Changes In Interest Rate For Foreign ECBs And TCs

Lending and borrowing rates between the banks are controlled by a benchmark rate, i.e., the rate of interest on which the bank borrows funds from another bank. Benchmark rates have a consequential impact on the consumer rate of interest, i.e., a higher benchmark rate results in a higher consumer rate of interest. 

Earlier, the benchmark rate for the banks was LIBOR. However, post the LIBOR Scandal, the LIBOR was transitioned to ARR. Accordingly, For Foreign External Commercial Borrowings (FCY ECBs) and Term Credits (TCs), the benchmark rate was earlier based on the LIBOR. However, post-transition of LIBOR, the Benchmark rates have been changed to Alternate Reference rates. 

Following is a detailed discussion of the rate of interest for Foreign ECBs and TCs:

1. What is LIBOR?

• LIBOR (London Inter-Bank Offered Rate) is the average rate of interest at which banks lend funds to each other in London.
• It acts as a benchmark interest rate for borrowing funds between major global banks. For many years, LIBOR was a globally accepted benchmark for borrowing between banks. 
• LIBOR rates were computed and published on Intercontinental exchange and they were based on 5 currencies and 7 maturities leaving a total of 35 different LIBOR rates.
• It affects the borrowing rates of the bank and therefore has a direct impact on consumer loans such as credit cards, car loans, etc.
• LIBOR is used for various products such as:
  • Standard interbank products like forward rate agreements (FRAs), interest rate swaps, interest rate futures, options etc;
  • Commercial products like floating rate certificates of deposit (CDs) and notes, variable rate mortgages, etc
  • Consumer loan-related products like individual mortgages and student loan
• However, after the involvement of LIBOR in major scandals, it was phased out in June 2023.
• Post removal of LIBOR, different benchmarks were notified for different currencies such as SOFR, SONIA, etc.

Read Also: Amendment in Safe Harbour Rules under Income Tax Act

2. What is ARR (Alternative Reference Rates)

• After the LIBOR scandal, the Alternative References Rates (ARR) Committee was established to provide more reliable benchmarking rates in replacement of LIBOR.
• ARRC was established in 2014 and had the first task of recommending a new benchmark rate.
• In 2017, ARRC recommended the adoption of SOFR as the same is based on greater transaction volume than the LIBOR.
• Apart from SOFR, ARRC recommended other benchmarks as well such as SONIA, for the UK, which is used for GBP Lending, SARON for Swiss francs (CHF), etc.

3. What is SOFR?

• SOFR (Secured Overnight Financing Rate) replaced the LIBOR and is a benchmark interest rate for dollar-denominated derivatives and Loans.
• SOFR is based on transactions in the Treasury repurchase market and it is based on data from observable transactions rather than estimated future borrowing rates.
• While SOFR became the benchmark rate for dollar-denominated derivatives and loans, other countries have sought alternative rates, such as SONIA and EONIA.

4. What is PLR (Prime Lending Rate)

• The Primary Lending Rate (PLR) is a key benchmark interest rate set by banks for lending funds to their most reliable customers.
• The PLR is used by financial institutions to determine the interest rate they charge on loans.
• PLR has a direct impact on the Interest cost of the borrower. If the PLR Increases, interest rate, and interest cost increase for the consumers and vice versa.

5. Change in the interest rate of Foreign ECB and TC due to LIBOR Transition

5.1 Original Rate of Interest of Foreign ECB and TC

RBI, vide Master Directions No. RBI/FED/2018-19/67 dated 26th March 2019, issued Master directions on External Commercial Borrowings (ECB), Trade Credits (TC)and Structured Obligation. RBI Specified the following rate of interest:

1. Benchmark Rate for FCY ECBs and TCs: As per Point No. 1.5, the Benchmark rate in the case of FCY ECB/TC refers to the 6-month LIBOR rate of different currencies or any other 6-month interbank interest rate applicable to the currency of borrowing, for eg., EURIBOR”.

2. All-In-Cost:
   1. All-in-cost refers to the entire cost of a financial transaction.
   2. As per Point No. 1.1 of the Master directions, All-in-Cost includes rate of interest, other fees, expenses, charges, guarantee fees, and ECA charges, whether paid in foreign currency or INR but will not include commitment fees and withholding tax payable in INR. 
   3. Under the TC Framework, all-in-cost shall include rate of interest, other fees, expenses, charges, and guarantee fees whether paid in foreign currency or INR. 
   4. As per Point No. vi of 2.1 of master directions, the All-in-cost ceiling per annum is “Benchmark rate plus 450 bps spread” for ECBs and “Benchmark rate plus 250 bps spread” for TCs.

5.2 Change in benchmark rate of Interest for FCY ECB and TCs:

Given the imminent discontinuance of LIBOR as a benchmark rate, the RBI issued a circular causing changes in External Commercial Borrowings (ECB) and Trade Credits (TC) Policy – Changes due to LIBOR transition vide circular No. RBI/2021-22/135 dated 8th December, 2021.

As per the circular, the CBIC has suggested the following changes to the all-in-cost benchmark and ceiling for FCY ECBs/ TCs:

1. Changes in Benchmarking Rate for FCY ECBs and TCs: Post transition of LIBOR, The RBI amended the master Benchmark in case of FCY ECB and TC to “any widely accepted interbank rate or ARR of 6-month tenor, applicable to the currency of borrowing”.

2. All-in-cost:  The RBI suggested following changes in All-in-cost Ceiling per annum:

External Commercial Borrowings:

1. Benchmark Rate plus 550 bps spread: For existing ECBs linked to LIBOR whose benchmarks are changed to ARR.
2. Benchmark rate plus 500 bps spread: For new ECBs.

Term Credits:

1. Benchmark Rate plus 350 bps spread: For existing TCs linked to LIBOR whose benchmarks are changed to ARR.
2. Benchmark rate plus 300 bps spread: For new TCs.

6. Conclusion:

Accordingly, as per the Circular dated 8th December 2021, the rate of Interest for all existing LIBOR-linked ECB/TC is converted to the respective Alternative Reference Rate (ARR). Therefore, the customers are required to revise their all-in cost of ECB and provide revised ECB along with other supporting documents. However, there are still various cases where customers are still following LIBOR-linked interest rates and All-in-cost. Customers are required to submit revised ECB documentation to AD Bank.