Libor gets better but still isn't perfect
New proposals to reform Libor are welcome, but further rate-rigging scandals are still possible.
Martin Wheatley, of the new Financial Conduct Authority, announced new proposals to reform Libor last week.
You may remember reading about Libor in the summer as part of the scandal surrounding Barclays. For a recap read Four thoughts about the Libor Scandal.
In short, Libor is a collection of average rates for when banks borrow and lend to each other. There are rates for different currencies and different loan durations. Three-month Sterling Libor is probably the best known rate.
Here are Wheatley’s main proposals:
1. The British Bankers’ Association will no longer be involved with setting any of the Libor rates.
2. NYSE Euronext will probably take over the management of the Libor rates. Bloomberg has offered to provide assistance.
3. More banks will be encouraged, or possibly forced, to provide information on what interest rates they’re paying on interbank loans. If more banks provide data, it will be harder for one rogue bank to rig rates by reporting dodgy figures.
4. Around 130 of the 150 Libor rates will be scrapped. Only the most widely used rates, with the greatest amount of lending, will continue to be published. Once again, this will make it harder for rogue banks to rig rates.
5. Submissions from individual banks won’t be published for three months. This means that in a crisis, banks will be less likely to lie about the rates they’re paying when they borrow from other banks.
Some banks lied during the financial crisis because they feared that telling the truth could trigger a massive loss of confidence in the financial markets.
Wheatly says he considered abolishing Libor completely, but decided against it because too many financial contracts are based on Libor rates. That includes a small number of mortgages where the interest rate moves in line with changes in Libor.
He’s right about that and I also think his proposed reforms are sensible. They should reduce the chance of further scandals in the future. However, I don’t think the reforms completely remove that risk. If enough banks work together, they might potentially be able to game the rate and profit from that fraud.
I suspect in the end, it will all come down to how well the regulator keeps tabs on what is going on.
And, of course, we also need to change the culture in the City. That’s the hardest thing of all - perhaps impossible.
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