The World Bank (WB) is likely to adopt a new reference rate from next year in calculating the interest of its high-cost loans, officials have said.
Presently, the interest rate of WB's high-cost loans is calculated on the basis of LIBOR (London Inter-Bank Offered Rate) index, which is now deemed 'unsuitable' due to its evolving risk of deterioration.
In mid-November, the WB Group board of directors approved a document titled "Proposed Modifications to the IBRD and IDA General Conditions to add flexibility in reference rate replacement provisions".
The modification enabled the global lender to use alternatives to LIBOR, if needed, in future.
Now the WB is planning to switch to a new reference index -- Secured Overnight Financing Rate (SOFR) -- for loans to be approved under the new general conditions.
WB's IBRD (International Bank for Reconstruction and Development) credits and non-concessional IDA (International Development Association) credits are considered the high-cost loans.
Their interests are now calculated based on LIBOR plus a variable or a fixed spread rates.
Bangladesh, being a least developed country (LDC), has been availing low-cost IDA loans since it became a member of WB. However, from last year the country started taking blended loans, a mixture of low-cost and high-cost loans.
Sources said the WB recently informed the Ministry of Finance about the development regarding the new reference rate in its loan interest calculation.
"The general conditions are being amended and are expected to be issued before year-end. They will be applicable to all projects, for which authorisation to negotiate has not been obtained prior to the date of issuance of new conditions," WB Lead Economist in Dhaka office Zahid Hussain wrote in a letter.
A senior official at the office, preferring anonymity, told the FE that the suitability of LIBOR index as reference rate for calculation of interest has been subject to questioning after a series of scandals broke out regarding its manipulation since 2008.
He said it was also found that several global banks colluded in manipulating the rate, and subsequently they were fined. Later, the LIBOR rate setting was transferred from the British Bankers' Association to the Intercontinental Exchange.
In addition, the reporting methodology was also switched from one based on estimates reported by banks to a more accurate method based on actual transactions executed.
Following these incidents, LIBOR index is no more considered as a benchmark reference rate. Rather, a new reference rate -- SOFR -- is developed, he added.
"LIBOR is expected still to be quoted, but its existence is not guaranteed after 2021, requiring preparations to adopt alternative reference rates," a short note of WB mentioned.
The board approval allows changes in the reference rate for new loans in any market transition period, whenever WB judges that LIBOR is not suitable anymore for its asset and liability management, it added.
The WB official also said mainly the borrowers of IBRD and non-IDA credits will be affected due to the reference rate change.
At present, Bangladesh yearly takes hard loans between US$400 million and $500 million from WB, which is below one-fifth of the total annual commitment from the multinational lender, he noted.
Asked whether the new reference rate will lead to interest rate hike, he opined that it will depend on global financial conditions.
