What Are Reference Rates For?

January 27, 2017

Preview Citation

Format: Chicago

Divya Kirti. What Are Reference Rates For?, (USA: International Monetary Fund, 2017) accessed December 24, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

What is the precise role of reference rates? Why does it matter if LIBOR was manipulated? To address these questions, I analyze the use of reference rates in floating-rate loans and interestrate derivatives in the context of lending relationships. I develop a simple framework combining maturity transformation with three key frictions which generate meaningful funding risk and a rationale for risk management. Reference rates like LIBOR mitigate contractual incompleteness, facilitating management of funding risk. As bank funding costs move with bank credit risk, it makes sense for the reference rate to have a bank credit risk component. Manipulation can add noise, reducing the usefulness of reference rates for this purpose.

Subject: Banking, Credit, Credit risk, Financial institutions, Financial regulation and supervision, Financial services, Hedging, Interbank rates, Loans, Money

Keywords: Credit, Credit risk, Europe, Floating rate, Global, Hedging, Interbank rates, Interest rate risk, Interest-rate derivative, Loans, Reference rate, Reference rates, Risk tolerance, Total utility, WP

Publication Details

Pages:

45
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2017/013
Stock No:

WPIEA2017013
ISBN:

9781475572315
ISSN:

1018-5941

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