This Treasury repurchase market is much larger than the interbank loan market that LIBOR used. This distinction is crucial because SOFR’s reliance on real transactions makes it less prone to the kind of manipulation that plagued LIBOR. Although SOFR offers several benefits for financial institutions, it’s not without downsides.
This process mirrors the accrual of interest over these defined periods. Daily simple SOFR is calculated daily without considering the interest accrued on previous days — essentially offering a simple daily rate measure without compounding interest. Industry experts often use this type when they need a straightforward day-to-day rate.
Because these loans happen on a regular basis on short notice, any rapid fluctuation in the overnight rate may signal a pending change in the economy. It’s an important rate used by financial services companies every day to set the interest rates that you might be paying. Learn about SOFR—how it’s calculated and why and when it fluctuates—to help you understand why, say, the interest on your credit card may have changed. While the transition had some challenges, including the lack of a built-in credit risk part and the initial absence of term structures, market changes like introducing term SOFR and spread adjustments have smoothed adoption. The latest published SOFR 1-month, 3-month, and 6-month averages are for November 5, 2025. Note these term rates are calculated in arrears (they average historical SOFR rates) as opposed to being forward-looking like swap rates.
Secured Overnight Financing Rate (SOFR)
SONIA, EURIBOR, and SARON aren’t denominated in U.S. dollars, so they are unlikely to affect U.S. consumers. Multinational corporations track them, though, because they often make short-term loans in different currencies. American consumers may see rates that are based on the Fed funds rate or the bank’s prime rate instead of SOFR. SOFR’s establishment, grounded in actual market transactions, marks a significant evolution in financial benchmarks.
Leveraging SOFR to Ensure a Transparent Financial Ecosystem
By relying on actual market transactions rather than estimates, SOFR offers a more transparent and reliable measure of borrowing costs. Its introduction has helped restore confidence in benchmark rates, ensuring that financial products tied to interest rates are grounded in observable data and less prone to manipulation. The secured overnight financing rate (SOFR) is an interest rate calculated by the Federal Reserve Bank of New York based on the overnight borrowing cost for secured funds (i.e., those backed by Treasury securities). It replaced the London interbank offer rate (LIBOR) as the standard benchmark for short-term borrowing among banks. SOFR is often specified in contracts—from swaps and OTC derivatives to your credit card agreement—as the basis for interest rate changes.
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The rate is used by other banks, financial companies, and corporations when setting interest rates. For example, a contract may call for an interest rate based on a multiple of SOFR, or an adjustable-rate mortgage may move based on changes in SOFR rates. Banks need to meet federally mandated capital reserve requirements each night.
Secured overnight financing rate (SOFR): Setting the variable interest rate standard
Its advent marks a shift from legacy benchmarks like LIBOR to a more transparent, transaction-based model, enhancing its reliability in financial operations. Overnight financing rates, such as SOFR, are key indicators of short-term borrowing costs. Derived from real transactions, SOFR offers insights into market liquidity and financial stability, reflecting the current state of the lending and borrowing environment. The Secured Overnight Financing Rate (SOFR) has successfully replaced LIBOR as the benchmark rate for U.S. dollar-denominated loans and derivatives.
LIBOR Rate + X or Spread or the Credit Risk
One major concern is that SOFR only looks at secure overnight deals and doesn’t consider credit risk, meaning the SOFR rate may drop in the event of an economic downturn. In theory, this could influence the Federal Reserve’s decisions on adjusting the federal funds rate, which could impact SOFR and other risk-free rates. It was based on the average interest rate at which major global banks borrowed from one another, most notably using the three-month U.S. dollar LIBOR rate. However, LIBOR’s vulnerability became evident following the 2008 financial crisis.
Daily Simple SOFR
In 2014, the Federal Reserve Board formed the Alternative Reference Rates Committee. The main objective of this committee was to find a new benchmark rate. In 2017, ARCC officially endorsed SOFR as its preferred benchmark rate.
