In the modern banking and financial system, benchmark interest rates and foreign exchange market practices occupy a very important position. International lending, borrowing, treasury management, derivatives trading, trade finance, and foreign exchange transactions depend heavily on benchmark rates and standardised operational practices. For several decades, the London Interbank Offered Rate (LIBOR) served as the most important global benchmark interest rate and was widely used in international financial contracts. However, due to serious concerns regarding its reliability and transparency, LIBOR was gradually replaced by Alternate Reference Rates (ARRs), also known as Risk-Free Rates (RFRs).
At the same time, in India, the foreign exchange market is guided by operational rules and standards prescribed by the Foreign Exchange Dealers Association of India (FEDAI). FEDAI plays an important role in ensuring uniformity, discipline, and transparency in foreign exchange dealings among banks and authorised dealers.
Understanding LIBOR, ARRs, and FEDAI is extremely important for banking professionals because these concepts are closely connected with international banking, foreign exchange management, treasury operations, trade finance, and risk management.
LIBOR (London Interbank Offered Rate)
LIBOR stands for London Interbank Offered Rate. It was one of the most widely used benchmark interest rates in the world and represented the average rate at which major international banks in London were willing to lend unsecured funds to one another in the interbank market.
In simple terms, LIBOR reflected the borrowing cost of banks in the international money market. It served as a benchmark for determining interest rates on a vast number of financial contracts around the world.
LIBOR was administered by the Intercontinental Exchange (ICE). Every day, selected international banks known as panel banks submitted estimates regarding the rate at which they could borrow funds from other banks in the London interbank market. After excluding unusually high and low submissions, the remaining rates were averaged to calculate LIBOR.
LIBOR rates were published for several major international currencies, including the US Dollar (USD), British Pound Sterling (GBP), Euro (EUR), Japanese Yen (JPY), and Swiss Franc (CHF). The rates were also available for different borrowing periods or tenors such as overnight, one week, one month, three months, six months, and twelve months. Among these, the three-month USD LIBOR became one of the most widely used benchmark rates globally.
The importance of LIBOR in the international financial system was enormous. Many international loans, syndicated loans, floating rate bonds, and trade finance facilities were linked to LIBOR. Banks commonly priced loans as “LIBOR plus spread,” where the spread represented the additional premium charged according to the borrower’s credit risk. For example, a borrower could receive a loan at “LIBOR + 2%.” If LIBOR increased, the borrower’s total interest cost also increased automatically.
LIBOR was also widely used in derivative contracts such as interest rate swaps, forward rate agreements, currency swaps, futures, and options. Trillions of dollars worth of financial contracts across the world depended on LIBOR as the benchmark reference rate. Because of this extensive usage, any movement in LIBOR directly affected global borrowing costs, investment returns, and financial market valuations.
Despite its importance, serious weaknesses gradually emerged in the LIBOR system. One of the biggest problems was that LIBOR was based mainly on estimated submissions by banks rather than actual borrowing transactions. Banks were required to estimate the rate at which they could borrow funds, even if actual borrowing transactions did not occur frequently. This estimation-based methodology created opportunities for manipulation.
After the 2008 global financial crisis, unsecured interbank lending activity declined sharply because banks became cautious about lending to one another. Since fewer actual transactions were taking place, LIBOR became less representative of real market conditions. In 2012, investigations revealed that several major international banks had manipulated LIBOR submissions to benefit their trading positions or create a false impression regarding their financial condition. These scandals severely damaged the credibility of LIBOR and raised concerns about the integrity of the global financial system.
Due to these weaknesses, international regulators decided that LIBOR should be phased out and replaced with more transparent and reliable benchmark rates. The UK Financial Conduct Authority (FCA), along with regulators from other countries, announced the discontinuation of LIBOR for most currencies and tenors after June 2023. Financial institutions were instructed to stop entering into new LIBOR-linked contracts and gradually transition existing contracts to alternative benchmark rates.
Alternate Reference Rates (ARRs)
Alternate Reference Rates (ARRs), also known as Risk-Free Rates (RFRs), were introduced as replacements for LIBOR. These benchmark rates are based on actual market transactions rather than estimates submitted by banks. Therefore, ARRs are considered more transparent, robust, and less vulnerable to manipulation.
Unlike LIBOR, which included bank credit risk and liquidity premiums, most ARRs are nearly risk-free because they are derived from overnight secured or low-risk transactions. Since they are transaction-based, ARRs more accurately reflect actual market borrowing conditions.
Different countries adopted different ARRs depending on the structure of their domestic financial markets. In the United States, the Secured Overnight Financing Rate (SOFR) replaced USD LIBOR. SOFR is based on overnight repurchase agreement (repo) transactions backed by US Treasury securities and is published by the Federal Reserve Bank of New York. Because it is backed by government securities, SOFR is considered highly secure and reliable.
In the United Kingdom, the Sterling Overnight Index Average (SONIA) replaced GBP LIBOR. SONIA reflects overnight unsecured borrowing transactions in the sterling market and is administered by the Bank of England.
In the Eurozone, the Euro Short-Term Rate (€STR) was introduced as the replacement benchmark. Japan adopted the Tokyo Overnight Average Rate (TONAR), while Switzerland introduced the Swiss Average Rate Overnight (SARON).
