Friday, May 30, 2008

BBA Avoids Changes to Libor, Seeks to Bolster Review

(Bloomberg) -- The group that oversees the London interbank offered rate will implement no changes to the way the measure is set, confounding critics who said it has become unreliable as a gauge of the cost of borrowing.

``The committee will be strengthening the oversight of BBA Libor,'' the association said in an e-mailed statement today. ``The details will be published in due course.'' The composition of the bank panels that contribute rates were left unchanged.

The BBA, an unregulated trade group, has been under pressure to overhaul the 24-year-old system after the Bank for International Settlements said in a March report some members understated their rates to avoid being perceived as having difficulty raising financing.

In the first four months of 2007, the difference between the highest and lowest rates for three-month dollar Libor didn't exceed 2 basis points, according to JPMorgan Chase & Co. In the same period this year, it was as wide as 17 basis points.

``The next time Libor spikes you don't want market participants looking at Libor and wondering whether it's a completely artificial number or shows a dislocation in borrowing costs,'' Brian Yelvington, a strategist at bond research firm CreditSights Inc. in New York, said in an interview yesterday.

Every morning the London-based BBA asks member banks how much it would cost them to borrow from each other for 15 different periods, from overnight to one year, in currencies from dollars to euros and yen. It then calculates averages, throwing out the four highest and lowest quotes, and publishes them at about 11:30 a.m. in London.

Gained Attention

Libor gained attention last August as banks suddenly became wary of lending to each other because of mounting losses linked to U.S. subprime mortgages. Three-month Libor soared to 2.40 percentage points above yields on Treasury bills on Aug. 20, the widest margin since December 1987 and up from 0.39 percentage point a month earlier. The figure was 0.79 percentage point as of 4:30 p.m. in London.

Today's statement followed a meeting of the BBA's independent Foreign Exchange and Money Markets Committee following a review conducted by director John Ewan.

Libor is used to calculate rates on at least $350 trillion of derivatives and corporate bonds as well as 6 million U.S. mortgages. Financial products worth about $150 trillion are indexed to Libor, according to the BBA's Web site.

The credit crisis exposed Libor's flaws, according to Peter Hahn, a London-based research fellow for Cass Business School and a former managing director at Citigroup Inc. That's because the BBA publishes the names of contributors and their rates, giving lenders an incentive to underestimate borrowing costs.

Misstated Costs

Banks routinely misstated borrowing costs to the BBA to avoid the perception they faced difficulty raising funds as credit markets seized up, turning Libor into ``a lie,'' according to Tim Bond, head of asset allocation at Barclays Capital, a unit of Barclays Plc

Rates offered by UBS and Lloyds TSB, the U.K.'s largest provider of checking accounts, underscore the range in quotes to the BBA since July. UBS, which took $38 billion of writedowns and losses, replaced its chief executive officer and chairman and saw its stock tumble 60 percent, quoted rates below Libor on 85 percent of the days between July and mid-April. The average was 1.3 basis points less than its peers. Lloyds TSB quoted rates that were 0.04 basis point above Libor on average.

The BBA threatened on April 16 to ban any member deliberately understating rates and said it would accelerate its annual review. The cost of borrowing in dollars for three months rose 0.18 percentage point to 2.91 percent in the following two days, the biggest increase since the start of the credit squeeze in August.

Loss of Confidence

The last time the BBA changed the system was in 1998, when the deteriorating creditworthiness of Japanese banks inflated the rates they contributed to yen Libor. The association responded by changing the contributor panels.

The loss of confidence in Libor spurred the world's biggest banks to recommend fixes. Morgan Stanley, the second-biggest U.S. securities firm by market value, said Libor should be based on trades rather than a survey. Credit Suisse, Switzerland's No. 2 bank, suggested increasing the number of U.S. participants. Zurich-based UBS, the world's largest wealth manager, advocated calculating the rate later in the day, while Barclays Capital said rates should be based on anonymous quotes.

Some strategists predicted little change to Libor because it's so ingrained in the global financial system.

``You can't change the rate completely,'' Kornelius Purps, a fixed-income strategist at UniCredit SpA in Munich, said in a Bloomberg Television interview before today's announcement. ``It would be like changing how crude oil is being refined and then having no car in the world that can drive on it.''

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