The Reserve Bank on Thursday asked banks and financial institutions to use any widely accepted alternative reference rate (AAR) instead of LIBOR (London Interbank Offered Rates) as the reference rate for entering into new financial contracts.

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The Reserve Bank's directive follows a decision of the Financial Conduct Authority (FCA), UK which on March 5, 2021 had announced that all LIBOR settings would either cease to be provided by any administrator or would no longer be representative.

In order to deal with the emerging situation, the RBI has asked banks and financial institutions to "cease entering into new financial contracts that reference LIBOR as a benchmark and instead use any widely accepted alternative reference rate (ARR), as soon as practicable and in any case by December 31, 2021."

The financial institutions, it suggested, should incorporate robust fallback clauses in all financial contracts that reference LIBOR and the maturity of which is after the announced cessation date of the LIBOR settings.

The RBI has also advised the financial institutions to cease using the Mumbai Interbank Forward Outright Rate (MIFOR), a benchmark which references the LIBOR, latest by December 31, 2021. The Reserve Bank of India (RBI) had in August 2020 asked banks to frame a board-approved plan, outlining an assessment of exposures linked to LIBOR and steps to be taken to address risks arising from the cessation of LIBOR, including preparation for the adoption of the ARR.

While certain US dollar LIBOR settings will continue to be published till June 30, 2023, the extension of the timeline for cessation is primarily aimed at ensuring roll-off of USD LIBOR-linked legacy contracts, and not to encourage continued reliance on LIBOR.

"It is, therefore, expected that contracts referencing LIBOR may generally be undertaken after December 31, 2021, only for the purpose of managing risks arising out of LIBOR contracts (e.g. hedging contracts, novation, market-making in support of client activity, etc.), contracted on or before December 31, 2021," the RBI said.

It has also asked banks and financial institutions to incorporate robust fallback clauses, preferably well before the respective cessation dates, in all financial contracts that reference LIBOR and the maturity of which is after the announced cessation date of the respective LIBOR settings. The central bank also said it will continue to monitor the evolving global and domestic situation with regard to the transition away from LIBOR and proactively take steps to mitigate associated risks in order to ensure a smooth transition.