Short-Term Rate Benchmarks: The Post-LIBOR Regime

Abstract

The London Interbank Offered Rate (LIBOR), the predominant family of global short-term rate benchmarks for the past 40 years, ceased to exist in June 2023. Given the low volumes of interbank loans on which LIBOR had been based, the revelations that LIBOR had been manipulated, and the risks that countless LIBOR-dependent financial instruments without fallback rates would be cast into limbo, regulators over the last decade pushed to replace LIBOR with risk-free overnight rate benchmarks. In the United States, the new benchmark, Secured Overnight Financing Rate (SOFR), is an overnight rate based on US Treasury repo transactions: Use of term rates and derivatives on term rates is limited, and use of credit-sensitive term rates is discouraged. This article recounts the rise and fall of LIBOR; reviews the academic literature on the efficiency benefits of benchmarks, the LIBOR scandal, and the pros and cons of risk-free versus credit-sensitive rate benchmarks; and calls for further academic work on the current policy of entrenching a single-benchmark SOFR regime relative to the alternative of encouraging a two- or multi-benchmark regime of SOFR and one or more credit-sensitive term rates. Expected final online publication date for the Annual Review of Financial Economics, Volume 15 is November 2023. Please see http://www.annualreviews.org/page/journal/pubdates for revised estimates.