Bankers Cast Doubt On Key Rate Amid Crisis

One of the most important barometers of the world's financial health could be sending false signals. In a development that has implications for borrowers everywhere bankers and traders are expressing concerns that LIBOR is becoming unreliable.

The concern: Some banks don't want to report the high rates they're paying for short-term loans because they don't want to tip off the market that they're desperate for cash. The Libor system depends on banks to tell the truth about their borrowing rates. Fibbing by banks could mean that millions of borrowers around the world are paying artificially low rates on their loans. That's good for borrowers, but could be very bad for the banks and other financial institutions that lend to them.

In one sign of increasing concern about Libor, traders and banks are considering using other benchmarks to calculate interest rates. Among the candidates: rates set by central banks for loans and rates on repurchase agreements.

A report published by the Bank for International Settlements raised concerns that banks might report incorrect rate information. It said that banks might have an incentive to provide false rates to profit from derivatives transactions. The report said that although the practice of throwing out the lowest and highest groups of quotes is likely to curb manipulation, Libor can still "be manipulated if contributor banks collude or if a sufficient number change their behavior."

[Source: WSJ, pointed out to me by MPC]