One of the key differences between LIBOR and ARRs is that LIBOR was a forward-looking term rate, while most ARRs are overnight rates. LIBOR directly provided rates for periods such as three months or six months, whereas ARRs are usually overnight borrowing rates that need to be compounded over a particular period to determine interest obligations. Another major difference is that LIBOR included a bank credit risk premium, while ARRs are nearly risk-free and therefore more stable.
The transition from LIBOR to ARRs created major challenges for banks and financial institutions across the world. Existing contracts linked to LIBOR had to be modified to include fallback clauses and alternative benchmark references. Treasury systems, accounting software, loan pricing models, risk management systems, and derivative valuation methods all required extensive changes.
Banks also had to educate customers regarding the new benchmark system and the changes in interest calculation methodology. Since ARRs are overnight rates and do not include bank credit risk in the same manner as LIBOR, pricing adjustments became necessary while shifting from LIBOR-based products to ARR-based products.
For Indian banks, the transition to ARRs has been especially important in areas such as external commercial borrowings (ECBs), trade finance, foreign currency loans, and derivative transactions. The Reserve Bank of India advised banks to stop using LIBOR in new contracts and ensure smooth migration to ARRs. Indian banks involved in international business therefore needed to update documentation, revise systems, and strengthen risk management practices.
Foreign Exchange Dealers Association of India (FEDAI)
The Foreign Exchange Dealers Association of India (FEDAI) is a self-regulatory organisation established in 1958 for regulating and standardising foreign exchange operations in India. FEDAI works closely with the Reserve Bank of India and provides operational rules, market conventions, and guidelines for banks and authorised dealers engaged in foreign exchange business.
The main objective of FEDAI is to ensure uniformity, professionalism, discipline, and transparency in foreign exchange transactions. It seeks to standardise operational procedures among banks so that foreign exchange dealings are conducted efficiently and consistently across the country.
FEDAI plays a very important role in India’s foreign exchange market because it lays down detailed rules regarding merchant transactions, interbank dealings, forward contracts, cancellation and rebooking of contracts, exchange rate calculations, transit periods, and interest calculations. These rules help reduce operational confusion and disputes among banks and customers.
Although FEDAI is not a statutory body, its rules carry significant importance because the Reserve Bank of India expects authorised dealer banks to follow FEDAI guidelines while conducting forex operations. Thus, FEDAI functions as a highly influential self-regulatory body within the Indian banking system.
FEDAI membership mainly consists of commercial banks and financial institutions authorised to deal in foreign exchange. These institutions follow FEDAI rules while handling import-export transactions, remittances, foreign currency loans, and treasury operations.
One of the major functions of FEDAI is to standardise exchange rate calculations. FEDAI prescribes methods for calculating telegraphic transfer (TT) buying and selling rates, bill buying and selling rates, cross-currency rates, forward premiums, and other forex-related charges. This ensures uniformity in forex pricing practices across banks.
FEDAI also issues detailed guidelines regarding forward exchange contracts. These guidelines cover booking, cancellation, extension, and rebooking of contracts. Such rules are extremely important for importers, exporters, and businesses dealing in foreign currency transactions because they help manage exchange rate risk.
Another important role of FEDAI is coordination with the Reserve Bank of India on policy matters and operational challenges faced by authorised dealers. FEDAI represents the concerns and practical difficulties faced by banks and helps in improving forex market practices.
FEDAI also contributes to training and skill development in foreign exchange operations. It conducts certification programmes, workshops, seminars, and professional training for banking personnel engaged in treasury and forex activities.
The importance of FEDAI in Indian banking is very significant. It promotes transparency and consistency in foreign exchange transactions, reduces operational risks, supports smooth functioning of trade finance operations, and strengthens market discipline. For banking examinations, FEDAI is an important topic, especially in relation to forward contracts, merchant rates, exchange rate calculations, and forex regulations.
Relationship Between RBI and FEDAI
The Reserve Bank of India (RBI) is the central authority responsible for regulation and supervision of foreign exchange management in India under the Foreign Exchange Management Act (FEMA), 1999. RBI formulates policies and regulations related to foreign exchange.
FEDAI complements RBI by providing operational guidance, standard market practices, and procedural rules for authorised dealer banks. Thus, RBI performs the regulatory role, while FEDAI acts as a self-regulatory operational body that helps implement forex market practices efficiently.
Both institutions work together to ensure stability, transparency, and orderly functioning of India’s foreign exchange market.
Conclusion
LIBOR served as the foundation of the international financial system for many decades and acted as the most important benchmark interest rate for loans, derivatives, bonds, and trade finance products. However, due to manipulation scandals, declining interbank lending activity, and concerns regarding transparency, LIBOR gradually lost credibility and was replaced by Alternate Reference Rates (ARRs), which are based on actual market transactions and are considered more reliable and transparent.
The transition from LIBOR to ARRs has transformed international banking, treasury management, and risk management practices worldwide. Banks across the globe, including Indian banks, have had to revise systems, contracts, and operational frameworks to adapt to the new benchmark regime.
At the domestic level, FEDAI plays a vital role in ensuring uniformity, discipline, and transparency in India’s foreign exchange market. Through its rules, guidelines, and coordination with RBI, FEDAI supports smooth forex operations, efficient trade finance activities, and sound banking practices in the country.