I am asking whether the industry, or single banks, have made up their minds already on how to replace the 'missing' interbank risk compensation component in their variable rate credit products when transitioning from LIBOR to SOFR, or whether (and how) they are about to change the financing (or hedging) mix to more closely reflect the RFR-based products.
If you feel that an answer to this question is overly opinion-based, I am of course happy to reformulate it in order to make it more helpful for the community.
My understanding of the status quo: LIBOR
Putting the LIBOR scandal aside, I understand that LIBOR is an inherently credit risky interbank rate reflecting the average (perceived) funding cost for a given tenor, say 3M. Let's assume our bank's funding cost $y_b$ to be linked to the interbanking market, and hence to LIBOR, as a somewhat stable spread $s_b$ over LIBOR. If my bank hands out credit to a customer at LIBOR plus a fixed spread, I am able to pass on the industry's 'average' refinancing cost to them, and hence also the corresponding risk from increasing LIBOR. The client rate $y_c$ consists of LIBOR plus a client spread $s_c$ $$ \begin{align} y_c&=LIBOR + s_c \\ &=LIBOR + m + k + \bar{s}_b+\alpha\sigma(s_b) \end{align} $$ The client spread $s_c$ is commonly fixed at closing of the deal. (Of course, there are provisions in place that adjust the spread when the client's creditworthiness deteriorates.) Here, $m$ are other undefined margin requirements, $k$ is a client credit risk component, and $\bar{s}_b$ and $\sigma(s_b)$ are my bank's 'average' spread and spread variability (think:vol), and $\alpha$ gives us some margin of error.
In this world, I think I could quite well price my client's contract at some well understood rate $s_c$ over LIBOR and refinance / hedge most of the interest rate risk conveniently at LIBOR for a steady income of (very roughly) $m$.
Question
In the future, with LIBOR out of the equation: Are banks, and if so how are banks, able to pass on parts of their (average) refinancing rates (and thus risk) to their customers? Will there be some form of regime shift where
- banks begin to assume the interbanking risk and charge more to their customers?
- and/or: refinancing will be based on some fudged RFR-curve with individualized banks spreads?
- and/or: we might see liquidity in banking-industry-CDS-index-swaps (yes, CDX-swaps) used to hedge financing risk, with hedging cost passed on to the customer?