A Model Transition? Surveying Banks’ Post-Libor Rate Choices

By Robert Strand

Figure 1 (click to enlarge)

Certain tenors of the U.S. dollar London Interbank Offered Rate are scheduled to begin sunsetting as soon as this year, with the rest ceasing to be published by mid-2023. With the Libor endgame now clearly in view—and banks and their regulators planning for the reference rate transition—ABA surveyed model risk managers from a range of banking firms with at least $10 billion or more in assets to learn about their Libor replacement plans. Here’s what we learned.

Progress in Libor replacement

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Most of the banking institutions surveyed reported plans to replace Libor with the Secured Overnight Financing Rate daily, term structure and arrears compounding. (The survey was conducted prior to the late July announcement about the term SOFR administrator.) However, several alternative reference rates are also being employed. (See Figure 1.)

The Libor transition is well under way at the firms surveyed. Those with over $100 billion in assets already have models in place to make loans indexed to something other than Libor. The model risk management function, or MRM, is represented on the Libor transition groups and committees in most of the institutions.

How much work is the Libor replacement?

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Across the asset size spectrum, MRM teams at large institutions anticipate a heavier workload through this year and into next. (See Figure 2.) This is largely due to the large number of models for which Libor must be replaced. In addition, most are seeing delays in model owners’ and vendors’ selections of alternative reference rates and in development of liquidity in markets for these alternatives.

Figure 4 (click to enlarge)

Many of the surveyed institutions plan to increase staff or otherwise outsource validations to handle the heavier workload. (See Figure 3.) For most, there is a common resource to oversee reviews of Libor replacement for both internal and vendor models to ensure consistency and report on practices.

Unique challenges for model risk managers

Particularly at the larger institutions surveyed, MRM will challenge business units on the reference rates selected to replace Libor, require assessments of the materiality of impact of the changes and ask for updated model documentation. (See Figure 4.) At several banks surveyed, MRM is also asking for user-acceptance testing and contingency plans, in case Libor replacement is delayed.

Figure 5 (click to enlarge)

None of the smaller survey respondents intend to impose limitations on models where Libor has been replaced, but MRM in one in five of institutions with over $100 billion in assets expects to place limitations on Libor-replaced models.

Rob Strand is a senior economist at ABA. To learn more about ABA’s Model Risk Management Working Group, click here to contact Strand.