Monday, June 3, 2013

ECB's pressuring banks to stay in interest rate benchmarks highlights failure of Wheatley Review reforms

Reuters reports that the ECB is pressuring banks to stay in the interest rate benchmarks, like Euribor or Libor, so that the benchmarks retain some measure of validity.

The need for the ECB to take this action highlights the failure of the Wheatley Review based reforms.

Regular readers will recall that your humble blogger recommended to the Wheatley Review that banks be required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

This disclosure addressed the two key problems with the benchmark interest rates.

The first problem is that the unsecured interbank lending market is prone to freezing because banks with deposits to lend cannot assess the risk of the banks looking to borrow.  With ultra transparency, this market will unfreeze and remain unfrozen as banks with deposits to lend will always be able to assess the risk of the banks looking to borrow.

The second problem is that the benchmark interest rates were not based on actual transactions and therefore they were subject to manipulation by the banks.  With ultra transparency, the benchmark interest rates can be based off of all the actual transactions.

Naturally, the Wheatley Review rejected this simple solution.  They even went so far as to not publish my response.

The European Central Bank put pressure on banks on Friday to stay in interbank lending benchmarks Euribor and Eonia, after a recent spate of high profile withdrawals which have put the future of the gauges in doubt. 
"The ECB strongly encourages banks to remain in, join or re-join the reference rate panels in order to ensure an appropriate level of participation, so that the reference rates serve their purpose of adequately reflecting market developments," the ECB said in a statement. 
Trillions of euros worth of financial products, from home mortgages to complex financial derivatives, are priced using Euribor and Eonia and a complete unravelling of the rates would be a major headache for the banking system....

The exodus has come as the credibility of the benchmarks has been called into question by an inquiry into Libor-style manipulation and the huge drop in lending during the financial crisis as bank-to-bank trust has crumbled....

The Frankfurt-based central bank already helps calculate Eonia and has been working with Euribor-EBF on new rates based on transactions rather than the so-called 'estimates' that gave banks the room to manipulate them for their own advantage.

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