NEW YORK (Reuters) - A broader definition of the benchmark Libor interest rate and a better alternative is needed, an influential U.S. Federal Reserve official said on Thursday, joining the chorus of world regulators calling for changes in the wake of abuse.
New York Fed President William Dudley highlighted two key areas of concern: the need for a definition of the rate that better reflects observable funding patterns; and the need for an alternative reference rate that works for all participants and is based on a deeper cash market.
“This combination, a more robust and resilient LIBOR for transactions that require a reference rate with a bank credit risk component and the development of an alternative reference rate for transactions like interest rate derivatives that don‘t, will strengthen our financial system and help undo some of the damage caused by earlier transgressions,” Dudley said in prepared remarks that did not mention monetary policy.
A critical tool in global markets, Libor, or the London interbank offered rate, is used in a large number of dollar-based contracts. It is also a reference rate for another $150 trillion in contracts denominated in other currencies and is common in financial derivatives.
Confidence was shaken when it was disclosed that the banks whose daily rate estimates are used to set Libor had been manipulating the process for years. More than $6 billion in fines were levied as a result of the scandal.
“More work needs to be done before confidence in these rates are put on a firmer foundation,” said Dudley, whose branch of the U.S. central bank acts as its eyes and ears on Wall Street.
Any solution will require appropriate incentives and controls at financial institutions, he added, largely backing the proposals raised by Fed Governor Jerome Powell a month ago.
Libor is used to set the terms of consumer loans, home mortgages, corporate bonds and other widely used forms of credit. Since the abuse was uncovered, global regulators have revised the process for setting the rate.
Reporting by Jonathan Spicer; Editing by Meredith Mazzilli