LIBOR is dead, long live LIBOR
A month ago almost no one had heard of LIBOR. However it is now almost infamous!
This highly technical and theoretical term arose in the early 1980’s when traders needed a benchmark to price the then new loan syndications. There were such a small number of deals that an index was not feasible and so the BBA created LIBOR, which was basically a basket of subjective views from the major banks.
This rate has grown in importance to the point where it is used to price over $500tn in derivative contracts as well as having a fundamental effect on the pricing of very many other financial instruments. It’s influence is widespread with analysts looking at LIBOR rates as a way of judging a banks relative risk – the higher a given banks LIBOR rates, the more risky that bank as a counterparty is perceived to be.
Recent events have led to a collapse in confidence in LIBOR – it has been shown just how easy it has been to manipulate the rate either to make money or to perhaps falsely reassure the markets about the financial strength of banks.
This episode has also shown just how ineffective the authorities have been in policing LIBOR and ensuring that everyone involved complied with the rules and regulations regarding conduct. There have been too many conversations which have at best ‘muddied the waters’ and too many incriminating e mails which are now in the public domain.
Politicians and regulators are now desperately looking for a replacement benchmark. Any replacement will, of course, need to be far more robust and transparent. The Government has announced a review of the LIBOR setting process, which is due to report in the autumn.
There remains one huge problem. LIBOR currently reports 6 & 12 month rates. However banks just do not lend to one another over such periods so these rates are almost completely theoretical and yet they looked at closely by the markets. Just how the review will resolve this issue is far from clear. Perhaps they need to scrap these rates altogether and let banks quote rates for actual deals, if indeed any take place and publish this real data.
My view is that the International Swaps and Derivatives Association is best placed to advise on how to proceed and is likely to consult with its members on the outcome of the BBA review.
One thing is for sure. We have to get it right this time and make sure that whatever mechanism we choose, it is strictly adhered to. If there is another similar scandal confidence in our banking industry will be irrevocably damaged worldwide and many clients will transact business elsewhere.
Hawkmoor Associates Limited
This was posted in Bdaily's Members' News section by Phil Dibbs .