LIBOR: THOSE FIVE LETTERS in that order are pretty powerful and impact many of us. LIBOR stands for London Interbank Offer Rate, the interest rate participating banks offer to other banks for loans on the London market. It is the average rate at which a group of 20 banks estimate they’d be able to borrow funds from each other in five currencies across seven time zones. In its simplest terms, LIBOR is a number produced daily in response to a theoretical question posed to a group of large banks: What interest rate would you have to pay to borrow money from other banks? It is the most widely used benchmark for short-term interest rates in the world, primarily because most of the world’s largest borrowers borrow money on the London market.

While you may not be familiar with the term, in all likelihood you have borrowed money, such as for a mortgage or a student loan, and the interest rate you paid was based upon LIBOR. If you have taken a loan with a variable interest rate, there is a high probability it was based on LIBOR.

This benchmark has been around for almost 50 years, but its funeral is being planned as you read this issue. LIBOR will be phased out in 2021 because there wasn’t enough meaningful data to sustain the benchmark. A few scandals associated with it also brought large fines and time behind bars for some, as authorities found individuals and banks manipulated the rates.

LIBOR matters to us because money is frequently lent to businesses and consumers based on the LIBOR interest rates. When LIBOR is no longer around, those credit agreements need to be modified and a replacement standard may not be calculated in the same manner, meaning the interest rate you pay may not be the same as was originally intended. This will merit attention as you borrow funds that will have repayment terms going into and beyond 2021.

In the United States, a newly created replacement rate called the Secured Overnight Funding Rate, or SOFR, references the cost of borrowing U.S. dollars overnight with U.S. Treasury securities as collateral. Thus far, SOFR rates have been similar to LIBOR rates since the SOFR rates began to be published in early April.

You could probably say so far, so good for SOFR, as it is ahead of its implementation schedule, devised by a panel in charge of this transition away from LIBOR. As referenced above, the year 2021 is the goal. Bankers are slowly adjusting, but according to studies, there are not yet many SOFR-based products in the bankfunding market.

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