According to the minutes1 of the facilitated panel discussion, the presentations2 at the July 22, 2020, second meeting3 of the Credit Sensitivity Group,4 a group of regulator-convened US regional banks, reinforced the banks’ argument that a more credit-sensitive rate is required as an alternative to SOFR with the currently contemplated spread adjustment. However, the meeting also included presentations5 by representatives of the Federal Reserve that attempted to show that: (1) while LIBOR rose in March 2020, it rose less than during the 2007-9 financial crisis, and LIBOR did not rise “reliably” in the 2001 recession or the 1990-1 recession; (2) bank funding has migrated significantly from wholesale unsecured funding such as that which underlies LIBOR; (3) with “cheaper” deposits rising in times of stress such as the recent COVID-19 pandemic, risk-free rates are more closely correlated to bank funding than LIBOR, even in financial stress; (4) while banks do experience lending drawdowns during times of stress, for domestic banks, core (and cheaper) deposits also increase; and, finally (5) an easier way to ensure that lending rates do not fall during downturns is to use a floor for the applicable benchmark rate. However, the minutes show that meeting participants questioned some of these views.
Bank of America also presented6 and noted that changing a pro-cyclical rate (such as LIBOR) to a counter-cyclical rate (such as SOFR) would fundamentally change how banks allocate capital and would ultimately increase lending costs and reduce credit availability.7 Bank of America also noted that, from a credit risk perspective, averages of overnight rates are not the same as short-term rates since short-term rates also reflect that liquidity is at risk for the duration of the related period.8
Finally, Professors Berndt, Duffie and Zhu presented9 the findings from their paper10 regarding an “across-the-curve” (AXI) approach to estimating bank funding costs that may be a more credit-sensitive adjustment to SOFR than the current proposed spread adjustment.
The agenda11 for the third and final meeting, on August 12, 2020, indicates that this meeting will cover the requirements for a robust reference rate, possible data sources for a credit-sensitive spread and related design and possible preferences for such a spread. The minutes for this meeting have yet to be posted.
However, with less than 500 days until LIBOR’s scheduled cessation, there is not a lot of time for market participants to coalesce and support a preferred credit-sensitive spread to SOFR or another benchmark rate so that the market has available an alternative to LIBOR that is “fit for use” for commercial and consumer lending.
1 Available at: https://www.newyorkfed.org/medialibrary/media/newsevents/events/markets/2020/csg-workshop-minutes-presentations-07222020.pdf. See pp.2-3 in particular.
3 Agenda available at: https://www.newyorkfed.org/medialibrary/media/newsevents/events/markets/2020/csg-workshop-agenda-07222020.pdf. The initial Credit Sensitivity Group meeting was described in our earlier Perspective “Comparable” Alternative Reference Rates to LIBOR: The Low Bar for Official Designation, the Much Higher Hurdle of “Fit for Use” and Implementation for Market Participants.
4 Generally, see: https://www.newyorkfed.org/newsevents/events/markets/2020/0225-2020.
10 Available at: https://www.gsb.stanford.edu/gsb-box/gsb-box-get-box-doc/499849/notcase.