Next year, the global financial services industry plans to move away from using the London Interbank Offer Rate (LIBOR) as a benchmark for setting interest rates.
Most U.S.-based credit card issuers already use the prime rate to determine their cards' variable interest rates. But financial institutions that rely on the LIBOR will transition to new benchmarks, which may include the Secured Overnight Financing Rate (SOFR).
- The London Interbank Offered Rate, or LIBOR, has long been used as a benchmark for financial institutions to set interest rates.
- Most financial institutions that use LIBOR are expected to transition to other benchmarks after 2021.
- Most variable rates on U.S. credit cards are pegged to the prime rate and won't be affected by the change.
- Cards with rates tied to the LIBOR will adopt another benchmark, and cardholders may see a change in their rates.
The End of the LIBOR as We Know It?
The LIBOR has been widely used since the 1970s as a reference rate for various financial instruments. The U.S. dollar is one of five active currencies for which the rate is calculated, and the U.S. Dollar LIBOR is fixed by 17 member banks, including major U.S. banks Bank of America, Citibank, and JP Morgan Chase.
Because the volume of transactions in markets underlying LIBOR has declined since the financial crisis of 2007-2008, compounded by scandals involving rate manipulation, global regulators have sought more reliable benchmarks for short-term interest rates. Andrew Bailey, the chief executive of the UK Financial Conduct Authority (FCA), announced in 2017 that the rate’s current member banks would only support the LIBOR through the end of 2021.
In 2014, the U.S. Federal Reserve formed the Alternative Reference Rates Committee (ARRC), to search for an alternative to the LIBOR and settled on the SOFR, which fits the criteria.
How the Transition From LIBOR Could Affect You
With credit cards, the prime rate and LIBOR both function as benchmarks. With the prime rate, for example, your interest rate might be the prime rate, which is variable, plus a fixed percentage like 15%. If the prime rate is currently 3.5%, the resulting rate on the account would be 18.25%.
The good news is that most credit card issuers use the prime rate as a reference, so nothing will change for most credit card users. However, if your card issuer does use the LIBOR—some examples include Citizens Bank, Commerce Bank, and Flagstar Bank—it may begin transitioning to a new reference rate starting March 15, 2021.
The ARRC has identified the SOFR as a suitable alternative, but lenders may also choose to use the prime rate instead or even another reference rate that meets the standards set by the committee.
Banks could also use the transition as an opportunity to hike interest rates, and there are currently no regulations restricting that. However, it’s unclear whether any will do that.
If your interest rate should change, the change will be based on the new benchmark rate versus the current LIBOR rate. Your credit card issuer should contact you to let you know about the changes in terms.