Tuesday, June 10, 2008

Libor to Be Set by More Banks as BBA Boosts Scrutiny

(Bloomberg) -- The British Bankers' Association, yielding to pressure from investors and regulators, will increase the number of banks that set the London interbank offered rate in the biggest change to Libor in 10 years.

The London-based trade group will also ``take soundings'' on adding a second survey of members to reflect U.S. trading hours when in sets the global benchmark rate, it said today in an e-mailed statement. Libor, used to calculate rates on about $360 trillion of financial products, was last changed in 1998.

The BBA, which holds its annual banking conference in London today, has been urged to overhaul the 24-year-old system since the Bank for International Settlements said in a March report some members may have understated their rates to avoid being seen as having difficulty raising financing. The changes will boost the ``confidence of its many users,'' the BBA said.

``It's a step in the right direction but I think we need a few more enhancements to make Libor accurate again,'' said Jan Misch, a money-market trader in Stuttgart at Landesbank Baden- Wuerttemberg, Germany's biggest state-owned bank. ``At the moment it's a lot of guesswork.''

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.

Avoiding `Stigmatization'

The London-based BBA, which isn't regulated, asks member banks once a day how much it would cost 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. Sixteen banks contribute to the setting, three of which are U.S.-based.

The BBA will discuss with members ``whether a second rate- fixing process for U.S. dollar Libor might be set after the U.S. market opening,'' it said in today's statement. To increase scrutiny, it will add non-contributing banks to the Foreign Exchange and Money Market Committee, the independent group that oversees Libor.

``This is a transparent benchmark,'' BBA Chief Executive Officer Angela Knight said in a Bloomberg Television interview today. ``We are improving the governance while avoiding stigmatization. It is a plank of the global financial system. We did not want to take knee-jerks and these are not knee-jerks. We decided to have some quiet consultation.''

Banks will be asked to explain ``erroneous rates,'' she added.

Wary Banks

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 0.81 percentage point as of 8:05 a.m. in London.

``There has been a lot of nervousness in the market that Libor is not calculated accurately,'' Giuseppe Maraffino, a bond strategist in Milan at UniCredit Markets & Investment Banking, a unit of Italy's largest bank, said today in an interview with Bloomberg Television. ``For sure the decision by the BBA to create more transparency will be met positively by the market.''

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.

Libor `Lie'

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. The association completed a review of the system May 30 without announcing any immediate changes.

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.

``Panel members should be made to ``prove they can transact'' at the rates they submit to the BBA, Misch said today.

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