Monday, July 30, 2012

Libor review chief Martin Wheatley says urgent reform is needed

In what is probably a classic understatement, the Telegraph reports that Libor review chief Martin Wheatley says urgent reform is needed in the way the rate is compiled.
Mr Wheatley's review will look at:
• Whether participation in the setting of Libor should be regulated
• How the rate is constructed and whether actual trade data can be used to set it
• Governance of Libor
• Sanctions for abuse of Libor - regulators have complained that they do not have sufficient powers to tackle the problem of rigging.
At present the rate is supervised by its sponsor, the British Bankers' Association.
As outlined by the Chancellor, the review will report by the end of the summer in order to enable the Government to consider recommendations with a view to taking legislative changes forward through the Financial Services Bill, which is currently being scrutinised in the House of Lords. 
Mr Wheatley will publish a discussion paper on August 10 to kick off a four-week public consultation with final conclusions by the end of September.
Regular readers know that actual trade data can and should be used.  This data needs to be part of a broader disclosure requirement placed on banks.  Under this broader disclosure requirement, banks must disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

This broader disclosure requirement is needed so that the currently frozen interbank lending market will unfreeze.  The reason this disclosure will unfreeze the interbank lending market is that banks with deposits to lend will be able to assess the riskiness of and monitor the current risk of banks that are looking to borrow.

By restoring liquidity to the interbank lending market, there is a lot more actual trade data to use and the actual trade data becomes a much truer measure of the risk adjusted cost of bank borrowing.

Of course, the banks and the rest of the Financial-Academic-Regulatory Complex (FARC) will fight requiring banks to make this broader disclosure.

For example, they might make an argument for basing Libor off of some other interest rate.  In making this argument, they are hoping that no one notices that it was the fact that Libor was suppose to represent the unsecured cost of funds to the banks that made it a benchmark interest rate.  Changing interest rates ends this relationship and the logic for why Libor is a benchmark.

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