Central Banks Have Plan to Replace Libor

Central Banks Have Plan to Replace Libor

Central banks worldwide want to replace the London Interbank Offered Rate (LIBOR) with a range of alternative reference rates after a scandal smeared its credibility, according report from the International Business Times.

Regulators in the United States and United Kingdom ordered Barclays PLC (NYSE:BCS) (LON:BARC), Royal Bank of Scotland Group plc (NYSE:RBS) (LON:RBS) and UBS AG (NYSE:UBS) to pay a total amount of $2.5 billion as a penalty to settle charges for involvement in manipulating the benchmark rate in all kinds of financial transactions.

Libor is the benchmark used by a group of banks in setting adjustable mortgage rate, interest-rate swaps bought by local and state governments, and other financial transactions worth trillions of dollars. However, central banks have indicated their intention to remove the use of the Libor.

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The Economic Consultative Committee (ECC) established a Working Group, composed of 13 central banks and monetary authorities, which has released a report that examined the issues related to use and production of reference rates. The issues reflect risks for monetary policy transmissions and financial stability that may arise from deficiencies in the design of reference interest rates, market abuse, or from market participants using reference interest rates, which embody economic exposures other than the ones they actually want or need.

 “The report released today makes a significant contribution to the on-going examination of reference rates used in financial markets. It is clear that central banks must play an important role in supporting the development of alternative reference rates,” said ECC Chairman and Bank of England Governor Mervyn King.

The Working Group identified an urgent need to strengthen the reliability and robustness of the current reference rate as well as the strong case for enhancing alternative reference rates.

The report cited that there is a demand for a range of reference interest rates that are suitable for different purposes. Some of the alternatives interest rates that central banks could promote include overnight rates, which can be used by money market participants to borrow and lend money at overnight maturities. Central banks may also promote an Overnight Index Swap (OIS) rate, which is a type of interest rate swap wherein parties agree to swap floating interest rates based on compounded overnight interest rates for a fixed interest rate.

“In certain cases, central banks or supervisory authorities could become more actively involved in producing reference rates,” The report further indicated.

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