FFIEC, on behalf of its members, issued a joint statement on managing the transition away from the London Interbank Offered Rate (LIBOR). The statement highlights the financial, legal, operational, and consumer protection risks that will result from the expected discontinuation of the LIBOR for institutions with exposure to the LIBOR reference rate. Institutions with LIBOR exposure should have appropriate risk management processes in place to identify and mitigate transition risks. In reference to this statement, FDIC also published a Financial Institution Letter (FIL-68-2020) that applies to all FDIC-supervised institutions with total assets exposure of under USD 1 billion to the LIBOR reference rate.
The financial services industry used LIBOR as a short-term reference rate to price variable rate loans and securities, deposits, borrowings, and interest rate hedging transactions. While some smaller and less complex institutions may hold little to no LIBOR-denominated assets and liabilities, the change will affect almost every institution. Impact is expected to be particularly significant for the largest institutions and those engaged materially in capital markets activities such as interest rate swaps, other derivatives, or hedging transactions. The statement highlights a number of potential preparedness and risk management actions that institutions should factor into their planning for the transition. Institutions should consider existing safety and soundness standards and consumer protection laws as they plan for and address risks that will arise with the transition from LIBOR. Careful planning will help institutions avoid financial losses or consumer harm. The following are the key highlights of the joint statement:
- Institutions should identify and quantify their LIBOR exposures to effectively plan for the transition and mitigate potential financial, legal, operational, and consumer protection risks.
- Institutions with LIBOR exposure should have commensurate with the size and complexity of the institution, its activities, and extent of exposure.
- Fallback language in financial contracts will determine how the replacement of a discontinued reference rate will be handled. Institutions with LIBOR-indexed contracts should take steps to include appropriate fallback language that considers a permanent discontinuation of the reference rate to avoid potential legal and safety and soundness risk.
- Transition plans should address consumer protection risk, including required disclosures to consumers regarding changes in terms and advanced communication for consumers to help them understand how new reference rates would affect their payments, Annual Percentage Rate, and other terms.
- Given the significant effort involved in preparing for the transition, the supervisory focus on evaluating institutions’ preparedness for the LIBOR discontinuation will increase during 2020 and 2021, particularly for institutions with significant LIBOR exposure or less-developed transition processes.
Keywords: Americas, US, Banking, LIBOR, Risk Free Rates, Benchmark Reforms, Interest Rate Benchmarks, FDIC, FFIEC
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