs” as long as it does the extra work needed to satisfy regulators on their decision-making, Quarles said.
“If market participants do use a rate other than SOFR, they should ensure that they understand how their chosen reference rate is constructed, that they are aware of any fragilities associated with that rate, and — most importantly — that they use strong fallback provisions,” Quarles said.
A handful of banks have said “they may want more time to evaluate potential alternative rates,” Quarles said, but that is not possible.
“There is no more time, and banks will not find Libor available to use after year-end no matter how unhappy they may be with their options to replace it,” he said.
