Many banks continue to struggle to identify the appropriate index to price loans. This has been a hot topic this week with the introduction of the Secured Overnight Funding Rate (SOFR) as a possible replacement to Libor. Most of the national and regional banks still prefer LIBOR, while community banks favor Prime, and still, other banks use Treasuries.
Community bankers are currently paying close attention to commercial loan pricing given near-record tight credit spreads and increasing interest rate risk. The vast majority of commercial loans in the market are priced to an index plus a credit spread. Determining the appropriate credit spread that will win the business and provide sufficient return to the lender is a key element of RAROC (risk adjusted return on capital) analysis. However, the underlying index to
Most community banks do not use LIBOR (London Interbank Offered Rate) to set loan or deposit rates, yet LIBOR is probably the most important index for community banks. In fact, while Prime and some form of Treasury indices are much more prevalent as a loan index for community banks, LIBOR is far more important for community banks in setting loan yields and determining deposit rates.