SOFR’s calculation uses data from a broad spectrum of repo transactions, ensuring a comprehensive market representation. This variety in data sources contributes to SOFR’s stability and reliability, making it a crucial tool for financial decision-making and policy development. The secured overnight What Is the Dow Jones Industrial Average financing rate (SOFR) is a standard, short-term, market-based interest rate that quietly underpins a significant—and growing—portion of the financial system. You may not follow it from day to day, but if you’ve had a credit card, a loan, or an adjustable-rate contract, you’ve likely crossed paths with SOFR or its predecessor, LIBOR. Knowing what it is can help you understand what’s driving the rates that affect you. The secured overnight financing rate (SOFR) is a rate that reflects the cost of borrowing overnight, backed by U.S.
Regulators discovered that banks were manipulating LIBOR rates to their advantage, leading to major fines and global efforts to find more reliable alternatives. A transparent global financial market is good for economies, businesses, and individuals alike. The shift from LIBOR to SOFR posed challenges, particularly in the derivatives market, where trillions of dollars’ worth of contracts were tied to LIBOR. Additionally, the transition affected consumer credit products, such as adjustable-rate mortgages and private student loans.
- This distinction is crucial because SOFR’s reliance on real transactions makes it less prone to the kind of manipulation that plagued LIBOR.
- Repos, or repurchase agreements, involve the sale and later repurchase of securities.
- The Federal Reserve Bank of New York began publishing SOFR in April 2018 to help financial institutions transition away from LIBOR.
- When financial institutions made the switch, they used these adjustments to better align the secured SOFR rates with the unsecured LIBOR rates, helping to bridge the gap between the old and new systems.
- For example, in a standard swap, one party agrees to pay a fixed interest rate, while the other party pays a floating rate based on SOFR.
- Because these loans happen on a regular basis on short notice, any rapid fluctuation in the overnight rate may signal a pending change in the economy.
- But both banks and corporations have wide fluctuations in the amount of cash they have on hand on any given day.
- XYZ’s chief financial officer (CFO) realizes that interest rates are increasing and sets up a hedge.
With SOFR, a creditor may use the daily compounded interest or the SOFR index value to calculate the interest rate on a loan. In 2014, the Federal Reserve Bank of New York convened an Alternative Reference Rates Committee to investigate other interest rates that could replace LIBOR. Congress passed the Adjustable Interest Rate (LIBOR) Act, which made SOFR the replacement rate for any contracts that specified LIBOR effective June 30, 2023. It uses the daily settlement prices of those futures contracts to calculate and publish the CME Term SOFR Rates, which are forward estimates for SOFR rates that look out one, three, six, and 12 months. Financial institutions and corporations can use that data in their financial planning and risk management.
For some time, the London Interbank Offered Rate (LIBOR) served as the benchmark for global interest rates. However, because of its reliance on bank estimates rather than real transactions, as well as scandals in the early 2010s, regulators sought to have it replaced. The move to SOFR not only impacted U.S. financial markets but also brought increased stability and transparency to the broader global financial landscape. Below are a few examples of market participants positively influenced by the shift to SOFR.
The LIBOR fallback rates are calculated by adding the SOFR rates for each term to the appropriate fallback spreads. Credit spread adjustments are another tool that made the LIBOR-SOFR transition possible. When financial institutions made the switch, they used these adjustments to better align the secured SOFR rates with the unsecured LIBOR rates, helping to bridge the gap between the old and new systems. Previously, people who opted for LIBOR-based car loans were required to pay interest rates in the LIBOR + X format. This 2.6% would typically increase if an applicant had a low credit score or several missed payments.
She holds a Bachelor of Science in Finance degree from Bridgewater State University and helps develop content strategies. Use of any data published by the New York Fed is subject to their Terms of Use for Select Rate Data.
Its role in providing stability and transparency is growing, poised to become a foundational element in financial markets and shaping a more resilient and transparent financial future. In the United States, SOFR has replaced LIBOR as the standard reference rate. Other countries use alternative financial benchmarks such as SONIA or ESTER. This type is calculated daily and takes into account the interest accrued — providing a comprehensive view of the total borrowing cost over a particular interest period. Use cases for daily compounded SOFR include financial products and contracts where the interest is expected to compound daily.
These benchmarks, like SOFR, are based on actual transactions, making them more reliable than the previous LIBOR system. In response, regulators, particularly in the U.S., took steps to replace LIBOR. In 2017, the Federal Reserve created the Alternative Reference Rates Committee (ARRC), which selected SOFR as the replacement for LIBOR. The Federal Reserve Bank of New York began publishing SOFR in April 2018 to help financial institutions transition away from LIBOR.