A1062
Title: Would a two-benchmark regime be better?
Authors: Chengguo Weng - University of Waterloo (Canada) [presenting]
Abstract: After the manipulation scandal during the global financial crisis, LIBOR was phased out, and regulators around the world have since transitioned to risk-free reference rates (RFRs). In the United States, the secured overnight financing rate (SOFR), which is an RFR based on overnight repo transactions, has been designated as the sole replacement for LIBOR. Meanwhile, Europe and Japan have chosen to establish a two-benchmark regime consisting of an RFR and a LIBOR-like credit-sensitive reference rate (CSR). A two-agent model is considered with one representative firm and one representative bank in the economy, and a tractable model is used to compare the single RFR regime against the two-benchmark regime with an RFR and a CSR. It turns out that adding a new credit-sensitive benchmark in addition to the existing risk-free benchmark always improves total welfare but not necessarily for both the bank and the firm in some scenarios. The study also indicates that credit supply is higher and borrowing cost is lower in the two-benchmark system than would be the case for the single RFR system. Furthermore, RFR could be driven out of the market when the correlation between CSR and the banks' funding costs is strong enough. The impacts of fixed-rate lending and interest-rate swap trading are also discussed.
