Exclusive: Future of bank benchmark rate under review

Fri Feb 10, 2012 1:25pm EST
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By Kirstin Ridley

LONDON (Reuters) - A global probe into whether banks colluded to set the interest rates at which they borrow money from each other has thrown into question the future of the benchmark they use to price financial products worth an estimated $360 trillion.

This intense scrutiny has prompted the British Bankers' Association (BBA), which establishes the parameters for the benchmarks, to hire consultants to ensure the rates are fit for purpose, a source familiar with the process said.

But despite widespread concerns about the way Libor (the London Interbank Offered Rate) is set, it remains at the heart of the financial system and is used to price anything from corporate loans to residential mortgages.

The BBA told Reuters the design and operation of Libor was under continual review and scrutiny by the independent board and committees that govern it.

"These bodies, from time to time, engage reputable professional services companies to ensure their work is carried out thoroughly and to the highest standards," it said in a statement. The trade body declined to comment further.

Like the credit ratings agencies whose role has been under fire both during and after the initial stages of the financial crisis, there are few credible alternatives to replace a system many now regard as outdated and discredited.

The BBA has watched with growing concern how Libor, designed in the 1980s to estimate the costs at which banks lend to each other, has become the key benchmark for anything from derivatives contracts in London to commodity trading in Chicago.

If Libor is found to have been distorted or manipulated it would cast doubt on every contract that has used it as a reference point. The first legal cases have already been brought, but these may not have much impact unless criminal wrongdoing can be proven.   Continued...