Saturday, July 21, 2012

Bank of England should only take responsibility for Libor if panel banks provide ultra transparency

In yet another article blaming the Bank of England for its refusal to play a formal role in the Libor rate-setting process, the Telegraph misses the simple fact that the Bank of England was being asked to bless a flawed process.

If you look at all the documents that have been released, nowhere do you find the British Bankers' Association saying that going forward all banks on the Libor panel will provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

What the BBA asked the BoE to do was to put its name on the Libor interest rates while the banks retained the ability to manipulate the rates.

While the reporters might not like how the BoE came to the decision not to endorse a manipulated interest rate, the BoE came to the right decision.

Now, that everyone is focused on the BoE leading the reform of Libor, the BoE is in a position to take responsibility and fix Libor.

This is easily done by requiring that all banks on the Libor panel provide ultra transparency.  

There are three major benefits to the ultra transparency solution.
  • First, it results in the setting of Libor based on actual transactions.  No more easily manipulated submissions.
  • Second, it results in unfreezing and maintaining liquidity in the interbank lending market.  With the information disclosed, the risk of each bank can be assessed and banks with deposits to lend can use this assessment in setting the amount and price they are willing to lend to each bank.  [Regular readers recall that at the beginning of the financial crisis the interbank lending market froze because banks couldn't tell which banks would repay a loan and which banks would not.]
  • Third, it restores trust and confidence not only in the Libor interest rates, but also in the global financial system.

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