PBOC tells lenders to get ready for life after Libor

China will help commercial lenders to shift from the London Interbank Offered Rate (Libor), which is facing global criticism, to a self-designed interest rate system, according to the People's Bank of China, the central bank.

Libor is the most widely used benchmark that emerged in the late 1960s to support the burgeoning syndicated loan market. It is formed by collecting interbank offered rate quotes from a panel of banks, which reflects the pricing level at which banks could borrow funds from each other.

The PBOC prefers to use depositary financial institutions' repo rates, called "DR", as the key reference to price financial contracts, which can better reflect the real liquidity situation in the banking system, said a white paper published by the central bank on Monday.

The move reiterated the PBOC's efforts to be a key participant in the global benchmark reform. The shift will allow commercial lenders in the country to shift away from the discredited Libor and improve the efficiency of the domestic monetary policy, said analysts.

So far Libor is still the key reference rate for 15 Chinese banks' financial contracts including loans, securities and derivatives by the second quarter of the year. The benchmark is used to price products worth $900 billion, which will expire after the year 2021, according to data from the PBOC.

Scandals related to Libor rose after the 2008 global financial crisis, as some banks manipulated the rate to misrepresent their creditworthiness by understating the borrowing costs. Regulators from the United Kingdom and the United States have confirmed that the benchmark will be abandoned by the end of 2021.

Global financial regulators are more keen on the use of the so-called risk-free rates, or RFRs, to provide robust and credible overnight reference rates, which are well suited for many purposes and market needs, especially for the cash and derivatives markets.

Preparations for the replacement of Libor with risk-free reference rates have progressed despite the novel coronavirus epidemic, and meeting the end-2021 deadline is still possible, said Fitch Ratings, a global ratings agency.

Major banks across the world have reached a consensus on replacing Libor with other benchmarks, and the key period for the shift will be next year, though several technical details are yet to be ironed out, said Ming Ming, a senior analyst with CITIC Securities.

Chinese banks, which have foreign currency-denominated businesses based on the Libor reference, have to face the same problems as other international banks in revising the old contracts and hedging risks.

A research report from PwC, a global consultancy, indicated that commercial lenders need to re-evaluate the liquidity and credit risks based on the new benchmark, which will be a big change.

"The PBOC has constituted a high-level working group, developed a road map and a timetable to shift the benchmark, along with plans for the design of new references and revision of the old financial contracts," said the white paper.

The central bank has guided commercial lenders to try and issue financial products based on the risk-free rates. It will encourage the issue of floating interest rate bonds based on the DR reference and urge more international organizations to use DR as the renminbi-denominated financial products' benchmark, it said.