In line with its earlier stand taken at the end of its annual review on 30 May 2008 that "there should be no changes to the way Libor is calculated" and that the foreign exchange and money markets committee would strengthen supervision of how the rate is arranged, the British Bankers Association (BBA) announced on 10th June 2008 the following changes in its supervisory mechanism,
- Tighter scrutiny of the rates contributed by banks into the setting mechanism, so that any discrepancies in the rates must be justified by individual contributing banks;
- Wider membership of the Foreign Exchange and Money Markets Committee, the independent body which oversees the process; and
- Increasing the numbers of contributors to some of the rate-setting panels.
The BBA will also take soundings on whether the historically transparent rate-setting mechanism is stigmatising contributors and whether a second rate-fixing process for US dollar LIBOR might be set after the US market opening.
BBA Chief Executive Angela Knight said: "These changes will further strengthen BBA LIBOR and the confidence of its many users."
Though welcome by most of the analysts this was not expected to improve the current difficult position in which the world financial market finds itself in at present.
The LIBOR as an accurate indicator of the credit crunch came under spotlight, as it follows the rates at which banks perceive borrowing risk in the markets. But as the credit crunch led to stress in the markets, it also stressed this benchmark.
The system was under further pressure following the recent comments from the Bank for International Settlements. According to Herald Tribune, “Libor came under attack this year when the Bank for International Settlements said some banks might have understated their borrowing costs to avoid being perceived as lacking creditworthiness. Banks, reluctant to lend to one another because of fears they would need the money themselves, pushed up the libor rate and lifted the cost for interbank borrowing.”
The recent steps are therefore seen by all as an attempt on the part of the concerned authorities for restoring the prestige and confidence of the general public in its reliability.
Mervyn King, governor of the Bank of England said that any future system would "need the right pricing structure and it will need to overcome the 'stigma' problem that has affected access to all central banks during the current crisis."
LIBOR was introduced officially from 01 January 1986 as a measure to ensure free growth of the London inter-bank financial market in the face of increasing popularity amongst the participants, of some of then relatively new financial instruments like swaps, options and derivatives by the British Bankers' Association.
Today it is by far the most widely referenced interest rate index in the world and is estimated to be used for determining rates for financial products worth around $350 trillion. Central banks may fix official base rates monthly, but BBA LIBOR reflects the actual rate at which banks borrow money from each other.
16 contributor panel banks meet every morning and provide the rates at which they borrow 10 world currencies and 15 lending periods ranging from overnight to one year.
The middle 50 per cent of these rates are taken to calculate an average, which then become that day’s BBA LIBOR rate. The BBA uses Reuters to fix and publish the data daily, usually before 12 noon UK time and data is released on more than 300,000 screens around the world.
The BBA LIBOR setting process is reviewed annually by the Foreign Exchange and Money Markets Committee, a group of active market practitioners who determine the membership of each panel (one for each of the 10 currencies covered) and review whether changes might be required in the setting process.
LIBOR rates are widely used as a reference rate for financial instruments such as:
- forward rate agreements
- short-term interest rate futures contracts
- interest rate swaps
- floating rate notes
- syndicated loans
- variable rate mortgages
- currencies, especially the US dollar .
Contributed By:
Prof. Bikramjit Sen
(Globsyn Business School)
Sources:
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