LIBOR Benchmark Interest Rate Replaced in Agreements
By the end of 2021, Latvian bank contracts which use the LIBOR (London Interbank Offered Rate) short-term interest rate index as a benchmark will be changed and replaced with alternative indices (benchmark rates) such as EURIBOR.
In a loan agreement, the bank lends and the client borrows money. An interest rate is set for the use of the loan, because the bank borrows this money for a set fee from investors, the financial market or interbank loans. Therefore, loan agreements have a benchmark rate which reflects the price of the money loaned to the bank, and the bank’s added interest rate, which reflects the bank’s expenses and risk. Historically, the benchmark rates have been linked to indices whose names include IBOR (Interbank Offered Rate).
A European Union regulation on indices used as benchmarks in financial instruments and financial agreements, or for measuring the results of investment funds, the Benchmarks Regulation, was published in 2016 and applied in 2018. This regulation sets the requirements with which a benchmark rate must comply in order for it to apply to a loan agreement, including after the regulation comes into force. Meanwhile, a transition period was set for replacing those benchmark rates which do not comply with the requirements set out in the regulation.
The regulation was set to avoid the risk of manipulation of benchmark rate setting methods in international financial markets, which negatively impacts both significant market participants and financial institutions in general, as well as all households.
Latvian banks are developing solutions for their clients to successfully replace LIBOR in loan contracts where the aforementioned rate is used as the benchmark rate. Solutions developed and offered by the bank may vary, which is why Finance Latvia and its members will continue to explain the replacement of LIBOR with other benchmark rates to borrowers.
Most frequently, the LIBOR EUR rate will be replaced with the EURIBOR EUR rate, but with regards to loans in US dollars, banks will most likely offer to refinance loans from USD to EUR, thus applying the EURIBOR EUR rate as the benchmark rate. For clients who receive their income in Euro, this will reduce the currency risk resulting from a difference in the currencies of the client’s income and loan agreement.
We ask clients to be understanding, and to contact their bank’s financial consultant if they have any questions.