The calculation of SOFR involves several factors that influence its determination. These factors include the interest rates on overnight Treasury repurchase agreement (repo) transactions, market activity, and other relevant factors. The Federal Reserve Bank of New York publishes the calculated SOFR rate daily. 3-month SOFR is a forward-looking interest rate based on the expected average Secured Overnight Financing Rate (SOFR) over the next three months. It provides a benchmark for longer-term borrowing costs in financial markets.
Additionally, services like Bloomberg and Thomson Reuters make SOFR data available through their platforms. The Secured Overnight Financing Rate (SOFR) is Libor’s replacement in the United States. Here’s what you need to know about SOFR, how it differs from Libor and how you might be impacted by the change. Use of any data published by the New York Fed is subject to their Terms of Use for Select Rate Data. Consequently, ARCC, the Federal Reserve, and other parties jointly rolled out this alternative rate. Financial authorities in the United States officially sunset LIBOR in June 2023.
They utilize real transaction data, making them less prone to bias and hence they are preferred by regulators. The SOFR Index value reflects the effect of compounding the SOFR each business day and allows the calculation of compounded SOFR averages over custom time periods. The integration of SOFR into loan agreements marks a significant shift for financial institutions and borrowers as the industry transitions away from LIBOR.
LIBOR’s Dominance and Downfall
The addition of daily morning SRF operations is intended to enhance the effectiveness of the SRF. The minimum bid rate for SRF operations is set by the FOMC and detailed in the most recent implementation note. Discover why this benchmark, set by banks and influenced by the Federal Reserve, matters. SOFR is a common index for interest rates, but even in the case where your interest rate is tied to it, it’s far from the only factor impacting your interest rate.
SOFR values over last 30 calendar days
Alternatively, lenders may look at an average over time to control for daily volatility. For the initial period—typically five or seven years—the interest rate is fixed and remains constant. After this phase ends, the loan transitions into its adjustable period.
- It’s based on a weighted average of all the treasury repurchases that take place between banks in a given day.
- Glen is an editor on the Fortune personal finance team covering housing, mortgages, and credit.
- Owing to the process of how the rate is derived and the liquidity and depth in the underlying markets, it is more resilient than LIBOR.
- If you had an ARM tied to Libor, the lender likely transitioned your index rate to a different rate during or before June 2023.
- LIBOR is based on estimates made by banks of the interest rate at which they would borrow funds from other banks in an interbank loan.
What Does SOFR Mean in Finance and How Is It Used?
The story of SOFR begins when LIBOR, an international benchmark, was deemed unreliable due to scandals and fundamental flaws in its structure. LIBOR is based on estimates made by banks of the interest rate at which they would borrow funds from other banks in an interbank loan. Many market participants did not trust the rate through the 2008 financial crisis, as banks manipulated quotes submitted, essentially eroding the integrity of the rate. SOFR, aka Secured Overnight Financing Rate, is a fully transaction-based rate that reflects the cost of borrowing cash Pit Bull overnight.
Cash Application Management
Following the 2008 recession, a sharp decline in economic activity was noticed. Due to the same, regulators became wary of over relying on LIBOR as LIBOR rates were largely based on global banks’ estimates and necessarily on actual transactions. The drawback of providing banks with this level of independence was exposed in 2012, when more than a dozen financial institutions were found manipulating their LIBOR rates so as to profit from trade. Secured overnight financing rate data is wholly derived from the transactions that occurred in the previous business day. Therefore, it accurately represents the market as it is directly related to the borrowing and repayment rates in the market.
“This market averages over $1 trillion daily, which means it reflects actual transactions, not quotes, and can’t be manipulated easily,” Patel says. SOFR is also used in adjustable-rate mortgages (ARMs) and commercial loans, where the benchmark rate determines how much interest borrowers pay when their loan resets. A distinct advantage of SOFR is that it uses observable transaction data rather than estimates. By extension, SOFR rates more accurately reflect actual overnight cash borrowing.
Liquidity
It’s similar to SOFR because it’s a benchmark for some financial products. However, banks set their prime rates, and they may use the federal funds rate as a starting point and then add a margin. Furthermore, the adoption of SOFR has led to discussions around the development of new financial products tailored to this benchmark rate. Market innovators are exploring the creation of SOFR-linked derivatives and structured products to meet the evolving needs of investors and borrowers in a post-LIBOR era.
- Use cases for daily compounded SOFR include financial products and contracts where the interest is expected to compound daily.
- This 2.6% would typically increase if an applicant had a low credit score or several missed payments.
- By virtue of the fact that US Treasury securities back it, it is less likely to change when the market does, in contrast to LIBOR, which was based on the estimates that banks themselves provided.
- The latest published SOFR 1-month, 3-month, and 6-month averages are for July 8, 2025.
Managing the LIBOR-SOFR Transition
Furthermore, SOFR is considered to be more representative of the current market conditions as it is based on a larger and more diverse set of transactions. This broad coverage helps reduce the risk of manipulation and provides a more objective benchmark for financial markets. Switching to SOFR poses big challenges especially in the derivatives market, however, its impact will be felt across credit related sectors. Consumer credit, adjustable-rate mortgages (ARM), and private student loans asset-backed debt securities, including commercial paper, will also be impacted. Similar benchmark transactions for derivatives and dollar-denominated loans were initially charged based on the LIBOR.
Despite these potential drawbacks, SOFR continues to gain prominence and serves as a cornerstone for the financial market. Its adoption and usage signify a significant step towards greater market transparency, efficiency, and resilience. As an extension of the Secured Overnight Financing Rate (SOFR), the SOFR Averages are compounded averages of the SOFR over rolling 30-, 90-, and 180-calendar day periods. Owing to the process of how the rate is derived and the liquidity and depth in the underlying markets, it is more resilient than LIBOR. ABC Bank has an average daily cash requirement of $100 million to cater to the 20 branches in the city and its customers. On the 12th of December, they had a cash reserve of $70 million towards the end of business hours.
The ARRC put spread adjustments in place along with term SOFR rates to make the transition rational for market participants, while still allowing them to maintain consistency with prior financial products. The process of SOFR calculation is designed to ensure transparency and accuracy. It utilises a vast amount of transaction-level data obtained from various market participants to provide a reliable benchmark rate for financial markets. 30-day SOFR is a forward-looking interest rate calculated based on the expected average Secured Overnight Financing Rate (SOFR) over the next 30 days. It provides a shorter-term benchmark for borrowing costs in financial markets over one month.
