Tucked deeply into Democratic Gov. Andrew Cuomo’s
The proposal to the fiscal year 2022 budget, if included, allows banks to apply a new interest rate benchmark on legacy loan contracts that were previously based on the London interbank offered rate (Libor), which is expected
The proposal would also offer a legal safe harbor to banks that use a replacement benchmark, mainly one that is predicated by roughly a dozen megabanks and a handful hedge funds, called the Secured Overnight Financing Rate, or SOFR.
This proposal could lead to three extremely negative consequences for the industry, people and businesses more broadly since New York is a financial hub for loans made across the country.
First, it will produce a new interest rate monopoly for this group of megabanks and hedge funds that are the
Secondly, it will reinstate an unreliable benchmark measure for interest rates on commercial contracts, destabilizing the market when other benchmark measures exist. Thirdly, it will strengthen non-competitive business practices within the banking industry.
To understand the implications, let’s start with a quick history of how interest rates are calculated.
For decades,
In the years since 2017, a group largely comprised of megabanks and hedge funds formed a committee (some of which were
While the SOFR index represents loans backed by Treasury bonds, it still heavily depends on the securities book of the mega players. This can make the index go haywire, like when SOFR jumped
Were SOFR to be the central rate for all consumer and business debt at that time (without Fed intervention), the credit markets would have seized up and shut off credit to those other than the mega players all because of the liquidity and trading operations of this group of mega firms. This heightened risk made other smaller lenders further determined to create other unsecured index rates, which are freely observable, non-biased and based on the actions of many investors.
These index rates have also been constructed to adhere to the
However, the group of megabanks and hedge funds that helped form the SOFR benchmark have heavily pushed for legislation that would
The megabanks know that if the price is free, then the user is the product. Similarly, SOFR may be posted for free, but if an institution is forced to use it, they will pay a toll to go through the megabanks in order to swap or hedge transactions with an interest rate based on the SOFR.
There are several alternatives to the SOFR that are transparent and good for loan contracts with business and citizens, and should not be quashed by a government provision.
For example, the preferred index that main-street banks like Signature Bank uses is freely tradable and observable on
Even though the current provision in the proposed New York budget only applies to legacy contracts, the legal safe harbor for the SOFR index would also steer new contracts and lenders into that sole benchmark.
New York State lawmakers should remove this provision from the budget or broaden rate index options to include any IOSCO-compliant rate, for the sake of consumers and businesses needing credit. There is no reason to give the megabanks a legislated monopoly.