In this episode, Forefront VP and Head of Content Sam Belden sits down with John Shay, CEO of American Financial Exchange (AFX) and Marco Macchiavelli, Assistant Professor of Finance at UMass Amherst, for a discussion on benchmark interest rates in the overnight lending market and the value of credit-sensitive rates in the post-LIBOR era. They discuss the difference between credit-sensitive and non-credit sensitive rates and why these distinctions are so important for commercial banks today.
First, the guests discuss the now defunct LIBOR interest rate, which was discontinued by regulators following years of manipulation scandals. They compare the other benchmark interest rates available today, and how the industry has responded to the alternatives. Macchiavelli and Shay discuss some of LIBOR’s limitations and why the methodology of allowing banks to submit their own rates is not a sustainable option.
Shay explains how the AMERIBOR interest rate was formed long before the IOSCO comment letters and the market’s acceptance of SOFR as an alternative rate. AFX was founded as an executable marketplace for banks to come together and execute empirical data in a calculation that is published daily. The platform, he explains, operates on a CLOB (Central Limit Order Book) model, where credit exposures are customizable. Risk-weighted averages are published on the platform so that market participants can use them as a measure to write loans – avoiding the freezes observed in unsecured overnight market.
Next, the conversation turns to Professor Macchiavelli’s recent whitepaper, which explores the need for a credit-sensitive reference rate in times of market stress. Macchiavelli’s previous experience on the Federal Reserve Board informed his research and enabled him to draw conclusions on how different alternative rates performed compared to LIBOR in a credit event. Data from the the March 2020 COVID-19 panic showed that when LIBOR rates went up, loans linked to secured credit rates like SOFR went down, causing regional banks to suffer losses. On the other hand, AMERIBOR maintained its positive correlation with LIBOR, displaying its beneficial cyclical properties during times of market crises.
Because the high-frequency changes in credit risk that LIBOR represents are absorbed by AMERIBOR, AMERIBOR proves to be a good proxy, Macchiavelli states. Other rates don’t correlate; in fact, they lead to negative margins in a panic. “If you’re a regional bank in the business of writing lines of credit to your corporations and local clients and are tied to SOFR, in the event of a credit event you are underwater,” John echoes.
Macchiavelli goes on to explain the importance of a credit-sensitive rate that is liquid and based on real transactions, and from which players can link credit exposures to. From a financial stability standpoint, credit-sensitive rates are needed for regional banks so they can keep a positive and stable net interest margin both when markets are performing well and when they aren’t. John chimes in to warn that asking regional banks to fund loans based on SOFR will lead to further consolidation with larger banks (those with assets in the single-digit trillions). An index like AMERIBOR, that takes the larger credit environment into account, will prove effective in preventing regional bank collapses like the industry saw in 2023.
Lastly, Shay discusses what’s down the road for AMERIBOR as the industry continues its pursuit of a rate that’s a true reflection of their overnight borrowing costs. AFX currently operates in an ecosystem of 300 regional banks across the nation, and aims to bring the other banks in the addressable market onto its technology. John shares that a major priority is developing a forward-looking rate for futures that is either risk-free or credit-sensitive. Overall, Shay and Macchiavelli express the shared sentiment that AMERIBOR is poised to make even more of an impact in the years to come, funding banks through all seasons.
If you’d like to learn more about AMERIBOR, you can go to theafex.com.
See below for a breakdown of what was discussed. Happy listening!
Timestamps:
2:00 – The discontinuation of the LIBOR interest rate standard
7:00 – Credit sensitive rates versus non-credit sensitive rates, and their relevant use cases
11:40 – Why AMERIBOR is appropriate for regional banks
17:02 – The bank failures of 2023, and how credit-sensitive rates can help navigate through instances of market stress
23:15 – How AMERIBOR stacks up compared to other credit-sensitive SOFR alternatives
35:45 – How AMERIBOR can solve for challenges that regional and community banks face today
41:20 – What’s next for AFX and for the future of the post-LIBOR era
