Is LIBOR Going To Be Replaced By OIS

What's Causing the Changes?

London InterBank Offered Rate (LIBOR) is the fundamental interest rate on which many other financial entities and systems are based. LIBOR provides every trader, investor around the world the most accurate costs involved in taking short term loans. Since February 2014, LIBOR has been renamed as ICE LIBOR.

Reported shortcomings in LIBOR:

The reliability of LIBOR was highly criticized after a scandal surfaced in 2008. The most prominent economic benchmark – LIBOR is based upon the interest rates as quoted by the bank, instead of the authentic market data. LIBOR is the average of all the costs for borrowing money from lenders in London InterBank as reported by the different established banks in the world.

An investigation carried out by Wall Street Journal revealed the shocking possibility that banks may have been reporting low interest rates to portray a stable economic prowess. The attempt was suspected to be made during the intense global financial crisis. A high LIBOR would have produced a very bad impression and would have stopped further investments derailing the whole economic system. Many renowned banks including Barclays, UBS and RBS were found rigging key interest rates.

Since the LIBOR is a widely recognized and accepted indicator, it will be difficult to completely replace it with a new signal within days. But there is no doubt the financial markets deserve a better benchmark entity – one which is perfectly unsuasible.

The alternative for the future:

Another benchmark which has come to everyone’s attention is the OIS (Overnight Indexed Swap) rate. This indicator is directly related to the rate as declared by the country’s central bank. So in USA, OIS will depend upon the Federal Funds Rate, which theoretically is impossible to manipulate. Some sectors have already started to favor OIS rather than LIBOR for certain consequential transactions. Furthermore, important financial figures have put their voices behind OIC, such encouraging personas include the chairman of CFTC (Commodities Future Trading Commission) – Gary Gensler.

But due to the sole fact that LIBOR has already been incorporated into business systems worldwide, there have been more widespread reforms instead of moves towards a complete replacement. IOSC (International Organization of Securities Commissions) have already formed a specialized committee which will provide suitable recommendations. One of their proposals that received appreciation was to make LIBOR independent from BBA (British Bankers Association). One more proposal is forcing the banks to back the figures with actual market data when contributing their interest rates in this new autonomous LIBOR, if they wish to be included.

The future still seems to be secure for LIBOR for now, as regulatory bodies of most countries are reluctant to rely on another benchmark; they are also not ready to formulate a financial system again. Most critics have considered the scandal as a slight bump in the otherwise successful history of LIBOR. Many have even labeled the Wall Street Journal investigation as a hoax and an attempt to undermine British supremacy in the financial industry. No matter whether LIBOR is replaced or continues to drive economic sectors, it will be surely be interesting to see how the financial structures respond to the impending changes in the future.