In the U.S., regulators urged financial institutions to stop basing rates for new loans on Libor starting in 2022. Outside the U.S., similar transitions happened to other benchmarks, such as the Tokyo Overnight Average Rate (TONA) in Japan and the Sterling Overnight Index Average (SONIA) in the U.K. For decades, the London interbank offered rate was the benchmark for pricing a wide variety of loans, including adjustable-rate mortgages.

SOFR Averages and Index Data

Regardless of the type of loan you’re dealing with, in an adjustable-rate situation, the index value is added to a margin specified in your loan documents to come up with your new rate. No matter how low rates go, they won’t fall below the margin and won’t be higher than any specified lifetime limits that may be included as part of your contract. In 2012, investigators discovered that bankers had for years been setting Libor for their own benefit by reporting incorrect rates. In 2017, the regulator that oversaw Libor also announced that it wouldn’t require banks to submit their estimated rates after 2021. Like any financial indicator or rate, SOFR has its own set of advantages and disadvantages.

Adjustable-Rate Mortgage (ARM): Definition, Pros, Cons And FAQs

After that, individual propositions may either be partially awarded or not awarded based on their proximity to those benchmark rates for each security type. Beginning June 26, 2025, how will the $500 billion SRF aggregate operation limit be allocated between the morning SRF operation and afternoon SRF operation? The current aggregate SRF operation limit of $500 billion will apply to the combined daily operations. The Desk intends to announce the aggregate limit of each business day’s afternoon SRF operation on the Repo Operations webpage shortly after the morning SRF operation has concluded. Upon effectively replacing LIBOR, Profit First SOFR became the new reference rate for many loan contracts that had previously been tied to the London-based index.

These repo agreements allow banks to make overnight loans to meet liquidity and reserve requirements, using Treasurys as collateral. This distinction is crucial because SOFR’s reliance on real transactions makes it less prone to the kind of manipulation that plagued LIBOR. This Treasury repurchase market is much larger than the interbank loan market that LIBOR used. The difference between the purchase price and the sale price of the securities implies a rate of interest earned by the Federal Reserve on the transaction. The FOMC sets the SRF minimum bid rate, which is the minimum interest rate the Federal Reserve is willing to receive in an SRF operation. Regulators, like the Reserve Bank of India (RBI), have encouraged banks to shift their dollar transactions toward SOFR to ensure no deviation from accepted international norms.

The Federal Reserve Bank of New York publishes rates daily based on the transactions made on the previous day. The calculation relies on the volume-weighted median of transactions after referring to data points from repo transactions and bilateral treasury repo transactions. The SOFR is calculated as a volume-weighted median of transaction-level data observed over the course of a business day. This data comes from the overnight repurchase agreements in the US Treasury repo market. SOFR is a broad measure of the interest rates banks pay each other for short-term loans collateralized by United States Treasury securities. In other words, it is a benchmark rate that sets the tone for interbank financial transactions.

Every business day, at approximately 8 AM ET, the New York Fed publishes the rate based on the previous day’s transactions on its official websites. SOFR relies on diverse data sources to ensure accuracy and reliability. The Federal Reserve Bank of New York serves as the primary source, offering daily updates that reflect the U.S.

Rather than being subject to a guess at market movements, each treasury transaction is negotiated at the lender level and rolls up into an overall average along with other transactions having taken place that day. If you have a loan with an adjustable or variable rate, there are many different indexes the rate changes may be tied to. We’ll go over how SOFR is set and its impact on consumer interest rates. Most credit cards have a variable interest rate, but they tend to use the prime rate as a benchmark instead of SOFR. However, if you have a variable-rate private student loan, your loan’s interest rate might depend on SOFR. This is because the interest rate on your mortgage remains unchanged for its entire term.

• SOFR reflects the cost of borrowing U.S. dollars overnight using Treasury securities as collateral.
• Any changes to the operational parameters not provided by the FOMC’s Continuing Directive for Domestic Open Market Operations and implementation note will be announced on the New York Fed’s website.
• Lenders and borrowers must choose an appropriate SOFR-based rate, such as the overnight rate or a compounded average over a specific period, which affects interest calculation methodology.
• When calculating SOFR, data from the United States Treasury repurchase (repo) market is used.

Ultimate Guide on SOFR: Definition, Rates, and Comparison with LIBOR

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 SOFR complete form is Secured Overnight Financing Rate, a benchmark interest rate that reflects the cost of borrowing cash overnight in the US, secured against U.S Treasury securities.

The Transition Process

The Desk conducts SRF operations via FedTrade, the Desk’s proprietary trading system, using a multiple-price auction format. On May 28, 2025, the Desk announced changes to the SRF’s daily operational schedule. The table below shows the SRF operational parameters once these changes become effective on June 26, 2025. The inception of SOFR can be traced back to 2014 when the Alternative Reference Rates Committee (ARRC) was established by the Federal Reserve.

• But in—relatively—simple terms, SOFR is calculated based on the volume-weighted median rate for transactions from three different U.S.
• Alternatively, lenders may look at an average over time to control for daily volatility.
• SOFR averages are measured by compounding rates over consecutive 30-, 90-, and 180-day intervals.
• Every morning, the New York Federal Reserve Bank publishes the SOFR rate it has calculated for repo transactions on the previous business day.
• These repo agreements allow banks to make overnight loans to meet liquidity and reserve requirements, using Treasurys as collateral.

How SOFR is calculated?

Concerning Indian firms, those engaged in U.S. markets (like the IT giants Infosys or the Pharma sites like Dr. Reddy’s Pharma) are converting their dollar loans and derivatives to SOFR. To set the daily LIBOR rate, the four highest and four lowest estimates were thrown out and the rate was based on the remaining average. In contrast, because it’s based on treasury repurchases (also known as repos), the transactions underlying SOFR have already happened. The advantage of this is it’s based on actual vs. assumed market fluctuations.

The United States government unveiled this system in June 2023, as a replacement for LIBOR. The Secured Overnight Financing Rate (SOFR) plays a vital role in the financial market, serving as a reliable benchmark rate for various financial products. Its calculation, history, and development represent a concerted effort to establish a trustworthy alternative to LIBOR. Although challenges exist, the benefits of using SOFR, such as robustness and transparency, outweigh potential drawbacks.

On average, $900 billion worth of FX trades during the day are used for the quotation of SOFR. On the other hand, the USD LIBOR depends mainly on the opinions of the panel for rate calculations. It was initiated and implemented in 2017 and will replace LIBOR entirely by 2023. The fundamental difference between the two benchmark rates is that LIBOR relies on borrowing estimates by banks, whereas SOFR uses factual transactional data in the United States treasuries market. Additionally, while government bonds secure SOFR, LIBOR does not require any collateral to be pledged. In summary, SOFR has emerged as a superior alternative to LIBOR due to its foundation in observable data and the security of government collateral.

However, in practice, the calculation involves a more complex process to ensure that the rate accurately reflects the market conditions. The Federal Reserve Bank of New York uses a strong method to figure out SOFR. This method includes getting rid of outliers and making sure that the rate is a good reflection of the market as a whole.

LIBOR vs. SOFR

However, Patel expects some rates based on SOFR to add a credit spread to make it more closely reflect the need for pricing in adjustable-rate products. This culminated in the official cessation of LIBOR in June 2023, after a transition period that began in November 2020, when banks were instructed to stop writing contracts tied to LIBOR. The shift from LIBOR to SOFR affected financial products tied to LIBOR. The International Swaps and Derivatives Association (ISDA) created rules or “fallback provisions” to manage this change, including how to adjust for differences between USD LIBOR and SOFR. 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.