Libor Is Over. We Still Need More Benchmarks to Replace It.
By Bruce Tuckman and J. Christopher Giancarlo
Today marks the end of the London interbank offered rate. Libor, as it’s better known, has been the world’s dominant interest rate benchmark over the last 40 years. Libor’s demise happens to coincide with a challenging environment for U.S. regional and smaller banks and is an opportunity to reflect on what should come next. We believe that regulators should not insist on replacing the one-size-fits-all Libor regime with another one-size-fits-all benchmark.
Benchmarks play a vital role in the U.S. financial system. The S&P 500 index, for example, enables countless investors, asset managers, corporate officers, and commentators to assess general market conditions quickly and easily. Yet, that index is by no means the only widely used benchmark of U.S. equity markets. Similarly, benchmarks of short-term interest rates enable a multitude of short-term lenders and borrowers to gauge conditions of money markets.
Until the 1980s, the dominant short-term rate benchmark in the U.S. was the Treasury bill or “T-bill” rate. Its benchmark status eroded, however, for two reasons. First, T-bill rates are not “credit-sensitive,” that is, they do not reflect the borrowing costs of banks and everyday businesses. This defect is particularly problematic in times of financial stress, when rates on corporate commercial paper increase while T-bill rates decrease with “flight-to-quality” purchases of government obligations. Second, T-bill rates fluctuate with idiosyncratic changes in the supply and demand for T-bills, which is a nuisance for many benchmark users.
Read the full Barron's article.
Bruce Tuckman is Clinical Professor of Finance at NYU Stern