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Transition from Libor to new benchmark should begin now: Fed’s Quarles

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WASHINGTON — Federal Reserve Vice Chairman for Supervision Randal Quarles said the time may be now for financial institutions to move on from using the the London interbank offered rate.

Quarles in a speech Monday urged the private sector to transition to a new benchmark known as the secured overnight financing rate immediately, or abandon Libor altogether.

Although Libor will not be phased out until at least 2021, regulators have already begun preparing for the switch to the new SOFR benchmark.

“Beginning that transition now would be consistent with prudent risk management and the duty that you owe to your shareholders and clients,” Quarles said at an event hosted by New York University and the Alternative Reference Rates Committee, a private-sector group formed by the Fed to ensure a smooth transition. “There is, however, also another and easier path, which is simply to stop using Libor.”

Quarles’ comments come as regulators have begun to move away from Libor, which has been plagued by scandal in recent years. The United Kingdom's Financial Conduct Authority will likely stop publishing Libor beyond 2021.

The Fed official advised financial institutions to take the warnings about Libor’s instability seriously.

“At this moment, many seem to take comfort in continuing to use LIBOR — it is familiar, and it remains liquid,” Quarles said. “But history may not view that decision kindly; after LIBOR stops, it may be fairly difficult to explain to those who may ask exactly why it made sense to continue using a rate that you had been clearly informed had such significant risks attached to it.”

The Fed has already included detailed questions about plans banks are making for the transition in their supervisory discussions with large firms, Quarles said.

He said that the Fed expects banks supervised by the central bank to show an appropriate level of preparedness, which “must increase as the end of 2021 grows closer.”

Quarles also sought to ease concerns that the switch to SOFR will hurt banks in their Fed stress tests by lowering projections of net interest income.

“The supervisory projections of net interest income are primarily based on models that implicitly assume that other rates such as LIBOR or SOFR move passively with short-term Treasury rates,” Quarles said. “Given these mechanics, choosing to lend at SOFR rather than LIBOR will not result in lower projections of net interest income under stress in the stress-test calculations of the Federal Reserve.”

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LIBOR SOFR Regulatory reform Lending Interest rates Randal Quarles Federal Reserve Financial Conduct Authority