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Libor faces overhaul after rigging scandal

Britain's Barclays was the first bank to be fined Keystone

Central bankers will meet in Basel on Sunday to discuss alternatives to the flawed Libor interest rate system following evidence that traders from several banks rigged data to pocket more profits.

Several alternatives have been put forward to replace the discredited London Interbank Offered Rate that is used as a reference for trillions of dollars of mortgages, credit cards, business loans and complex financial deals.

United States Federal Reserve chairman Ben Bernanke and Bank of Canada governor Mark Carney – who is also chairman of the Financial Stability Board (FSB) that monitors the global financial system – are among those who have condemned the current system.

Carney has indicated that a decision must be made whether to tinker with the current system or rip it up and replace it with another model.

“There are different alternatives if Libor cannot be fixed,” he said in June. “If it’s structurally flawed and can’t be fixed, which is a possibility, there may need to be different types of approaches, and we need to think that through.”

Lost trust

The US has recommended setting daily rates according to hard data, such as treasury bills (short term credit), rather than the antiquated and fanciful notion that a banker’s word is his bond.

Other indices have also been put forward, such as repurchase (or repo) rates that set a pre-defined price on the sale of securities between parties.

The implications of the Libor fraud, the latest in a series of scandals to hit the international banking sector, could be far reaching, according to Hans Geiger, former head of the Swiss Banking Institute at the University of Zurich.

“The financial system is based on credit and that credit is based on trust,” Geiger told “The system was nearly destroyed during the financial crisis when a loss of trust between institutions brought the credit system to a virtual standstill.”

“Libor has to be made more effective to regain trust in this essential part of the system. Unfortunately, the reaction will probably be the introduction of yet more regulations which will make banking less efficient.”

Transparency needed

However, a root and branch overhaul of the Libor system is unnecessary, according to Stewart Hamilton, professor of finance and accounting at Lausanne’s IMD business school.

Rather than create new supervisory bodies and legislation, central bankers have the opportunity to fine tune the old model, he argued.

“The only credible alternative to the current system is one based on documentable evidence of actual transactions rather than taking the word of traders,” Hamilton told

“Introducing greater transparency would be far more practical than creating a new supranational regulatory body.”

Hamilton believes the responsibility for overseeing an improved Libor system may be taken out of the British Bankers’ Association’s hands and placed under the control of a central bank, such as the Bank of England.

“There is probably a degree of regret in some quarters that the British bankers’ Association was put in charge of such a vitally important system,” he said. “It is quite clear that a lack of oversight and a failure to act on certain warning signals is an issue that needs to be addressed.”

Payback time

Some 16 banks are being investigated by global regulators and prosecutors. Britain’s Barclays bank was fined £290 million (SFr445 million) in August and estimates of how much other banks might have to collectively pay out start at $8 billion (SFr7.6 billion).

Swiss bank UBS blew the whistle on its own involvement in 2010 while Credit Suisse has said it is also cooperating with several investigations. If found guilty, banks could be subject to multi-million dollar fines and potential civil lawsuits.

In its 2011 annual report, UBS revealed that it had negotiated conditional immunity or leniency from the United States Department of Justice and the Swiss Competitions Commission.

Several civil lawsuits have already been initiated against banks in the US by mortgage lenders and local municipal authorities while some of the largest fund managers – such as Blackrock – are considering their positions.

In the meantime, central banking bankers begin sorting out the Libor mess at their meeting on Sunday.  The Financial Stability Board will then take the issue forward during the course of next week before concrete proposals are put onto the table.

The London Interbank Offered Rate (Libor) measures the daily cost of lending between banks and is a reference point for trillions of dollars of current derivatives deals, such as interest rate swaps.

Mortgage rates, business loans and credit cards are also linked to the Libor system, or its euro and yen equivalents the Euribor and Tribor, affecting many people in the “real” economy.

The estimated cost of interbank borrowing is reported each day to the British Bankers’ Association from a range of global banks.

A growing mountain of evidence has been unearthed that traders from several global banks have been giving false information to boost their own profits on derivative trades.

This was exacerbated by the financial crisis that struck in full force in 2008 and threatened to completely seize up lending between banks.

It is thought that traders downplayed their borrowing costs during this period to force down interest rates and help free up credit.

Some countries, including Switzerland, set their national interest rates according to these reference points.

The Swiss National Bank has said that there is no evidence that Libor manipulation has affected its national interest rates, that have been sitting at practically zero for a year.

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SWI - a branch of Swiss Broadcasting Corporation SRG SSR

SWI - a branch of Swiss Broadcasting Corporation SRG SSR